By Adam Atlas
Attorney at Law
If you're in the payments biz, you've heard of payfacs. Acquirers, processors and ISOs are all cutting new ground with payfacs, and each has an opportunity to set the right tone for using them to board merchants in a somewhat new way.
A payfac, also known as a payment facilitator or payment services provider (PSP), is an aggregated merchant account serving multiple merchants. Usually, a payfac assumes liability for chargebacks and other losses related to its sub-merchants. The acquirer or processor for a payfac looks exclusively to the payfac for all legal liabilities related to the sub-merchants under it.
The payfac has its own merchant agreement with each sub-merchant and makes underwriting decisions, such as what merchants to board, settlement amounts, reserve accounts, etc. Not all payfacs are the same. Some sub-merchant agreements are tri-party agreements, with the acquirer or processor being parties together with the payfac and the sub-merchant.
A payfac is basically a legal aggregator. For a long time, aggregation was taboo in merchant services. Aggregation means using a single merchant account to process for multiple merchants. High-risk processors have been doing this for decades, but normal ISOs and processors have avoided it because it results in the acquirer processing transactions for merchants with which it has no direct connection.
For example, if an acquirer boards a bookstore, but that bookstore uses its merchant account to process transactions for a dozen dubious debt repair merchants, the acquirer cannot calibrate reserves and controls that are commensurate with the real risk: the risk of debt repair services.
The fact that payfacs are aggregators is, perhaps, one reason why payfac processing volume is capped at $100,000 per annum. Most sub-merchants under a payfac will require more volume than that, at which point, they will "graduate" to become "real" merchants in the traditional ISO/processing sense of the term.
Payfacs receive a specific kind of registration with the payment networks, similar to an ISO registration. It's noteworthy that payfacs carry more technical responsibility vis-à-vis their sub-merchants than regular ISOs do for their merchants. Processors expect payfacs to manage more of the gateway elements of transactions than typical ISOs do. Thus, becoming a payfac requires either having a high degree of technical sophistication or purchasing a license to a payfac management technical platform.
The payfac is a perfect example of the acquiring industry keeping up with contemporary fintech. When an entity like Square promises to allow just about anyone to start processing almost immediately, the acquiring industry has to supply tools to make that possible. Hence the payfac. The payfac is allowed to board almost any number of sub-merchants at almost any speed without the usual 48-hour review of financial statements, background checks, etc. A payfac can therefore serve as an easy on-ramp for what may ultimately become "real" merchants.
Also, today's market mandates instant delivery of products. Countless fintech startups pivot off of the simple idea that a payee (sub-merchant) needs to start accepting payments right away. The payfac feeds this market. Given that payments are now independent of hardware (POS terminals being more or less obsolete), sub-merchant accounts can be created instantly and deployed with equal speed.
Popular examples of payfac implementations are Square, WePay and Stripe. But if you scratch the surface of nine out of 10 fintech startups, you are likely to see a payfac carrying the payments. Another reason for the popularity of the model is that it enables payments from Party A to Party B at a much lower financial and regulatory cost than that of a money transmitter.
An MSB is a money services business. There are a few key types of MSBs, including money transmitters. MSBs must register with the U.S. Department of the Treasury Financial Crimes Enforcement Network (FinCEN) and obtain licenses from about 49 states. This process costs a couple million dollars and takes two years. A typical payfac would not want to be an MSB.
Whether a given payfac is an MSB or not depends on the specific facts of the payfac, its flow of funds, its contracts, and the federal and state laws where it proposes to serve customers. However, most payfacs claim they are not MSBs, principally because they contract with the payee (the sub-merchant) in the transaction and not the payer (the cardholder). This, together with a handful of other conditions, gives most payfacs comfort that they are not MSBs in most states.
To be clear, I am not providing a legal opinion here on the MSB status of payfacs. That is not possible given that each payfac has its own flow of funds and contracts, which may result in one or another interpretation under federal law or the 49 state laws that govern MSBs.
I recommend reading the leading U.S. federal law on the subject of the payment processor exemption to MSB status. It helps explain the key criteria for avoiding MSB status under federal law as a payfac or an ISO. The guidance is FinCEN's FIN-2014-R009, issued: Aug. 27, 2014, on Application of Money Services Business Regulations to a Company Acting as an Independent Sales Organization and Payment Processor. It is available at www.fincen.gov/news_room/rp/rulings/html/FIN-2014-R009.html. I'm proud to mention this leading U.S. law was produced by our law firm, and virtually identical rules are part of a new draft MSB law in the State of Washington.
Technically, within the payments space, U.S. federal law makes anti-money laundering (AML) programs mandatory only for MSBs. My view, however, is that all payfacs should have an AML program even if they are not MSBs.
Indeed, many payment businesses could benefit from an AML program. The reason for this is that a significant amount of illicit money passes through the financial system without ever being caught. In 2011, the United Nations estimated that only 1 percent of an estimated $1.6 trillion in illicit funds laundered in 2009 was actually seized. (See www.unodc.org/unodc/en/frontpage/2011/October/illicit-money_-how-much-is-out-there.html.) Payfacs and other payment processors can do their part to improve those statistics. 
In publishing The Green Sheet, neither the author nor the publisher is engaged in rendering legal, accounting or other professional services. If you require legal advice or other expert assistance, seek the services of a competent professional. For further information on this article, email Adam Atlas, Attorney at Law, at atlas@adamatlas.com or call him at 514-842-0886.
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