Lessons from the Automated Electronic Checking Inc. Case

by Manatt, Phelps & Phillips, LLP
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This article was previously published in E-Finance & Payments Law & Policy (2013).

Recent action by the Federal Trade Commission against a third party processor found to be processing transactions for a merchant engaged in wrong-doing, indicates the necessity of processors employing adequate due diligence and monitoring to avoid being liable for merchant actions. Barrie VanBrackle of Manatt, Phelps & Phillips LLP, examines best practices to avoid such scenarios.

Section 5 of the Federal Trade Commission Act (‘FTC Act’) (15 USC 45) prohibits 'unfair or deceptive acts or practices in or affecting commerce.' The prohibition applies to all persons engaged in commerce, including banks, and is not solely directed at actions taken against 'consumers.' The Consumer Financial Protection Bureau has as its mandate the protection of consumers from any financial products, and protects against unfair or deceptive acts or practices, and adds a layer that also prohibits 'abusive' acts or practices. The foregoing acts work in concert so as to protect the public (whether commercial or consumer) against those who seek to propagate 'unfair or deceptive' (or 'abusive' with respect to consumers) acts or practices. However, the FTC took action against a third party processor who was processing transactions for a wrong-doer, alleging that processing transactions for an entity that violated the FTC Act, in and of itself, also was a violation of the FTC Act as the company knew or should have known of the wrongful acts of its merchant. This case, the FTC v. Automated Electronic Checking, Inc., (‘AEC’) (and two individual officers of the defendant company), 3:13-cv- 00056-RCJ-WGC, in the District Court for the District of Nevada, should cause processors to increase their due diligence and other monitoring of their merchants.

AEC was a 'third party processor.' The rules of Visa International, Inc. ('Visa') set forth a definition for 'Third party Agent,' which means 'an entity, not affiliated with Visa which provides payment-related services to a Member and/or processes, stores or transmits cardholder data.' MasterCard Worldwide, Inc., ('MasterCard') on the other hand, specifically sets forth that a 'Third Party Processor' is a service provider to a Member and also provides certain enumerated payment related services to the Member. A Member under the rules of both Visa and MasterCard is a client of Visa or MasterCard (most usually an FDIC financial institution). The rules of both Visa and MasterCard require that third party processors be registered through Visa and/or MasterCard; such registration includes, among other matters, that the third party processor (or agent) comply with the rules of both entities, which would include conducting due diligence with respect to any merchant for which the third party agent conducts payment services (on behalf of the Member) to ensure that the merchant complies with applicable laws. In addition to AEC's obligations under law, it was contractually obligated by the rules giving AEC the authority to provide payment related services to also confirm that its merchants comply with applicable law.

The FTC commenced an action against AEC, alleging that several of its merchants engaged in unfair and deceptive practices by inducing their customers to buy these merchants' products and AEC knew (or should have known) that the merchants used fraudulent representations regarding their products, and that customers of these merchants were deceived into purchasing the goods (and AEC used unfair or deceptive payments methods). The FTC determined that AEC expedited the merchants' unfair or deceptive activity by giving the merchants the means to access the merchants' customers bank accounts for payment. The FTC further alleged that AEC allowed merchants to obtain payments for products from consumers that had not even authorised a debit to their account. Each of the foregoing allegations are examined below and best practices provided for Member banks and Third Party Service Providers (TPSPs) so as to confirm that a merchant is not engaged in unfair and deceptive sales practices (obviously such best practices cannot take into consideration any entity that is actively engaged in bad conduct):

1. TPSPs should know the products and services their merchants are providing. TPSPs are merchant acquirers under the rules of Visa and MasterCard. This means that such entities acquire merchants to process under the underwriting and other guidelines of the Members for which the TPSPs are registered to conduct payments related services. Each Member should have a list of merchants for which they will not provide payments services, and if a merchant is not on the 'prohibited' list, the TPSP should conduct a background check on the merchant (including a visit to the merchants' website) to conclude the merchant is indeed selling the good or services that it purports to sell (i.e., it does not claim it is selling a good or service not included on the Member's 'prohibited' list and is really selling illegal goods or services). The monitoring of the merchants should not cease once the merchant is processing but should continue on a regular basis. Thus, as a best practice, a TPSP (and a Member bank) should oversee a fulsome monitoring of merchants, both during the acquisition phase and at regular intervals during the term of the merchant agreement. The merchant agreement (and/or application) should include a provision that would allow for termination in the event the merchant deviates from the goods or services which it represented as providing to the public.

2. TPSPs should be aware of the sales tactics of their merchants (and by way of corollary, Member banks should suspect those TPSPs who accept RCPs as payment, as described below). Even if a TPSP has confirmed that a merchant is indeed selling the goods or services as represented, the merchant may engage in high pressure sales, disallow returns and employ other tactics which may be viewed as unfair or deceptive. Thus, while the TPSP is monitoring the merchants, it should also require that the merchants provide it with copies of any complaints filed by consumers with the FTC, the BBB or any state Attorney General complaint. At the least, it should require that it receive a summary of the complaints (if any) on a regular basis, with an announced resolution. If the merchant fails to do so, again, the merchant should be terminated.

The foregoing paragraph describes high-pressured sales tactics. However, in the instant case, although the sales tactics were an issue, also at issue were the sales methods employed by certain of the merchant clients. The FTC alleged that certain of AEC's merchant clients marketed and sold their products and services through a website and through telemarketing. This in and of itself is common as an enormous amount of business is conducted online. However, at particular issue is that AEC allowed its merchants to accept bank debits processed through a device known as remotely created payment orders ('RCPOs'). By doing so, AEC could expedite its merchants to 'authorise' payment from a consumer, when in fact it was alleged that the consumer did not authorise the payment. Specifically, a RCPO works as follows: the payment processor creates a virtual check using a consumer's name and account information (which should have been provided by the consumer, but obviously an unknowing consumer could provide this information and not understand it may be mis-used). This RCPO does not require the consumer's signature, and when presented to the consumer's bank, the payment processor need only state that the consumer's authorising signature is on file. If a bank accepts it, the consumers' account will be debited. Thus, this type of payment mechanization has the potential to defraud the consumer, especially as it is not subject to the oversight of any particular entity in the check clearing system, and is not a typical method employed by traditional TPSPs supporting their merchants' business. Thus, due diligence should be employed on the authorisations for those merchants who request using this payment mechanism (as stated, the Member bank should set forth underwriting guidelines and strict parameters for allowing a TPSP to accept this payment mechanism on their behalf, if at all).

3. TPSPs should carefully monitor chargebacks and use their termination ability to terminate the merchant agreement of a merchant with excessive chargebacks. Customers can chargeback an unauthorised charge, or a product that did not meet the sales description (and have numerous other chargeback rights). TPSPs can monitor chargebacks and if chargebacks exceed 1% per month, should investigate whether there is an issue regarding the merchants' sales tactics (and Member banks should require this monitoring). However, although a consumer does not have the ability to chargeback a RCPO, he or she could effectuate a return. Again, a high rate of returns for RCPOs (in excess of 1% of sales per month) should provide a Member bank and TPSP with an indication that the particular merchant is indeed engaged in potentially unfair and deceptive acts and practices (and as a best practice, such a merchant should be terminated). The foregoing 'best practices' pertain to those of businesses in payments that wish to operate in a safe and sound manner, and should alert Member banks and TPSPs to potential fraud (which would implicate the FTC Act). In the AEC case, the TPSP paid $950,000 as consumer redress to resolve the lawsuit. If the TPSP did not have the available funds - potentially if the FTC did not have jurisdiction over the Member banks - it could have referred the case to the CFPB. As a result, Member banks, which have ultimate liability to Visa and MasterCard under the card brand rules, and to consumers through the CFPB's authority under the Dodd-Frank Act, should ensure that they have appropriate due diligence (and require all necessary monitoring by TPSPs) in an effort to avoid the type of liability that confronted AEC.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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