Small Merchants Get Stuck for Unreimbursed Charges

John Chung and Alice Satterfield own competing jewelry stores in Laguna Beach, but they have much in common.

Both operate on thin profit margins. Both allow customers to charge purchases on credit cards and dislike the big bite that banks take for processing credit purchases. Both signed up with a Lansing, Mich., company that did the job for half the cost.

And both are now stuck with thousands of dollars in unreimbursed charges because the company, Check Reporting Services Inc., abruptly halted operations last month and was forced into bankruptcy last week.

CRS’s debts include about $4.8 million in credit card payments that the company collected but never disbursed to about 1,000 merchants--mostly mom-and-pop stores--in 37 states.

The CRS failure is the third debacle involving independent credit card service firms to jolt the financial industry in the last 2 years. Total losses to merchants and to consumers in the three cases are estimated at $18 million.

The cases raise concern about the growing use of independent firms to process credit card purchases and the question of who should pick up the tab when those firms fail.

Comerica Bank in Detroit, for instance, said its agreement with CRS contains a clause that protects the bank from liability for any problems created by CRS.

But the two major credit card companies, Visa International and MasterCard International, maintain that no bank should be allowed to avoid all responsibility for the actions of such firms, and Visa sued Comerica Bank last Wednesday over the CRS fiasco.

Both Visa and MasterCard are implementing new rules that they hope will halt the sometimes slipshod arrangements between banks and their independent firms as well as the potential for outright fraud.

“The situations we’ve seen have involved poor management, but the area has been ripe for someone to just walk in and take the money,” said William Neumann, chief of security for Visa.

CRS officials declined to discuss the issue, though James Schramm, the company’s lawyer, acknowledged that the 28-year-old, family-owned firm was shutting down.

CRS, which functioned as a credit reporting agency and a check guarantee service before it began processing credit card accounts, has not decided yet if it will fight the bankruptcy action, said James Croom, its bankruptcy lawyer. Only eight of its 60 employees remain on the job, he said.

Some merchants are owed up to $150,000. One of them, a Kalamazoo computer store, joined with two other merchants to file the involuntary bankruptcy action against CRS in U.S. Bankruptcy Court.

Local authorities in Michigan are investigating allegations of diversion of funds, said Eaton County Sheriff’s Detective Dale Lauerman. And the FBI has opened a preliminary investigation to determine if any federal wire fraud or mail fraud statutes may have been violated by CRS, said Dennis Anderson, the agency’s senior resident agent in Lansing.

Chung and Satterfield said they may ask lawmakers to enact stiffer measures to control third-party credit card firms.

‘Go to the Bank’

“The government should have some kind of laws to control these people,” said Chung, who figures he is owed nearly $13,000 by CRS. “There must be 10 or 15 companies like CRS existing in California. I want to warn all the merchants: Don’t go to these people. Go to the bank.”

The actual number of independent firms handling credit card processing for banks is difficult to determine but probably is in the hundreds, Neumann said. And some of them are very large and reputable firms, he said.

That’s no consolation to Chung, who has operated John’s Jewelry & Gems Co. out of a small store in downtown Laguna Beach for the last 20 months.

When he moved his jewelry operation from his native Hong Kong to the Jewelry Mart in downtown Los Angeles more than 3 years ago, Chung initially sent his credit card receipts to Sumitomo Bank for processing.

3.5% Processing Fee

Sumitomo, like many banks in the Visa-MasterCard network, charged a processing fee of 3.5% of every purchase and credited his account with the difference.

That’s the standard processing fee for small merchants like Chung. Many banks offer a lower rate--about 1.5%--to merchants who process $10,000 or more in credit purchases a month, said merchants and officials at credit card companies.

The third-party companies such as CRS process credit card transactions for small businesses at a discount rate by accumulating many accounts and processing credit sales as if they came from one big merchant, they said.

As part of the national credit card network, banks clear transactions electronically with each other, collecting from other banks what is due them for sales made by their merchant customers and paying other banks what their credit card consumers owe for purchases made.

No Local Branch

When he moved to Laguna Beach, Chung found that Sumitomo had no local branch, making it inconvenient as well as expensive to stay with the bank.

But his friendly competitor, Alice Satterfield, who runs B. Hall Estate Jewelry a few blocks away, told him about CRS, which had recently sent a salesman through the business district.

CRS processed credit slips at less than half the cost charged by the banks--1.482% of the purchase price--and tacked on a 62-cent charge for each transaction, regardless of the purchase amount. Satterfield already had signed up with the firm.

After talking with a CRS salesman, Chung decided to do the same.

“The reason I trusted them is they said they were backed up by Huntington National Bank in Columbus, Ohio,” Chung said. “There was also a signature from a bank official in the contract.”

‘I Can Trust a Bank’

He admitted he knew nothing about Huntington National. “But it’s a bank, and I can trust a bank in America,” he said. “That’s how I interpreted it.”

Chung and Satterfield said that CRS sold each of them an electronic machine to run credit cards through. The machines, which cost them $250 plus a one-time $50 fee, authorize each sale and record the amounts.

At the end of the day, they used the machines to electronically transmit the credit purchases to CRS. The Michigan firm which collected similar receipts from all its merchant customers and transmitted the entire batch to Huntington National. The bank then reimbursed CRS, which distributed the money to the individual merchants.

“They guaranteed a week’s turnaround, which wasn’t bad considering our savings,” Satterfield said.

Payment Delays

“Then it got to be where it was 10 days, then 2 weeks, then 3 weeks,” she said. “Then, if you got a credit charge for $1,100 in the day’s credit receipts, you’d get the money for the rest of the slips, but not that one. You’d call and complain, and then you’d get it--a week later.”

For Chung, who had received reimbursements from Sumitomo within 3 days of sending in credit slips, the turnaround time from CRS gradually grew to more than a month.

Unknown to Chung and Satterfield, Huntington National decided last February that it wasn’t a good idea for a regional Ohio bank to have credit card merchants “all over the country,” said Paul Ayres, a bank vice president. The bank terminated its contract with CRS, which affiliated with Comerica Bank in Detroit.

Since then, delays in repayments continued to worsen, the merchants said. Comerica, though, received few complaints from credit card merchants, said Randy Boileau, a Comerica spokesman.

But on Jan. 13, under terms of its contract with the bank, CRS notified Comerica that it was insolvent. Comerica dissolved the contract.

Transactions Halted

All transactions Comerica received before that date were processed, which meant CRS was paid on behalf of all merchants. All transactions received after that date were returned to the merchants so they could be processed elsewhere, the bank said.

Chung and Satterfield said they never were notified that Comerica had been substituted for Huntington National and had not received any formal explanation of what happened.

“After this, I’d be real skittish about trusting any middleman,” Satterfield said. “I’ll just pay the extra money, but I’m going to have to charge more.”

So far, Comerica hasn’t been willing to discuss the possibility of covering losses incurred by the merchants.

Comerica Released

“The agreements signed between CRS and its customers specifically released Comerica from liability in the event of difficulties between CRS and its customers,” the bank said in a release. “And, under the contractual agreements in effect, neither Visa U.S.A. Inc., MasterCard International or Comerica are liable for the losses caused by CRS.”

Boileau noted that the bank’s contract was with CRS, not the merchants.

That stance angered Visa and MasterCard executives.

“The bank should be controlling the transactions and is responsible for all activity that is taking place,” said Harry Hasselmann, MasterCard’s vice president and counsel.

He said the company’s board is expected to enact new rules this month that will require banks to send money it collects from credit card receipts directly to merchants, not to third-party companies.

‘This Weakens the Confidence’

“Member banks are responsible for the actions of their agents,” said Dan Brigham, Visa’s media relations manager. “This weakens the confidence of merchants in the Visa system. If they’re not getting paid, they’re not going to accept the card. This strikes at the very root of the business.”

On Wednesday, Visa sued Comerica in U.S. District Court in San Francisco, claiming that the bank owed the merchants $2.9 million in purchases charged on Visa cards. The suit alleges breaches of contract and fiduciary duties, negligence and other misdeeds.

Comerica responded that it was “gravely disappointed” in Visa’s lawsuit. “Visa’s precipitous action has removed at least for the immediate future any chance of quick relief for the merchants affected by CRS’s insolvency,” the bank stated.

Two years ago, Visa sued Bowery Savings Bank in New York over a similar problem with Chargit Inc., a third-party firm that went bankrupt owing merchants more than $10 million. That suit is still pending.

Left Holding the Bag

In June, consumers were left holding the bag by MoneyCard Systems Inc., a credit card marketing firm in Washington.

MoneyCard marketed Visa and MasterCard to about 10,500 consumers with poor credit or no credit. The customers posted security deposits of $300 or more at a Maryland bank to obtain charging privileges.

But MoneyCard clients who sent in deposits often found that merchants wouldn’t honor the cards they received. Some also failed to get cards. And they later learned that their deposits were gone.

Visa and MasterCard canceled the charging privileges. MoneyCard customers lost about $2.3 million altogether.

“I think there are a lot of things these third-party companies can do constructively,” said Visa’s Brigham. “It’s just that handling money isn’t one of them.”

HOW CREDIT CARD TRANSACTIONS ARE PROCESSED Merchant to bank:

Visa and MasterCard have built up a network of member banks that interact with each other in processing credit card transactions. Just a few years ago, merchants dealt directly only with banks.

A merchant deals directly with a bank, typically to “clear” credit card transactions daily. The merchant sends a day’s worth of credit card slips to the bank so it can process the receipts through the interbank network and bill the merchant’s customers.

Meanwhile, within a few days, the bank uses the credit from the banks of the merchant’s customers to pay the merchant the total amount for the goods purchased--minus 3% to 5% of the total to represent the bank’s costs in clearing the credit slips. Middlemen between merchant and bank:

Middlemen, called third-party firms or independent sales organizations, emerged a few years ago with a bargain for both parties: less work for banks and less cost to merchants. By offering a bank a large number of merchants, electronic sales processing and relief from some of the paper work, a middleman could get the bank’s volume discount rate--usually 1.5% or less. The middleman makes money on volume, fees and sales and servicing of the electronic machines used to authorize credit purchases and transfer credit information over telephone lines.

At the end of the day, the merchant uses the machine to send the total amount of credit purchases electronically to the middleman.

The middleman totals the day’s receipts from merchant customers and sends the information electronically to a bank with which the middleman has contracted.

The bank uses the Visa and MasterCard interbank network to bill customers and take funds electronically from the customers’ banks to cover the purchases.

The bank forwards the total due all merchants to the middleman.

The middleman breaks down the amount, sending merchants their respective shares--less the fee.