Credit Card Processing Blog

Most merchants who have accepted credit card payments for longer than a few months, especially in a card-not-present environment, know that their processors can be annoyingly sensitive to any deviations in their established payment processing patterns. So sensitive, in fact, that they can initiate a review of the merchant and request a host of documents to explain why the pattern has changed. Furthermore, often the review is accompanied by a frieze of the merchant’s funds until the processor is satisfied with the explanation.

Why Merchant Accounts Get Suspended

So that being the case, let’s take a look at how processors monitor merchant activity and what can trigger a review. Processors are required by Visa and MasterCard to generate daily reports of their merchants’ processing activity, monitoring the following parameters:

1. Number of authorization requests above a pre-set threshold.
2. Ratio of card-present to card-not-present transactions that is above the threshold.
3. Personal account number (PAN) key entry ratio that is above the threshold.
4. Repeated authorization requests for the same amount or the same account number.
5. Increased number of authorization requests.
6. “Out of pattern” fallback transaction volume.
7. Increases in merchant deposit volume.
8. Increase in a merchant’s average ticket size and number of transactions per deposit.
9. Change in frequency of deposits.
10. Frequency of transactions on the same cardholder account, including credit transactions.
11. Unusual number of credits, or credit dollar volume, exceeding a level of sales dollar volume appropriate to the merchant category.
12. Large credit transaction amounts, significantly greater than the average ticket size of the sales.
13. Credits issued subsequent to the receipt of a chargeback with the same account number and followed by a second presentment.
14. Credits issued to an account number not used previously at the merchant’s store.

Industry Rules and Regulations

90-day rule. Visa and MasterCard require that processors compare each merchant’s daily deposits to the average transaction count and amount for the merchant over a period of at least 90 days, to account for the effect of normal variances in the business. For new merchants, with no processing history, processors compare the average transaction count and amount for other merchants within the same merchant category code (MCC). If the processor identifies suspicious credit or refund transaction activity, the account can be suspended and a review initiated.

Processing banks are required to compile monitoring reports for merchants, based on the 90-day rule. Typically, whenever a merchant’s daily deposit exceeds the average transaction count and amount by 150 percent or more, the merchant is added to the monitoring report.

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Prior to signing a new merchant agreement or renewing an existing one, processing banks are required to verify that the applicant is a bona fide business, has in place sufficient safeguards to protect sensitive transaction and cardholder information and that it generally complies with applicable laws. Additionally, the processor is required to ensure that each transaction processed by the merchant will reflect bona fide business between the merchant and the cardholder.

Verification procedures will typically include the following:

• Credit check, background investigations, and reference checks of the merchant.* If not satisfied by the credit check, the processor can also conduct a credit check of:
  • The owner, if the merchant is a sole proprietor; or
  • The partners, if the merchant is a partnership; or
  • The principal shareholders, if the merchant is a corporation.
• Inspection of the applicant’s premises. The processor will want to ensure that the merchant has facilities, equipment, inventory, agreements, and personnel required to conduct the business and, if applicable, license or permit. If the merchant has multiple outlets, the processor is required to inspect at least one of them.
• Search the MasterCard Member Alert to Control (High-risk) Merchants (MATCH) system. MATCH is a database that includes information reported by processing banks about merchants and their owners whose merchant accounts have been terminated for cause. If a MATCH inquiry returns a positive result, the application will be rejected.
• Investigation of the merchant’s previous merchant agreements. Typically, merchants are required to provide their three latest processing statements. The processor will be examining the merchant’s processing volumes and transaction amounts, as well as records of chargebacks and refunds, which would help establish the risk classification.

  
  *Credit checks are not required of public or private companies with annual sales revenue above $50 million (or the foreign currency equivalent). The processor will want to review the merchant’s most recent annual report, including audited financial statements. However, a private company that does not have a recent audited financial statement is still subject to a credit check and inspection even if its annual sales revenue exceeds $50 million.

Once the screening process is completed, the processor keeps the following documents for any merchant with which it has entered into a merchant agreement for a minimum of two years after the date that the agreement is terminated:

• Signed merchant agreement.
• Previous merchant statements.
• Corporate or personal banking statements.
• Credit reports.
• Site inspection report, including photographs of the premises, inventory verification, and the name and signature of the inspector of record.
• Merchant certificate of incorporation, licenses, or permits.
• Verification of references, including personal, business, or financial.
• Dated MATCH inquiry records.
• All correspondence with the merchant.
• Signed MSP contract, including the name of agents involved in the due diligence process.
• Any due diligence records concerning the MSP and its agents, if applicable.

Once the merchant account is set up, the processor continues to regularly review and monitor the merchant’s business activities and website to ensure compliance with the terms of the contract. Processors typically use website monitoring services to do that.

Learn how to lower your card acceptance cost

Learn how to accept credit and debit cards at the lowest processing costs. The Payment Card Acceptance kit contains a video and an e-book:

• Video – Card Acceptance Best Practices for Lowest Processing Costs (18 min).
• E-Book – Payment Card Acceptance Guide (19 pages).

In the Payment Card Industry, factoring occurs when a merchant deposits card transactions with its processing bank on behalf of another merchant. This is against the rules set in the merchant’s processing agreement and is considered a fraudulent activity.

Why is factoring prohibited? There are plenty of reasons why factoring is prohibited, but the biggest one is that the processing bank has not been given the chance to examine and approve the type of card sales processed by the third party. Processors are required to ensure that every merchant whose payments they acquire is a legal entity and complies with applicable industry regulations regarding types of goods and services sold, return, credit and refund policies, etc. For example, a merchant who sells adult products will not be able to get a merchant account with most U.S. processors. To circumvent this hurdle, the merchant may try to use another merchant’s card processing account.

What types of merchants solicit factoring? There are two types of merchants who solicit factoring.

• Low-volume merchants. The first type consists of merchants who do not process payments in sufficient volumes to justify the expenses and time commitment associated with setting up and maintaining a dedicated merchant account.
• High-risk and prohibited merchants. The other type consists of merchants who are either too high-risk to be approved for a U.S.-based merchant account or are involved in some kind of fraudulent activity. Multi-level marketing (MLM) organizations, for examples, find it very hard to set-up a merchant account and have often tried to circumvent the rules. One way such business types have used to try to go around the rules, for example, is to set up a merchant account for an easily-approved type of activity and to then use the merchant account to process MLM-related card payments. Processors have come down hard on such schemes and this is now very difficult to do.

What are the issues involving factoring? The main issue for a merchant with an active merchant account, which a non-authorized entity also uses to process card payments, arises when a customer files a complaint about a product or service sold by the non-authorized merchant. When this happens, the sale will be charged back to the authorized merchant who submitted the sale. This means that the authorized merchant will suffer any losses resulting from sales by the non-authorized entity. Moreover, if any fraud is involved, the authorized merchant could face criminal prosecution.

What are the consequences faced by merchants caught factoring their merchant accounts? In addition to possible criminal prosecution in case of fraud, merchants caught factoring their merchant accounts to third parties, will have their merchant accounts terminated for cause and they will be listed on the MATCH file. Additionally, merchants are liable for any financial losses associated with the unauthorized transactions.

There is another type of transactions in the Payment Card Industry that can be referred to as “factoring.” It is the sale by a merchant of future credit card receipts to meet short-term capital needs. This type of factoring is legitimate and many merchants are utilizing it, although it is by far not the most advantageous form of financing.

Learn how to lower your card acceptance cost

Learn how to accept credit and debit cards at the lowest processing costs. The Payment Card Acceptance kit contains a video and an e-book:

• Video – Card Acceptance Best Practices for Lowest Processing Costs (18 min).
• E-Book – Payment Card Acceptance Guide (19 pages).

Both Visa and MasterCard use special Reason Codes to designate chargebacks resulting when a card issuer receives a complaint from a cardholder stating that a merchant did not issue a refund when a purchased product was returned or services canceled, or a refund was issued but for a reduced amount, without proper disclosure. Visa uses Reason Code 85 and its MasterCard’s equivalent is 4860.

What causes these chargebacks? Chargeback Reason Codes 85 and 4860 may be caused because the merchant:

• Did not issue a credit.
• Issued the credit but did not deposit it with its processing bank in time for it to appear on the cardholder’s next statement.
• Did not issue a credit, because it does not accept returns, but did not properly disclose its return policy.

How to manage such chargebacks? The time frame to respond to Reason Codes 85 and 4860 is 120 days. Your response will depend on the particular transaction circumstances and the actions you have taken (or not) so far:

• Returned product or cancellation was not received. If you never received the returned merchandise or the service was not canceled, contact your processor immediately and explain the situation.
• Product was returned contrary to the disclosed policy. If the merchandise was returned not in the manner described in your return policy, provide your processor with documentation proving that the customer did agree with it and signed it. Keep in mind that, if your return policy is located on the back of the sales receipt, you will have to obtain your customer’s initials there, in addition to the signature on the front. When providing supporting evidence, you must send copies of both the front and the back of the receipt.
• Credit was issued. If you did issue a credit for the returned merchandise at issue, contact your processor and provide them with the date and amount of the credit.
• Credit is not yet issued. If you did not issue a credit for product that was returned according to your return policy, there is no remedy and you should accept the chargeback. Do not process the credit now, as the chargeback has already done that for you.

How to prevent chargeback Reason Codes 85 and 4860? Many of these chargebacks can be prevented by implementing the following best practices:

• Issue credits promptly and as agreed. If merchandise is returned according to your return policy, make sure to promptly issue a credit and to immediately notify your customer that it has been issued.
• Only issue credit to the card used in the sale transaction. Credit for returned merchandise should only be issued to the same card that was used in the original transaction. Ask your customers to retain the credit receipt until they see the credit posted on their accounts.
• Gift returns. If product was returned by a gift recipient and not by the cardholder, the credit to the gift recipient must be in the form of cash, check or a store credit. Be advised that, if the credit is to be issued to a bank card, it can only be issued to the one used in the transaction.
• Return policy disclosure. Make sure that your return policy is posted on the sales receipt. If not and until you do that, present an additional document (an invoice or contract) to your customer to sign. If the return policy is on the back of the receipt, make sure the customer initials it.
• No-return policy disclosure. If your organization does not accept returns, your policy should be clearly posted on the sales receipt and at checkout, for both virtual and physical stores.
• Obtain customer signature. Customer signature should always be obtained on your return policy; a verbal disclosure is not enough.

While it is not likely that you will ever be able to completely eliminate this type of chargebacks, developing a customer-friendly return policy will go a long way toward minimizing them. Customers expect that, if they are not satisfied with their purchase, a return will be accepted and a full refund issued. Otherwise, they will probably file a dispute with their credit card company. You will want to avoid such disputes, even if you believe you will win them, because customers are likely to broadcast them on the internet and damage your reputation. Customer disputes and resulting chargebacks are also closely monitored by processing banks that will promptly freeze your merchant account, if there is any uptick in such activities.

Learn how to minimize chargebacks and fraud

Learn how to minimize chargebacks and reduce your processing costs. The Chargeback Management kit contains a video and an e-book:

• E-Book – Chargeback Manual (40 pages).
• Video – Card Acceptance Best Practices for Lowest Processing Costs (18 min).

Visa and MasterCard can initiate an audit of a merchant’s credit card processing account, whenever they have reasons to believe that the merchant may be a high-risk one or is processing invalid transactions. In particular, the following two reasons can be sufficient to trigger an audit:

• The processing bank may have reason to believe that the merchant is engaging in collusive or otherwise fraudulent or illegal activity.
• The processor determines that the merchant’s chargeback ratio or credits-to-sales ratio exceeds the standards set by Visa and MasterCard or its own standards, or both. We have discussed the Associations’ rules on excessive chargebacks in previous posts and encourage you to revisit them.

Processors will typically act quickly when they notice an activity that is outside of the established merchant pattern, because they are responsible for fraud-related chargebacks. For example, if a merchant submits a transaction at an amount substantially higher than the average transaction amount approved for the account, the processor will probably contact the merchant and want to find out why the amount is so high. Similar attention is paid to sales volumes. As completely legitimate merchants have learned to their surprise and annoyance, a rapid rise in their monthly sales invariably attracts their processor’s attention.

Moreover, even when fraud is absent or nor suspected, processing banks can have good reasons to be alert. The Associations assess processors penalty fees for merchants with high levels of chargebacks. For example, processors are required to report every merchant whose chargeback-to-transaction ratio (CTR) exceeds 50 basis points (0.50 percent) and pay a reporting fee of $50 for each report submitted. The fee rises steeply when the CTR exceeds 100 basis points (1 percent). To avoid paying these fees, processors will initiate a review long before the merchant comes even close to reaching either of these thresholds.

Whenever an audit is initiated by one of the Associations, it will contact the processor to explain the reasons why it believes the merchant may be in violation of the rules against processing invalid transactions and request information. Processors have 30 calendar days to return the requested information to the Association. Requested information typically includes the following items:

• A statement explaining whether, when, and how the processor became aware of fraudulent activity or chargeback or customer service issues, the steps it took to control the occurrence of fraud, and the circumstances surrounding the merchant’s termination.
• All internal documents about the opening and signing of the merchant including its application, merchant processing agreement, credit report, and certified site inspection report.
• All internal documents regarding the due diligence procedures followed before signing the merchant, including background checks of the company and its principals, as well as trade and bank references that the processor verified during the due diligence procedure.
• If an Independent Sales Organization (ISO) or a Member Service Provider (MSP) of the processing bank has facilitated the signing of the merchant, the ISO / MSP must include the due diligence documents. (In such cases the processor must distinguish between the due diligence conducted by its employees and its ISO’s / MSP’s employees.)
• Additionally, if an ISO / MSP assisted in the signing of the merchant, the processing bank must provide all due diligence documents regarding the representative that signed the merchant.
• Reports confirming an inquiry by the processor into the Member Alert to Control High-Risk Merchants (MATCH) system before signing the merchant and, if applicable, input of the merchant to the MATCH system database within five business days after its decision to close the merchant.
• Additionally, during the review period, the processor will be required to provide the following documentation:
  • Authorization logs for the merchant.
  • A monthly breakdown of chargeback and credits by count, amount, and issuer bank identification number (BIN) for the violation period.
  • A complete record of the merchant sales volume, including the number of transactions at the location, for the period for which the authorization logs are requested.

As you see, there is a lot of documentation that will be looked at and, if something is not done according to the applicable rules, it will most likely be found and the account will be terminated (if it has not been already) and the merchant will be added to the MATCH file. Moreover, during an audit, the merchant may be listed on the MATCH system under MATCH reason code 00 (Questionable Merchant).

Learn how to lower your card acceptance cost

Learn how to accept credit and debit cards at the lowest processing costs. The Payment Card Acceptance kit contains a video and an e-book:

• Video – Card Acceptance Best Practices for Lowest Processing Costs (18 min).
• E-Book – Payment Card Acceptance Guide (19 pages).