United States: FTC's Order Against Payment Processor Highlights Liability Risks Posed By Aiding And Abetting Provisions

Last Updated: May 29 2015
Article by Ellen T. Berge and Peter Frechette

On May 20, 2015, the Federal Trade Commission (FTC) obtained a final order against a payment processor, Universal Processing Services of Wisconsin LLC d/b/a Newtek Merchant Solutions (Newtek), for processing payments for a telemarketing scheme. In conjunction with a settlement agreement, Newtek was ordered to pay $1.7 million in restitution for its involvement in the "Treasure Your Success" (TYS) robocalling credit card interest rate reduction program. Newtek will pay the restitution jointly with an independent sales organization (ISO) and telemarketing company, HES Merchant Services Co., and HES's owner, Hal Smith, which were subject to permanent injunctions and monetary judgment on February 11, 2015.

In the TYS case, the FTC alleged that telemarketers made robocalls that deceived consumers about the companies' ability to relieve credit card debt. The behavior, the FTC argued, violated the Telemarking Sales Rule (TSR). The FTC also alleged that Newtek violated the TSR by assisting and facilitating the telemarketers' violations by processing credit card payments. HES/Smith were implicated both in the TYS scheme itself, and as the ISO that opened credit card merchant accounts for TYS.

The order against Newtek serves as a reminder to payment processors of the potential liability for "assisting and facilitating" violations of the TSR in telephone-based commerce.

"Assisting and Facilitating" Liability under TSR

In the district court's November 2014 summary judgment ruling in favor of the FTC, the court found Newtek liable for "assisting and facilitating" the TSR violations of the other defendants by providing the interface with the banks to handle credit card payments while knowing (or avoiding knowing) of the underlying TSR violations. The court found that providing merchant accounts, which enable companies to process credit cards, was "essential to the success" of the TSR violations.

Red Flags: The district court found that Newtek ignored numerous red flags that, if properly investigated, would have led Newtek to decline TYS as a client. In its motion for summary judgment, the FTC listed problematic issues (noted in a Newtek internal report) regarding accounts opened by Smith and HES:

  • Newtek's Senior Vice President and Chief Operating Officer gave a low assessment of the quality of the HES/Smith accounts;
  • Newtek described the HES/Smith accounts as "the largest, highest risk, most profitable, and highest maintenance accounts in the portfolio";
  • Some of the HES/Smith accounts "began to incur chargebacks as far back as August 2011 [months before TYS submitted its application]";
  • A large portion of HES/Smith accounts were considered high risk and required holdbacks as high as 30%; and
  • HES/Smith accounts were not subject to the normal underwriting process.

Specific to the TYS scheme, the FTC also alleged, and the district court cited, nine specific red flags that, taken together, should have resulted in Newtek's refusal to open merchant accounts for TYS:

  1. TYS's application claimed, without any support, anticipated annual credit card sales of $2.7 million;
  2. Credit reports on TYS's principals warned of serious credit risks;
  3. TYS's application stated the company's plan to engage in potentially high-risk forms of business for credit card processing: outbound telemarketing with "card-not-present" transactions;
  4. Internal inconsistencies in the TYS application with regard to the types of services the merchants would provide;
  5. TYS's application stated that TYS planned to bill consumers on the sale date, while the services it claimed to provide would be delivered over the next 30 days;
  6. TYS's lack of cancellation policy and statement in its application that it would provide a refund only if consumers cannot meet the quoted (interest) savings;
  7. TYS's multiple corporate entities and "doing business as" or "dba" entities;
  8. TYS left portions of its application blank and failed to provide all requested documentation; and
  9. The other merchant accounts referred to Newtek by Hal Smith and HES were experiencing unacceptably high chargeback-to-transaction ratios.

Newtek argued that the TYS merchant accounts were improperly approved by an individual Universal Processing Services employee. However, the district court rejected Newtek's "adverse agent" argument, holding that the defense of a rogue employee applies only when "the agent's conduct is entirely in the agent's interest without even incidental benefit to the principal."

Newtek Settlement

Under its settlement agreement with the FTC, Newtek is required to permanently refrain from processing payments for merchants engaged in certain types of business, including lead source providers, payday loans, moneymaking opportunities, mortgage loan modification, and debt relief products or services.

Additionally, Newtek must comply with FTC-mandated screening and monitoring requirements for card-not-present (CNP) merchants exceeding $200,000 in annual processing volume. Screening includes determining whether the merchant's business practices are likely to be deceptive, unfair, or abusive acts of practice prohibited by Section 5 of the Federal Trade Commission Act. As an example, the order indicates that a total return rate above 2.5% or a chargeback rate above 1% in any month during the previous two years is a potential red flag that the CNP merchant is engaged in unfair or deceptive practices.

Among other monitoring requirements, Newtek must investigate any CNP merchant whose total monthly return rate exceeds 2.5% in two of the past six months or whose monthly chargeback rate exceeds 1% and whose total number of chargebacks exceeds 35 per month in two of the past six months.

HES/Smith Injunction

The court entered a permanent injunction against HES and Smith that includes 20-year bans on robocalls, telemarketing, and marketing debt relief products or services. It also permanently prohibits Smith and HES from making misrepresentations in the sale or marketing of any product or service, including financial products or services.

Broader Outlook

The Newtek settlement is the latest example in a long line of FTC cases demonstrating a broad law enforcement approach that targets not only merchants who allegedly harm consumers, but also service providers that supply critical functions to those merchants' operations. For example, the screening and monitoring requirements in the Newtek settlement are similar to others imposed by the FTC in recent orders against payment processors, but far more restrictive than current requirements established by card brands like Visa and MasterCard. Moreover, in effecting bans against entire lines of commerce, settlement orders like the Newtek case may have the effect of choking off the ability of many types of merchants to obtain processing accounts. Other processors and ISOs that are not subject to the FTC's settlement orders may nonetheless terminate or stop accepting new merchants in these industries, including merchants operating lawfully, rather than risk the possibility of dealing with a law enforcement investigation or lawsuit for serving these types of merchants.

The FTC is not the only agency that can take a law enforcement approach that covers service providers. With even greater impact, the "substantial assistance" provision in the Consumer Financial Protection Act (CFPA), enforced by the Consumer Financial Protection Bureau (CFPB), presents significant risks to payment processors on a broader scale that reaches all forms of commerce. This provision prohibits "knowingly or recklessly provid[ing] substantial assistance" to violations of the CFPA, which is a standard that remains relatively undefined within the scope of CFPB actions and creates uncertainty for processors and ISOs.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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