What Is a Merchant to Do?

Melody L

The Ivory Tower of Officialdom is at it again. They have spent time and resources on developing ways to reduce fraud in their network and they now want people’s opinions on their solution. The current proposed solution is ... wait for it ... to do more of the same! Wow, what a brilliant idea; an absolutely stunning example of understanding the issues that exist and creating a solution which addresses those issues and, thus, reduces fraudulent payments.

Fraud is being measured based on the rate of return of transactions. No account, invalid account, unauthorized and even insufficient funds returns are considered to be leading indicators of fraud. Merchants and the banks that process for these merchants are being penalized for entering transactions into the network which are returned for any reason.

Thanks Ivory Tower, for providing a revenue center for the consumers’ banks to be incented to return transactions to the poor merchants ...

Today, just like the day in 1974 when the network started, transactions are processed in a batch system. For those readers who might not fully understand a “batch” as the readers were born after 1985, transactions are collected and stored up to a cut off time, when a process kicks off to bundle all the transactions up to this time into a file, and send it to the bank, who then bundles it with their other merchants and sends their file to the operator who then unbundles the files, sorts the transactions, rebundles the transactions into new files and sends out the files to the respective consumers’ banks to process. The receiving bank then has two days to return a transaction to the operator who then delivers it back through the same network to the merchant who initiated the transaction.

There is no concept of a real-time validation through the network that could possibly let the merchant know that the transaction was not going to be successful. It seems the Ivory Tower is aware of this batch process and have determined that it is best for an independent industry to come up with a solution to this problem and not burden the organization that oversees the network or the network’s participants with improving the validation.

This appointment of industry to derive a solution seems like a convenient solution for the network, but it means that merchants and banks are not on equal footing when it comes to transaction validation, and this inequality leads to punishment for merchants that have not discovered or do not meet the criteria of the optimal partner for transaction validation. This leads to the network punishing merchants for its own deficiencies. Further, companies that offer validation services, based on their data collection and algorithms that are designed to score a consumer on behalf of the merchant, are now under the FTC “lifeguard” microscope for potentially being unfair or deceptive in making a determination that might adversely affect a consumer.

Today there exists a rule that says unauthorized transactions shouldn’t be more than 1 percent of a merchant’s sales. This 1 percent can be measured in a couple different ways but essentially, in any 60-day period, the number of unauthorized returns compared to sales transactions should be no more than 1 percent. The proposal involves moving that rate to no more than .5 percent. The Ivory Tower argues that the network as a whole operates below .3 percent so this still gives sufficient allowances for merchants.

How does a transaction become unauthorized? In very simple terms, the account holder calls up their bank and states that they have a transaction on their account that is either no longer authorized, was never authorized for the amount or the timing was not what they agreed to. The consumer’s bank tells the consumer (their customer) to complete a written statement of unauthorized debit and when it is returned they will initiate the return. The bank must have the written statement of unauthorized debit from the consumer before they initiate the return and they must do this within 60 days of the settlement date according to the rules. The bank must also hold on to this written statement for a period of a year.

The next part of their proposal suggests that a merchant should be held to no more than a rate of 3 percent for invalid account or no-account-found returns. This is interesting since there is no way for a merchant to validate these transactions within the network. For those of you astute enough to know that there is a concept of a pre-note that is a transaction type built specifically for this purpose, it is appropriate to remind you that this is a batch system, meaning any notice of invalid information will not be received in a timely fashion. Further evidence that it is not a meaningful validation method for ecommerce is the requirement that a debit transaction can not be initiated until 6 days after the point of a pre-note being submitted. One last compounding issue around the pre-note is that banks are known to ignore pre-notes as they are $0 transactions so the merchant may never receive notice that the information was incorrect.

These ratios are not enough to ensure that the network is safe and sound, so one more ratio is being proposed. That ratio is a 15 percent return threshold for the merchant on all of their returns. This threshold includes insufficient funds returns.

There is absolutely no way through the network to check an account balance but the merchant will be held to account for their consumers’ inability to manage their money.

As you can imagine, the overhead for a bank to process these returns is taking a toll on the bank. This is where the Ivory Tower really gets innovative. The solution to this issue is to charge the merchants’ bank that will inevitably mark up and pass on the charge to the merchant for these returns.

These fees will then be given to the banks from where the return originated! Fantastic! Thanks Ivory Tower, for providing a revenue center for the consumers’ banks to be incented to return transactions to the poor merchants who are already being charged for returns, for sales, for account validation in the private sector and for the merchandise or services that were just stolen, not just stolen, but stolen with your official assistance.

As a bank, you would think that a cost of doing business would be to service your consumers and provide your consumers with products and services that meet their financial and daily banking needs. One of these products is ACH. Consumers use ACH to get paid, pay their utility bills, pay their mortgage, pay their credit card bills and now to pay for items online. Why would a consumer pay for an item online with their bank information? For starters, because that is using money they theoretically have versus a credit card that encourages people to pay for things based on credit. Some consumers don’t have a credit card so they use their bank information.

Other consumers prefer the security they feel around the banking system. Yet others know that they can play the system and get something for nothing. Why not, the merchant isn’t going to know that they don’t have the money, that they gave them the wrong information and if they change their mind, they can simply call their bank and tell them they didn’t do it and know that the banks aren’t going to argue with them ... especially if there is a chance the bank can make a little money from that return.

What is a merchant to do?

  • You can do nothing and let the noose get tighter.
  • You can stop using the ACH network altogether and only accept payments from Credit Cards, wires, and checks. But don’t just stop ACH for your consumer payments, stop using it in all that you do. Stop auto pay on your utility bills, stop your direct debit payroll and issue checks, stop your online bill payment. Start using the postal service, your credit card and your checkbook.
  • Request every written statement of unauthorized debit for every unauthorized return that is a fraudulent return.
  • Insist that your bank return transactions that are not timely.
  • Make your voice heard. You can respond to the survey they have published on the NACHA.org website.

Whatever your plans are with ACH, rest assured the merchant will be held accountable for all returns into the network no matter how much scrutiny the merchant has applied to those transactions, how many times the consumer has claimed a transaction was unauthorized, or how little the consumer’s bank delves into this consumer’s claim.

In the past I have made recommendations about actually lowering the rate of fraud in the network. These are very simple actions that will truly reduce fraud.

Feel free to pass on these actions, or ones that you create, to the Ivory Tower so that they can eliminate their myopic view of fraud starting with the merchant, as it more often starts with the consumer at the time of purchase or at the consumer’s bank when the consumer calls in to claim fraud.

Melody L is chief operating officer for L3 Payments