Paying employees through prepaid debit cards is efficient, but potentially risky for employers
March 2017 | EXPERT BRIEFING | LABOUR & EMPLOYMENT
The use of payroll cards is widespread and becoming more popular. In 2012 alone, businesses loaded $34.1bn worth of wage payments onto prepaid debit cards, according to Aite Group.
The benefits of using prepaid debit cards are numerous for both the employer and the employees. In most instances the programmes are well received by employees. Employees can have instant access to their wages even if they do not have a bank account, they do not need to pay cheque cashing fees, and can receive their wages even if they are not working on payday. Once wages are paid, an employee can instantly withdraw cash at an ATM instead of waiting for a deposited cheque to clear. Debit cards are accepted all over the world, and can be used to make purchases online as well. Employees can often transfer the money on the prepaid cards to other accounts, and wire funds to family overseas. This last function is particularly useful for employees working far from home. Some processors also issue ‘companion cards’ to an employee’s family, allowing family member to have direct access to the funds immediately without incurring wire costs.
For employers, the switch to payroll cards from physical pay cheques results in cost-savings and increased efficiency. For example, in the cruise line industry cash payments are often required by statute or contract, and the use of payroll cards reduces the need for regular large cash deliveries to the vessel which are costly in terms of security, logistically difficult and give rise to theft and embezzlement concerns. The use of payroll cards also streamlines an employer’s human resources and payroll systems, particularly where one company is paying employees in various locations in the country or around the world. A single batch file to the processor and a wire transfer refills the cards already distributed to employees.
Employers are finding that the use of prepaid cards is not without drawbacks, however. The risks to employers are numerous and include ultimate liability for wage monies misappropriated by theft and fraud, potential unintentional violations of federal or state laws, insolvency and reputational risks.
The processor generally makes most of its income from fees associated with employees’ use of the payroll cards. For example, an employee may be charged an ATM fee for withdrawing money, or a fee for retrieving the card’s balance, or calling customer service. Such fees may result in improper reduction of an employee’s take-home pay which is prohibited by various state and federal statutes and has been the subject of at least one investigation by New York authorities. For example, employers cannot force their employees to receive their wages via a payroll card, as explained in the Consumer Financial Protection Bureau Bulletin 2010-10. In 2013, the New York attorney general’s office opened an investigation into payroll card programmes after receiving complaints from employees. The resulting report indicated that employees compensated through payroll cards were often given insufficient information about how to retrieve their wages without incurring a fee, and nearly 40 percent of the employers surveyed by the office did not provide employees the choice of receiving a paper pay cheque.
The fees applied to a payroll card are the subject of significant negotiation between the employer and processor. If the matter is raised by the employer, the processor will usually allow at least one free withdrawal of the full wage amount under certain circumstances in order to satisfy particular statutory requirements, but employers cannot depend on the processor to raise such concerns, which are violations of the employer’s duties, not the processor’s.
In addition to the risk of violating statutory requirements, there are other significant risks that are often not known or considered by employers utilising payroll cards, due to a lack of understanding regarding the process. Payments through payroll cards typically work as follows. First, the employer enters into a contract to engage a payment processor to facilitate the distribution of funds. Usually, the payment processor itself does not have a relationship with the card issuer, typically Visa or MasterCard, and therefore must engage a bank (the issuing bank) to issue the debit payroll cards. These cards are branded by Visa or MasterCard and often bear the employer’s name or logo but generally do not prominently mention the issuing bank with whom the processor has a relationship and is the bank actually issuing the debit cards and the owner of the ‘aggregate’ account containing the wages. The processor will generally choose an issuing bank willing to accept the lowest fees for issuing the cards. Often these correspondent banks are located overseas in jurisdictions like Africa or South America. The issuing bank’s aggregate account may hold funds for many different employers or customers of the processor. The aggregate account may be held in a correspondent account of the issuing bank in the US or in any other jurisdiction. The issuing bank generally has free use of these funds until the card issuer reports a transaction resulting in the processor debiting the specific employee sub-account in the aggregate account. These sub-accounts may only exist on the computers of the processor. This raises the risk of what would happen if the issuing bank becomes insolvent, or is subject to political risks which are not uncommon in the locations where the issuing banks are often licensed. In addition, depending on the location of the aggregate account established by the issuing bank, and how the sub-accounts for each employee are established, the funds in these account may not be insured, which can result in violations of federal law – see, e.g., the Seaman’s Wage Act, 46 U.S.C. §§ 10101-11507.
If the issuing bank has established the aggregate account in a correspondent bank, the bank maintaining the aggregate account only owes duties to the customer – that is, to the issuing bank – not to the employer or its employees. If these risks are known to the employer, they can often be mitigated through specific agreements with the issuing bank and its correspondent, clarifying the fiduciary relationship of the issuing bank and its correspondent to the employees who are the real owners of the individual sub-accounts.
Additionally, depending on the location of the aggregate account, there could be increased exposure to fraud and hacking, resulting in the depletion of employee accounts or theft of the funds before they are even credited to the employee’s sub-account. In the latter case the employer would likely be required to pay the same wages twice. Employers could also find themselves the victim of cyber hacking. In 2013, nearly $45m was stolen in a matter of hours when hackers infiltrated the system of a credit card processing company that handled Visa and MasterCard prepaid debit cards. Cyber hacking can also compromise a payroll cardholders’ personal information. The use of skimming devices at ATMs can result in the same exposure. These risks can be mitigated or shifted from the employee and employer to the processor or issuing bank in the contracts negotiated by the employer if employers are aware of these threats. Commonly, however, processors seek to limit their liability to some multiple of the fees charged absent gross neglect, and these limitations, if reasonable, are enforceable in most states.
In the course of engaging a payment processor, the employer and processor should agree on security protocols, including notification and confirmation procedures for checking the accuracy of payment instructions sent by the employer to the payment processor. Access to the batch files and who may change or send theses files directing the processor how much to pay each employee must be closely monitored and limited by the employer. The agreement should include adequate time to notify the processor of unauthorised transfers and clearly state who is liable for the risk of fraudulent or mistaken instructions
Debit cards have been criticised as a major avenue of money laundering. Indeed, once the card is loaded, it can be mailed along with the PIN to anyone in the world who will then have access to the funds. The US Treasury Department’s Financial Crimes Enforcement Network (FinCEN) has recently been contemplating proposed rules that money stored on prepaid cards will count toward a requirement to report cross-border movement of cash of $10,000 or more, but the industry has been able to stave off these regulations for the time being. International employers should also be aware of screening requirements. Employees must be screened against the OFAC and other sanctions lists. Generally the processor will agree to complete the screening, but it is the employer’s duty to provide accurate information on the employee and anyone receiving a ‘companion’ card. Failure to ‘catch’ a blocked person, country or account could result in not just that employee’s sub-account being frozen but the whole aggregate account or payroll payment being seized.
At the end of the day, employers are ultimately responsible for paying their employees in a timely manner and pursuant to applicable law. As such, even if the funds sent by the employer to be processed and distributed to its employees are misappropriated or frozen – through no fault of the employer – the employer must still find a way to pay its employees. The issues potentially affecting employers utilising prepaid debit cards are complex. Experienced counsel can advise employers on potential risks and how to limit liability and mitigate against fraud.
Payment by debit cards offers significant convenience to employers and employees, and can result in a cost-savings for employers. However, employers should take great care to mitigate potential risks by effectively negotiating the programme with the processor, issuing bank and the holder of the aggregate account, and carefully vet entities in light of security and insolvency concerns. Further, employers should seek counsel about applicable laws and regulations and what recourse is available should issues arise. While there are a number of potential risks to switching to a prepaid debit system of wage payment, its popularity and widespread appeal cannot be denied.
John Kissane is a partner and Celinda J. Metro is an associate at Watson Farley & Williams. Mr Kissane can be contacted on +1 (212) 922 2200 or by email: firstname.lastname@example.org. Ms Metro can be contacted on +1 (212) 922 2200 or by email: email@example.com.
© Financier Worldwide
John Kissane and Celinda J. Metro
Watson Farley & Williams