During 2002, the first ever federal district court complaint was filed against an ISO for unfair and deceptive practices, leading to the current federal case of Federal Trade Commission v. Certified Merchant Services, Ltd., et al. This case has caused a ripple effect throughout the bankcard industry that is prompting a variety of reactions from key industry players and a mountain of speculation about what changes lie ahead for ISOs.
This article reviews the industry's response to the CMS situation and identifies resources that are available to help ISOs and others learn about best practices. Finally, the article examines what several ISOs are doing to educate their representatives, and what changes the industry is expecting in the wake of the CMS case.
The ETA's Response
To address industry issues resulting from the FTC case against CMS, the Electronic Transaction Association has responded in a variety of ways.
During the midyear meeting in Seattle, in September 2002, the ETA held a breakout session entitled "An Overview of State/Federal Legislative & Regulatory Action Affecting Your Business." This session was presented by Barrie Berman Van Brackle, an attorney from Manatt, Phelps & Phillips, LLP. The breakout included an update on regulatory activities in the industry and FTC, as well as a discussion of actions and options that the industry needs to undertake for regulating itself.
The ETA's position is clear, according to ETA President Mary Gerdts, "Education is the name of the game it always has been and always will be. The ISO is looking for information, guidance on how to run his business the best he can. That is what we as an organization came out of the gate trying to give him."
Earlier in the year, before the ETA's annual April meeting in Orlando, organizers hosted a session called "FTC Update & the Legal Implications for Your Business." This three hour session focused on best practices, laws governing business practices, a primer on receiverships and what can lead to an FTC action in the acquiring business. The session also featured a round table discussion. A number of speakers presented at the session including Mary Dees, representing the CMS receivership team, and Douglas Wolfe representing the FTC's Bureau of Consumer Protection department.
In July, the ETA formed an ad hoc committee that began looking more broadly at establishing best practices to prevent another situation like CMS. "The goal of the committee is to explore the types of best practices issues we need to be looking at for our members and the ISO industry, and put together a white paper as well as recommendations for the ETA regarding whether we need a permanent committee," said Gerdts. Because it is an ad hoc committee, its' initial term is six months. The Committee hopes to have the white paper out prior to the ETA's annual April 2003 meeting in Las Vegas."
Resources for ISOs
A small amount of literature and information about best practices is currently available to ISOs, acquirers and merchants.
Addressing the issue of ISO best practices more directly, MasterCard International announced in April 2002 that it was developing two guides for the acquiring community. In September 2002 it published "The Acquirer's Guide to Working with ISOs" and "The ISO Guide to Working with Acquirers." The detailed guides explain the role of ISOs and acquirers, the rules governing their behavior, and ways to form a successful relationship between the two. The guides were distributed to all members of MasterCard.
Gerritt Kerkstra, MasterCard's Senior Vice President for Acquirer Relations adds, "In these guides we tried to give direction to ISOs as to the kinds of topics they should cover when developing a relationship with a member/acquirer. We want to advise members as to the kinds of screening processes they should conduct with ISOs," Kerkstra said. "MasterCard can do more, and where it can, we will." (See page 11 of this issue for more from Kerkstra.)
In addition to those guides, a 2-page educational piece for merchants developed by VISA-USA and the FTC prior to the CMS case has been widely distributed to acquirers and ISOs. The piece, entitled Merchant Messages -- Calling All Merchants: News You Can Use from the FTC and VISA-USA, was written to help small merchants with best practices.
Now that the industry has seen what practices aren't acceptable to the FTC, its main task is to implement best practices that work.
Attorney, Holli Hart Targan, outlined several lessons ISOs should learn from the CMS action. "One top lesson ISOs should learn is that clearly it seems the government's approach to the ISO industry is the same as the government's approach to any other business out there and ISO's are going to be subject to general FTC requirements. This was struck home pretty forcefully by their action in the CMS case," she said.
Targan said there has to be:
- Clear and conspicuous disclosure of fees,
- Fees must be written on the first page of a contract,
- Fees must be in a type size sufficient for an ordinary person to read it, and written in an understandable language.
Targan also points out that the FTC says oral disclosure of fees:
- Must be clear, and
- Can't be misrepresented.
"The FTC also requires that you can't change a contract without the approval of the customer. You can't increase fees or impose new fees. Sometimes that consent can be 'backed' into an agreement but in some way you have to get the merchant's consent at some time.
"This is broad and seems to be common sense but sometimes in the heat of a sale it can be forgotten; the FTC also requires that there can't be deceit or fraud during the sales process, including the sales materials. And the materials must be consistent with the terms of the contract," Targan continued.
"You have to have proper debit authorization for fees if you are gong to ACH debit fees out of a merchant account. The industry is so sales oriented, and particularly the ISO in the industry. In the heat of the hunt, things get lost," Targan said.
If all else fails, Targan suggests that an ISO talk to a lawyer. "I have had clients ask me to review merchant contracts and the methods of the way they do sales and the way they do business to ensure they are complying with the law," she said.
Common Best Practices ISOs Use Today
When asked what best practices ISOs use and recommend, they highlight a number of common points, including:
- A commitment to full disclosure
- An emphasis on extensive employee training
- Careful monitoring of employee performance
- Maintaining a clear channel of communication with merchant customers from the start
- Designing compensation so that sales representatives are motivated to develop long-term merchant relationships
- Eliminating the temptations that are associated with equipment sales by downplaying their importance to the reps' overall compensation
Bruce Schratz, President of Payment Transaction Solutions, a medium-sized ISO that signs approximately 250 new accounts each month, said, "Our company works through community banks so we're a little different than the average ISO on the street. We do a fair amount of training on the front end. We teach our reps the history of the industry, how it evolved into what it is today and about the structure of Visa and MasterCard and how it is made up of member banks. We also offer base salaries to our salespeople so they're not as dependent on selling equipment. We don't do a lot of equipment leasing so we've avoided a fair amount of the temptations to a salesperson to not disclose the whole picture to a merchant. We have 25-30 reps in the field and have very low turnover, which has helped us dodge some bullets, also.
"We don't have a cancellation penalty or annual fees that would have to be disclosed, so our program has very little room for misrepresentation."
Mark Lewis, President of Transcom Payment Services, agreed that encouraging reps to engage in a long-term transaction processing relationship, rather than a quick equipment deal, helps his reps steer clear of temptations. "Many of our competitors rely on new equipment deployment through leasing to fund their new account acquisition. We deploy POS equipment to about 30% of our merchant applicants. If a merchant has a terminal that works for their business, such as an older Tranz 330, why upgrade them unnecessarily? But if a merchant needs additional functionality only a current generation terminal can provide, such as for commercial card prompts or online debit card acceptance, there are valid reasons to provide them a new POS equipment solution."
On the subject of best practices and communication with merchants, Lewis has several pointers. "Our practice is to disclose the fees prominently on a very simple 2 page application and agreement written in plain English. We also call every merchant one week after they activate and again at the end of the first month to make sure they're delighted with our service and confirm that their bankcard sales are qualifying at the correct interchange level. We have extensive classroom and on-the-street training, and have a sales reference product manual that is constantly being updated with industry changes."
"Regarding early termination practices, we have a 12-month term with a $175 early termination fee. We waive this fee if they leave us because we dropped the ball in taking care of their account. It pains me to see some of our competitors actually charge an early termination fee equal to the number of months of remaining on a 24-60 month term times the average monthly bankcard fees the merchant has paid. You should be able to keep a merchant with your service excellence and competitive pricing, not because of an absurd termination penalty fee."
Bill Blakey at Electronic Data Resources explained their training and communication mix. "At our company we go at lengths to provide training to our sales employees and agents we do business with. We have hardback sales manuals, web-based tutoring on best practices including the rules and regulations of Visa, MasterCard, and National City Bank, our banking partner. We require full disclosure across the board.
"We also monitor the paperwork that comes in, and we contact every customer we sign to go over the rules and regulations of the contracts they sign. We send each customer a second copy of the terms and conditions of their contract with a welcome letter. That information is also on their support web site. We have done this since mid-1999 when the company started. This is all about full disclosure and asking your customer for referral business," Blakey said.
Opinions vary on just how the ISO industry will change because of the FTC's action.
As a result of the CMS case, many industry observers believe that Visa, MasterCard and the ETA will become even more vocal in promoting best practices in the industry.
Blakey said, "I think that what will come down the pike is Visa and MasterCard are going to react in a big way to ensure the sponsor banks are in compliance with published rules regarding ISOs' and agents. In return, sponsor banks will insist that all agents and ISOs are qualified, and probably stipulate more extensive training and monitoring in regards to merchants. All those things are good for the business and good for the industry."
While some ISOs like the fact that Visa and MasterCard are finally acknowledging the role of ISOs in the acquiring industry, many doubt that the card associations will take much meaningful action to avoid another situation like the CMS case. The card associations may be reluctant to upset their members by levying fines against them for the misdeeds of their ISOs.
"I would be surprised to know that any of the larger players have done anything dramatically different," said one ISO who asked not to be identified. "Some of the ISOs are large enough and have enough independent representatives out in the street, that they tend to look the other way. They are in the mode of acquiring merchants, and they don't have concern or compassion for their clients. They just care about growing the merchant base."
For its part, the ETA will evaluate the findings of its best practices committee to see if a more permanent best practices body should be formed. The ETA President confirmed their intention to include best practices sessions in upcoming ETA meetings and activities.
But Granville Loar, Director of Education at the ETA acknowledges that it is unclear how much the ETA can really do on its own to improve best practices in the ISO industry. "ETA currently does not set standards and guidelines for the ISO community. With recent events in the industry, it has been a topic at our board meetings regarding how much ETA should get involved, and how so, in the various ethics issues."
Thanks to recent events, some more drastic measures to bring ISOs and their sales reps in line are now getting airtime. One ISO suggested creating a regulatory body for sales reps. By requiring reps to register with the body, ISOs would have a way to screen reps before hiring them. If a rep had a history of going from company to company wreaking havoc on merchants, they could be identified before they are hired by another unsuspecting company.
Raising the visibility of ISOs in the overall bankcard industry was also suggested as a way to help the system work better for everyone involved. "I think change and leadership needs to come from different fronts, be it from those established ISOs with solid, hard-won reputations participating at an ETA function, or from Visa/MasterCard acquiring staff. Also, senior ISO management should get out of their offices and onto the street more often to be reminded how challenging it is to sell payment card transaction processing services with a long-term perspective while satisfying sales associates' short term compensation needs," remarked Lewis.
Blakey summed up nicely where he thinks the ISO industry is going from here, "In this industry it is the gun slingers versus the guys trying to do it the right way. We've been at a disadvantage in the marketplace because we don't use deceptive pricing techniques, and we don't teach them to our agents, so we're looking forward to a level playing field."
If you thought that the FTC v. CMS case might give other ISOs the opportunity to beat out CMS in the marketplace, think again. On November 26, 2002, The U.S. District Court for the Eastern District of Texas, Sherman Division issued a court order, stating that all persons and entities in the merchant processing industry:
- May not use the existence of the Injunction and/or the Receivership as a reason, argument, or method of persuasion to solicit, recruit or enter into an agreement for transaction processing services, directly or indirectly, with any merchant whose transactions are processes by or is under contract with one of the Corporate Defendants,
- May not use the existence of the Injunction and/or the Receivership as a reason, argument, or method of persuasion to solicit, recruit employ or contract with directly or indirectly any employee, agent, independent contractor or other person working for or under contract with one of the Corporate Defendants,
- May not make false, misleading or disparaging statements or allegations pertaining to the Corporate Defendants in an attempt to harm the assets of the Corporate Defendants,
- May not commence, prosecute, continue or enforce any claim, suit or proceeding against any of theDefendants of the FTC v. CMS case or the court's receiver, Mary Dees, except with permission of the court;
- May not take any action to impound or take possession of, interfere with, create or enforce a lien upon any property owned by or in the possession of the Defendants or the Receiver,
- May not attempt to modify, cancel, terminate, call, extinguish, revoke or accelerate the due date of any lease, loan, mortgage, indebtedness, security agreement or other agreement with the Defendant or the Receiver
- May not seek to obtain, acquire, use or in any way interfere with the assets or confidential, proprietary or trade secret information of the Defendants, including the customer or employee information, sales and marketing materials and data, training materials, processes, records,and pricing information
- May not do any act or thing whatsoever to interfere with the possession and/or control of the Defendants, by the Receiver, or the property and assets owned, controlled or in the possession of the Defendants, or in any way interfere with or harass the Receiver, or to interfere in any manner with the exclusive jurisdiction of the court over the Defendants.