Acquiring: The Baby And the Bath Water

Linda Punch

The Federal Trade Commission wants to outright ban four payment methods used by legitimate telemarketers and fraudsters alike. That would shut off a significant source of transactions for at least some merchant processors.

Alternative payment methods such as remotely created checks have become increasingly popular over the past decade, aided by federal legislation such as Check 21 and support from the financial industry and other groups. But the growing acceptance of these emerging payment vehicles may be endangered by the Federal Trade Commission’s all-out war on telemarketing fraud.

In a proposed rulemaking posted in May, the FTC called for a sweeping ban on telemarketers’ use of remotely created checks and three other payment methods in any transaction. The ban also would prohibit telemarketers from collecting payments via remotely created payment orders, remittances, and authorization codes for prepaid cards.

Under the rulemaking procedure, the FTC publishes proposed rule changes or amendments in the Federal Register and posts the document on its Web site for public review. Interested parties are given a specific time period for posting comments before the FTC takes final actions.

The deadline for commenting on the FTC’s proposed changes to the Telemarketing Sales Rule originally was July 29 but was extended to Aug. 8 due to slight modifications to the original notice. In all, 40 organizations and individuals filed comments on the proposed changes. Commenters were evenly split on the issue.

The proposal is supported by the U.S. Department of Justice and consumer organizations such as the American Association of Retired Persons.

Opponents to the ban say the FTC action would harm legitimate payment vehicles that give consumers alternatives to traditional methods such as credit cards and checks. They contend the proposed rule puts the payments industry in the unwelcome role of policeman, a duty it is not equipped to handle. The proposal also gives the FTC some control over the payments industry, an authority that already lies with the Federal Reserve.

“This is really Federal Reserve territory, not FTC territory,” says David Walker, president and chief executive of the Dallas-based Electronic Check Clearing House Organization.

Indeed, in a comment filed with the FTC, the Federal Reserve Bank of Atlanta said that approval of the proposal could lead to a “fragmented ‘law of payments’ in which multiple federal agencies take differing and/or conflicting views on the legitimacy of specific payments instruments.”

The proposed rule is technically an amendment to the FTC’s Telemarketing Sales Rule (TSR) implementing the 1994 Telemarketing and Consumer Fraud and Abuse Prevention Act. The proposed rule also would prohibit telemarketers from charging an advance fee for so-called recovery services that promise to restore money to consumers who previously have been defrauded.

Although the rule is aimed at curbing telemarketing fraud, it would apply to all telemarketing transactions, effectively cutting off a sizable market for payment processors that handle any of the four targeted payment methods.

Losing Patience

In proposing the rule, the FTC said it is losing patience with the amount of fraud connected to these methods. But the rulemaking doesn’t state an estimate for how much these losses come to, saying only that they are in the “hundreds of millions” of dollars.

In the rulemaking, the FTC said that payment processors “play an indispensable role in furtherance of their clients’ fraudulent and deceptive schemes.” In settlement of such a case a year ago, First Bank of Delaware paid $15 million in civil fines in a lawsuit brought by the U.S. Department of Justice. It also paid $500,000 to cover consumer claims.

The bank, which worked with a number of independent sales organizations toprocess remotely created checks, allegedly ignored return rates in excess of 50%.

One of the ISOs, Landmark Clearing Inc., was sued by the FTC in another case for allegedly processing remotely created payment orders for suspect merchants that generated an 83% return rate. Landmark later settled with the FTC. First Bank ended up dissolving, selling most of its assets and deposits to Bryn Mawr Bank Corp., Bryn Mawr, Pa.

‘An Unfair Practice’

Processors create and print remotely created checks on behalf of merchants that are supposed to have received authorization from consumers. The checks may then be imaged and clear the banking system as would any other check. Remotely created payment orders are similar but are created in the first place as electronic images.

The FTC says telemarketers favor these payment types because they are faster than obtaining checks from consumers and are subject to less regulation than are cards and automated clearing house transactions.

Remittances, also known as money transfers, and prepaid authorization codes operate in much the same manner. With authorization codes, consumers typically hand over cash to a retailer to buy the code, which they can later use to load the funds onto a prepaid card. Telemarketers instruct consumers to give them the code so they can load the funds.

But statistics on the extent of fraud linked to transfers are hard to find. The rulemaking cites surveys indicating a high incidence of fraud in cross-border remittances. It also cites cases of fraud related to authorization codes.

“[T]he Commission, consumer advocates, [the American Association of Retired Persons], and the Better Business Bureau have observed a significant increase in the number of scams involving cash reload mechanisms,” the rulemaking document says. “These schemes have involved payments made to cover taxes on purported lottery winnings, settle phony debts, pay for advertised goods and services, and obtain advance fee loans.”

The FTC contends that both forms of cash transfer have enabled too much fraud. “The Commission’s experience in combating telemarketing fraud operators that use these transfers to pocket consumers’ money, and pursuing the third parties that assist and facilitate them, suggests that the use of these transfers in telemarketing is an unfair practice, and that prohibiting them would serve the public interest,” the FTC says in the rulemaking.

The FTC’s concerns were echoed in comments on the proposed rulemaking filed by AARP and the U.S. Department of Justice. In its Aug. 8 filing with the FTC, AARP said that because banks have limited liability for fraud committed using novel payment methods, “they have not established controls to detect fraud, such as those employed to combat credit and debit card fraud. Telemarketing fraud is therefore enabled by the use of such payment frauds.”

AARP also noted that because legitimate businesses “have access to a variety of other payments that do provide consumers with more robust protections, the benefit to consumers of the proposed rule outweighs the burden to businesses in complying with this rule.”

For its part, the Justice Department says that “mass-marketing fraud schemes, both domestic and international, make use of each of these payment methods because they represent the most effective means by which these schemes can rapidly receive and transfer victim proceeds with less regulatory or industry oversight than traditional payment methods such as checks and payment cards.”

‘A Premature Ban’

But opponents argue that the FTC is turning its sights on the wrong group. “Our concern is that the illegal behavior by telemarketers is the proper focus of the FTC’s law-enforcement activity,” says Jason Oxman, chief executive of the Electronic Transactions Association, a Washington, D.C.-based acquiring-industry trade group. “It should not be methods of payment because those methods of payment by themselves are not bad actors. The methods of payment are merely a means of paying for a good or service.”

Adds Steve Kenneally, vice president at the American Bankers Association’s Center for Regulatory Compliance: “[Regulators] would probably be a lot more effective if they actually went after the bad guys and not after a payment channel. It just doesn’t make sense on its face.”

The FTC’s proposed rule is similar to one suggested by a New York state official who wanted to block automated clearing house debits to consumers who had taken out payday loans, Kenneally says. “If the problem is the payday loan, go after the payday lender, not after the payment type or the bank that’s simply processing a transaction,” he says.

Indeed, Oxman likens the FTC’s proposed rule to targeting the telephone company “for the fraudulent activity of a telemarketer because were it not for the telephone, the marketer would not be able to reach a consumer.”

Opponents to the rulemaking say they support the goal of shutting down fraudulent telemarketers, but that the FTC is taking the wrong approach. “It’s not the payment that is actually the problem,” Walker says. “It’s that telemarketers are doing payments without authorization. And banning any one or multiple payment types doesn’t really address that issue.”

Further, the ban on remotely created payment orders could “stifle innovation that includes the use of electronically issued payments” and the potential adoption of effective consumer protection authentication methods, said Marie Gooding, Federal Reserve Bank of Atlanta chief operating officer and retail payments product director, in the FRBA’s comment.

“There is an opportunity, through authentication and other technology-driven solutions, for RCPOs to provide many of the benefits of checks without carrying many of the risks,” Gooding said. “A premature ban on their use in the telemarketing context may limit their use elsewhere as they would be stigmatized as a ‘risky’ form of payment.”

The FRBA also is concerned that if the proposed rule is approved, depository banks would stop accepting RCCs and might be reluctant to offer remote deposit capture services “out of fear that impermissible items might lurk in the image files,” Gooding said.

Banning certain payment options also won’t prevent telemarketers from committing fraud, Kenneally says. “If you’re a fraudster, you’re going to steal money however you can,” he says. “If it’s not through remotely created checks, what’s going to stop you from putting through fraudulent credit and debit card transactions?”

In its comment, the ABA argued that the FTC has not shown that “all (or even a majority) of telemarketers commit fraud whenever they use RCCs. Nor have they shown the fraudulent telemarketers commit their frauds using RCCs exclusively … In fact, many of the cases illustrate that fraudsters are ecumenical in their choice of payment processes in executing their schemes and will use whatever is at hand.”

‘Robust Protections’

The FTC proposed rulemaking also ignores the huge volume of transactions that are legitimate, Walker says. For example, in the most recent payment volume estimate from the Federal Reserve (2010), remotely created checks in 2009 accounted for 2.1% of checks.

“The vast majority of those payments don’t really have any problems to begin with,” he says. “You’re talking about impacting a pretty small percentage of a very large number of transactions, most of which are perfectly good and normal.”

The FTC’s contention that novel payment methods such as remotely created checks and payment orders don’t carry adequate consumer protections is “simply untrue,” Kenneally adds. “Yes, they don’t have Reg E or Reg Z protection, but they have other protections under state laws that they [the FTC] just dismiss.” The Federal Reserve Board’s Regulation E sets out rules for direct debits such as those done with debit cards. Regulation Z concerns lending practices related to credit cards.

Existing regulations such as Regulation CC and Federal Reserve Bank Operating Circular 3 and the Uniform Commercial Code provide consumers with “robust protections as parties to check transactions,” the ABA says.

Because RCCs and RCPOs are relatively new payment methods, consumer-protection and authentication requirements aren’t yet fully developed, the FRBA’s Gooding said. The FTC might accomplish its goal of protecting consumers from fraudulent telemarketers by working with payments-industry regulators to strengthen anti-fraud and consumer-protection methods for existing and emerging payments mechanisms rather than “by prohibiting the use of specific payment methods only in the telemarketing industry,” she said.

The FTC also should give financial-industry regulators an opportunity to address problems with RCCs and RCPOs before imposing the ban, Gooding said.

‘A Slippery Slope’

Already, some payments-industry players are working to address the problems represented by the use of RCCs and RCPOs in telemarketing fraud. For example, whether RCPOs should be subject to the Electronic Fund Transfer Act is part of pending rulemaking being considered by The Board of Governors of the Federal Reserve System, Gooding said.

The ETA also expects to issue by the end of this year a set of best practices for screening potential merchants and monitoring existing merchants that will help prevent fraudulent activity by telemarketers, Oxman says. “The FTC raised concerns and we want to address those concerns,” he says.

Whether the ban on RCCs and RCPOs in telemarketing survives the rulemaking process has major implications for both telemarketers and the payments industry. As of mid-November, the FTC hadn’t scheduled any further action on the proposal.

But if the ban is approved, the many acquirers that provide payment services to telemarketers may decide the business just isn’t worth the risk.

“That’s certainly a possibility, and obviously there are legitimate telemarketers out there,” Oxman says. “There’s no reason why a payments company shouldn’t be able to provide services to a legitimate telemarketer.”

For the payments industry, the resulting changes could be long-term and much more significant. “Our real concern is that regardless of the payment method the FTC targets, it’s a slippery slope,” Oxman says. “If you hold the payment mechanism responsible for illegal behavior by merchants, then that theory could well be extended to any form of payment regardless of the otherwise legitimate uses.”