The Green Sheet Online Edition
November 09, 2009 • Issue 09:11:01
Legal aspects of high-risk processing
Once in a while, an ISO will run into a merchant account that is not acceptable to the underwriting departments of their primary processing partners. Any number of reasons may trigger this rejection of the merchant: the wrong standard industrial classification code, questionable volume, poor credit of operators and so forth.
Accounts that fall into this rejected category are often referred to as high-risk because they may pose a greater than normal level of risk to the acquiring bank that processes for them. Having advised on a number of high-risk relationships over the years, I thought it would be useful to identify a few key legal considerations for ISOs looking to place high risk accounts.
Never assist in breaking the law
There is high-risk processing on the one hand, and illegal activity on the other. If you have reason to believe a given merchant is accepting transactions for illegal products or aggregating transactions for third parties that sell illegal products, or if something about the merchant does not add up, walk away.
Thousands of illegal businesses are waiting for the opportunity to process payment transactions. Those illegal operations will pay enormous amounts to acquirers willing to turn a blind eye to their activities. No amount of profit is worth facilitating illegal activity. Individuals from our industry are in jail right now or facing indictments for facilitating such illegal transactions as online gambling transactions for U.S. residents.
Get a second opinion
The high-risk community is smaller than the regular low-risk payments community, and most people know each other. Before investing in a relationship, ask around to see if the person you are going to work with is known to be trustworthy. Individuals often have a reputation in the niche in which they work - a relatively easy thing to discern by speaking with a few of their business partners.
Don't bet the farm on high-risk
By their very nature, high-risk merchants are unstable. Thus, one must never think of high-risk merchants as stable sources of residuals. Beyond the inherent volatility of their businesses, high-risk merchants receive constant solicitations from other agents who specialize in the high-risk sphere and are trying to entice them into terminating
any relationship that you may have with them. Every such agent is well advised to have a well-tended low-risk portfolio to carry the agent through the ups and downs of high-risk processing.
Do not take risk
Unless you have been in the acquiring business for years, know how to underwrite a merchant account and have the financial means to absorb a large loss, do not take a chance on high-risk merchant accounts. Taking on risk means assuming liability for chargebacks, fraud or other losses that a merchant may create for a processor.
Banks that process for high-risk merchants are usually sophisticated enough to underwrite the merchants and manage reserves and settlement in a way that will mitigate possible damages. ISOs and merchant level salespeople (MLSs) however, are not usually in a position to take on that kind of risk.
High-risk accounts are also notorious for creating big problems quickly. For example, a high-risk merchant may be able to bring millions of dollars per month of processing to a bank, but the ISO or MLS who found the merchant is likely not in a position to determine whether all of those funds should actually be settled out to the merchant.
Legal remedies are limited
Some high-risk processors are in foreign jurisdictions, such as Europe, Central America or Asia. If they do not pay your merchants or you, or if they cease to exist, your chances of recovering lost income through legal channels are limited.
This is not to say that agreements in this part of the business are not worth review by counsel; however, your chances of using the agreements to recover funds overseas are slimmer than they would be with domestic, low-risk relationships. This goes to reinforce the importance of strong relationships in the high-risk segment: they are your best insurance against losing residuals in a high-risk agent business.
Some of the merchants seeking high-risk processing, while legal, are not the kind of merchants that all ISOs are comfortable working with.
Adult entertainment, debt counseling, herbal remedy sales, network marketing, affiliate marketing and online marketing services are examples of high-risk areas in which you might be reluctant to conduct business. Naturally, each individual has a personal set of moral standards that play a role in determining what kinds of businesses he or she chooses to avoid.
High-risk processors and their MLSs often fudge the rules concerning merchant funds and merchant reserves. Do not engage in schemes whereby merchant funds do anything other than get paid to the merchant that sold the goods or services. Merchants can entice ISOs into facilitating schemes in which more than one merchant processes through a single merchant identification number. Referred to as "aggregation," it is forbidden.
Even for low-risk merchant accounts, always verify that the merchants are indeed selling the goods or services relating to the transactions they are processing. Placing random calls to customers, reviewing of shipping records and other underwriting techniques should be done more in high-risk settings than elsewhere.
High risk is not for everyone
If you do decide you would like to participate in this arena, do so carefully. Procure all the legal protection you would seek in any acquiring relationship, including limitation of liability, stable residuals and some measure of portability under specific circumstances. Above all, be sure you are not facilitating an illegal business - it's just not worth it.
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, e-mail Adam Atlas, Attorney at Law, at firstname.lastname@example.org or call him at 514-842-0886.
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