Facing the Growing Problem of Transaction Laundering

Merchant acquirers and payment service providers (PSPs) have faced greater Know Your Customer (KYC) challenges in recent years as authorities around the world have cracked down on money laundering. With the boom of eCommerce, the opportunities for electronic money laundering, or transaction laundering, have mushroomed.  Transaction laundering accounted for $200 billion a year in processed payments in 2019 in the U.S. alone, according to PYMNTS and the problem is growing.

Entire industries rely on transaction laundering to bypass the underwriting standards set by acquirers. Between 50 and 70 percent of online sales for illicit drugs, counterfeit goods, and unlawful adult content involve some form of transaction laundering, according to the Electronic Transactions Association (ETA), a trade association for the payments industry. Unsanctioned online gambling is even more dependent on this type of money laundering. More than 90 percent of illegal gambling sites make use of transaction laundering to move their credit card receipts into the payment system, according to the ETA.

MasterCard defines transaction laundering as “the action whereby a merchant processes payment card transactions on behalf of another merchant.” It also refers to this approach as factoring, transaction aggregation, or unauthorized aggregation.

Transaction laundering is a method used by high-risk or illegal goods merchants to gain access to merchant accounts. These merchants will obtain merchant accounts to process transactions for a seemingly legitimate business, but the business is not what it appears to be. For example, an illicit merchant’s website may make it appear to be a clothing retailer, but its actual business involves selling illegal merchandise.

The payment provider authorizing the transaction is usually unaware of the illicit business being conducted. Nevertheless, the acquirer or PSP will be held accountable for facilitating illegal activity. Payment providers that unintentionally allow illegal activity to occur can be hit with steep fines from Visa and Mastercard and face anti-money laundering (AML) scrutiny from regulators.

EverC, a vendor that offers software that finds and fights transaction laundering, estimates that on average an acquirer will process transactions for an additional 6% of their “known merchant base” without their consent or knowledge. This means that a significant number of transactions passing through merchant accounts are unknown and illegitimate. 

Three major types of transactions laundering exist:

• Front companies — These appear to sell legitimate goods but are actually set up by money launderers to help them issue fake receipts, inflate or invent transactions and otherwise misreport their earnings to process stolen funds. This form of transaction laundering is most similar to traditional brick-and-mortar money-laundering front businesses but exists instead on the Internet. 

• Pass-through companies – Are legitimate companies that allow or forced by criminals to process illicit transactions through their accounts online, for example, by embedding a payment link on an illegitimate company’s web page.

• Funnel accounts – Exist when a legitimate business unknowingly accepts credit card charges from an illegal business, entering the charges as legitimate transactions in the card payment processing system.

These schemes vary greatly in the difficulty it takes to locate and shut them down. Oftentimes, detection drives the offender to another site under a different name. This pushes higher the costs faced by acquirers performing initial due diligence and ongoing maintenance checks on merchants.

Another problem besides identifying the illicit transactions themselves, is figuring out who is behind the transaction laundering. Due to the effort most acquirers and PSPs undertake to minimize the customer due diligence done in order to speed up and smoothen the onboarding process, they have great difficulty in identifying the actual people behind the transactions.

This is a direct result of the pressure to offer zero hassle and low fee structures in a highly competitive marketplace. Payments players have popularized these offerings with the term “frictionless onboarding.” The tiny amount of customer information required to open a merchant account under such conditions, information that isn’t necessarily verified, creates most of the problem. 

To address this problem, acquirers and PSPs that wish to implement frictionless boarding may offer conditional approval followed by more stringent scrutiny in a post-boarding “containment” area. This way they can allow merchants to start processing payments quickly without entirely jettisoning more thorough due diligence.

Justt deals with chargeback mitigation not transaction laundering, but we know companies that do address this important issue. If you work at an acquirer or PSP facing a transaction laundering problem, feel free to contact us for advice and contacts at relevant companies.