ake note: The Federal Trade Commission (FTC) has ISOs within its regulatory sights. The FTC is an independent federal agency that oversees consumer protection and fair competition laws. Its interest in ISOs relates to its consumer protection responsibilities, in particular the extent to which ISOs might be aiding and abetting fraudsters who bilk consumers with bogus goods and services.

"If you're using ISOs to bring in business, you need to be careful," Laureen France, an attorney at the FTC's Northwest Regional Office told bankers attending the Western Payments Alliance (WesPay) 2005 Payments Symposium earlier this month. "You need to know who you're doing business with," she said. WesPay is a regional automated clearing house (ACH) association; its membership includes financial institutions from several Western states, including Hawaii.

France's comments came during a panel discussion on financial fraud. She specifically referenced a legal settlement reached in August with Universal Processing Inc., a transaction processor specializing in high-risk merchants, and Rey Pasinli, an officer of that company.

The settlement wasn't particularly costly. Universal forfeited less than $10,000 in what the FTC deemed as ill-gotten gains. The settlement doesn't constitute an admission of guilt, but it speaks volumes about the agency's interest in companies selling payment services.

According to the FTC, at least one of Universal's merchants, Pharmacycards.com, wasn't on the up and up. Transactions it was sending through Universal, so-called demand drafts (check-like transactions processed through the ACH) were intended to bilk thousands of people out of millions of dollars, the agency said.

Making matters worse, no due diligence was performed when Universal signed on Pharmacycards. No one at Universal ever met with the folks who operated the Web site or required that they complete a standard payment processing application.

"No [company] bank statements were reviewed, nor credit reports," France said. Nor did Universal ever look at the products and services being sold, she added, products the FTC said were practically nonexistent.

According to the FTC's official complaint against Universal and Pasinli, made public on Sept. 7, 2005, "They agreed to use their entr‚e to the banking system to debit consumer checking accounts on behalf of two individuals they had never met ... who were using a Montreal customer service center, free, untraceable e-mail accounts, an unsecured Web site hosted in India, a Vancouver, British Columbia mailing address, and who directed that the proceeds be sent to a bank in Cyprus."

Last year, the FTC charged Pharmacycards with bilking thousands of consumers out of $139 each for pharmacy discount cards that never materialized. According to that complaint, Pharmacycards attempted to debit $10 million from consumer checking accounts in less than three months.

Return rates for the transactions "started high and almost immediately skyrocketed," the FTC said, a tip-off that accountholders did not authorize the payments.

Nonetheless, Universal continued processing approximately $1.2 million in debits to consumer checking accounts and attempted to convince upstream processors to continue taking the transactions.

More than 70% of the demand drafts initiated through Universal by Pharmacycards (about 50,000 in all) were returned as unauthorized. Still, more than $1 million was siphoned from U.S. bank accounts and subsequently wire-transferred to a bank account in Cyprus. The FTC said Universal should have known that the transactions initiated through Pharmacycards were fraudulent.

"This hurts the credibility of the entire ACH system," France said. "It's a problem for the industry, not just for us."

Demand drafts look like checks, and banks usually treat them like checks, except no signature is required. Demand drafts were designed to accommodate telemarketers who receive authorization from consumers to debit funds from checking accounts.

Demand drafts have always been problematic because they can be created so easily; an account number and a bank routing number are all that's required. In the past, demand drafts have been the subject of Congressional inquiries, warnings from NACHA - The Electronic Payments Association and federal bank regulators, new state laws, and a proposed Federal Reserve ruling.

The Fed proposal, announced in March, would shift liability for losses tied to bogus demand drafts to banks accepting the transactions for deposit. Under current Fed rules, the banks on which demand drafts are drawn bear liability when the transactions go south.

Under terms of the FTC's settlement, both Universal and Pasinli are barred from processing payments without taking steps to ensure that consumers authorized the transactions. They are barred from misrepresenting that consumers authorized payment, and from processing transactions when they know, or consciously avoid knowing, that the client doesn't have a relationship with the consumer whose name is on the transaction.

Before taking on any new clients Universal must take proactive steps to ensure each is a legitimate business and that it complies with federal telemarketing sales rules and the FTC Act. The company was ordered to monitor return rates for payments, investigate the causes of any return rates exceeding 2.5%, and cease processing payments on behalf of any clients engaged in "unfair or deceptive acts or practices."

Universal also had to forfeit $9,476, an amount the FTC deemed as ill-gotten gains.

This isn't the first time the FTC has taken on an ISO. Last year, the agency garnered a multimillion dollar settlement from Certified Merchant Services, forcing the sale of that ISO's assets.

That settlement stemmed from charges the FTC filed in 2002, claiming the company had falsified merchant signatures on credit card services contracts, altered signed documents and misrepresented savings merchants could realize by doing business with CMS, among other violations of federal law.

It's not apt to be the last time the FTC takes action against an ISO or other payments company. France made it clear to bankers attending the WesPay conference that the agency is paying close attention to this line of business.

These are not idle threats. The FTC is responsible for protecting consumers and promoting market competition, and the agency takes this responsibility seriously. So banks and others in this business need to assume similar attitudes.

"Your corporate reputations are on the line," France warned bankers during the WesPay conference.

Patti Murphy is Contributing Editor of The Green Sheet and President of The Takoma Group. E-mail her at patti@greensheet.com .