KYC, Anti-Money Laundering and Underwriting, or Why I Have to Submit So Much Info to Open a Payment Processing Account

Introduction

Why do you have to submit so much information when applying for a payment processing account? There are two reasons:

1. The government enlists payment processors to help combat financial crimes. As a result, processors are required to take certain steps to verify the legitimacy of a firm.
   
   
2. When a firm accepts online payments, financial risk is created for both the firm and the payment processor. Processors ask for documentation on the firm to help prevent these losses. 

In this article we will cover the types of documentation that fit into the two categories listed above. More specifically, we'll cover the Know Your Customer (KYC) and anti-money laundering (AML) requirements, the concept of beneficial ownership and how financial risk is created and managed in payment processing.

KYC and AML

KYC and AML processes serve as the first line of defense against financial crimes like money laundering, terrorist financing and fraud. KYC procedures involve verifying the identity of law firm owners to ensure they are who they claim to be. AML measures are designed to detect and report suspicious activities that may indicate illicit financial behavior. This is why you are required to submit detailed information on the firm and its owners when applying for a payment processing account. 

Defining Beneficial Owners

Beneficial owners are individuals who exert significant control over, or have an ownership stake of 25% or more, in a legal entity. These individuals wield substantial influence or benefit financially from the entity, even if their names are not listed as official owners on paper. The government requires payment processors to verify and list the identity of anyone who falls into the beneficial owner category. The original iteration of the beneficial ownership requirements went into effect in 2016, so if you applied for a payment processing account before then, you likely didn't have to submit beneficial ownership information. 

The Corporate Transparency Act (CTA), enacted in 2021, is designed to further increase corporate transparency and better combat financial crimes in the United States. Its primary objective is to gather accurate and up-to-date information about the beneficial owners of companies operating in the United States. It requires payment processors to ask for additional information from beneficial owners, such as government-issued IDs and ID numbers. 

Underwriting and Risk Management

Underwriting plays a pivotal role in the process of opening a payment processing account. It's essentially a risk assessment carried out by the payment processor or financial institution to determine the level of risk associated with allowing a firm to process online transactions. Here's why this underwriting process is important:

First, payment processing involves financial transactions and potential risks. Firms are essentially granted access to a stream of revenue from these transactions under the assumption that the firm will deliver the legal services they have promised to their clients. 

What happens if a firm doesn't deliver the services? Chargebacks occur when a cardholder disputes a transaction with their issuing bank, claiming that they did not authorize the transaction or receive the services they paid for. This initiates a process where the funds are reversed, an arbitration-type process ensues and the firm may be held liable for the chargeback amount, along with additional fees (See How to Protect Your Law Firm from Chargebacks).

Chargebacks are a critical concern for payment processors because they can generate substantial financial risk for a firm and its payment processor. To mitigate these risks, underwriters assess various factors, including the firm's financial stability, credit history and past chargeback history. This information helps payment processors determine whether the firm is likely to generate an excessive number of chargebacks and whether they can manage these risks effectively.

While underwriting information requests may be a hassle to fulfill, working with a payment processor that has a diligent underwriting process may allow you to reap some of the financial rewards. Processors must build in the cost of financial losses, and a processor that has fewer losses may charge less than one that must account for higher losses. 

Conclusion

In order to comply with the regulations outlined above and manage risk, payment processors ask for four sets of information:

1. Information to verify the legal business entity
2. Information on the beneficial owners to verify their identities and that they are in fact involved in the firm
3. Information on the firm's bank account(s) to ensure the firm owns those accounts
4. Additional financial data on the firm so the processor can assess the risk of potential financial loss 

Submitting this information when applying for a payment processing account plays an important role in safeguarding the financial system. KYC, AML, and beneficial ownership checks are vital in detecting and preventing financial crimes, ensuring transparency, and complying with regulations like the CTA. By understanding these requirements and their importance, firms can contribute to a more secure and transparent financial environment while benefiting from the acceptance of these consumer friendly payment methods. 

Sources:

1. Office of Foreign Asset Control - U.S. Department of the Treasury. Link
2. Financial Crimes Enforcement Network (FinCEN). Beneficial Ownership Information Reporting Requirements. Link