United States: Transaction Laundering: The Next Threat To The Payments Industry

Last Updated: June 3 2015
Article by D.E. Wilson, Jr.

Transaction Laundering (TL), sometimes referred to as "undisclosed aggregation," or "factoring," is a growing threat to the payments industry. Money laundering by another name, it is the dark side of payment facilitation, an established, legitimate aggregation model that provides smaller merchants, ones usually not qualified because of their size, a way to take credit and debit cards for payment. While potentially benign, aggregation violates both the merchant's agreement with its acquiring bank and, potentially, a number of federal and state laws, including the U.S. anti-money-laundering (AML) laws.

This article focuses on the responsibility of electronic payment industry participants—banks, payment processors, and independent sales organizations (ISOs)—to keep merchants that abuse their merchant processing accounts out of the payments system.

What Is Transaction Laundering?

TL takes a number of forms. Here are three:

  1. Front company. A pizza business passes the due diligence underwriting tests. However, rather than just making pizza, the company also (or instead) launders drug money or sells illegal products disguised as the pizza Merchant Category Code (MCC).
  2. Pass-through company. A company with a legitimate processing account takes on a "silent partner" in one of several ways. The legitimate company:

    1. Allows (or is forced to allow) an illegitimate entity to use its account.
    2. Embeds a payment link on an illegitimate company's web page.
    3. Enters the illegitimate company's sales into its system manually, making TL more difficult to detect.
    4. An example is the recent indictment of former NBA All-Star Chris Gatling for credit card fraud, in which he "persuaded" a fitness studio owner to charge credit card numbers for him in return for a 10% share of the amounts charged.
  3. Funnel account. A legitimate business accepts credit card charges from companies that do not have merchant processing accounts, entering the charges as legitimate transactions in the card payment processing system.

These schemes are sometimes easy to detect, and other times they are devilishly hard to identify, uncover, and shut down. Frequently, detection drives the bad actor to another site under a different name. A major result of this is that the costs of performing initial due diligence and ongoing maintenance checks on merchants are driven higher, with limited ability to share these costs among participants in the payments industry.

The products involved are everything imaginable—illegal street drugs, prescription medication, counterfeit brands, unlicensed gambling, illicit pornography, etc. But both the products and the means are changing and evolving, as the bad actors become more sophisticated.

Anti-Money Laundering and the Financial Crimes Enforcement Network

Regulatory pressure is most likely to come from the Financial Crimes Enforcement Network (FinCEN). Unfortunately for the card industry, FinCEN sees TL as variations on well-documented AML themes. In view of this, the payments industry should expect little patience from FinCEN or the Federal Financial Institutions Examination Council (FFIEC) on TL enforcement and should quickly adapt FinCEN's prior guidance to the electronic payments world.

The increasing number of FFIEC examinations of payment processors and merchant acquirers illustrates that the same rules are being applied to all participants in the financial services industry. Failure to prevent uninvited (or unknown) guests from gaining access to the payment system will subject financial industry participants to substantial fines and penalties, including restrictions on participating in the payments industry, individual fines, and bans from the business for a period of time (from months to a lifetime).

The Federal Trade Commission, the Consumer Financial Protection Bureau, and the Department of Justice

Recent enforcement actions brought by the Federal Trade Commission (FTC) and the Department of Justice (DOJ) illustrate that financial industry participants are expected to know their customers and to keep bad actors out of the payment systems. The FTC and DOJ, like the FFIEC, expect payment processors to be financial system gatekeepers.

The Consumer Financial Protection Bureau (CFPB) also requires that payment system participants know what their customers are doing, and how, so that consumer harm may be kept to a minimum and, where it occurs, stopped quickly. Like the FFIEC, the CFPB has supervisory and examination authority that extends to acquiring banks, payment processors, and all other FIs involved in consumer financial products and services.

Points to Consider

  • TL is a variation on a threat well known to law enforcement and regulators.
  • The electronic commerce industry is expected to:

    • Be aware of current threats and anticipate new ones;
    • Take steps to prevent abuse of the payments system; and
    • Appreciate that it is subject—in most instances—to the same rules that govern banks and to examination by the same regulators.
  • If the electronic commerce system wants to keep the confidence of the public, it must police the system. The government simply does not have the time or the resources for this.
  • Successful compliance requires:

    • A focused approach that is analytical, practical, and technical;
    • Collaboration with other industry players, regulators, and law enforcement; and
    • Strong and visible support from the C-Suite.

For those who have not yet experienced the strong shift toward gatekeeper responsibility, there is a growing risk that federal regulators will hold FIs—and their officers—responsible for transaction laundering, fraud, and consumer harm in the payments system.

With thanks to the Electronic Transactions Association and the Transact 15 panelists on "Undisclosed Aggregation: What you can't see will hurt you," Joan E. Herbig, CEO, ControlScan, Alpharetta, Georgia, Moderator, and speakers John Verdeschi, MBA, Group Head & Senior Vice President, MasterCard, Purchase, New York; Georgia Stavrakis, CPP , Senior Director of Loss Prevention, Heartland Payment Systems, Jeffersonville, Indiana; Deana Rich, President, Deana Rich Consulting, Inc., Van Nuys, California; and Karen D. Leasure, Vice President of Payment Network Compliance, Bank of America Merchant Services, Hagerstown, Maryland.

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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