What Startups Must Know About Payment Compliance Before Launching a Productized Service

The payments industry is one of the most regulated spaces in the business world. As a startup preparing to launch a productized service, failing to understand and implement proper payment compliance controls can have disastrous consequences. Lawsuits, fines, account freezes, and even criminal charges are all possible outcomes for non-compliant merchants.

However, with some diligence on the front-end before launch, startups can set their productized services up for payment success. This article will provide an overview of the major payment compliance considerations startups must evaluate, including:

1. Payment Card Industry Data Security Standard (PCI DSS).
2. Strong Customer Authentication (SCA).
3. Anti-Money Laundering Regulations (AML).
4. Know Your Customer Requirements (KYC).
5. Data Protection and Privacy Regulations.

Understanding these key compliance frameworks, assessing requirements, and building internal controls are absolute must-dos for startups before officially opening for business. Doing so early on can prevent regulatory infractions and save startups from potentially business-crippling consequences down the road.

PCI Data Security Standard Overview

Payment compliance is the foundation of secure transactions in any business that handles customer payments. The PCI Data Security Standard (PCI DSS) is a set of mandatory policies all merchants and payment processors must comply with to accept, store, process, or transmit credit and debit cardholder data. It was established by the Payment Card Industry Security Standards Council to create a universal standard for safeguarding sensitive cardholder information and reducing payment card fraud.

The core principles of PCI DSS focus on:

1. Building secure payment card networks and systems.
2. Protecting cardholder data.
3. Ensuring ongoing vulnerability management.
4. Implementing strong access controls.
5. Regularly monitoring and testing networks.

There are 12 overarching PCI DSS requirements startups must meet to be compliant. Within these 12 areas are over 200 granular controls ranging from encryption protocols to password policies to anti-virus defenses.

While larger enterprises often have dedicated resources to manage PCI compliance, for early-stage startups, this can be a more challenging undertaking. Leveraging user-friendly merchant services equipped with embedded compliance tools can help streamline oversight of the many PCI DSS controls.

Additionally, the PCI Security Standards Council offers a range of training programs and risk assessment tools to aid smaller businesses with understanding exactly where their PCI obligations lie. Identifying scope early on, based on your business model and infrastructure plans, is key.

For software companies and technology providers that don’t directly store, process, or transmit card data, PCI requirements may not apply. However, ensuring your productized service is compatible with clients’ PCI DSS controls and performs as expected is still important for marketability.

Startups that will handle card data should engage qualified security assessors (QSAs) to audit their compliance status before launch. A clean bill of health from a QSA verifies your startup has correctly implemented PCI standards across people, processes, and technology.

Strong Customer Authentication (SCA)

Strong customer authentication, commonly referred to as SCA, is a European Union regulatory requirement aiming to reduce online payment fraud and increase security for electronic payments.

SCA mandates that all electronic payments require multi-factor authentication to verify customers are who they claim to be. This means at least two of the following three categories must be validated before a transaction can proceed:

1. Something only the user knows, such as a password or PIN.
2. Something only the user possesses, such as a phone or hardware token generator.
3. Something unique to the user’s person, such as a fingerprint or face ID.

Although SCA is mostly applicable to companies working in the EU and the UK, other startups that do not conduct their operations in these countries should also be informed about the possible effects of this regulation on the service delivery to European clients.

In case your productized service has EU-based users, it is possible to avoid future obstacles to revenue and growth by making it SCA-compatible as early as possible. This involves the incorporation of SCA-enabled payment gateways, the development of multi-factor authentication into your system, warning users to have authentication tools ready, and adhering to certain transaction exemptions.

Also, ensure that your EU terms of service, privacy policy, and other documents that face your customers are updated to the latest SCA requirements.

Anti-Money Laundering Regulations

Money laundering is the process of concealing illicit funds by filtering them through legitimate businesses to hide criminal origins and make dirty money appear clean. According to United Nations estimates, somewhere between 800 billion to 2 trillion is laundered globally every year.

To combat this, financial institutions and merchants are legally required to have safeguards in place to detect and prevent money laundering and terrorism financing.

In the United States, anti-money laundering (AML) regulations are primarily governed by the Bank Secrecy Act. Startups that qualify as money services businesses under FinCEN guidance must comply with the BSA.

This includes implementing a comprehensive AML program covering:

1. Internal policies and procedures.
2. Designated compliance officers.
3. Employee training.
4. Transaction monitoring and suspicious activity reporting.
5. Verifying customer identities.
6. Performing risk assessments.
7. Record retention.

Depending on your business activities, parties you deal with, and perceived weaknesses, the level of AML obligations will differ. Not complying with BSA may result in high civil and criminal fines imposed on you by FinCEN or your regulator.

Even if your productized service does not deal with money directly, but is involved in money transfers, it is possible to supplement the internal controls in your startup with a payment provider that enables AML transaction monitoring.

Local AML regulations can also apply to global companies. It is wise to understand the difference between the European AMLD directives, the UK Proceeds of Crime Act, and other laws of different countries regarding money laundering, depending on your targeted markets.

Know Your Customer (KYC)

Know Your Customer refers to due diligence activities and ongoing screening required to verify customer identities, source of funds, and mitigate financial crime risks.

Robust KYC procedures are a core component of AML programs as well as general risk management for fintech companies or startups maintaining customer accounts.

At a minimum, KYC involves collecting identifying information such as:

1. Full legal name.
2. Physical address.
3. Date of birth.
4. Government ID.

It is necessary that you cross-reference the data gathered with a number of watchlists, sanctions lists to screen individuals with high risk. It is also vital to monitor the activity in accounts and update KYC information regularly.

Manual KYC may be very resource-demanding for startups. It can be made more efficient by partnering with specialized vendors of identity verification, which can combine biometric authentication and AI-based compliance checks.

Note that the privacy of data laws extends to the way you capture, store, and utilize the information about the customers to conduct KYC. Make sure your workflows comply with the regulations, such as GDPR and CCPA, in terms of data transparency, consent, disclosures, and deletion procedures.

Data Protection and Privacy Regulations

As a final consideration, startups must familiarize themselves with relevant data protection and privacy laws based on where they operate, where customers reside, and the types of data processed.

While specific requirements vary widely, common regulatory themes include:

1. Disclosing how consumer and employee data is collected, shared, secured, and retained.
2. Providing opt-in/opt-out consent mechanisms.
3. Enabling consumers to access or delete personal information.
4. Establishing protocols for dealing with breaches.
5. Limiting data retention periods.
6. Permitting cross-border data transfers under approved circumstances.

Specifically, startups ought to be keen on new state consumer privacy regulations in the United States, such as the California Consumer Privacy Act (CCPA) and the Virginia Consumer Data Protection Act (VCDPA). Both of them regulate the way companies manage the data of state residents and provide high fines in case of non-compliance.

Since other states will be introducing similar laws in the future, startups will need to monitor such changes so that they can have a compliant data infrastructure and methods of notice. The risk of not doing it is considerable in terms of finances and reputation.

Also, in case of overseas expansion, it is crucial to learn about where to expand to and the GDPR and data regulations in the countries of expansion.

Conclusion and Next Steps

Before going live with any sort of financial services offering, startups have a long list of payment compliance obligations to address. Falling short in any area could mean painful enforcement actions or lawsuits.

While the sheer volume of moving regulatory parts like PCI DSS, AML, KYC, GDPR, and others can seem extremely daunting to small, scaling teams, a methodical approach is key.

These suggested first steps can help startups begin navigating payment compliance:

1. Clearly define your revenue models, payment flows, and data collection plans as they relate to customers.
2. Research regulators and directives that apply based on those service offerings and locations.
3. Conduct a gap assessment evaluating where your people, processes, and systems currently stand on compliance.
4. Create a roadmap for achieving compliance before launch, focused on the highest risk areas.
5. Determine if third-party services like identity verification or payments infrastructure can offload compliance burdens.
6. Assign internal ownership across essential compliance domains as you scale.

With deliberate effort and priority placed on payment compliance, startups can certainly still achieve ambitious business goals without running afoul of regulators. Balancing innovation ambitions with legal obligations remains an ongoing, yet mandatory, balancing act.