Transaction Trends by Content Communicators, LLC

Transaction trends | June 2010

The Official Publication of the Electronic Transactions Association

Obstacles

Ahead

M&A transactions are up, but strategic buyers continue to steer most deals

ALSO INSIDE:

Advice for Processing High-Risk Merchants ETA Annual Meeting & Expo Recap

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Transaction trends The Official Publication of the Electronic Transactions Association

Vol. 15 | No. 6

cov e r s tory

12 Obstacles Ahead By Richard H. Gamble

Along with the economy, M&A activity in the payments industry is starting to pick up. But challenges of a still-tight credit market, distressed portfolios, and high seller expectations need to be overcome. 10

F EATU RES

Hard to Place, Easy to Find By Julie Ritzer Ross While taking on high-risk merchants requires careful strategy, resulting revenues make it worth considering. Several experts help ISOs look before they leap.

22 Special Series: Startup Stories The Race Is On

By Julie Ritzer Ross Our three ISOs make strides in expanding and perfecting their businesses.

More Than a Meeting By Josephine Rossi Upbeat conversations and in-depth education highlight this year’s Annual Meeting and 20th Anniversary event.

18 29

d e pa rtm e n tS

President’s Message

Industry News

Insights from ETA’s elected leader Trends, strategies, and news in the payments business

ISO Corner

Security & Compliance

31 32

Ad Index

What to consider when signing up with a processor Will EVM conversion finally come to the United States?

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Electronic Transactions Association 1101 16th Street NW, Suite 402 Washington, DC 20036 202/828-2635 www.electran.org ETA Chief Executive Officer Carla Balakgie

President’s Message

ETA Director, Communications & PR Thomas Goldsmith

Influence Your Future

Transaction Trends Publishing office: Stratton Publishing & Marketing Inc. 5285 Shawnee Road, Suite 510 Alexandria, VA 22312 703/914-9200

ow quickly things change. A few short months ago, the predictions of the most perceptive prognosticators were that interchange would escape legislative action. But in May, while the financial reform bill was being debated on the U.S. Senate floor, an amendment was introduced that gives the Federal Reserve Board authority to regulate certain aspects of interchange. As of this writing, it appears likely that the amendment will be enacted and signed into law. ETA opposed the amendment and mustered its resources to educate lawmakers on the inadvisability of its passage. We were disappointed by the Senate vote, but the outcome is a reminder that legislation can emerge quickly, with very little advance warning, and have a profound effect on our companies and our industry. Recently ETA’s Board of Directors decided to increase the association’s emphasis on advocacy, particularly government relations.This was done because it became all too apparent that the payments industry has caught the attention of Congress, the executive branch, and state governments around the country. Unfortunately, as is true with the population at large, few lawmakers understand how the payments business works. After all, it is a complicated business. And neither do many appreciate how vital electronic payments are to the smooth functioning of the entire economy. This has regrettable consequences for both federal and state legislation. So educating elected and appointed officials is at the top of ETA’s list in its advocacy efforts. In fact, ETA has been working away at that goal by sponsoring Electronic Payments Education Days for Capitol Hill staffers and federal government regulators since 2006. But you, individually, play a vital role in this effort. Congress and state legislators must understand that the payments industry is composed of businesses of all sizes and many thousands of people who work, support their local communities, pay taxes, and vote. ETA realized early on that it needed to harness the voices of industry companies to enable them to educate their representatives about this. That’s why ETA created the Voice of Payments™ Web site. Check it out at www. voiceofpayments.org. That tool makes it easy to connect with the legislators who represent you, and who are most likely to listen when you explain how their actions affect you and your company. You also can sign up to receive alerts when something important is happening or about to happen. Every single industry participant must make its position heard, and this is the way to do it. Voice of Payments got its first test during the deliberations on the Senate amendment. The site helped direct hundreds of letters and phone calls to senators. It proved that our industry can mobilize when the issue is important. Only you, individually and collectively, can help us become a stronger voice for your business and the payments industry. Add your power to those of your colleagues. And take charge of influencing your future.

Publisher Debra Stratton Features Editor Angela Hickman Brady Managing Editor Josephine Rossi Art Director Janelle Welch Contributing Writers Richard H. Gamble, Bryan Ochalla, Julie Ritzer Ross Advertising Sales Steve Schwanz or Fox Associates (800/440-0232; adinfo.eta@foxrep.com) Fox Associates Offices Chicago 312.644.3888 Atlanta 800.699.5475 Los Angeles 213.228.1250

New York 212.725.2106 Detroit 248.626.0511 Phoenix 480.538.5021

Ad Production/Billing Carrie Wood Editorial Policy: The Electronic Transactions Association, founded in 1990, is a not-for-profit organization representing entities who provide transaction services between merchants and settlement banks and others involved in the electronic transactions industry. Our purpose is to provide leadership in the industry through education, advocacy, and the exchange of information. The magazine acts as a moderator without approving, disapproving, or guaranteeing the validity or accuracy of any data, claim, or opinion appearing under a byline or obtained or quoted from an acknowledged source. The opinions expressed do not necessarily reflect the official view of the Electronic Transactions Association. Also, appearance of advertisements and new product or service information does not constitute an endorsement of products or services featured by the Association. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided and disseminated with the understanding that the publisher is not engaged in rendering legal or other professional services. If legal advice and other expert assistance are required, the services of a competent professional should be sought. Transaction Trends (ISSN 1939-1595) is the official publication, published monthly, of the Electronic Transactions Association, 1101 16th St. N.W., Suite 402, Washington, DC 20036; 800/695-5509 or 202/828-2635; 202/828-2639 fax. Postage paid at New Richmond, Wisconsin and additional mailing offices. POSTMASTER: Send address changes to the address noted above. Copyright © 2010 The Electronic Transactions Association. All Rights Reserved, including World Rights and Electronic Rights. No part of this publication may be reproduced without permission from the publisher, nor may any part of this publication be reproduced, stored in a retrieval system, or copied by mechanical photocopying, recording, or other means, now or hereafter invented, without permission of the publisher. Nonmembers, government agencies, $150 per year; single copy, $20. Subscriptions are available for 12-month periods only, at the quoted rates.

Warm regards, Holli Targan Holli Targan is president of ETA and a partner at Jaffe, Raitt, Heuer & Weiss, P.C.

Transaction trends | June 2010 5

INDuSTRYnews 20 YEARS

ETA Anniversary Fast Facts

› The first issue of Transaction Trends published in 1997 as a quarterly magazine serving the ISO community. Later that year, ETA launched the organization’s first Web site.

› In 2001, Transaction Trends became a monthly publication, and the first edition of ETA Currents e-mailed in 2006. These moments in ETA’s history are brought to you by NPC.

FOUR-YEAR LOW FOR U.K. FRAUD LOSSES Total fraud losses on U.K. debit and credit cards fell by 28 percent between 2008 and 2009 to £440.3 million, according to new statistics from the U.K. Cards Association. It is the first time card fraud has decreased since 2006. Online banking losses totalled £59.7 million in 2009, up 1 4 percent from 2008. The association largely attributes this increase to criminals using more sophisticated methods that target online banking customers’ computers, rather than the banks’ systems, which are more difficult to attack. In addition, more than 51,000 phishing incidents—16 percent more than in 2008—were recorded last year. Check fraud losses also decreased to £29.8 million in 2009. While the major-

ity of attempted check fraud is stopped before payment, the association says the industry’s use of fraud prevention profiling and the continuing decline in usage have played a part in the 29 percent fall. As for the reasons behind the drop in card fraud, the association points to a number of initiatives, including a successful chip and PIN program and the cards industry working closely with retailers to raise fraud awareness and offer methods for securing chip and PIN terminals from criminal attack.

Info Graph ISO Satisfaction With Vendors/Providers Likelihood an ISO will change its relationship with the following provider in 2010:

ETA Unveils New Logo ETA recently announced an updated take on its well-recognized transaction “swoosh” logo, which will be used across all of the association’s events, products, and services. “We wanted to create a new iteration of the logo that would capture the dynamic and evolving nature of the payments industry,” says Carla Balakgie, ETA’s CEO. “Our new image icon recognizes and preserves the tremendous value of our well-known brand, while better aligning us with organizational goals moving forward.” ETA members can receive a ‘member of’ version of the new logo for use in print and electronic media by contacting Del Baker Robertson, director of membership and marketing, at del.baker@electran.org. 6 June 2010 | Transaction trends

Acquiring bank

79%

21%

Front-end provider

83%

17%

Technology service provider

83%

17%

Back-end provider

87%

13%

Telemarketing service

87%

13%

Customer service provider

92%

Not at all likely to neutral

Likely to very likely

Source: Aite Group

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INDuSTRYnews Strong Volume Increases Among ACH Payments Automated Clearing House (ACH) payment volume increased by more than 475 million transactions in 2009, bringing year-end total volume to 18.8 billion, a 2.6 percent increase over 2008, according to NACHA—The Electronic Payments Association. Year-over-year comparisons demonstrate strong volume increases in ACH native electronic payments, such as direct deposits, consumer Internet transactions, and B2B transactions, as well as in back-office check conversion. In addition, NACHA reports a continued positive trend in risk mitigation, witnessed by the ongoing decline in the unauthorized debit volume, which declined 9.6 percent over 2008. “The trend we’re seeing with unauthorized debits is a direct result of new NACHA rules and other enforcement efforts that went into effect in 2008,” says Janet O. Estep, president and CEO of NACHA.

“Analyzing the data, we see the absolute volume of unauthorized debits dropped following the implementation of the Network Enforcement Rule and the Company Name Rule.” Detailed information from NACHA includes: n ACH native electronic payments (noncheck conversion transactions) increased by 4.2 percent in 2009. These payments constituted 12.2 billion transactions on the ACH Network. n Direct deposit continued to be a critical piece of network volume, delivering 4.5 billion payments in 2009—an increase of 4.9 percent. n B2B transaction volume was up to more than 2 billion payments in 2009, an increase of 3.2 percent over 2008. n Year-end 2009 consumer Internet transactions grew 8.8 percent to nearly 2.4 billion payments. Internet-initiated vol-

ume continued on an upward trajectory through the close of 2009, with a 9.7 percent increase over 2008. n Back-office conversion (BOC) continued its growth pattern as more companies seek ways to streamline administrative tasks for processing checks presented by their customers. In 2009, BOC transaction volume more than doubled over 2008, resulting in 160.5 million transactions. n The fourth quarter of 2009 provided the first full-quarter transaction data for international ACH transactions (IAT). Combined with the nine banking days in Q3 where IATs were available, the year-end total for IAT was 1.7 million with a dollar value of $7.4 billion. n Total federal government ACH transactions increased by 5.5 percent to 1.2 billion transactions in 2009, while dollars increased 7.2 percent to $4.3 trillion.

U.S. Consumers Most Confident in Mobile Security The majority of mobile device owners worldwide feel safe using their devices as airline boarding passes, to make in-store purchases of low-cost items, or to access online banking options, according to recent research conducted by Unisys Corporation. The overwhelming majority of mobile device users in the United States (83%), Spain (80%), and the United Kingdom (75%) as well as about half of device users in the Netherlands, Belgium, and Germany are comfortable using the devices for one or more of the applications. Of the 80 percent of Americans who own cell phones or handheld devices, 40 percent feel safe using them to receive notifications regarding credit card charges, and 38 percent feel safe using them to purchase cinema, sporting event, or theater tickets. Younger consumers worldwide expressed

8 June 2010 | Transaction trends

greater confidence in the devices’ security. For example, 76 percent of U.K. citizens ages 18-24 feel secure using their mobile devices as airline boarding passes, compared with just less than half of all U.K. users. In the United States, 53 percent of consumers ages 18-34 feel safe purchasing theater, sports, or cinema tickets via mobile device, compared with 38 percent of U.S. citizens overall. Additional key findings: n B razilian citizens reported the lowest confidence levels—only 47 percent. n Only 9 percent of German device users feel confident accessing their online banking systems via mobile. n One quarter of device users in the Netherlands and 31 percent in Belgium feel safe using their mobile device to purchase theater, sports, or cinema tickets.

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ISO Corner

Just Sign on the Dotted Line?

Some provisions in processor contracts require extra scrutiny, legal advice By Bryan Ochalla

t’s one thing to be good at selling merchant processing services. It’s quite another to be good at negotiating contracts and deals with large ISOs and processors. Unfortunately, many of the industry’s smaller ISOs don’t always know the basics of these kinds of agreements, says Jay Reeve, founder of The Reeve Law Firm, PC, in Gun Barrel City, Texas. “Or they don’t think they need to pay attention to the details of the agreements or contracts they’re about to sign.” Smaller ISOs that fall into the latter situation tend to do so because they are comfortable with the deal they shook hands on. Maybe they’re signing up with a friend or former boss they trust.“But what if that person leaves six months into the deal?” asks Reeve. “And what if the person who takes your buddy’s place picks up your contract and says, ‘Let’s see what we’ve got here.’” Reeve fields questions about such situations almost daily. “I get calls from small ISOs all the time who tell me, ‘My ISO or processor shut off my residuals, what can I do?’The first thing I do is tell them to send me their contract, and often I look it over

and tell them, ‘They can probably do this.’ Even if they can’t do it, though, the ISO has to have the means and wherewithal to stop them.That can be difficult.” Bottom line: ISOs need to educate themselves up front about every word, sentence, and paragraph of the agreement they’re planning to sign.

Crucial Provisions Residuals are among the most important contract provisions that small ISOs should scrutinize. Many smaller ISOs sign agreements and contracts believing they’ve been promised “lifetime residuals” when that’s not always the case, says Reeve. Sometimes, the large ISO or processor includes provisions in the agreement saying those residuals can end upon termination of the agreement—or if the smaller ISO breaches the agreement or defaults.This is especially true when the provisions are general and not surrounded by a lot of detail, he adds. “You’ve got to be very careful on the front end, and you’ve got to make sure that the large ISO’s or processor’s ability to terminate your residual stream is very narrow and very specific,” Reeve explains.“Ideally, they’d never be able to terminate your

residual stream, but most large ISOs and processors won’t agree to that these days.” Another important provision deals with merchant portability. “Many smaller ISOs believe they’re building their own merchant portfolio, which they will be able to transfer to another ISO or to another processor. Unfortunately, that’s not always the case in these kinds of agreements.” ISOs that value merchant portability probably will have to negotiate to get it in the agreement or contract.“If that’s not possible, try to get the ISO or processor to agree to let you sell your residual stream to somebody else so you can cash out,” Reeve advises. Small ISOs should make sure the agreement or contract they’re about to sign doesn’t require them to assume liability for merchant lawsuits.“Obviously, it would be devastating to a small ISO if it agrees to be responsible for that liability and then one of its merchants goes bankrupt and has $100,000 in chargebacks,” says Reeve. “It could wipe out their residual stream and completely devastate their business.” Bryce Collman, CEO of Fort Worth,Texas-based Ardent Giving Solutions, agrees, saying that it’s vital for both players to have “joint skin in the game. If you’re staring at a high-risk deal, the contract needs to be structured [so] the responsibility and risk on that account is shared,” he says. Other provisions to look out for include chargeback responsibility, indemnification, and platform flexibility, as well as the following: Exclusivity. When possible, ISOs should strive to retain the ability to write merchant services agreements for multiple processors, and avoid being locked into just one,“especially if that one doesn’t have a very broad service offering, or if it places limitations on the kinds of merchants it will underwrite,” says Mike Goding, senior associate at The Strawhecker Group in Omaha. Collman offers another take:“Typically, everyone is going to ask for it. But it can

10 June 2010 | Transaction trends

be a bargaining tool, though. If you give it to [the processor], concessions should be made elsewhere, particularly in pricing.” Quotas. These are particularly important if some sort of penalty is attached to them.“You want to try to steer clear of any provision that says you have to generate a certain number of accounts per month [or] there’s a penalty in the form of reduced residuals, for instance,” Goding says. Dedicated BIN and ICA. Obtaining one or both may not be possible, especially if you’re a retail ISO, but it’s definitely something to shoot for. “It gives you a lot more flexibility in terms of managing the portfolio,” says Goding. Interest. Most agreements and contracts won’t require retail ISOs to hold a percentage of their merchants’ daily settlements in a reserve account, according to Goding.“If, for some reason, that provision creeps into your agreement, make sure you’re the recipient of whatever interest accrues on the account.”

“You have to be willing to negotiate the things that make you uncomfortable out of the agreement or contract.” —Jay Reeve, The Reeve Law Firm

Minimum fees, personal guarantees. Both of these are unlikely to find their way into retail ISO agreements and contracts, Goding says, but it’s a good idea to keep an eye out for them anyway.And if they do find their way into your agreement, try to negotiate them out.

Legal Review Not surprisingly, all three sources also rec-

ommend ISOs seek industry-specific legal assistance and consultation when they are considering an agreement or contract with a processor. “I think it’s a big mistake if you scrimp on legal review and negotiation of these kinds of agreements,” Reeve says,“because they serve as the foundation of the business that you build—and your business will only be as strong and vibrant and valuable as that agreement allows it to be.” Taking the time up front to fully understand the agreement or contract allows ISOs to accept and be comfortable with the risks they are taking.“And if you’re not comfortable with those risks,” says Reeve, “you have to be willing to go in and try and negotiate the things that make you uncomfortable out of the agreement or contract.” TT Bryan Ochalla is a contributing writer to Transaction Trends. Reach him a bochalla@yahoo.com.

Transaction trends | June 2010 11

[ COVER STORY ]

Obstacles

Ahead While the best M&A deals get done, securing debt remains elusive By Richard H. Gamble

ike the broader economy, the mergers and acquisitions market for merchant portfolios is improving by fits and starts. What you see depends on where you sit. Jeff Baker sees a lot of open road.“Inventory is up. There are definitely more deals in progress,” reports the chief development and strategy officer at Global Payments in Atlanta.“Valuations are coming back. It’s a market in recovery. It’s been full-steam-ahead since mid-January, when the holidays ended.” Private equity and venture capital funds are getting back in the game after being sidelined for the past year or two, he reports, and good companies are selling at high premiums. But debt is still hard to get, so more transactions are being settled with equity, he adds.

12 June 2010 | Transaction trends

KEY NOTES 8 Pent-up need among sellers waiting for a chance to sell and the reappearance of buyers with money and motivation bring the market back to life. Private equity and venture capital funds get back in the game, and good companies are selling at high premiums.

8 Todayâ&#x20AC;&#x2122;s buyers are generally well-established players who know the market, the companies theyâ&#x20AC;&#x2122;re offering to buy, and what they should pay.

8 Sellers are seeing increased emphasis on robust due diligence before a transaction is completed and additional buyer protections in the purchase agreement.

[ COVER STORY ] Sales Group Survival When people in a merchant-level sales group working for an ISO or community bank hear the portfolio is on the market, it’s time to go into action and look out for themselves, advises Chris Baugher of McKenna Long & Aldridge. The seller will try to drive its best deal and typically not worry about what will happen to a sales force. “Get out in front and start conversations about what role you will have after the sale,” he says. The bigger the merchants and the tighter the ties between the merchants and the sales reps, the more leverage a sales group will have, he notes. But most deals are premised on synergies and economies of scale, so costs associated with the seller’s business are potentially on the chopping block after the deal, he points out.

“We’re seeing an uptick in transactions across all size groups and market segments,” reports Omid Tofigh, the principal and head of the mergers and acquisitions practice at First Annapolis Consulting in Linthicum, Maryland. Prices are holding up pretty well for quality portfolios, but the market is weak for portfolios on the low end of the credit quality spectrum, he notes. “Would-be sellers are disappointed because the offers are not coming close to their expectations, which is why you still see quite a few failed auctions.” Deal activity is not up that much from last year, but the talk definitely is, observes Chris Baugher, chair of the payments practice group of Atlanta-based law firm McKenna Long & Aldridge. “There are more conversations with investment bankers occurring, and there is anticipation of more transactions than last year,” he says. The opportunities are particularly promising for buyers looking to acquire merchant portfolios of community banks that need to raise capital to combat deteriorating balance sheets and actively seeking to divest non-core assets for precious cash, he explains. Activity started to pick up in the fourth quarter of 2009 after a 12-month stall, reports Ray Sobczyk, senior associate at the Strawhecker Group in Omaha. For about a year, sales dropped off precipitously and were largely distressed sellers unloading assets at whatever they could get. Now, with plenty of pent-up need among sellers who have been waiting for a chance to sell and with the reappearance of buyers with 14 June 2010 | Transaction trends

money and motivation, the market is coming back to life, he explains. The recent acquisition of 51 percent of First National Merchant Services of Omaha by Columbus, Georgia-based TSYS continues the trend of large processors becoming acquirers as well as processors, Sobczyk notes. Transactions are up from a year ago, but are still down from the busy market of three or four years ago, reports Marc D’Annunzio, a member of Siavage Law Group, LLC in Atlanta.“Players are coming off the sidelines, albeit slowly,” he observes. “Things may be looking up for the rest of the year.”

Driver’s Seat It’s hard to generalize about a patchwork marketplace, but would-be sellers usually outnumber would-be buyers, so it’s largely a buyer’s market. A buyer with cash can choose among a variety of would-be sellers, while a would-be seller has to work to find the right buyer, Baugher explains.“The good deals are getting done. The marginal deals are struggling, partly because buyers have choices and can pick and choose which ones they will take,” he says. For deals that close, the seller typically wants and gets cash at closing, he adds. With credit markets still somewhat constricted, today’s market is driven largely by buyers with cash to spend and incentives to spend it, D’Annunzio reports. And it helps that merchant acquiring, while by no means recession-proof, has fared better than other sectors of the economy. “The

payments mix continues to move away from cash and check generally, which can help offset decreases in card volume brought about by the recession,” he notes. With capital hard to come by, businesses that are solid cash generators are finding favor, he points out. It’s a big plus in today’s economy to be able to build reliable cash generation projections into an acquisition decision, he explains. Today’s buyers are generally well-established players. “We don’t see a lot of new faces these days,” says Mark Dunn, president of Field Guide Enterprises, Hartland, Wisconsin. These veterans know the market.They know the companies they are offering to buy. They are under no compulsion to buy, and they know their top price, he explains. Most acquisitions are being made by strategic players who already have operations going and “have practical experience and a platform they can bolt the acquisition onto,” Tofigh says. A pure financial investment is rare, he points out.“Very few investors will buy a property to sit on it for a few years and then sell it. They almost all have a sizeable stake that they want to add to. The goal is to achieve economies of scale, introduce better technology, and wait for the market to revive so that they can sell something they have built and improved.” Private equity firms are showing tentative interest, Tofigh says. “We talk to new investors all the time, but they are cautious.” Real buyers are more likely to be experienced players who know the market well, and what to buy and what to pay for it. Financial buyers are “slow to pull the trigger,” he observes. Indeed, financial buyers remain scarce due to tight credit markets. The strategic buyers continue to be active and opportunistic, Baugher notes. Large, leveraged deals like the KKR acquisition of First Data have dried up in tight-money times. Financial buyers who leveraged up to secure deals are sometimes struggling with high debt loads in today’s market, he says. Borrowing money to finance an acquisition is still tough, Sobczyk agrees, so most buyers are venture capital or private equity groups that have money to invest or strategic buyers with enough of their own cash to swing the deal without borrowing from a bank, he says. “Buyers have always liked

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[ COVER STORY ] this market. Now, with their other options not looking so good, interest is picking up.”

Read the Fine Print

Stalled Deals

Expect complex contractual terms to work through in a merger or acquisition,

In general, sellers still face a shortage of well-funded, highly motivated buyers. “It’s a tough time to be selling,” Dunn observes. A lot of sellers are event-driven, he notes. They have a specific need or opportunity and need to sell to raise the money. At today’s prices, they have to decide to take whatever they can get now or hold on and hope things get better, he says. “A lot are holding on when they can,” he adds. If the seller is the Royal Bank of Scotland and the property is a large, global portfolio, that puts a rare property on the market and attracts plenty of eager buyers, Baker notes. “There aren’t many deals that size. RBS has large portfolios in the United Kingdom and the United States, the two biggest payments markets in the world. It appeals to a buyer that wants to accelerate global growth.” And because such portfolios are in short supply, they attract more competition and go for higher prices, he explains. Small portfolios are another matter. “Down market, a lot of ISOs are coming onto the market, and it’s definitely not a seller’s market for them,” Baker says. Like many small businesses, ISOs are having a hard time raising capital, which is stunting their growth. “It takes working capital to grow those businesses, and they’re feeling the impact of the banks tightening credit,” he points out.“That could be a reason why we’re seeing more merger and acquisition activity in the ISO space.” Among ISOs, a technology ISO or valueadded reseller that has strong product ties will go for higher prices than sales-centric agent-ISOs.“It’s all about stickiness,” Baker explains. A portfolio of retailers with integrated POS systems that manage inventory and also happen to take payments is more attractive than a portfolio of merchants assembled by sales agents who walk in and sell price. The stickier the relationships, the more value attaches to the portfolio, he explains.

says Marc D’Annunzio of Siavage Law. “A bank selling a merchant portfolio

Sticker Shock Prices are a mixed bag. There’s a shortage of really attractive portfolios being offered, which boosts their value, Baker says. “It’s 16 June 2010 | Transaction trends

may have contracts with its existing processor or other third parties,” he notes. “In some instances, the very fundamental question of who owns the portfolio may even be unclear. Also, a seller may need to get consent from a third party or pay a substantial termination fee in order to complete a deal.” In addition, portfolio deals may also include marketing or referral agreements between the seller and its legacy business partners. Because these agreements tend to be long-term, parties may want protections during the contract term—quality standards for the services provided to merchants, provisions that address what happens if a party is acquired, etc. Because these issues can be anything but simple or manageable, expert advice and counsel can be beneficial, D’Annunzio suggests.

hard to find a company that is growing organically, with good growth metrics and no issues with attrition, channel conflict, etc.,” he says. Good portfolios are selling at close to normal multiples, Sobczyk says. But because the recession has made many of those portfolios smaller, the overall price would be lower. “Buyers are hoping that an economic rebound will expand those portfolios and give them a boost in value.” Prices being paid for merchant portfolios have been hurt by uncertainty, Dunn explains. Consumer spending and merchant revenue are so fragile and processing volumes are so volatile that it’s hard for prospective buyers to have confidence in their valuation process. “They’re less willing to buy and spend. The offers in 2009 and in the first quarter of 2010 have been very conservative. We’re seeing small signs that buyers are becoming more confident, but only slightly so.” With cautious buyers, distressed sellers face pretty deep discounts. Distress comes in two forms—a distressed portfolio that has been deteriorating or a distressed seller who needs to raise money. A distressed seller could have a quality portfolio to sell but still not get top dollar if his distress is known,Tofigh explains. Most sales are cash at close, Baker says. Few deals involve earn-outs because “earnouts are hard to do.The buyer wants syner-

gies, wants to consolidate systems and cut overhead. That’s hard to do without getting sideways with the earn-out agreement.” Because buyers are more risk-averse these days, contract language is defensive and more likely to include additional representations, warranties, covenants, and other buyer protections, adds Baugher. For example, private equity company Advent International recently bought the Fifth Third Bank’s portfolio but included a “poison pill” clause in the contract so that if the bank is sold or liquidated, it would have to pay Advent a large penalty fee to essentially buy them out of the contract, says Baker. And there’s already litigation between Elavon and First Data in Georgia, stemming from the merger of Wachovia and Wells Fargo, over which processor is entitled to referrals now that the banks have merged. “Buyers are looking for protection from claims brought against whatever business they buy,” he observes. “These days you see an increased emphasis on robust due diligence before a transaction is completed and additional protections in the purchase agreement entered into as part of the sale.” TT Richard H. Gamble is a contributing writer to Transaction Trends. Reach him at gamble10@earthlink.net.

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Hard to Place

Easy to Find While high-risk merchants open new doors for revenue, theyâ&#x20AC;&#x2122;re not for the faint of heart By Julie Ritzer Ross

oarding high-risk merchants and placing them with processors can involve a lot of red tape and legal hoops, but the rewards are worth it for some ISOs. Many high-risk merchants transact business on the Internet in a card-not-present environment, and they may include everything from online date services, auctions, astrological services, gambling, and adult Web sites, to travel agencies, prepaid phone card sales, debt collection entities, telemarketing firms, loan modification companies, and neutraceutical/vitamin purveyors. Small businesses with average credit and Fair Isaac Corp. scores also may be considered high risk based on their questionable credit. So, too, might

18 June 2010 | Transaction trends

merchants that have recently declared bankruptcy and are attempting to launch a new business, whether brick-and-mortar, mail order/telephone order, or Internet. High-risk merchants are unstable by nature and shouldn’t be considered a stable source of residuals, says Adam Atlas, a Montreal-based attorney who works in electronic transactions law. They also may receive frequent solicitations from other agents working the high-risk territory who can persuade them to jump ship for a better deal. Still, working with high-risk, hard-toplace merchants does offer some concrete advantages. Among them: Higher profit margins. For ISOs, and MLSs,“the high-risk value proposition ISO or MLS is that profit margins are significantly greater than with merchants involved in the traditional retail arena,” asserts Jeffrey Shavitz, a founder of processor Charge Card Systems Inc. of Boca Raton, Florida. “A greater risk factor due to chargebacks, higher returns, and increased attrition allows agents to charge higher rates and thus whole points rather than basis points.” In fact, compared with low-risk accounts, high-risk accounts can yield a five- to 10-fold multiple in terms of the gross dollars ISOs and MLSs can bring in, adds Lane Gordon, a partner at Boston-based Merchant Portfolios. Equal, or more, pay for less work. High-risk processing candidates are often easier to attract than low-risk ones because there are fewer ISO/MLS contenders willing to serve them. “Finding 10 ‘plain vanilla’ accounts is much harder these days than finding one high-risk client—and that single account will earn you as much—or probably more—money,” says Gordon.

The Downside Boarding high-risk merchants isn’t for everyone. Consider the disadvantages: Significant red tape. The preliminary steps to boarding a low-risk merchant are fairly straightforward; ISOs and MLSs typically can get the job done very quickly. But preparing to submit a high-risk merchant to underwriting and risk management is a time-consuming process. Getting the paperwork in order involves 10 times the effort required on the low-risk front, Gordon estimates. “With a low-risk merchant, you can pull the credit report, check the average trans-

“If you have reason to believe a given merchant is accepting transactions for illegal products or aggregating transactions for third parties that sell illegal products, or if something else about the merchant does not add up, walk away.”

—Adam Atlas

actions, and get a handle on the merchandise that’s being sold,” he asserts. “With a high-risk merchant, other paperwork, from passports to miscellaneous supporting documents, must be gathered.You need to figure out what the business really is.Then there’s finding a processor and getting a bank on board. It’s not your basic 24-hour turnaround, by any means.” Difficulty getting partners on board. Not all banks are amenable to accepting high-risk merchant clients. Forging relationships with multiple banks you can approach if the primary bank declines a client is generally necessary. “The underwriting criteria for highrisk merchants have become increasingly stringent,” says Henry Helgeson, Co-CEO of Merchant Warehouse, a Boston-based ISO. Merchant Warehouse has “dabbled on and off” in the high-risk merchant space for several years, Helgeson notes, because the demand for such service does exist. However, underwriting headaches—coupled with the fact that many potential high-risk accounts are startup Internet merchants that often don’t generate much revenue—have caused the ISO to put handling high-risk merchants on the back burner. “We’re looking at underwriting partners again, but I’m not entirely optimistic about it, and I recommend that any ISO getting into this market needs a very thick skin,” he says. Limited legal recourse. Some processors that take on high-risk merchants are situated abroad, in Europe, Central America, or Asia. Should they decline to pay their

merchants or the ISO/MLS, or if they close up shop, the potential to recoup lost income through legal U.S. channels is limited.

Before You Jump For ISOs willing to take the plunge, sources recommend the following practices: Choose niche(s) carefully. ISOs and MSPs should not enter into partnerships with high-risk merchants whose line of business, while legal, falls outside their own comfort level or spectrum of moral values. “Not everyone is happy with the idea of having an adult content Web site or neutraceuticals merchant in their portfolio,” says Gordon.“Don’t sacrifice your principles to take a risk with high risk.” Thoroughly investigate each prospect. The high-risk merchant community is far smaller than its low-risk counterpart, and most entities have a reputation in the niche in which they operate, points out Atlas. Before signing a deal with a high-risk prospect, speak with its business partners to determine whether all parties involved are known to be trustworthy. Ensure the merchant is engaged in a legitimate business. The consequences of ignoring this advice can be dire; as an example, some industry players have gone to jail or been indicted for playing a part in the processing of unlawful online gambling transactions by U.S. residents.

KEY NOTES 8 Profit margins for ISOs and MLSs are significantly greater for high-risk merchants—as much as five to 10 times more than with traditional accounts.

8 Preparing to submit a high-risk merchant to underwriting and risk management is a complicated, time-consuming process.

8 Thousands of illegal businesses are waiting for the opportunity to process payments and will compensate acquirers handsomely for agreeing to overlook their activities, but no amount of profit is worth facilitating illegal activity.

8 Before signing a deal with a highrisk prospect, speak with its business partners to determine whether all parties involved are known to be trustworthy.

Transaction trends | June 2010 19

[ FEATURE] “Thousands of illegal businesses are waiting for the opportunity to process payment transactions” and will compensate acquirers handsomely for agreeing to overlook their activities, Atlas says. “However, no amount of profit is worth facilitating illegal activity. If you have reason to believe a given merchant is accepting transactions for illegal products or aggregating transactions for third parties that sell illegal products, or if something else about the merchant does not add up, walk away.” He adds that some high-risk merchants attempt to lure ISOs into aggregation schemes, wherein multiple merchants process transactions through a single transaction number, which is forbidden. ISOs and MLSs should verify that the merchant in question is really selling the goods or services associated with the transactions it’s processing. Be especially vigilant in scrutinizing so-called “higher-than-high-risk” merchants, recommends attorney Holli Targan, a partner with the law firm of Jaffe, Raitt, Heuer & Weiss, P.C., in Detroit. Such operations include online gambling, online tobacco retailers, and adult content Web sites, to name a few. State and federal laws that prohibit the sale of individual items or, in the case of Internet gaming, processing payment transactions associated with such activities necessitate a separate and stringent set of due diligence procedures. The risk of allying with a merchant whose business places it in the “higher-than-high-risk” group can be mitigated somewhat by establishing policies and procedures that must be followed before accepting any entity of its ilk into the fold, says Targan. Enter into a legal agreement that contains protective provisions. Contracts should specify that a reserve account be established with the merchant upon boarding or, alternatively, should grant the acquiring bank the authority to create one. It should also incorporate a similar stipulation that yields the ISO or MLS a security interest in the merchant account or merchant deposits. “If the contract authorizes the acquiring bank to establish and maintain a merchant reserve account, and the authorization is broad enough, the processor will hopefully be able to minimize loss by continuing to process transactions, depositing all or a portion of daily batches into the reserve account, and offsetting losses against the established reserve,” Targan explains. Moreover, any contract for high-risk processing must clearly state that all deposits are provisional pending final settlement, and that the merchant is liable for all charged-back transactions. Finally, the document should specify that the acquirer is authorized to automatically debit, and may set off, any deposit or reserve account for amounts owed under the contract. Minimize exposure. Even when plans to solicit high-risk merchants and handle their processing needs are carefully thought out and methodically executed, ISOs and MLSs should minimize such accounts to 10-15 percent of their portfolio, suggests Shavitz. And be sure to place them with a processing partner that is experienced in handling these accounts. “High-risk processing is a different culture,” Shavitz concedes.“However, in the next five to 10 years, we should continue to see significant business and residuals from the hard-to-place side.” TT Julie Ritzer Ross is a contributing writer to Transaction Trends. Reach her at jritzerross@gmail.com. 20 June 2010 | Transaction trends

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The Race Is On Entrepreneurs run toward new ventures while continuing to perfect their techniques By Julie Ritzer Ross

» Express Transact, Orem, UT » Leap Payments, Agoura Hills, CA » Paymint Associates, Brooklyn, NY ISOs We’re Following:

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22 June 2010 | Transaction trends

lthough Leap Payments is the only startup in our series with a reference to movement in its name, all three entrepreneurs we’re following picked up the pace last month. Leap Payments, Paymint Associates, and Express Transact have each jumped into new territory—from new pricing plans to prepaid offerings and software solutions to new office space. “We’re very excited about our new interchange-plus pricing plan for merchants,” says Will Detterman, Leap Payments’ CEO.“I know it will result in groans from” other ISOs, “but we would rather educate our clients on how to process transactions at the lowest possible rates and provide these rates, so that they don’t come back to us in a few months with a competitive bid we have to match. We want to get it right the first time and keep accounts for life, because we know that there are three competitors that are going to knock on their door this week.” With the new pricing structure, merchants are charged the interchange rate on card transactions, plus a small markup, in an effort to simplify the fee structure and be more transparent. The markup remains the same for every transaction processed by an individual merchant, but varies in accordance with its transaction volume. Interchange-plus pricing has historically been offered only to large, high-volume entities rather than small merchants, and it isn’t the typical model for ISOs of Leap Payments’ size. The company’s portfolio currently includes more than 2,000 merchants whose credit card transaction volumes average $500 to $500,000 per month. “Yes, we’re taking a big chance with this plan, and we’re making less money on every merchant this way,” Detterman concedes.“However, it’s a way to set ourselves apart from everyone else that handles our

market, with payback being the ability to bring more permanent ‘client partners’ to the table. And if there is one thing I have learned in this business, differentiation is key.” The move has already garnered Leap Payments coverage in American Banker magazine and, consequently, a flurry of merchant inquiries as well as several new accounts.Yet no matter how many merchants eventually board with Leap Payments in response to interchange-plus pricing or other enticements, the ISO intends to maintain a low “accounts-to-employee” ratio. While such an approach will undoubtedly lead to increased overhead expenditures, Detterman believes it will also benefit the bottom line by keeping attrition at zero.

Building the Team Renamed Paymint Associates after a failed attempt to trademark its original name, the ISO formerly known as PayMint Partners has launched a comprehensive suite of prepaid products, including debit and gift cards as well as wireless and long-distance telecommunications services. Like Leap Payments, Paymint Associates has taken an untraditional approach. Its prepaid business line is being administered by Payment Alliance International (PAI), a Louisville, Kentucky-based processor and payment services provider, in tandem with Now Prepaid. Now Prepaid, rather than Paymint Associates, will handle all technical and customer service issues. “Prepaid is a very low-margin business that requires a lot of customer support,” notes Steven Feldshuh, Paymint Associates’ vice president of business development. “Through PAI, we can be in the market for those agents looking to sell prepaid products, at competitive rates, without the liability and intense customer service attributed to running this type of program.”

The arrangement comes as part of a larger deal wherein the ISO will submit a portion of its credit card business to PAI. Paymint Associates will then be able to offer its agents upfront compensatory payments of $200 to offset the cost of any free terminals they may need to distribute in order to procure, as well as to help pay for, referrals and telemarketing initiatives. Feldshuh and his partner, George Sarantopoulos, consider PAI’s program a viable vehicle for growing their company without continually hiring additional personnel. Just as significantly, leveraging the arrangement to its greatest potential should decrease the ISO’s own outlay of funds for terminal placements. In yet another step forward, Paymint Partners recently wrapped up negotiations with Midax Inc., a Virginia Beach, Virginia-based software vendor and systems integrator, to configure a payment solution geared toward building management and rental companies. The ISO has been pursuing this vertical since its inception. Finalizing the deal required Paymint Associates to alter its initial relationship with Midax in order to maintain more control over the final product and, in turn, enhance the potential for successful deployment by its real estate clients. “Midax has some other interesting products to tie into our overall offering, which may present unique opportunities for our sales partners that do business in the convenience store, petroleum, and supermarket sectors,” Feldshuh explains. The ISO has also launched initiatives aimed at improving the caliber of sales

agents’ performance. While many agents that team up with Paymint Associates have industry experience and a strong knowledge base, attending several internal training meetings and shadowing an agent in the field are prerequisites for all new recruits. “What we offer agents, experienced or inexperienced, is much hands-on training and support,” Feldshuh says.“Because we are a small organization, we are even able to help our agents with proposals and field support in the New York/New Jersey/Connecticut tri-state region. In many cases, along with assisting our sales partners in closing deals, we have been providing installation of new terminals.” In accordance with its training policies, the ISO also positions itself as a resource for agents in the areas of PCI compliance and interchange. “We have been much more successful in the reprogramming of POS computer software after an agent has had some basic instruction on what to look for, what to ask, and how to deal with the current situation, in which most merchants’ POS software does not meet PCI standards,” Feldshuh states.

Bulking Up For Express Transact, moving has been literal as well as figurative. Richard Davis, founder and executive vice president, announced in early April his decision to leave the company and sign on with CAM Commerce Solutions, a Fountain Valley, California-based provider of highly integrated retail and payment processing solutions. At press time, CAM was in the midst of a

restructuring and rebranding effort aimed at moving it into the ISO space. Express Transact will continue to serve merchants, but will concentrate almost exclusively on its proprietary e-commerce platform. New Express Transact merchant clients seeking services that transcend the platform will be referred to CAM, under terms of a partnership between the two organizations. “As great as things were going at Express Transact, we were focusing so much on our proprietary platform and the micromerchant businesses that we were falling behind on where we ultimately wanted to go with larger, enterprise-level merchants,” Davis says. “CAM was seeking to move in that direction in line with starting up on the ISO side, so for me the change was right.” Davis still believes that the proprietary platform helped his former company to build and maintain an “excellent” reputation among micro-merchants. However, he recently realized that such a reputation was beginning to impede, and would continue to hinder, his efforts to take the processing side of the business to the level he ultimately wanted to attain. As for Express Transact itself, the ISO recently relocated within its home town of Orem, Utah, from a 6,500-square-foot building to a 13,000-square-foot building. Additionally, Express Transact opted to move in order to afford it more room to develop and implement new technology, attract new partners, and increase/expand its brand recognition, Davis notes.The move was also designed to increase the cohesiveness of Express Transact’s individual departments.“In the old building, all the departments were kind of thrown together because of space limitations,” he says.“For example, sales, support, marketing, and the design teams were all interspersed. This made it harder to get things accomplished.” “Departmentalizing,” as Davis calls it, is already facilitating the launch of new product. While he was not yet able to reveal details, he describes the solution under development as a user-friendly, professional e-commerce payment processing platform. The merchant service side of it will have a new pricing model that will better cater to small startups, Davis concludes. TT Julie Ritzer Ross is a contributing writer to Transaction Trends. Reach her at jritzerross@gmail.com. Transaction trends | June 2010 23

[ FEATURE]

More than a Meeting ETA’s Annual Meeting and 20th anniversary celebration infuses excitement and optimism in the industry By Josephine Rossi

ince 1992, ETA members have come to rely on the Annual Meeting and Expo for strong leadership, educational, and networking opportunities. This year’s event, held in Las Vegas April 13-15, not only continued that tradition of inspiring and empowering members, but also demonstrated the industry’s resilience, as many attendees came in search of post-recession strategies to expand their businesses. “I had a lot of discussions around portfolio acquisitions this year. It seemed people were looking to grow their business via acquisition, and wanted me to let them know if I hear about an ISO looking to sell,” says 24 June 2010 | Transaction trends

Brian Goudie, senior vice president of partner sales at First Data Corp. “Last year people were shopping because they had to; this year ISOs were seeing new business growth,” says Bill Clark, executive vice president and general manager, North America, of Scottsdale,Arizonabased Apriva’s point of sale division. “The conversations were definitely upbeat.” His colleague Stacey Tappin, vice president of sales, agrees:“The economic downturn created a sense of anxiousness last year. This year, it was evident that everyone understands that change is always happening in the merchant acquiring space—regardless of the economic conditions.”

These notions of optimism and strategy were reflected in keynote speaker Rudy Giuliani’s keynote presentation on leadership.The former New York Mayor cited examples from his early days as a trial lawyer and the rationale behind his political decisions to illustrate how having an extensive set of goals and powerful solutions is not enough without a positive outlook. “No one wants to follow a pessimist,” he said during his keynote. “A pessimist sees difficulty” in every situation.

Networking and Innovations From a timeline illustrating the industry’s growth over the past two decades dis-

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[ FEATURE] played at the entrance to the expo hall and the more than 150 booths and product demonstrations inside, the expo this year was full of big ideas and high expectations for solid relationship building. “Trade show time, when everyone is on the floor and open to conversations, is the best aspect of the ETA event for us,” says Leslie Norris, executive vice president for Panoptic Security in Salt Lake City.“We are a fairly young organization, and we look to broaden our brand awareness, [increase our] competitive positioning strength, and gain access to companies and individuals that want to develop a relationship [with us]…. Face to face in a strong exhibitor and attendee environment really concentrates this effort for us.” “This is the industry’s staple event,” says Theodore Svoronos, vice president of business development and strategic partnerships for Group ISO in Newport Beach, California. “This is a great place to talk to colleagues and market movers and shakers and to put together what the industry needs, find out where it is headed, rekindle business relationships, and [discover the] latest and greatest.” Over the years, the expo floor at “the ETA” also has become a testing ground for new product launches and partnership announcements. “ETA has become a great forum to showcase new solutions and gather insights into changing needs,” says Dan Loomis, global product manager for VeriFone.“We get a lot of important feedback and tap into the issues that people are dealing with on a dayto-day basis. For many attendees, this was the first opportunity to get a first-hand look at our latest products and brainstorm with us on how they can get them into the field.” “This year, we announced the launch of our multi-currency solutions with Absa Card in South Africa,” says Seth Asofsky, senior vice president of the U.S. region for Long Beach, New York-based Planet Payment. “The response we received from those that attended the ETA and stopped by our booth is strong evidence” that our solutions are attractive to acquirers and processors around the world. Similarly, first-year member and first-time exhibitor ROAM Data in Boston chose the event to announce a significant reseller agreement that expands the reach of its 26 June 2010 | Transaction trends

Technology Product Showcase Much like the innovative devices and services it features, this year’s reformatted Technology Product Showcase was an interactive experience for participants. Simulated merchant locations were set up on along the back of the expo hall, and attendees were able to walk through various merchant settings and watch the products in action close-up. “Rather than showing one vendor’s technology per demo, we wanted to demonstrate how different vendors’ technologies could work together in one environment,” says Sarah Owen, vice president of mobile commerce solutions for First Data Corp. and vice chair of the ETA Technology Committee. “This format allowed two to three vendors per storefront and for more participants to ask questions.” More than 25 companies submitted applications, which were rated by the committee based on criteria such as time to market, relevance, and creativity of demonstration. Top scoring applicants were selected to participate: n

American Bancard

Planet Payment

First Data Corp.

ROAM Data Inc.

Hypercom

SoundPOS LLC

Ingenico

USAePay

Invenstar LLC

VeriFone Inc.

MagTek Inc./Magensa.net

mobile payment processing technology. “It is a big event, and it was good for us to get the word out to the industry there,” says Ken Mages, vice president of business development.

Knowledge Sharing A streamlined educational program at this year’s event featured strategic sessions to help members build core operations and understand the ever-changing rules of the payments business.Topics included alternative payments, sales force development, industry regulation, and global opportunities. New to the fold, however, was the Investment Community Forum. This all-day event capitalized on renewed interest from investment firms in the payments sector and united both sides for an educational mix of speaker presentations and panel discussions. Greg Cohen, U.S. group president of Moneris Solutions, kicked off the event by outlining key stakeholders in the business, their business models, revenue streams, and trends. He pointed to opportunities outside

of credit, global expansion, emerging technologies, and a new breed of ISOs to fuel changes in future business. “The ISO of tomorrow will look more like a tech provider,” he noted. Later, investment banks, venture capitalists, and private equity firms had their turn at the podium, explaining their business strategies and needs, followed by ample time for networking by all participants. “[It] was full of knowledgeable industry veterans, and the opportunities to network were unmatched,” says first-time attendee Leonard DeProspo, an associate with Janney Montgomery Scott in Philadelphia.“The attendees that I had the chance to speak with were all outgoing and eager to share their knowledge and contacts as though we’d been friends for years. I’m already looking forward to San Diego next year.” Running concurrent with the Forum, ETA’s Prepaid Day and Compliance Day offered similar expert discussions and insights into the exploding prepaid market as well as the latest information on compliance standards and new security threats.

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[ FEATURE]

ETA recognizes founders Biff Matthews and Joyce Cook at the Gala.

Leaders from ProPay receive the ISO of the Year award from ETA president Holli Targan (second from left) and ETA CEO Carla Balakgie (far right).

ETA Awards At the 20th Anniversary Gala Celebration and annual President’s Dinner, ETA members and leaders honored the organization’s founding members. Two of the original founders—Biff Matthews of Cardware International and Joyce Cook of International CyberTrans—were recognized on stage, along with the payments professionals whose hard work and dedication have helped propel the industry. n

Business Partner of the Year: The Strawhecker Group, Omaha

ISO of the Year: ProPay, Lehi, Utah Member of the Year: Todd Ablowitz, president, Double Diamond Group, Denver

n n

Technology Innovation Award: ROAM Data, Boston

Susan Smith, senior trial attorney for the U.S. Department of Justice, gave participants an inside look at the evolving criminal use of card and consumer information, noting that payment methods that closely mimic cash are at most risk. She discussed details of several fraud trials and investigations, including those at Heartland Payment Systems and RBS WorldPay. Meanwhile, Steve Streit, founder of Green Dot Corp., talked to Prepaid Day attendees about the ongoing success of prepaid in merchant acquiring, and Stephanie Teta, president of Philadelphiabased Lepta Consulting Inc., led participants through a detailed presentation of prepaid basics, key players, statistics, and predictions for the future. “In a changing economy, payments professionals’ ability to make quick decisions will dictate their success,” says ETA CEO Carla Balakgie.“This year’s Annual Meeting offered participants the in-depth intelligence and access to experts they need to make educated, timely decisions.” Josephine Rossi is managing editor of Transaction Trends. Reach her at jrossi@ strattonpublishing.com.

Special Thanks to ETA’s 20th Anniversary Benchmark Builders and Anniversary Supporters:

28 June 2010 | Transaction trends

SECURITY ISO Corner & Compliance

Chipping Away at Resistance

High costs and logistics may keep the United States an island in a sea of EMV adopters By Richard H. Gamble

he global spread of computer-chipembedded EMV cards is bumping up against U.S. borders. Now that Canada and Mexico are well on their way to converting to the chip technology,“we are the donut hole in the EMV migration,” says Randy Vanderhoof, executive director of the Smart Card Alliance in Princeton Junction, New Jersey. Whether those borders will be a speed bump or an impenetrable wall remains to be seen. Handicappers say the chances of the United States embracing EMV are better than ever, but it’s still a long shot. Europe invented the EMV card to stop rampant card counterfeiting when it was a less serious problem in the United States. EMV gradually spread to Asia, Latin America, and now North America, Vanderhoof explains. The initials once stood for Europay MasterCard Visa but now are simply EMV. Vanderhoof understands and acknowledges all the impediments to adoption in the United States, but says that others have overstated the cost of upgrading or replacing the terminals.“Everyone agrees this would be done during the natural refresh cycle of upgrading POS systems, so you’re only looking at the incremental cost of chip, which becomes nominal over time,” he says adding that U.S. migration to EMV is becoming more likely.

History of Failure Regardless, bringing EMV to the United States would take “an act of God,” insists Donna Embry, senior vice president for strategic product development at Payment Alliance International in Louisville, Kentucky. People have been talking it up since the late 1980s, she recalls. Visa launched a showpiece test during the 1996 Olympics in Atlanta.“It was well received. They distributed free cards. Loading stations were conveniently accessible. Merchants did not have to upgrade. But it died when the Olympics and the subsidy ended.”

The United States faces a chicken-andegg impasse: Chip cards are useless without merchant terminals to read them, and terminals do nothing without the cards. Further, the right cards and terminals won’t do anything without a processing changeover, Embry explains. In Canada, moving to EMV for debit is feasible, she says, “because Canada has a single debit network. It’s relatively easy to retrofit the machines for EMV.” But too many different factions and channels exist in the United States, and getting them all to move in sync when the costs are high and the rewards are less than compelling would be almost impossible, Embry points out. “We’re finding it difficult to move to the next generation of POS terminals and enforce a mandate for PCI compliance among Level 4 merchants.” Moving to EMV would be much harder. “The value proposition just isn’t there yet,” Embry says. It would take something

like a significant interchange premium to get all the players to move, and that hasn’t been offered, she says. It might start small if a big issuer offered an EMV card to a consumer segment that is big on international travel, she suggests. As a banker back in the 1980s, Embry helped develop an EMV card program for her bank. “We were the issuer. We were the acquirer. It used our ATM network. It worked, but we tried and tried and just couldn’t make it profitable,” she reports, noting she doesn’t think it would be any more profitable today. Though a U.S. migration to EMV infrastructure would be difficult, Vanderhoof thinks there are indications among the stakeholders that the timing is right to all come together and move in this direction. “At our recent Payments Summit, we heard the head of an association of large retailers say that he sees EMV as a foregone conclusion in the United States and they’d like to move forward.” Transaction trends | June 2010 29

SECURITY ISO Corner & Compliance

If the market won’t drive U.S. EMV adoption, it will take intervention by the card brands to make it happen, says Les Reidl, president of Speer & Associates in Atlanta. “Visa took the lead in Canada,” he reports.“They provided both an interchange incentive and a fraud-reduction incentive by shifting liability when EMV cards and EMV-compliant terminals are used,” he explains.

Signs of Change The business case against a U.S. conversion to EMV is familiar, but faint suggestions that EMV prospects are improving are something new. “A couple of years ago, I would have counted EMV out,” says Steve Elefant, chief information officer at Heartland Payment Systems in Princeton, New Jersey, “but we’re hearing more and more about something EMV-compatible or some form of EMV Lite coming to the United States. MasterCard has announced support for EMV in the United States, and I’ve seen reports that Visa people are talking about EMV Lite—using a chip without a PIN— in meetings here,” he reports, noting that Heartland has built EMV capture capability into its new E3 terminals. If adoption happens, it will be slowly. For U.S. EMV, the brands would have to create standards, and then issuers would have to introduce the cards over several renewal cycles, which run three to seven years, Elefant explains. Large global merchants already take EMV cards in their POS systems in other countries, and Walmart has reportedly adopted them in all of its POS systems now. And manufacturing the cards would be no problem because factories already produce millions of them for use in other parts of the world, he says. Acceptance of mag-stripe cards is becoming an issue as EMV solidifies as the global standard. “Europe has moved almost entirely to EMV cards,” Vanderhoof says. Merchant locations are starting to process only chip data and no longer use mag-stripe readers, he reports. “You find this at pay-at-the-pump gas stations. You find it at transit ticket dispensers. You find it at a variety of self-service kiosks and vending machines where a person is not present to manually process a stripe card,” he says. 30 June 2010 | Transaction trends

If adoption happens, it will be slowly. For U.S. EMV, the brands would have to create standards, and then issuers would have to introduce the cards over several renewal cycles, which run three to seven years. —Steve Elefant, Heartland Payment Systems

When U.S. travelers discover their card won’t work at a European location, they are inconvenienced and have to revert to cash. They become less sure which locations will take their card so they use their card less often,Vanderhoof says. It’s primarily a European problem now, but as Mexico and Canada go chip and if they start to abandon the stripe-reading technology, that problem would grow, he reasons. Elefant wants to carry an EMV card when he travels abroad, but he has been told by the issuer that EMV is not available for the premium affinity card he prefers. To get EMV, he would have to change card programs. “I don’t want to wait in line to ride the subway in London because I don’t have an EMV card,” he emphasizes. Reidl is skeptical. He thinks that very few European merchants will drop magstripe readers and risk losing U.S. card purchases. “That should not happen,” he insists. “It’s usually a malfunction or a mistake. Nobody wants to reject U.S. cardholders.”

Fraud Protection Value The value discussions still center mostly on fraud. The countries that originally adopted EMV had high fraud rates, which were cut substantially after conversion to EMV. However, the United States already has in place effective fraud-protection measures, and EMV wouldn’t help enough to justify the tremendous cost of conversion, Reidl says. The United States took a different

route and developed sophisticated authorization routines that also kept fraud at manageable levels, he notes. “We have very good fraud-management tools. Our systems can look at all sorts of patterns at the individual card level and spot suspicious deviations from normal patterns by transaction size, geographic location, type of merchants patronized, and goods and services purchased. When anything unusual occurs, the cardholder is called,” he explains. But Vanderhoof thinks fraud prevention is growing as an EMV incentive. The attacks have changed from compromising individual cards to penetrating large data bases, and fraud protection has swung to PCI compliance with standards around protecting stored data. EMV cards protect against counterfeit and theft, but data collected and stored from EMV transactions also are less useful to fraudsters than stripe-lifted data, so having an EMV infrastructure would reduce the cost and trouble of complying with PCI, he points out. “The mag-stripe produces static data. The chip produces dynamic data. Dynamic data are safer,” Vanderhoof says. “Merchants spend billions of dollars to comply with PCI and get certified. If the stored data were devalued, as dynamic data are, the rules around its storage would be less stringent and the cost of complying would be lower.” However, EMV cards are no security panacea, Elefant notes.“There’s a misconception that EMV would make us safe. It has to be combined with end-to-end encryption and back-end tokenization to provide a real security solution,” he says. The cost of conversion is a challenge, but the combined payoff in cardholder convenience, fraud reduction, and global interoperability now puts the benefits in line with the costs, Elefant argues.As costs fall, benefits rise, and global pressure increases, EMV for the United States at some point begins to seem inevitable. “We’re surrounded,” Elefant points out.“It’s coming to Canada and Mexico.We have a lot of cross-border traffic. Eventually it will have to come here.” TT Richard H. Gamble is a contributing writer to Transaction Trends. Reach him at gamble10@earthlink.net.

ETA 2009-2010 BOARD OF DIRECTORS OFFICERS PRESIDENT Holli Targan Partner Jaffe, Raitt, Heuer & Weiss, P.C. PRESIDENT-ELECT Rick Pylant President & Chairman COCARD Marketing Group LLC

Kim Fitzsimmons Senior Vice President–First Data Services First Data Corporation

Advisory Council Robert Baldwin President & CFO Heartland Payment Systems, Inc.

Heidi Goff President & Managing Director, The Americas Hypercom, Inc.

Joe Cohane CEO Veracity Payment Solutions

Stuart Harvey CEO Elavon

TREASURER Eddie Myers President & COO Payment Processing, Inc.

Robert McCullen CEO Trustwave

SECRETARY Roy Banks CEO CAM Commerce Solutions

Bob Philbin Industry Consultant

IMMEDIATE PAST PRESIDENT Nick Baxter Senior Vice President First National Bank of Omaha

Debra Rossi Executive Vice President Merchant Payment Solutions Wells Fargo Bank

DIRECTORS Todd Ablowitz President Double Diamond Group

Dave Siembieda President & CEO CrossCheck, Inc.

Greg Cohen President Moneris Solutions

Tom Wimsett President & CEO National Processing Company

Dean Leavitt Chairman & CEO Unicorn Partners, LLC Ed Myers U.S. President Global Payments

ex-officio Carla Balakgie CEO Electronic Transactions Association Jan Estep President & CEO NACHA Sameer Govil Head of Acceptance Solutions Global Acceptance Visa Matt Johanson Vice President Acquirer Relations Discover Network

Deana Rich President Rich Consulting Jeff Rosenblatt President EVO Merchant Services

Gerritt Kerkstra Senior Vice President Acquirer Relations MasterCard International

Kurt Strawhecker Executive Partner The Strawhecker Group

Bryan O’Malley Vice President American Express

Buzz Stryker President & CEO POS Portal, Inc.

LEGAL COUNSEL Dave Goch Attorney at Law Webster, Chamberlain & Bean

Advertisers index Company

Page

Phone

Web

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Discover Network

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EVO Merchant Services

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CREDCO Merchant Screening

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First American Payment Systems

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First Data Corporation/Partner Sales ISO

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First Data Corporation/TASQ

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Hypercom Corporation

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Authorize.Net

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National Processing Company

Planet Payment

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Total Merchant Services, Inc

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TransFirst

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USA ePay

866-872-3729

www.usaepay.com

Transaction trends | June 2010 31

Industry Insider

Proven Package In the business for decades, Certegy offers time-tested check-management and payment solutions By Bryan Ochalla

rich business history has spurred a wide variety of products and services offered by Certegy, a division of Jacksonville, Florida-based FIS. Although the company didn’t appear in the payments space until 2001—when Atlanta-based Equifax spun off its payment services division—Certegy founders began working in the industry nearly 50 years ago as part of a Los Angeles-based check guarantee company called Telecredit. (Telecredit was acquired by Equifax in early 1991, and Certegy merged with Fidelity National Information Services in late 2005.) For Certegy’s clients, the decades of experience translate into a full suite of check-management, collections, and credit card products, including back-office conversion, “We are seeing more traction check authorization, collections, for check authorization and credit card processing, e-commerce, back-office check conversion electronic check authorization, mail order/lockbox processing, and payin the medical/dental space, roll check cashing. as well as the government “It’s no secret that checks presented at the point-of-sale are despace.” —Bill Roese clining as a preferred payment tender,” says Cindy Knowles, Certegy’s vice president of marketing. Consequently, Certegy, which guaranteed more than $20 billion worth of checks in 2008, offers its clients “the full gamut,” from paper check processing and credit card authorization to back-office settlement solutions and electronic check conversion. As a result, she adds,“we’re able to authorize checks over the phone [and] over the Internet.We can basically provide [our multi-channel clients] with check services any time, anywhere—and in a cost-effective way.”

Client Base Traditionally, Certegy’s client list has been stacked with retailers both big and small.“We do business with large, national retailers like Macy’s and TJX Companies all the way down to small, local mom-and-pop retailers that are just looking to outsource their check services and collections business so they can reduce their risk and streamline their expense,” explains Bill Roese, senior vice president of fraud management solutions for FIS. As the business climate changed, the company ex32 June 2010 | Transaction trends

panded into other key growth areas. For instance, Certegy continues to do a great deal of business with auto dealers and the auto after-market industry. “And we are seeing more traction for check authorization and backoffice check conversion in the medical/dental space, as well as the government space,” he says. Additionally, Certegy has started providing check authorization and check cashing services to casinos and payroll check cashing services to national supermarket chains, convenience stores, and mass merchandisers. “These retailers have instituted a financial services type of model into their stores whereby they want to attract unbanked and underbanked customers who need to cash a payroll check,” says Knowles.“And by working with us, they’re able to put more money back into a particular store, supermarket, or retailer.”

Fraud Mitigation Certegy’s payroll check cashing services also have attracted the attention of financial institutions, especially those that are “leery of a customer they’re not familiar with coming into their lobby and trying to cash a payroll check,” Roese notes.“So we offer that same service [payroll check cashing] to financial institutions and, as a result, give them an opportunity to take that person and try to make them a customer.” The situation allows the company to leverage the strength of the fraud prevention and risk management tactics it’s developed over the years, says Roese, who oversees fraud management and risk management for both the check and card services divisions at FIS. “We can scale our service to the amount of fraud that could be present at any of our retail clients,” he says. The company relies on data and sophisticated analytical tools, along with employee expertise, in its decision-making process. The goal is to prevent fraud, drive down the retailer’s expense, and improve the customer experience. “We’ve built and continue to expand and enhance our business and risk systems based on the needs of our retailers and the continued evolution of fraud,” adds Knowles. TT Bryan Ochalla is a contributing writer to Transaction Trends. Reach him at bochalla@yahoo. com.

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