In connection with what the Federal Trade Commission has described as an "ongoing crackdown" on the payment processing industry, there has been a disturbing uptick in the FTCs attempts to hold processors and independent sales organizations liable for the deceptive trade practices of their merchants. These legal actions have taken two predominant forms.
First, in a somewhat rare (and remarkably aggressive) move, the FTC has pursued processors as co-defendants in civil actions against untoward merchants, asserting that by virtue of their facilitation of the merchants payment card transactions, the processors should be held jointly liable for the injury that the merchants deceptive practices inflicted on the consuming public.
The argument tends to be that, because the processor ostensibly knew of unusually high chargeback ratios and consumer complaints associated with the merchant, it effectively turned a blind eye to "red flags" of consumer fraud. Thus, in the parlance of the FTC, the processors allegedly provided "substantial assistance or support" to the bad actors, while "consciously avoid[ing] knowing that the [merchant] is engaged in" deceptive marketing practices all in violation of the FTCs Telemarketing Sales Rule.
Second, and more commonly, the FTC has pursued contempt sanctions against processors and ISOs for continuing to honor consumer-initiated chargebacks following a court-imposed "asset freeze" over a merchants funds. In those cases, the FTC has argued that once the processor and ISO were put on notice of the asset freeze, it became their responsibility to stop processing chargebacks from reserves associated with the affected merchant.
If the processor nevertheless debited the chargebacks from "reserve accounts" linked to the merchants transactions, then the FTC takes the position that the processor and ISO violated the asset-freeze order, subjecting them to sanctions including turning over the original balance of the reserve account to an FTC receiver.
To soften predictable judicial resistance to such sanctions, the FTC will often seek to portray the processor and ISO as somehow culpable in bringing about the consumer fraud for example, by arguing that the presence of high chargebacks should have alerted them to the merchants questionable business activities. The suggestion is that, by continuing to do business with a merchant who experienced a high chargeback volume, the processor or ISO implicitly assumed the risk that they would be left "on the hook" for those chargebacks (no matter what contractual protections were built into their merchant services agreement).
The FTCs goal of compensating injured consumers is laudable. But in most instances, effectuating that goal through a "crackdown" on processors and ISOs, which effectively makes them insurers of merchant fraud, seems misguided.
At the outset, a number of potential legal flaws are associated with the FTCs approach. It remains to be seen how willing courts will be to accept the argument that processing payment transactions equates to "substantial assistance or support" to an untoward merchant. At least in the context of contempt proceedings, moreover, the exercise of allocating blame to a processor or ISO for not ferreting out merchant misdeeds sooner is jurisdictionally impermissible.
And then there is the mistaken notion that "reserves" held by a processor are property of the merchant and, thus, subject to an asset freeze. After all, such funds tend to be held in the processors name, at its acquiring bank, in an aggregated account encompassing myriad merchants, with the target merchant having no rights to such funds until, for example, the expiration of the applicable chargeback period.
A "freeze" on the merchants assets, at least until such an expiration occurs, should have no impact on the processors reserves. And, even putting that aside, the argument that a processor should be compelled to turn over reserve funds without accounting for chargebacks, ignores the processors contractual rights to recoup those chargebacks from the merchant.
But the questionable legal reasoning underlying the FTCs "crackdown" is not the only flaw with its approach. Misplaced factual assumptions seem to be driving the uptick in claims against processors and ISOs.
To begin with, much of the FTCs apparent hostility to the payment industry seems to be predicated on the belief that chargebacks are necessarily (or at least typically) indicative of deceptive business practices. As those in the industry know, that is simply not the case. Chargebacks can arise for any number of reasons most entirely innocuous and, thus, higher-than-average chargeback ratios may have nothing to do with fraud. Furthermore, the notion that processors have violated an asset freeze order by "allowing" chargebacks to be debited against reserve funds ignores the fact that chargeback processing is hardly a voluntary exercise.
Processors are subject to chargebacks not because they choose to be, but because that is what the payment networks and applicable law mandate. And the beneficiaries of those chargeback rights are often the very same consumers the FTC is charged with protecting.
Requiring a processor to stop processing chargebacks from a "reserve account" established for that purpose and instead, forcing it to pay those chargebacks from its general funds, effectively makes the processor the unwilling insurer of merchant misdeeds.
The most troubling aspect of the FTCs crackdown is neither the legal flaws nor the factual misconceptions that seem to be driving its actions. It is the unintended consequences of that crackdown on legitimate merchants and the economy. If processors and ISOs are forced to serve as involuntary insurers against merchant fraud, then that risk will be passed along to merchants in the form of higher fees.
Merchants perceived to be working in "high risk" markets may be excluded from the payment card market, or forced to migrate their business to offshore service providers who operate beyond the reach of the FTC. And, if high chargebacks continue to be misconstrued as a badge of fraud, then it may lead processors and ISOs simply to "drop" merchants (even entirely legitimate ones) that experience high chargeback ratios, which can be the death knell for a merchant that depends on payment card transactions to sustain its business.
Ultimately, there may be much to gain from a collaboration between the FTC and the payment systems industry. But the FTCs continued crackdown on processors and ISOs seems not only legally and factually misguided, but prone to creating unintended ripple effects that will extend well beyond the few "bad" merchants the FTC should hope to shut down.
Edward Marshall is a litigation partner at the Atlanta law firm of Arnall Golden Gregory LLP, and serves as co-chair of the Payment Systems Subcommittee of the ABA Section of Litigations Commercial and Business Litigation Committee.