• Yitz Mendlowitz

What’s behind the Square-merchant dust up?

There’s been a lot of buzz around recent reports—notably one in the New York Times—that Square has been withholding money from merchants. Apparently, with little to no warning, the company has been holding back up to 30% of merchant sales in some cases.

The merchants affected, obviously, aren’t pleased. With the uncertain economic conditions we’ve collectively experienced in 2020, waiting months to collect a third of your expected revenue can cause significant disruption to the livelihoods of those involved.

For their part, Square says that the company has the right to do so per their terms and conditions, and that they’ve done so to protect against risky transactions or customers asking for their money back during a period of economic upheaval. Many of the businesses whose payments are being held up claim to have documentation showing that they don’t have any returns or risk flags. So, what gives?

Accepting payments during the new normal

At the heart of the issue may be a discrepancy between how a business usually accepts payments, and how they’re being forced to change during the era of isolation and lockdowns.

Essentially, credit card transactions are broken down into two types: card present (CP) and card not present (CNP). CP is a swiped or chip transaction, and is considered the lowest risk type of transaction. In a CP transaction, merchants pay the lowest interchange rates, and issuing banks are liable for fraud on the transaction. CNP transactions are considered inherently riskier; therefore, merchants pay higher interchange rates and they’re liable for fraud.

When a processor or acquirer underwrites a merchant account, they first look at the type of merchant to see what percentage of their sales will be CP vs. CNP, as well as the average ticket size. The processor or acquirer uses this information to determine a merchant’s risk profile, which in part dictates the fees (and whether a reserve account is required) for processing a merchant’s payments.

Because CNP merchants are considered inherently higher risk, they generally pay higher rates, and many are required to have a rolling reserve account as they’re liable for fraud. A cardholder can technically dispute a charge for up to 180 days after a charge, so most processors require a rolling reserve to cover them in the event there is a chargeback, because a merchant either may not have the money or may have gone out of business.

What COVID has done is accelerated the shift from CP to CNP. Mastercard announced that in April 2020, 50% of their transactions were CNP. That’s a 40% increase from April 2019. That shift is in part due to the fact that businesses that were almost entirely CP are now primarily CNP, as pick-up and delivery have become the norm.

That means that businesses which had been underwritten as CP merchants (in the low risk bracket), are now considered CNP merchants (in a higher risk category). So, while they may not have had a history of chargebacks, Square likely assessed that the move to accepting primarily CNP transactions could lead to an increase in chargebacks.

Additionally, the very nature of many businesses transformed. Many whose model relied on in-person interactions were forced to shift to remote services or a delivery model. Even without the inherent risks of CNP transactions, a dramatic shift in how a business administers goods and services is a major disruption that could cause the business to fail. So it’s likely that Square was worried that there would be an increase in business failures due to the COVID crisis, as well as an increase in chargebacks.

As far as chargebacks are concerned, Square could very well be on the hook for them because they don’t currently utilize EMV 3DS, which would shift liability back to the card issuer for fraudulent CNP transactions. Because of this, and the possibility of businesses failing, they implemented rolling reserves for the merchants in question to account for the increased risk and potential increase in chargebacks. While rolling reserves are a common policy for many payment processors, the added protections of 3DS 2.0 could see their usage drop due to a lack of necessity.

What can merchants do to protect themselves?

Square has asserted that they legally had the right to do this per their terms and conditions. As far as we know, the legality of what’s happened isn’t really in question. And, this decision does have a basis, as explained in the section above.

But on the PR front, it’s not doing them any favors. Holding back payments at a moment when many merchants need them more than ever is a bad look. Doing so without forewarning, and without a real explanation of why (other than saying “it’s our right to do so”), was avoidable. A better explanation could have mitigated some raw feelings.

It’s not out of the realm of possibility that other processors could do something similar to what Square has if economic behavior and trends continue. Whether you use Square or not, if you’re a merchant whose business is shifting from primarily CP transactions to CNP transactions, call your processor to discuss possible rate changes and reserve policies.

Ultimately, the acquirer that a processor uses will have their own risk appetite, which will dictate rates and reserve policy. When merchants initially look for a processor, they shop around to see what solution fits their needs best. If the nature of the type of payments you’re accepting is changing, you should be doing so again, particularly since we don’t know how long this shift in consumer behavior (either because of necessity, or a longer-term trend) will last.