Eleventh Circuit Imposes Joint and Several Liability on Payment Processor for Alleged Fraud by Client

Linda A Goldstein

Last month, the Atlanta-based United States Court of Appeals for the Eleventh Circuit handed down a decision that could send a chill through the payment processing community and result in increased scrutiny by payment processors of the underlying activities of their clients. Specifically, the court affirmed a decision by a Florida District Court holding that payment processors providing services to telemarketers engaged in fraudulent or unlawful activities could be held jointly and severally liable for the full amount of the consumer injury.

As some readers may recall, in 2013, the Department of Justice embarked on an initiative called Operation Choke Point in which the government used legal and regulatory pressure to choke off the financial oxygen for businesses engaged in certain high-risk activities by threatening action against banks and other financial institutions that provided services to such marketers. While Operation Choke Point was officially discontinued in 2015, the Federal Trade Commission (FTC) has continued to pursue enforcement actions against payment processors and other vendors who have provided “substantial assistance” to telemarketers engaged in fraudulent activities. This recent decision is likely to fuel these efforts by the FTC to expand the net of liability.

The case arose of out an action brought by the FTC against a company that allegedly violated the Telemarketing Sales Rule (TSR) in connection with its marketing of credit card interest reduction services. After some discovery, the FTC amended its complaint to charge the payment processor, Universal Processing, and its then-president Derek DePuydt with aiding and abetting the telemarketing scheme. The FTC alleged and the district court found that the processor “knew or consciously avoided knowing” that the merchant defendants were engaged in unlawful activity and provided “substantial assistance” by providing merchant processing services.

The court entered judgment in the amount of $1,734,972 and ruled that the merchant processing defendants were jointly and severally liable with the merchants for the full amount of the judgment. The payment processor did not appeal the underlying finding of liability, but did appeal the court’s ruling that it was jointly and severally liable for the full amount of the judgement. The processing company claimed that it should only be liable for $410,000 in fees that it received. 

In affirming the district court’s imposition of joint and several liability, the Eleventh Circuit concluded that apportionment of the damages was not appropriate in this case because without the payment processing services, no money would have been stolen by the defendants.

The implications of the case are significant because under the TSR, liability can be imposed upon those who provide “substantial assistance” to marketers engaged in unlawful activity, if those providing the assistance knew or consciously avoided knowing that the underlying activities were fraudulent. The FTC has historically taken a liberal view of what constitutes “conscious avoidance” and the court’s decision in this case is consistent with that interpretation. The following are among the factors that the court believed demonstrated that the processors either knew or should have known that their clients were engaged in unlawful actions:

  • The processor’s independent sales agent reviewed the scripts and marketing materials.
  • The processor’s independent sales agent was involved in the marketing activities.
  • The processors underwrote the application despite credit deficiencies and a high-risk fraud alert on the principals of the underlying merchant.
  • There was a high chargeback rate of more than 30 percent.

Processors and other service providers should take note of the factors that the court believed were sufficient to establish constructive knowledge that their clients were engaged in unlawful activity. High chargeback rates have historically been held to be a trigger of such knowledge. It is interesting to note that the processor’s review of the telemarketing scripts was deemed a negative rather than a positive factor. While service providers often shy away from script review for fear that they will be charged with having constructive knowledge, the message of this case is that if you do undertake review of the underlying marketing materials then you must also refuse to provide services if you do not believe those materials pass legal scrutiny.

While payment processors have long faced the prospect of liability for the actions of their clients, the appellate court’s affirmation that the processors can be held jointly and severally liable for the full amount of damages adds a new dimension to the equation. In many cases, the underlying merchants do not have the ability to pay the full amount of the judgment, and the FTC will often suspend a portion of the judgement based on the marketer’s inability to pay. This case will likely encourage the FTC to name the processors as additional defendants because they may often have deeper pockets than their clients. 

Processors and companies providing services and assistance to telemarketers would be well advised to revisit their underwriting and screening processes to help mitigate risks of performing services for unscrupulous marketers.