f the term "high-risk merchant" figures in to your recurring headaches, you're not alone. Try explaining to the owners of a mom-and-pop stamp shop that they fall into the high-risk category along with porn sites, escort services, online casinos and phone psychics. Very few processors are willing to accept high-risk merchants, even though processors they can charge a significantly higher discount rate for these customers. The risks are greater, and managing a high-risk portfolio requires a much more aggressive monitoring system to mitigate those risks, which is a double whammy that few are willing to chance.

"Each processor would need to develop a plan to handle high-risk merchant accounts and devote significantly more time to monitor these merchants," said David H. Press, President of Integrity Bankcard Consultants Inc., a firm that advises ISOs on how to best work with high-risk merchants. "Each high-risk merchant requires a different approach to control the risk of loss."

For large processors, the individualized approach to monitoring the accounts may seem too time consuming to implement effectively, while smaller processors, which can individualize their systems more easily, find that they don't have the reserves to manage a high percentage of high-risk merchants. This can cause real problems not only for the merchants, who may rightly complain that they're being unfairly punished for belonging to a high-risk industry, but also for merchant level salespeople (MLSs) who find themselves unable to place these merchants.

The lists of merchant types often considered high-risk reads like the Yellow Pages: any merchant with poor credit; any merchant showing up on the Member Alert to Control High-risk merchants (MATCH) list; any Internet-based business.

In addition: cruise lines, airlines, travel agents, travel clubs, vacation packagers, tour or charter services, or time shares; multilevel marketing, telemarketing or infomercials; check cashing services, collection agencies, credit card protection services, wire transfer services, investor services or investor clubs; refinan-cers or mortgage brokers.

There are also employment agencies, talent agencies, membership organizations or tenant screening services; in-home computer software/hardware sales and service or Web site design; 900 numbers, gaming, sex or psychic services, online porn sites, sports forecasting, lottery agents, dating or escort services, adult products; online pharmaceutical companies or tobacco sales; weight loss centers or health clubs; subscriptions; seminars; and stamp stores or bridal shops.

"For ISOs, the restriction of whole categories of businesses restricts their income," said Gene Lieb of International Merchant Solutions LLC, a consultancy with resources for placing high-risk merchant accounts. "If you look individually at a business, most can find processing.

"If the financials are strong, or the business model is sound; if the business is willing to be incorporated overseas to get processing from an overseas bank; if you can find a bank who will bond or insure a merchant to increase their comfort level with a merchant, you can make it work.

"We work with a number of banks, both domestic and overseas, who, because of their ability to manage fraud are willing to consider merchants considered high risk," Lieb said. The vast majority of businesses considered high-risk are those with contingent liability; those that have a high likelihood of creating a loss due to chargeback exposure.

"Merchants that deal with contingent liability are probably the most common high-risk merchants," said Ken Musante, President of bankcard acquirer and processor Humboldt Merchant Services LP.

"Liability is usually assumed for 120 days from the date of the service. But some businesses (airlines or travel agents are the classic examples) use 'forward commitments'; their sales are booked now for future fulfillment, which means chargebacks can happen anytime up to 120 days from when the tickets are used.

"That is a substantial liability, if for example, the airline declares bankruptcy," Musante said.

Other risks include theft, fraud, card Association fines and the sale of illegal goods.

According to Press, chargebacks cost acquirers and merchants hundreds of millions of dollars each year. A single scam or losses from only one merchant can cost an acquirer millions of dollars. Actions of one ISO sales agent, Press said, who submitted high-risk telemarketing companies for merchant approval resulted in the Office of the Comptroller of the Currency closing a bank when about $13 million in chargebacks from the agent's merchant portfolio virtually wiped out the bank's capital.

"The message to acquirers is clear and unmistakable," Press said. "Loss reduction awareness must be incorporated into every aspect of the merchant relationship and business processes."

Further complicating the picture: Processors that accept one high-risk category may not accept another.

Some won't consider individual businesses if they fall into a high-risk category at all; others will look at each high-risk business individually, albeit very carefully.

"We are a small acquirer, and we may not have the lowest prices, but we can service a wider range of merchants than some of the bigger institutions," Musante said. "We can monitor our high-risk accounts more aggressively, so we are able to look at merchants individually and take some merchants with poor credit.

"Or, some of those that fall into categories of businesses that are considered high-risk. For example, Internet-based businesses, adult-oriented businesses or some direct marketing infomercial-type businesses.

"But we won't service businesses that may cause legal liabilities. Internet-based pharmaceuticals, for example, bear the risk of illegal sales of prescription medications, or gaming businesses.

"And we can't take those with contingent liability," Musante said. Lieb points out that when Visa U.S.A. and MasterCard International closed the domestic processing of online tobacco and pharmaceutical sales (see "Card Companies Agree to Ban Transactions From Online Cigarette Sales," The Green Sheet, April 11, 2005, issue 05:04:01), he was still able to place those types of merchants with overseas banks for processing.

"I've even been able to get processing for some merchants who've been TMF'd [placed on the Terminated Merchant File], depending on the reasons, of course," Lieb said.

The MATCH list, sometimes referred to by its previous name, TMF, is often misunderstood, Press agreed.

"Just because a merchant application gets a 'Possible MATCH' response, doesn't mean that the merchant can't get processing," Press said. "The card Association rules do not prohibit signing up merchants or principals on the MATCH list. There is no MATCH regulation stating that acquirers not process for merchants on the MATCH, once they have determined they will not be a risk."

MATCH is a program, maintained by MasterCard and used by Visa and American Express Co., to identify merchants whom acquirers have terminated for specified reasons. Since risk assessment includes both a merchant's corporate identity and the identity of the business owners, MATCH stores and reports on possible matches for up to five principals.

"The acquirer should make its acceptance decision based on further investigation and use the MATCH data only as an informational tool in the decision-making process," Press said. "Acquirers are required to contact listing members to determine why they added merchants to the MATCH.

"A Possible MATCH may not even be the same merchant, a situation that becomes more prevalent as common last names and addresses in large buildings can generate many Possible MATCH listings, which may or may not be for the same merchant or principal," he said. Clearly, processors bear most of the risk, although merchants pay heavily for the risk that the processors assume. The potential for profits is there, but the potential for losses, and even liability, are also there.

According to Press, under certain circumstances, even MLSs could be liable for losses, although in general MLSs would have to have participated in fraud in order to be liable for those losses.

"For example," Press said, "cases where the merchant application submitted contains significant inaccuracies or omissions, including signature by an unauthorized individual, provided that the MLS had actual knowledge of the inaccuracies or omissions at the time the merchant application was submitted, or situations where the losses were caused by agent's willful misconduct."

The Federal Trade Commission (FTC) recently went after not only a fraudulent merchant but also a payment processor that specialized in high-risk merchants (Universal Processing Inc.) and its principal (Rey Pasinli) because they allegedly "knew or should have known the debits were not authorized by consumers," according to an FTC statement (see FTC Has ISOs in Its Sights," By Patti Murphy, The Green Sheet, Sept. 26, 2005, issue 05:09:02).

The case was settled in September, but among the key issues in the FTC's official complaint were that Universal performed no due diligence when it signed on Pharmacy Cards, the company accused of bilking consumers and that Universal continued to process the debits in spite of the fact that the return rates for the transactions "started high and almost immediately skyrocketed."

The financial settlement wasn't particularly onerous, but some viewed it as a warning shot across the bow from the FTC: ISOs can be held liable if they don't have careful fraud prevention measures in place.

It's a fine line for ISOs to walk, Press said. "We've seen countless good and highly profitable merchants leave an ISO simply because the amount of reserves the ISO held was unreasonable."

Reserve accounts are smart to have when dealing with high-risk merchants, but there are alternatives to reserve accounts, Press said. The alternatives may be more difficult to set up, but may be easier to deal with day to day.

These include things such as irrevocable letters of credit; hold period extensions; proof of delivery before payment requirements; surety or insurance products; third party or guarantor indemnity; and power of personal indemnity.

Although, unlike many acquirers, Humboldt does take on some high-risk merchants, Musante said there are many other high-risk merchants that the company cannot take.

"Really, there aren't a lot of options out there, and I think there are fewer every day," Musante said.

"If an ISO doesn't already have a good relationship with an overseas processor, I think the best bet is to just browse the ads in The Green Sheet.

"But they should always, always, get references before their merchant actually applies. High-risk merchants may have to pay very large, say $5,000 or so, nonrefundable application fees.

"Understandably, those merchants don't want to walk away from that investment and start new with another processor. And it can take a very long time.

"The ISOs, and the merchant, can find themselves just hanging there without processing.

"Let's face it, at the end of the day, it's a risky business," he said. "That's what acquirers are paid to do, to service the merchants and manage the risks."