Fear the Fee
Our industry like most of the other financial industries is increasingly relying upon adding on new fees in order to preserve profit margins. Below I will look at the evolution of fee based income in the bankcard industry and its potential effects on the industry.
When I first started in the industry over 15 years ago, there were very few fees being changed to the merchant. Of course there was almost always monthly minimum and statement fees charged to the merchants but not much else. Most of the income derived from the merchants came from the mark up on interchange and the transaction fee. The market was not near as competitive back then as leasing income was more important to sales agents, there were less sales agents chasing the same deals and the internet was in its beginning stages denying merchants of a powerful price comparison tool. In addition, merchants lacked information they have today to compare fees and therefore merchants were being charged much more on the markup on the interchange and transaction fees then they are today.
In that time period, one of the first fees that started to be introduced in the industry was the annual fee. The ISO I was working for was considering whether or not to charge such a fee during that time period. We looked at the option and saw the incredible potential for us to make a lot more money with no associated cost to our company. Trouble was that our merchant agreement and applications did not provide for us to charge for such a fee as they were then written.
As we were considering that item, one of the only 2 actions in our industry by Federal Trade Commission (“FTC”) occurred in 2002 when the FTC sued Certified Merchant Services, Ltd. (“CMS”) of Texas for deceptive sales practices. The FTC’s complaint alleged that “CMS violated the FTC Act by unfairly and deceptively: 1) modifying customer contracts; 2) debiting their accounts without authorization; 3) making misrepresentations regarding various goods or services offered; and 4) failing to disclose various charges or fees.” We decided not to charge an annual fee to our merchants partly as a result of that action.
The industry continued along for a number of years without any new fees other than the termination fee for the most part until fairly recently. With the advent of PCI compliance for our industry, processors and ISOs had an additional expense to become PCI compliant. Add to that the competitive pressure as our industry continued to mature and the margins in our industry were falling. In order to recoup some of those internal PCI expenses, processors started to charge PCI fees, either a small monthly payment (less then $10) or a small fee per transaction.
From the contractual side, the merchant agreements were also changed to accommodate such new fees. Merchant agreements were modified to state that in essence new fees could be added at any time usually by way of a statement message notifying the merchant of the new fee on 30 days notice.
As time went on in the recent years the fees started to multiply. The simple monthly PCI fee was increased in some circumstances to $20 a month or even more. Some companies charged an annual PCI fee in place of or in addition to the monthly PCI fees. Then when merchants were required to and failed to show they were PCI compliant, the PCI non-compliance fee was born. The latest wave of fees are related to the pending IRS requirements for reporting merchant income to the IRS and also the pending Durbin amendment debit interchange limitations. As a result, theses “IRS compliance fees” are becoming more and more common in the bankcard industry.
The main issue is that these additional fees do not reflect direct increases in costs that the industry is incurring. Sure there are some costs incurred with an ISO or processor becoming PCI compliant and for getting a merchant portfolio PCI compliant. But those costs from my experience get passed through to the merchants at a considerable mark up.
The issue then is that all these fees I believe are inviting more governmental intervention in our industry. We have already had a first taste of that with the Durbin Amendment. Although the climate as it relates to Congress trying to regulate our industry seems to have gotten better, that could change very quickly. Congress could serve to limit fees such as Arkansas did a number of years ago when it legislated a maximum termination fee of $50.00 in that state.
In addition, intervention from the FTC is also a strong possibility. The only other time a company was targeted by the FTC in our industry was in 2007 when Merchant Processing, Inc. (“MPI”) of Beaverton, Oregon was sued. Many of the allegations of deceptive sale practices against MPI had to do with hidden fees. The FTC stated in its press release that the “FTC also charged the defendants with failing to disclose fees and concealing pages of fine print from the merchants until after they had already signed contracts.” Again there is a consistent theme in the 2 FTC actions that the main issue in both instances was inadequate disclosure of fees that were being charged to the merchants.
Fee based income is becoming more and more important to our industry given the compressing profit margins from competitive pressures. It on the face seems to be a good way to recoup lost profits but in the long run could end out doing more harm than good.
The information contained herein is for informational purposes only and should not be relied upon in reaching a conclusion in a particular area. The legal principles discussed herein were accurate at the time this article was authored but are subject to change. Please consult an attorney before making a decision using only the information provided in this article.