Surcharging and Fraud

The New Battle: Surcharging Fraud

I have witnessed a new type of fraud by unscrupulous salespeople, their ISOs, and a few leasing companies recently. This fraud stems from the abuse of rules on surcharging implemented by Visa and MasterCard in 2013 in the aftermath of their $5.7 billion settlement loss allowing merchants to add surcharge to some card transactions.

Surcharge is a separate line item fee that is added to the total transaction amount. It is a bad business practice and is not as readily allowed by card companies–except for a few industries such as government, real estate rental, utilities, and schools. These industries often add what is called a convenience fee to each transaction.

A few ISOs and their agent companies owned by criminal minds deceive merchants by telling them surcharging is allowed all over the world, consumers don’t mind it, surcharging is allowed on all cards, and the software to set it up costs a few thousand dollars. Nothing is further from the truth. Then they sign up these trusting and unsuspecting merchants on one or two non-cancellable equipment leases each up to a staggering $150 per device per month for five years, and the ISO underwrites the merchant application. The leasing agent makes off with over $3,000 per device and is paid the very next day. This is the same business strategy and pattern that has got Northern Leasing into hot seat.

The terminal of choice is always PAX (from PAX Technologies) because, first, it allows adding a surcharge as a line item at the terminal level, and, second, the ISO holds the master password to the terminal, therefore ensuring merchants are locked in and cannot switch processors. Also, processors do not have to, and will not, know surcharge is being assessed, nor do they care to know, as long as they will not be in a non-compliant status on surcharging rules. And the acquiring banks have a totally hands-off approach, as usual.

The numbers of this type of fraud will grow substantially if card brands, i.e. Visa and MasterCard, processors, ISOs, acquiring banks, and lawmakers close their eyes and ears and walk the other direction. But is surcharging even allowed?

There seems to exist different opinions on whether card transactions can be surcharged. A few have expressed their view that this trend may work. These few individuals are offering their opinions as experts while not knowing the exact details. I believe the following researched information, also verified recently in writing to me by both sides on the 2012 settlement, will answer most, if not all, questions and uncertainties.

Visa Core Rules and Visa Product and Service Rules Section 5.6 offers clear and strict guidelines on surcharging by merchants based in the U.S.

The following conditions have to be met:

1. Merchant cannot impose a surcharge if other card brands do not allow it.
2. Merchant has to inform the Acquirer and Visa in writing at least 30 calendar days before implementation of surcharge.
3. Surcharge is not allowed on debit (check) cards as well as on PIN-based debit and prepaid cards. A gift card is a prepaid card.
4. Merchant has to post a conspicuous signage at the point of entry and at the point of sale stating that the surcharge is being assessed by the merchant and is only applicable to credit transactions. The disclosure has to state the exact amount or percentage of the surcharge. The dollar amount of the surcharge must appear on the transaction receipt.
5. The signage must make it clear to the cardholder that surcharges are not permitted on debit transactions regardless of whether a cardholder selects the credit or debit button.
6. The POS disclosure must read that the U.S. credit card surcharge amount is not greater than the applicable Merchant Discount Rate at the merchant location. In no event could the surcharge be greater than 4%. Merchant Discount Rate is the same as effective rate, and it does not include monthly equipment fee due to lease or rental.
7. For electronic commerce (Web), mail order – telephone order (MOTO), and an unattended transaction, the cardholder must be provided the opportunity to cancel the transaction subsequent to the surcharge disclosure.
8. Surcharging is allowed only in the U.S. and U.S. territories. The following ten states do not allow surcharging: California, Colorado, Connecticut, Florida, Kansas, Maine, Massachusetts, New York, Oklahoma, and Texas.
9. Surcharging is prohibited outside of the U.S. except if a local law or variance allows merchants to engage in the practice.

MasterCard Operating Manual Rule 5.9.2 offers similar guidelines on adding a surcharge to transactions, except that it does not mention a cap of 4%. Merchants can provide a discount for cash transactions, a practice exercised by many petroleum stations in the U.S. The discount on gasoline is an entirely different program than the surcharging authorized under this program for small retail and restaurant merchants.

American Express does not allow surcharging. It reached a $75 million class-action settlement with a group of retailers that have been fighting for the right to charge consumers more for using Amex’s credit cards. However, due to what U.S. District Court Judge Nicholas Garaufis described as egregious conduct by one of the lead attorneys of American Express, the judge rejected the settlement on August 4, 2015. As of this writing, the matter is still unresolved.

Based on the existing rules, surcharging is not allowed for merchants who do accept American Express credit card because American Express does not allow it as of now.

If and when a merchant is properly set up on such account, a few points are noteworthy:

Surcharges may appear to save merchants by passing the cost on to cardholders. But majority of consumers frown on it.

The rules on capping surcharge by both Visa and MasterCard are convoluted and vague enough that they leave them open to interpretation and abuse.

On the accounting side, the added surcharge is reported to IRS by processors as a taxable income. So, the gain is diluted by the tax.

Most importantly, ISOs and agents who promote surcharging transactions market equipment leasing at high monthly cost, a completely unnecessary expense to merchants. These fraudsters are not doing merchants and consumers any good through their misrepresentations. They are using existing loopholes and lax to no enforcement by Visa, MasterCard, processors, and the upper-level super ISO they may have signed up with, to get rich quick at the sole expense of merchants and consumers alike.

Merchants often do not know the difference between a credit, debit, and branded gift cards. So, by adding surcharge to all cards, they will be in violation of these rules.

The device cannot yet be programmed so that it could add surcharge only to credit cards.

Consumers and merchants can complain to both Visa and MasterCard by visiting each company’s Web site and searching for the appropriate links.

Although we should expect a reasonable resolution within a reasonable amount of time, the speed and the outcome may not be what we expect due to extreme bureaucracy, inattention, and lack of accountability. I know from personal recent experiences both Visa and MasterCard come severely short in offering assistance and enforcing their own rules. MasterCard makes it virtually impossible to get hold of a person one can talk to in case of a complaint or violation. The contact information on its Web site is only for cardholders and does not deal with such matters. My own dealing with Visa’s Rules Management Department has made it abundantly clear that Visa’s enforcement of its own rules is lax at best and ineffective at worst. This department operates behind a secret curtain; they do not even introduce themselves in their emails and do not honor one’s request to talk to a supervisor.

Visa’s inability to hold its own employees accountable for tarnishing its image and to resolve simple problems runs counter to the spirit of establishing rules and makes Visa’s claim of enforcing its own rules disingenuous.

Inadequate to no enforcement signals to violators that they can continue their actions with no fear of consequences. Indeed they can and have been doing it ever so audaciously. This could attract others with nefarious mindsets. Some others may be tempted to follow the same path. One small merchant I know has been told by the leasing company that he has to pay $9,000 (nine thousand) dollars to buy out the lease for two terminals and cancel his merchant contract. There was not a need for a second device.

I strongly admonish merchants against signing up for surcharging services. As discussed, it will most likely cost them more down the line than what they think they may save. Depending on what state they operate in, they may be in violation of the law.

Leasing companies should do their due diligence on agents, cap the monthly payments, do not accept Delivery and Acceptance form with the same date as that on the lease application, record the installation call, and send a welcome letter with a 30-day cancellation allowance with full recourse to merchants. They should also be completely transparent and provide copies of all documents and audio recordings to merchants when requested. I know not adhering to these policies is what attracts the wolves and the foxes. The few leasing companies that are assisting these greedy gangsters know exactly what they are doing.

ISOs and processors, too, should avoid setting up such merchant processing accounts until American Express allows surcharging (for merchant who do accept American Express credit card), and only if the specific aforementioned rules are adhered to. What compounds this problem is when the registered ISO itself is a registered ISO of the larger super ISO and provides its own technical support 24/7. This virtually ensures a self-contained operation giving the lower ISO absolute control over all operation virtually guaranteeing the merchant will never know the name of the main ISO and the processor. The lower ISO and its agents continue to operate unscrupulously while enjoying impunity.

Last, but not least, card brands must finally roll up their sleeves and design and implement appropriate process and communication channels that will stop these abuses. Otherwise, the assault on merchants will continue for years to come.