This paper discusses the qualitative and quantitative impact of the Federal Trade Commission’s (“FTC”) potential aggressive actions against card-based payment transaction processors and merchant acquirers (herein referred to as “acquirers”) and models at a high-level the potential financial impacts of those actions on the broader market.
First Annapolis is a management consulting firm focused exclusively on the payments industry. For over 20 years, First Annapolis has specialized in advising clients on payments-related strategies, products, and services; the First Annapolis practice areas serve all stakeholders in the payments industry.
First Annapolis is able to leverage the knowledge gained by having teams dedicated to every link of the payments value chain. First Annapolis clients include the most prominent financial institutions, retailers,manufacturers, merchant acquirers, transaction processors, payment networks, government entities, and affinity organizations throughout the world. First Annapolis is well versed in risk management, risk operations, risk and fraud management policies and procedures, and many other issues impacting acquirers on a day-to-day basis.
The FTC is considering potential action against acquirers and processors alleging that the acquirers in specific cases are abetting merchants engaged in illegal activity by processing transactions while knowing, or consciously avoiding knowing, that the merchant was violating the Telemarketing Sales Rule (“TSR”) or that the acquirer’s conduct was otherwise illegal. The TSR has traditionally been applied to merchants rather than to those that support merchant operations. However, the emerging trend from the FTC is to sue and penalize the acquirers that are processing the transactions for merchants who violate the TSR.
Through these actions, the FTC would have acquirers effectively repay consumers for transactions consumers conducted with merchants. For clarity, the acquirers were not a party to these transactions; they simply provided electronic payment services to make the payment more convenient for the consumers and merchants in return for a small fee. The consumers were unaware of who the acquirer was and had no expectation that a third party would provide any form of guarantee or repayment if goods or services did not meet expectations. The FTC’s expectation that the acquirer should repay consumers for transactions that were not even disputed is far outside the long-established operating model utilized in the card-based payments industry.
Electronic Transactions Association
I. Introduction 2
In some of the recent FTC investigations, the merchant acquirer appears to have conducted ample upfront due diligence and performed ongoing credit monitoring that is in line with industry standards but failed to identify that the merchant provided false information (such as covering up the fact that the merchant was selling debt relief services in violation of the TSR). In other instances, in the view of the FTC, the acquirer may not have conducted sufficient upfront diligence on the merchant to identify potential consumer harm or the acquirer failed to act on potential red flags such as Better Business Bureau scores. Seeking to impose liability in these types of fact scenarios raises significant issues for the acquiring industry and the economy as a whole.
Acquirers are service providers, and in that capacity they contract with businesses to provide access to the electronic payment card networks such as Visa, MasterCard, American Express, and others (“Card Networks”); facilitate payment card transactions over those networks; and settle sales made via payment cards to their merchant-customers’ bank accounts. In the same way that an office supply company or an electric utility is not required to audit the use of the product or service, acquirers are not, as service providers, based on the current Card Network rules, required to perform a comprehensive review of the business practices of their customers to ensure compliance with each individual law or regulation applicable to the merchants’ business.
Acquirers are also not specifically restricted from doing a comprehensive business review or audit of a prospective merchant applicant, but competitive pressures limit the information that merchants are willing to share and access they are willing to provide. It is our view that the possible actions by the FTC will set a precedent detrimental to merchant acquirers, as well as business service providers more generally, and be detrimental to society in that it will create a supply disruption to merchants who are ethical and honest but now will bear the higher costs as acquirers who cannot cost effectively monitor the additional risk, or choose not to, will simply avoid the risk for large groups of potential customers, potentially leaving many businesses without access to electronic payment acceptance.
Including acquirers as defendants in FTC lawsuits will result in significant impacts on the business practices of merchant acquirers, including what acquirers charge their merchants and what types of merchants the acquirers choose to serve. This paper will lay out our views on the harmful consequences likely to impact merchant acquirers, small businesses, and the economy more generally should the FTC continue with its current initiative.
The FTC’s Potential Impact on the Merchant Acquiring Industry
Prepared for the Electronic Transactions Association
First Annapolis Consulting, Inc.
July 15, 2014