Cover Story
What You Don't Know
About the FTC's Case Against CMS
May Hurt You

Part 1
by Christine Harland Williams

   It was an interesting year with respect to corporate misdeeds:Enron, WorldCom, Martha Stewart, ISOs...ISOs? If you haven't heard, even the ISO world has been shaken by what is arguably one of the most important events to touch the industry in the last ten years.
   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 brought forward several issues related to ISOs and the bankcard industry. If you are an ISO or work with ISOs, this case has important implications for your business.
   This two-part article looks at the events surrounding the CMS case, including the misdeeds CMS is accused of committing and the guidelines and regulations ISOs should be studying to stay out of trouble. This article also 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.
   Many across the industry believe that unfair or deceptive practices in the ISO industry have increased in recent years.
   "I've seen more bad stuff out there [in the ISO industry] in the last 18 months than in the last 17 years. I think we've really gone out in the wrong direction. You ought to be able to keep a customer based on your service level. Now they have cancellation fees, etc. But right now, many companies out there treat merchants as just a means to an end," said Bruce Schratz, President of Payment Transaction Solutions, an ISO.
\    Schratz's point is highlighted by the May 16, 2002 report made by Concord EFS revealing that EFS National Bank agreed to pay $37.55 million to settle a Class action lawsuit originally filed in Tennessee alleging that certain of EFS National Bank's rate and fee charges were improper under Tennessee law due to allegedly deficient notice. The settlement was reported only two days after the plaintiffs filed a second amended complaint alleging that the class consists of over 100,000 merchants who were subjected to the allegedly improper rate and fee charges over a several-year period.
   While some think the ISO industry may be suffering from a lack of ethics, some believe many parties are doing their part to ensure ISOs are educated about the rules governing their business practices. For example, the FTC's regulations that affect ISOs were discussed in a breakout session at the ETA's mid-year meeting in Seattle. Even Visa and MasterCard are now recognizing the role of ISOs, issuing best practices guidelines to merchants, acquirers and ISOs about topics such as rules governing ISOs and how to develop successful ISO-acquirer business relationships. (See MasterCard ISO Guidelines, page 24)
   No matter which viewpoint you hold, there is no doubt that the CMS litigation is a landmark case. It has put ISOs on alert and created a ripple effect across the industry.
   When asked about the importance of the CMS case on the ISO industry, Mary Gerdts, President of the Electronic Transactions Association, observed, "I think it basically stopped the industry in its tracks and made it take a hard look at what is going on. We know there will be a few bad apples in any industry, but we want to make sure that we as an industry are trying to do the best we can. There is always room for improvement."
   Holli Hart Targan, Attorney and Partner of Jaffe, Raitt, Heuer & Weiss, P.C., board member of the ETA, and former member of the CMS receivership team, agrees with the state of the industry, "I think every single ISO out there has to take a hard look as to how they are doing business. Now they have some good clues about what the FTC would consider egregious and what steps they can take to avoid this action. They must conduct business the way all other businesses conduct business. Does the FTC have it out for the card industry? No. But now they do have a heightened sense of awareness."
   Let's begin by clarifying what the Federal Trade Commission does and why CMS fell under the FTC's scrutiny.

Understanding the FTC

   The Federal Trade Commission, plaintiff in the case against CMS, is an independent agency of the US Government that enforces a variety of federal antitrust and consumer protection laws. One of the primary objectives of the FTC is to ensure that the nation's markets function competitively. The Commission also works to enhance the smooth operation of markets by eliminating acts or practices that are unfair or deceptive, and this is how CMS landed on the radar screen of the FTC. In general, the Commission's efforts are directed toward stopping actions that threaten consumers' opportunities to exercise informed choice.
   To stop unfair and deceptive actions in the marketplace, the Commission may ­as it did in the case of CMS ­initiate federal district court proceedings to charge parties with violations of the FTC Act. The FTC can also push to secure appropriate relief for these types of inappropriate actions in a couple of ways:

  • Injunctive relief - a final court order that forbids the defendants to do certain actions (think of this as a "thou shalt not" order), and/or
  • Equitable relief - monetary compensation that goes to the victims or is taken away from the perpetrators.

   With this understanding of the FTC's role and enforcement capabilities, let us examine the events related to the case of FTC v. CMS.

Building A Case Against CMS

   Sometime before February 2002 (Commission officials won't say exactly when), the FTC received numerous complaints from CMS merchant customers regarding the business practices of CMS. The volume of complaints was high enough to warrant an investigation that lead to the first-ever federal district court complaint against an Independent Sales Organization (ISO) for unfair and deceptive practices. As you will see by the actions following this complaint, there is no doubt the FTC wanted to send a clear signal to the entire industry that its business practices would receive the same scrutiny as any other industry.
   Following its investigation into the complaints, the FTC filed an ex-parte motion for a Temporary Restraining Order (TRO), which was signed by Federal District Judge Paul Brown, US District Court for the Eastern District of Texas, on February 11. Under the terms of the TRO, a Receiver was appointed to take control of CMS temporarily and the assets of the Company and the Individual Defendants were frozen.
   The Receiver and his team entered the corporate offices of CMS on the morning of February 12, 2002, effectively seizing control of business operations.
   At the time that the FTC filed the TRO, they also filed a "Complaint for Injunctive and Other Equitable Relief" and volumes of declarations from CMS' merchant customers. The CMS complaint outlined a number of unfair and deceptive practices related to the marketing of credit- and debit-card merchant accounts by CMS to small businesses nationwide. It named as defendants Certified Merchant Services, Ltd., several of its corporate entities and three CMS officers, Jonathon Frankel, Craig Frankel and Randel A. Best.
   The Commission files a complaint when it has reason to believe that the law has been or is being violated, and it appears to the Commission that a proceeding is in the public interest, but a complaint is not a finding or ruling that the defendants have actually violated the law.
   With the 61-page "Temporary Restraining Order" the Commission requested and received permission to prohibit CMS from certain behaviors and to freeze the business and personal assets of the named defendants. The individual defendants had to respond to 15 pages of probing questions such as their children's birth dates, the amount owed on their cars, what money or assets they have saved, what stocks they own, their credit card accounts, and even their average monthly food and clothing expenses.
   The Order named a Receiver to be appointed by the court to manage the company. Since many CMS merchant customers depend on credit- and debit-card transactions on a daily basis, the Commission proposed a limited asset freeze that would allow the receiver to operate the merchant accounts, deposit net card sales' proceeds into the merchants' deposit accounts and carry out the Company's day to day business.
   Garrett Vogel was appointed as Receiver by the Court to oversee CMS's business operations while the FTC worked to get the court to remedy the alleged violations. Mr. Vogel's assembled Receivership team included legal, financial, operations and technical professionals, as well as transaction processing industry experts, in order to review the management and operational issues that had come into question.
   This team performed a thorough review of the Company's entire business operations and merchant relationships and provided a report to the Court assessing the Company's current situation including a financial review, business process analysis, customer service analysis, contract process, underwriting and risk management.
   On March 6, 2002, the FTC then filed a "Stipulated Preliminary Injunction with Asset Freeze, Appointment of a Receiver and Other Equitable Relief" (a stipulation is an agreement). To translate, essentially the FTC and the defendants agreed to the wording of the order and the judge signed it after a brief hearing where the parties' lawyers were allowed to make arguments. Although similar in terms to the temporary restraining order filed in February, this filing could stand until the end of the case or until the court modifies it, without requiring extensions. In fact, this injunction is still in effect today and was only slightly modified by the September 16 Order appointing a new Receiver, discussed below.
   For its part, since Feb. 13, the FTC has conducted further research and investigation into CMS' business practices, and gathered testimony from various parties involved. On June 14, the Commission filed an amended complaint in the matter pending against CMS. The FTC added specific allegations to the existing counts based on new evidence and named a fourth corporate entity (which allegedly is under the control of the individual defendants) as a defendant.
   Since its appointment on Feb. 11, the receivership team has investigated customer complaints and worked with the management of the Company on various changes in internal processes as well as sales practices that addressed both the allegations of the merchants in the FTC action, as well as improve productivity, operations, sales administration and confirmation of the sales process with the merchant. The receivership team also administered the implementation of special employee training in the areas of sales, customer service, business ethics and compliance.
   On September 16, Judge Paul Brown signed an Order appointing Mary Dees as the Receiver for the Company and removed the former receiver and his team. Dees is a 22 year veteran of the financial services, payment, product, credit card and transaction processing industries.
   This Order also provides a stay (pause) in discovery for 90 Days while the FTC, the corporate defendants and the individual defendants review ways to resolve the matter without going to trial. If, however, the matter goes to trial it would now most likely be scheduled for June 2003. This Order also lifted the Administrative leave, which had been initiated by Garrett Vogel, and allowed Jonathon & Craig Frankel to return to the Company to begin working again at CMS on special projects aimed towards the company's future.
   As Receiver, Ms. Dees manages the Company, reporting to Judge Brown and is responsible for the continued adherence to the terms of the Preliminary Injunction, managing the Company's day to day business, protecting the assets of the company and ensuring that the company is not harmed while under the Federal Court's protection.
   The executive management team which includes: Blake Pyle, CFO; Greg Robertson, EVP Marketing; Mark Harrelson, EVP Sales and Chris Heider, VP Operations; were with the company prior to the February 11 FTC action and they continue to work closely with Ms. Dees, as they have since the inception of the initial receivership.
   Mary Dees, Receiver for CMS said, "As a group, the team continues to focus on improved products and services for customers, increasing customer satisfaction, improved training and administrative of the sales process, and proprietary technology development to improve the company's ability to serve and satisfy its merchants. This team has been dedicated and attentive to the task of improving the company's performance towards a successful future."

What Went Wrong

   FTC lead attorney on the CMS case, Doug Wolfe, makes it clear that the FTC wasn't picking on the ISO industry when it began investigating CMS. "With the ISO industry, as with any industry, if we receive enough complaints about something that it reaches critical mass showing a violation of laws we enforce, we wouldn't hesitate to take action. If you are deceiving your customers, or if you are not adequately disclosing to them the terms and conditions of your agreements, then you should change your business practices immediately, or if you are making certain cost savings claims to your customers, you better be able to have some math to back up those cost promises that you are making."
   On February 13, the Federal Trade Commission publicly announced details about its actions of two days before, which was the first-ever federal district court complaint against an Independent Sales Organization (ISO) for unfair and deceptive practices related to the marketing of credit- and debit-card merchant accounts to small businesses nationwide.
   According to the February 13 announcement by the FTC and the subsequent amended complaint, the FTC complaint stated that the defendant, CMS, and its principals misrepresented the terms of - and then inserted fine print into - merchant account agreements, allowing them fraudulently to debit previously undisclosed fees from the merchants' bank accounts.
   According to the Commission, since at least 1998, CMS and the individual defendants - either directly or through sales agents - initiated contact with small business owners throughout the United States to induce them to purchase their goods and services, including the establishment of merchant accounts.
   The Commission's complaint alleges that CMS and the individual defendants violated the FTC Act by unfairly and deceptively:

  • Modifying customer contracts;
  • Debiting their accounts without authorization;
  • Making misrepresentations regarding various goods or services offered;
  • Failing to disclose various charges or fees.

   The complaint states that in numerous instances, after merchants had signed applications and without their knowledge, CMS inserted pages of fine print, including fee and expense information. CMS allegedly then used these pages to justify debits of fees or expenses from the merchants' deposit accounts with no notification. CMS allegedly tried to disguise these debits, listing "H-Semi," and "H-Can," instead of CMS, as the company withdrawing the fees.
   The FTC further contends that in many cases CMS debited the fees from the merchants' accounts before providing the merchants with promised card-processing equipment or supplies, before the merchants signed up for processing services or before such services were activated, and despite the fact that some merchants had cancelled their service.
   In addition, according to the complaint, CMS deceptively represented that:

  • If merchants purchased their services they would save money each month on their card processing expenses;
  • If merchants were dissatisfied with any services or representations made by the company they could cancel or transfer the service to another card processor at any time with no further obligation;
  • There was no minimum monthly fee for the services offered; and
  • If merchants were charged cancellation fees by prior card processors, the company would reimburse them.

   The amended complaint describes that when faced with unauthorized debits or fees to which they did not agree, merchants often could not contact the defendant's sales agents. Many merchants went through CMS' customer service department, which often placed merchants' calls on hold, disconnected them, or transferred them to voice mail. When merchants did reach CMS customer service representatives, the reps promised return calls that were often not made and promised refunds that were not given or were delayed for months.
   When merchants had no choice but to cancel their agreement with CMS, initially undisclosed cancellation fees of up to $400 were debited by CMS from the merchants' deposit accounts. Some merchants were even forced to change their bank accounts to prevent CMS from performing unauthorized debits.
   Many merchants sought mediation efforts by the Better Business Bureau or state Attorneys General, and in response CMS routinely denied requests for reimbursement and blamed misrepresentations on their sales agents, over whom they claimed not to have any control.
   Finally, the Commission said that in many instances CMS deceptively failed to disclose, clearly and conspicuously, that they would charge merchants certain fees, including a minimum of $25 if the merchants did not reach a certain level of card sales; a semi-annual fee of between $33 and $50; and a cancellation fee of between $300 and $400 for canceling within three years of signing a service contract.
   Before this article goes any further, let's recap.
   The FTC will put an ISO on its radar if it is unfairly and deceptively:

  • Modifying customer contracts;
  • Debiting their accounts without authorization;
  • Making misrepresentations regarding various goods or services offered;
  • Failing to disclose various charges or fees.

   If any of these activities sound familiar to you, take the advice of FTC attorney, Doug Wolfe. "I think that any ISO should take a look at the allegations that were made here and they should know the FTC had taken action on complaints we received either directly from victims or other law enforcement agencies. Lightning can strike twice but because the FTC does put information out there for business about how to operate legally and about the laws we enforce, we provide lightening rods. ISOs should take advantage of the lightening rods," Wolfe said.
   A few of the "lightening rods" Doug suggested can be found at the FTC's web site at www.ftc.gov. While the information at this site doesn't talk specifically about ISOs, and can be a bit dry, it does provide general information about rules and acts that the FTC is in charge of enforcing. "We also offer a guide against deceptive pricing, how to substantiate claims in ads and a guide about using the word Œfree'," Wolfe said. "This information can help ISOs operate legally and profitably."
   The FTC is not alone in its efforts to provide information that can help ISOs comply with the law. Closer to home, industry players including the ETA, MasterCard and Visa are offering a variety of resources to help ISOs, acquirers and merchants adopt better business practices. Part II of this article will review what those resources are and how ISOs can get them. In addition, you'll hear the strategies that several ISOs are following to ensure best practices, and what they think is in store for the industry in the wake of the CMS case.