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The risk of fraudulent transactions involving the automated clearinghouse network is low, and the likelihood ISOs will be liable for such transactions typically is even lower, according to industry observers.
Yet some ISOs may be liable to cover returned transactions and the costs associated with them based on their agreements with other parties involved in the ACH transaction, including originating depository financial institutions.
"ISOs are in a unique position. There isn't really any risk to them directly," says Jeff Gonzales, director of marketing for ACH Direct Inc., an Allen, Texas-based ACH payment processor. ISOs sell ACH services to merchants, but merchants typically work directly with originating institutions or ACH processors when making transactions over the ACH network, he says. An originating depository financial institution facilitates transactions over the ACH network.
ACH-transaction risk can arise for an ISO if its agreement with an originating financial institution stipulates the ISO is liable for returned transactions, says Jan Estep, chief operating officer and president of NACHA, the Herndon, Va.-based electronic payments association that manages the ACH network. "There may be agreements in place that call out how the responsibilities of the [originating institution] pass through the different parties" involved in the ACH transaction, Estep says, adding that any party involved, including ISOs, processors or merchant acquirers, may be held liable if the liability is specified in an agreement.
Contracts with originating depository financial institutions are explicit in their terms, says Ed Bachelder, a director of Boston-based Dove Consulting, a Division of Hitachi Consulting.
"Through the agreement, the originator of the transaction, a processor or merchant or ISO takes on the full responsibility of the dollar amount of the transaction if it is returned," says Estep.
ISOs are responsible for understanding where potential liability occurs in the flow of ACH transactions, adds Estep. "All parties to the agreement with the [originating depository financial institution] need to be aware of their responsibilities," she says. "They need to read their agreements."
Low Risk Overall
ACH-transaction risk for returned payments remains low. Most ACH payments go through, says Bachelder. Transaction return rates typically are between 1% and 2% per NACHA category, he says.
However, risk levels can vary by transaction type, Gonzales notes. "Some [transactions] are inherently more risky," he says.
ACH transactions initiated by telephone or on the Internet are riskier than transactions made in person or reoccurring transactions because it is difficult to know if "the person on the line or at the computer is who they say they are," says Gonzales.
Reoccurring transactions, such as utility or payroll payments, are least likely to be returned, says Estep. The potential for fraud is low because both parties know each other, she says. "For the most part ACH transaction are completed. Some of that has to do with many parties transmitting ACH transactions knowing each other," says Estep.
Mitigating ACH Risk
Regardless of liability for returned-transaction costs, ISOs can help mitigate ACH-transaction risk by learning how the ACH network operates and by offering ACH services to low-risk merchants, industry observers say.
Education is one of the best weapons against fraud, says Gonzales. "The two biggies when it comes to risk management are know your customer and education," he says.
ISOs should research merchants before doing business with them, says Derron Winfrey, president of Electronic Check Services Inc., a Springfield, Mo.-based provider of check processing and verification. An ISO's due diligence should include a credit check, research into the merchant's background and an understanding of the merchant's typical transaction load, he advises.
If ISOs choose to work with high-risk merchants, they need to understand the ACH options available, says Don Singer, senior vice president with EZCheck, a Houston-based financial-services provider.
If a merchant is high-risk, the originating institution may place a daily limit on the funds the merchant can process over the ACH network, says Bachelder.
"It's important for [ISOs] if they're in the high-risk world, to work closely with ACH vendors to learn what expectations need to be set," Singer says.
