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 Payments Systems in the U.S.
A GUI DE FOR THE PAYM ENTS PROFESSI ONAL

Carol Coye Benson

Scott Loftesness
Glenbrook Press
Menlo Park, California
Copyright © 2014 by Glenbrook Partners, LLC.

All rights reserved. No part of this publication may be reproduced, distributed or

transmitted in any form or by any means, including photocopying, recording, or other
electronic or mechanical methods, without the prior written permission of the publisher,
except in the case of brief quotations embodied in critical reviews and certain other
noncommercial uses permitted by copyright law. For permission requests, write to the
publisher, addressed “Attention: Permissions Coordinator,” at the address below.

Glenbrook Partners, LLC

1100 Alma Street, Suite 101
Menlo Park, CA 94025
www.glenbrook.com

Email:books@glenbrook.com

Quantity sales:
Special discounts are available on quantity purchases by corporations, associations, and
others. For details, contact us at the email address above.

While every precaution has been taken in the preparation of this book, the publisher
assumes no responsibility for errors or omissions, or for damages resulting from the use
of the information contained in it.

Book Layout ©2013 BookDesignTemplates.com

Payments Systems in the U.S./ Benson, Loftesness. —2nd ed. Kindle edition
ISBN 978-0-9827897-3-5
About Glenbrook
Carol Coye Benson and Scott Loftesness are two of the founding partners of
Glenbrook Partners. Founded in 2001, Glenbrook is a consulting, research and education
firm focused on the payments industry. Glenbrook brings to financial services and
financial technology clients a unique combination of specialized skills in payments,
many years of senior, hands-on experience, and a network of professional relationships.

About the Authors

Carol Coye Benson’s work is concentrated on mobile payments in the U.S. market,
business-to-business payments and bill payments, with a focus on product strategy
around consumer and business adoption of new payments methods.
Before founding Glenbrook Partners, Carol was a managing director of the Global
Institutional Services division of Deutsche Bank, leading marketing, client online
services, and Internet development. At Visa International, she led groups working on
eCommerce card security, database marketing, and technology investments. Also with
Visa International, Carol founded and managed a European product development office,
where she managed a series of eCommerce and chip card projects for banks across
Europe. Earlier, Carol spent twelve years with Citibank, where she managed the
development and market introduction of new commercial payments products. Carol
began her career as a corporate lending officer for large multinationals at both Bank of
America and Citibank.
In addition to her work as a consultant, Carol is the Partner in Charge of Glenbrook’s
Payments Education program, which provides executive training for professionals in the
payments industry.
Scott Loftesness works with major clients as well as financial services startups and
investors, helping with the refinement of business models, approaches to technical
design, and go-to-market strategies.
Scott brings over 30 years of experience in information technology and its
application to payments businesses. In his roles as a technologist, senior executive, board
member, venture investor, consultant, advisor, and mentor, Scott provides seasoned
judgment and a unique business perspective clients.
Earlier in his career, Scott was group executive vice president at First Data Merchant
Services. Scott also served as group executive vice president at Visa International, where
he led the development of Visa’s global payment systems strategies, including Visa’s
research and development initiatives related to card payments, ecommerce payments and
advanced card technologies.
Scott began his career as a systems engineer with IBM where he held a series of
technical management and product planning positions.
Thanks!
Carol and Scott want to thank Allen Weinberg, who co-founded Glenbrook Partners
with them in 2001, and their other partners: Russ Jones, Dennis Moser, Bryan Derman,
Jay DeWitt, Erin McCune, Jacqueline Chilton, Elizabeth McQuerry and George Peabody.
Thanks as well to our many clients and friends in the industry, who work on bringing
innovation to payments and making this the exciting business it is!
 Contents
Introduction
Payments Systems Overview
Core Systems: Checking
Core Systems: ACH
Core Systems: Cards
Core Systems: Cash
Core Systems: Wire Transfer
Perspectives on Payments Systems Users
Perspectives on Payments Systems Providers
Emerging Payments
Resources
 CHAPTER 1

Introduction
Payments are a big part of all of our lives. We pay for things we want and need. We
scramble for change in our purse or pockets; we shuffle through the cards in our wallet to
find the right one for a purchase. We write checks or pay bills online. We buy gift cards
and schedule mortgage payments. We worry about funding big purchases; we try to find
the right path for ordinary purchases. We’re all different. For some of us, convenience is
king; for others, control, or the collection of rewards, or following the patterns our
parents taught us, determine how and why we make payments.
As businesspeople, we may be involved in how our businesses make payments—to
employees, to suppliers, to governments. We may also be involved in how our businesses
collect payments—from consumers or from businesses.
These activities are central to our personal and business lives. And for some of us,
they are also the services that fuel our livelihoods. “Under the hood” of these simple
payment transactions are the systems, products, and companies that form the payments
industry.
This book is written for the payments professional. Payments professionals may work
for companies that enable payments transactions. This includes banks, of course, but also
many other types of companies—processors, payments services, software companies,
point-of-sale terminal manufacturers, service providers, risk managers, and others. Some
of these companies are powerful incumbents, while others are their competitors—start-
ups that are bringing innovation to the industry. Many of these fail or stagnate, but a few
succeed—and join the incumbents watching nervously for the next round of new
challengers. Other payments professionals are responsible within an enterprise for the
collection or disbursement of payments. Still others work as advisors, consultants,
lawyers, or investors in the industry.
As in any industry, the professionals in the payments industry struggle to keep up
with changes in the environment, in technology, and in the payments behavior of
consumers, merchants, and other users of payments systems. Some payments
professionals are well versed in one payments system (cards, perhaps, or ACH); others in
a function such as consumer marketing or risk management. This book provides a
comprehensive view of the entire payments industry, including all its systems and
functions.
This book is not a source for statistics or “league tables” on payments. There are
many such industry sources; each chapter includes a list of resources that offer more
information about a particular payments system or topic.
We have tried to be as unbiased as possible; any opinions, speculations, or anecdotes
on a topic are set in shaded boxes.
We very much welcome your questions and comments. Email books@glenbrook.com
and we’ll respond!
 CHAPTER 2

Payments Systems Overview

Payments transfer value from one end party to another. A payments system, as shown
in the figure below, defines how such value transfers are done and provides a framework
of rules for users of the system. ​

​
There are many types of payments systems. Most share these common
characteristics:
They operate within a single country, but on a national basis within that country.
They are denominated in the currency of that country.
They are subject, directly or indirectly, to regulation by the government of that
country.
They enable multiple parties to transact with each other.
Payments Systems in the United States
There are six core payments systems in the United States:
Cash
The checking system
The credit card and charge card systems
The debit card systems
The ACH (Automated Clearing House) system
The wire transfer systems
 As we will see in Chapter 10, there are many additional ways of making payments,
including methods such as online banking/bill payment and products such as email and
mobile telephone payments services. Almost all of these methods rely on one or more of
the core payments systems to actually transfer value between parties.
The Domains of Payment
Payments are used, of course, for multiple purposes. We categorize these uses into
six domains of payment, each of which exhibits unique characteristics and requirements:
Point of Sale (POS). Payments made at the physical point of sale. Includes store
and restaurant payments, but also unattended environments such as vending
machines and transit kiosks. POS payments are sometimes referred to as
proximity payments.
Remote commerce. Payments made for purchases where the buyer is remote.
This includes online and mobile purchasing, as well as mail-order or telephone-
order buying. Key segments are eRetailing, online travel and entertainment,
online subscriptions, and digital content.
Bill payment. Payments made by individuals or businesses based on receipt of
what is typically a monthly bill.
P2P payment. Person-to-person payments. Includes domestic payments among
friends and families, but also cross-border remittances (e.g., migrant worker
payments to relatives in home countries), and account-to-account transfers by
individuals (referred to as “A2A” or, sometimes, “me to me” payments).
B2B payment. Business-to-business payments. Includes payments from buyer to
supplier, but also intracompany payments and, significantly, financial market
payments (bank-to-bank payments, securities purchases, foreign exchange
transactions, etc.). For the purposes of this framework, governments, nonprofits,
and other types of enterprises are included as “businesses.”
Income payment. Payments to individuals for salary, benefits, and expense
reimbursements.

TERMINOLOGY
Throughout this book, we use the term “end party” to refer to both the receiver and the
sender of funds. An end party may be a consumer, or may be a merchant or other
enterprise—for example, a biller, small business, government, or non- profit. In any
payment transaction, one end party is the payer, and one the receiver, of funds; as we
will see, either the payer or the receiver may initiate the payment, depending on
payments system and type.
We will use the term “provider” to refer to parties who are providing access to the
payments systems to end users and/or other providers. Banks, networks, clearing
houses, processors and service providers are all types of providers. Finally, we use the
term “bank,” unless otherwise noted, to refer to all depository financial institutions in
the United States, including credit unions, thrifts, and savings banks.

The payments systems support activity across these payments domains, and, in fact,
compete with each other at a systems level. A good example of this occurs in the B2B
payments domain where checking, the traditional payments system used, is in decline.
All of the electronic payments systems are competing for volumes shifting away from
check. The ACH system has specialized transaction codes for B2B payments, and carries
remittance data along with the payments. The card networks have business purchasing
cards and small-business credit and debit card products. The wire transfer systems are
enhancing their networks to carry remittance data to meet the requirements of this
domain. Meanwhile, the checking system itself, through imaging, remote deposit
capture, and other advances, is competing to maintain volume.
Payments System Volumes
Payments system volumes are measured in two ways: by count and amount. “Count”
refers to the number of transactions made, and “amount” to the Total dollar value of
those transactions. (Note–other sources, in the card systems in particular, use the term
“volume” refers to the amount, or the dollar value of the transactions.)
Some systems do a better job of measuring themselves than others. The card and wire
transfer systems, for example, have quite precise measures. But checking, and especially
cash, have no formal mechanisms for national measurement, and are therefore simply
estimated.
The table below shows Glenbrook’s estimates for U.S. payments systems volumes as
a percent of total payments systems transactions for the year 2012. Note that wire
transfers are excluded: had they been included, wire would represent less than 1% of the
total “count”, but 93% of the total “amount”—this is because of the high-value financial
market transactions that use that system. The totals shown are large—much larger than
GNP, for instance. This is because a single payment transa ction (such as a consumer
purchase) can result in multiple payments system transactions, as the various parties in
the value chain move funds to effect payment, settlement, etc.
Payments System Models
Payments systems can operate on a variety of models.
Open Loop Systems
Open loop systems operate on a hub-and-spoke model. Almost all large-scale
payments systems use this model. An open loop system requires intermediaries (almost
always banks or depository financial institutions) to join the payments system. These
intermediaries then form business relationships with end parties (consumers, for
example, or merchants).

A transaction is passed from one end party to his or her bank, on to the network, on to
the other end party’s bank, and on to that end party. This structure allows the two end
parties to transact with each other without having direct relationships with each other’s
banks. The banks, similarly, can transact with each other without a direct relationship.
Today, most electronic payments systems—both paper-based and electronic (cards,
ACH, wire transfers and even check images)—operate on this model. This is true despite
the fact that current technology would quite easily permit the exchange of electronic
transactions on a bilateral basis. But, as we will see, the open loop model also creates an
effective means of allocating liability.
 The advantage of the open loop structure is that it allows a payments system to scale
quite rapidly. As intermediaries join the payments system, all of their end party
customers are immediately accessible to other intermediaries participating in the
payments system.

ORIGINS: CHECK CLEARING HOUSES

Initially formed in the 1800s, check clearing houses were the first large-scale open
loop systems in the United States. Before clearing houses existed, each bank receiving
a deposit containing a check drawn on other banks needed to present that check
directly to the check writer’s bank in order to collect payment on it.
As the volume of checks in use rose, this required a complex web of bilateral
relationships among banks in a city. Clearing a check drawn on a bank in another city
was even more complicated, and often required one or more correspondent banks to
effect payment.
The earliest check clearing house was a simple meeting, each business morning, of
representatives from each participating bank in a city. Clerks from each of the banks
would come to the clearing house bearing bags of checks. At the clearing house, the
checks would be exchanged and each clerk would depart with the checks written on
accounts at his bank. (It is interesting to note that in the early phases of the card
industry, paper “sales drafts” were cleared in much the same way.)

Closed Loop Systems

A closed loop payments system operates without intermediaries. The end parties,
most typically consumers and merchants, instead directly join the payments system. The
original American Express and Discover systems, and the proprietary card systems (for
example, a Sears credit card accepted only at Sears) are examples of closed loop
systems. Most payments services providers operate as closed loop systems, although
some may access open loop systems for transaction funding or delivery.
Closed loop systems have the advantage of simplicity. As one entity sets all of the
rules, it can act more quickly and more flexibly than the distributed open loop systems,
which must propagate change throughout the system’s intermediary layers. The
disadvantage of closed loop systems is that they are more difficult to grow than open
loop systems; each end party must be individually signed up by the payments system.
As we will see in Chapter 5, some of the closed loop card payments systems are in
the process of evolving toward more open loop models.
Payments services providers, such as PayPal or Western Union, operate closed loop
systems. But it is important to note that these providers themselves are users of the open
loop systems, often on an aggregated basis. They use the open loop systems to fund
transactions from senders and/or to deliver payment to the receiving party.
Payments System Functions
Payments systems must provide three key functions: processing, rules, and brand.
Some payments systems provide all three functions through a single organization. Others
accommodate these functions via a virtual, or distributed, model.

Processing means switching—the way in which a transaction moves from one party
to another. In a closed loop system, this transfers value between the end parties. In an
open loop system, this transfers value between intermediaries on behalf of their end
parties. As the term is used here, processing also includes settlement—the process by
which intermediaries in an open loop system transfer value—usually on a net basis—to
cover the individual transactions each has been party to.

PAYMENTS SYSTEMS

“On-us” transactions occur when the bank intermediary is the same on both sides of a
transaction. Depending on the payments system, the transaction may stay within the
bank (e.g., never be submitted to a clearing house or “hub” for switching), in which
case the bank settles the transaction through an internal book transfer. In other
systems, an on-us transaction is passed through the system and returns to the bank, just
like a regular “off-us” transaction. The growing concentration of U.S. banks is
increasing the percentage of “on-us” transactions.
Correspondent banking relationships between banks allow smaller banks, which may
not participate directly in a payments system, to access that system on behalf of their
customers through a relationship with a participant bank. Many smaller banks in the
United States gain access to the wire transfer systems in this way. This model is also
used extensively for cross-border payments.

Rules (sometimes called “operating rules” or “operating regulations”) bind each of

the participants in a system. In an open loop system, the rules bind the intermediaries.
Although the rules may require intermediaries to require certain things of their end
parties, the end parties are not directly bound by the rules. In a closed loop system, the
rules bind the end parties directly.
Brand is the means by which the parties to a transaction communicate to each other
how they will pay. This is sometimes branding with a “capital B” (e.g., “do you take
MasterCard?”) and sometimes with a “small b” (“I’ll give you a check”.) For the card
networks in particular, significant brand advertising has been an important driver of
payments system growth.
Payments Systems Flow
The switching function in an open loop payments system is a message flow from the
first intermediary to the network (which could be, in a centralized model, the payments
system itself, or, in a distributed model, a hub or a clearing house) to the second
intermediary. This message always flows in the same direction. What the message says,
however, is different depending on whether the payment is a “push” or a “pull” payment.
While the concept of push and pull payments can be confusing, it is essential to
understanding the workings of payments systems—in particular the risks and liabilities
borne by the parties to a transaction. “Push” or “pull” refers to the action of the
intermediary entering the transaction into the system. Push and pull payments are
illustrated below:
 Any time that “End Party A” is sending money to “End Party B,” it is
considered a push payment—for example, a wire transfer or an ACH direct
deposit of payroll. Taking the direct deposit as an example, we see that the
employer (“End Party A”) is instructing its bank to send money to employees
through the ACH network. In effect, the first bank is saying to the second bank,
“I am debiting myself; you should credit yourself.”
When “End Party A” collects money from “End Party B,” it is considered a pull
payment. Checks, cards, and ACH debit transactions are pull payments. Using a
check as an example, we see that the merchant (“End Party A”) is, by depositing
the check, instructing its bank to send that check through a clearing method to
collect payment from “End Party B” (the check writer). In effect, the first bank
is saying to the second bank, “I am crediting myself; you should debit yourself.”

PAYMENTS AND RISK

“Push” payments are fundamentally much less risky than “pull” payments. In a
“push” payment, the party who has funds is sending the money, so there is essentially
no risk of NSF, or nonsufficient funds—”push” payments can’t “bounce.”
Furthermore, in a “push” payments system the transaction is initiated by the sender’s
bank, which knows that its end party has the money. Other types of fraud, of course,
are still possible.
“Pull” payments are inherently subject to “bouncing.” The bank initiating the
transaction does not know whether or not the bank receiving the transaction will be
able to successfully apply that transaction to the credit or debit account of its
customer. Furthermore, “pull” transactions depend on the payer (“End Party B”)
having authorized the “sender” of the message to effect the transaction. (A signed
check presented to a merchant, or a card swipe with signature or PIN, are examples of
such an authorization.)
Card networks are fundamentally “pull” payment networks. Card payments don’t
bounce—but this doesn’t mean that they are push transactions. They are rather
guaranteed “pull” transactions. The card networks accomplished this by adding a
separate message flow, called the authorization, that runs through the network before
the “pull” payment transaction is submitted. This authorization transaction asks, “Are
there sufficient funds, or available credit balances, to pay this trans- action?” If so,
the “pull” transaction is submitted. Card network rules specify that merchants
receiving this “yes” reply are covered for both insufficient funds and fraud risks.
(Important differences in eCommerce and other environments in which the card is not
present will be discussed in Chapters 5 and 8.)

Payments System Settlement

Settlement in an open loop system refers to the process by which the intermediaries
actually receive or send funds to each other. The settlement function in an open loop
system can be done on either a net or a gross settlement basis:
 In a net settlement system, the net obligations of participating intermediaries
are calculated on a periodic basis—most typically daily. At the end of the day, a
participating intermediary is given a net settlement total and instructed either
(a) to fund a settlement account with that amount, should it be in a net debit
position, or (b) that there are funds available to draw on in its settlement
account, should it be in a net credit position. Checking, card payments systems,
and the ACH are all net settlement systems in the United States. In a variant on
the net settlement approach, settlement of checks and ACH, when handled
through a Federal Reserve bank, is done on a batch basis: a bank’s account at a
Federal Reserve Bank is periodically credited or debited with total amounts
from a batch of transactions which have been processed.
In a gross settlement system, each transaction settles as it is processed. With the
Fedwire system, for example, a transaction is effected when the sending bank’s
account at a Federal Reserve Bank is debited and the receiving bank’s account at
a Federal Reserve Bank system is credited. No end-of-day settlement process is
necessary.
How end party settlement is effected depends on the payments system. The timing
and manner of a credit or debit to a consumer, merchant, or enterprise account may be
defined by the payments system, by regulation, or simply by market practices.
In a closed loop system, the only settlement is the end party settlement. The operator
of the system defines how such a settlement is handled.
The Virtual Systems
Two core United States payments systems, cash and checking, operate on a virtual
basis. By this we mean that there is no formal payments system that end parties, or bank
intermediaries, “join.”
We all know, of course, how cash works. The transaction is “switched” and “settled”
directly between the two end parties. From that perspective, it is a push system. Other
aspects of cash payments are covered in Chapter 6.
The checking system in the United States automatically includes all depository
financial institutions—they do not have to “join.” Banks do, however, usually join one or
more clearing houses to switch and settle the checks they receive in deposits. The
clearing houses have rules, but these are much more limited in scope than the rules of the
card or ACH networks. In part, this is because paper checks are covered more
extensively by U.S. law and regulation. Other aspects of checking are covered in Chapter
3.
These virtual systems have no “capital B” brand, and no central network that
promotes their use.
Payments System Ownership and Regulation
Ownership
Most United States payments systems began as bank-owned systems. Over the past
decade, as the table below shows, many of these systems have migrated to different
ownership models. Some of the non-bank-owned payments systems are publicly traded
companies; others are privately held.

Payments systems that are owned by large groups of banks tend to make rules that
benefit the banks as a group. This can have the effect of “leveling the playing field”—all
participating banks have equal access to products and services. Systems with large
budgets for staff and advertising (notably the card networks) create fully defined
products that the member banks then distribute to their customers. Systems with smaller
budgets (such as the ACH) do much less in the way of product definition and
management, and only provide the operating rules and/or platforms that the banks then
use to create products.
Regulation
Payments systems in the United States are regulated by a mix of governmental and
private rules. Government rule, of course, is by law, and by regulations issued by
agencies of the government to implement those laws. In the United States, the primary
issuer of payments regulations is the Federal Reserve Board. Private rules can either take
the form of network rules, or of simple contracts applying to a service used: the Federal
Reserve Bank’s operating circulars (governing the use of the Federal Reserve Bank
payments services offered to banks) are an example of this. Private rules can be thought
of as “agreement-based”.
Private System Rules
Most payments systems require either intermediaries (open loop systems) or end
parties (closed loop systems) to formally join the system. The party joining the system is
bound by the rules of the system. In an open loop system, the intermediary’s contract
with its end party often contains provisions dictated by the operating rules, making the
end parties indirectly governed by some of the rules. These operating rules are extremely
important, particularly for open loop networks, as they define the parameters necessary
for successful interoperability among thousands or millions of end parties.
Operating rules cover a wide range of topics, including:
Technical standards . Data formats, token (e.g., card) specifications, delivery
and receipt capabilities, data security standards, etc.
Processing standards. Time limits for submitting and returning transactions,
requirements for posting to end party accounts, etc.
Membership requirements. Types of institutions that can join, capital
requirements, etc.
Payment acceptance requirements. Constraints on the ability to selectively
accept payments transactions.
Exception processing and dispute resolution. Rights and requirements of
intermediaries and end parties, often with respect to disputing or refusing a
transaction.
Fees. Processing and other charges paid to the payments system; interchange, if
any, among the intermediaries.
Brands and marks. Standards for use of the payments system brand.
A new product at the payments system level (for example, contactless cards) or a new
transaction type (for example, NACHA’s WEB transaction) generally requires a new set
of operating rules that apply to that particular product or transaction type. Operating
rules requirements can have significant financial impact on both users of and providers
to a payments system. Investment may be required to meet technical standards, or to
provide certain forms of services, such as dispute resolution; changes in definition of
liability or allocation of risk can also have large effects.
Some open loop payments systems, Visa, MasterCard, and NACHA, make most of
their operating rules publicly available on their websites. (Note that in the global open
loop card networks, each region has its own operating rules; an additional set of
international operating rules covers cross—border transactions.) Other payments
systems, such as CHIPs and most of the PIN debit networks, do not make their operating
rules available to nonmembers.
Changes to the operating rules of a payments system can be difficult and take years to
implement. Most payments systems have several tiers of committees through which
participants consider proposed rules changes. There is often a year or more of lag time
between approval and implementation of a new rule.
The check payments system in the U.S., as discussed above, is a “virtual” system
with no central authority. Banks do, however, join one or more check clearing houses to
process checks. These clearing houses act like payments systems in that their operating
rules bind the members. Such rules tend to be narrow in scope, however, compared to
those in the card, ACH, and wire transfer systems. Check clearing house rules may
specify times for presenting or returning items, image standards, etc.
United States Law and Federal Reserve Bank Regulation
 U.S. law regulates some payments systems specifically, and others more generally.
Federal Reserve Bank regulations implement law and specify requirements that are
binding on the banks that they regulate. Key laws and regulations include:
U.C.C. Article 3—Negotiable Instruments.
U.C.C. Article 4—Bank Deposits and Collections.
U.C.C. Article 4A—Funds Transfers.
The Check Clearing for the 21st Century Act (Check 21).
The Credit Card Accountability Responsibility and Disclosure Act of 2009.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010,
including the Durbin Amendment
Federal Reserve Bank Regulation E (implementing provisions in the Electronic
Fund Transfer Act) applies to consumer electronic transactions including debit
cards, ATM withdrawals, and ACH transactions (but not credit cards). Among
other provisions, Regulation E establishes key consumer rights for repudiation
and reversal of non-authorized transactions.
Regulation CC—Availability of Funds and Collection of Checks.
Federal Reserve Bank Regulation Z - Truth in Lending, prescribes uniform
methods for computing the cost of credit, for disclosing credit terms, and for
resolving errors on certain types of credit accounts.
Federal Reserve Bank Regulation J - Collection of Checks and Other Items by
Federal Reserve Banks and Funds Transfers through Fedwire, establishes
procedures, duties, and responsibilities among (1) Federal Reserve Banks, (2)
the senders and payers of checks and other items, and (3) the senders and
recipients of Fedwire funds transfers.
Federal Reserve Bank Regulation II, limits the amount of debit card interchange
for regulated (large) banks and specifies minimum routing options for debit
card networks.
IMAGE CLEARING AND REGULATORY FRAMEWORK

Today, banks, processors and clearing houses are dealing with a complex regulatory
framework following the dramatic shift to image clearing. For example, some
regulations that apply to paper check clearing no longer apply to image clearing.
This is a transitional period for the industry as it evaluates the right regulatory
model for an all-image clearing world.
A number of other significant laws, regulations, and orders fall under the general
category of bank regulation. These include regulation around money laundering, privacy,
credit reporting, and other issues relevant to payments. Regulatory requirements around
“Know Your Customer” (KYC) are particularly important for banks and non-banks in the
payments industry. Provisions mandated by the Bank Secrecy Act and USA PATRIOT
Act require a variety of identity checking procedures prior to opening a customer
account.
State Banking Authorities
State law and regulations by state banking authorities apply mostly to non-bank
providers of payments services, and are referred to as “money transmitter regulations.”
They regulate sales and issuance of payments instruments, as well as transmitting or
receiving money. Many states require that money transmitters obtain a state license, post
a bond, and/or maintain certain levels of net worth or permissible investments. Notably,
state money transmission regulation is not uniform, creating additional challenges for
payments companies with national ambitions. State banking authorities also regulate
state-chartered banks.
THE FUTURE OF PAYMENTS REGULATION

It is interesting to reflect on what the future may hold for U.S. payments regulation.
One can argue that the U.S. permits much more self-regulation of key payments
systems than do other countries. This may be because banks in the U.S. are heavily
regulated, by multiple authorities. The payments systems, historically owned by
banks, were therefore de facto under a regulatory “umbrella.” Today many payments
systems are no longer bank-owned. Does this mean that federal regulators may begin
to take a more active role in the industry?

Economic Models for Payments Systems

Payments systems providers, including banks, networks, and processors, make money
by providing access to payments systems for end parties. End parties include consumers,
merchants, and enterprises (billers, other businesses, governments, and nonprofit
groups). Processors and networks also make money by providing payments services to
intermediaries such as banks. Many banks provide payments services to other banks as a
part of correspondent banking relationships. Merchants may also provide payments
services—for example, when they provide private-label or gift cards to consumers.

In this book, we will examine the economics of each core payments system in turn.
But a few general observations can be made about payments system economics:
 In both open loop and closed loop payments systems, providers have a direct
business relationship with end party customers. Providers set prices for their
services, as do other businesses. Providers realize revenue from payments
through direct and indirect sources. This is true whether the end party is a
consumer or an enterprise. Direct revenue comes from fees explicitly charged to
the end party; these may include transaction fees, interest on associated loans,
monthly maintenance fees, and exception fees (overdraft fees, bounced check
fees, late payment fees). Indirect revenue comes from net interest income on
deposit balances, float, and interchange.
In some open loop payments systems, the rule-making body may define
interchange for the system: a fee paid by one intermediary to the other in partial
compensation for handling the transaction.
Providers often price payments products as part of an overall bundle of services
—for example, a checking account with bundled ATM access, checkwriting
privileges, and a debit card. Similarly, a processor may price card acceptance
services to a small merchant on a bundled price model—but may price the same
service to a large merchant on an unbundled basis.
Costs associated with providing payments services are a mix of fixed and
variable costs. Typically, payments system providers have very high fixed costs
and very low incremental costs for each transaction. A bank, for e xample, needs
to cover the costs of staffing and maintaining a branch, engaging the service that
replenishes its ATMs, and working with a check processing center. While unit
costs may be calculated (add up the expenses and divide by the number of
transactions), they are not always accurate indicators of incremental costs.
Many banks realized this as a problem in the last decade when check volumes
began to drop sharply, creating a “death spiral” in which the same fixed-cost
base was spread over a smaller and smaller number of checks. With the advent
of image clearing, however, banks were able to stop this process and reduce
check processing costs.
The payments industry is different from other processing industries in one very
important aspect—the value of the money being transferred through the system.
Providers who realize revenue related to the gross value of the payment
transaction (the “amount”) are more likely to have profitable businesses than
those who realize revenue simply on a fee-per-transaction basis (a “click fee”).
This type of ad valorem (percent of value) revenue may be direct (a fee
calculated as a percentage of the amount of the transaction, or an interest rate
applied to a loan balance) or indirect (the value of deposit balances held at a
bank, or float).

INTERCHANGE

What is Interchange? Interchange is an element of payments system economics used

by some open loop systems, particularly by card networks. Interchange is a transfer
of value from one intermediary in a payments transaction to the other intermediary in
that transaction. The payments system sets the interchange prices, but does not itself
receive the value of interchange. Inter- change creates an incentive for one “side” of
 the transaction to participate, by having the other “side” reimburse some of the costs
incurred.
PAYMENTS SYSTEMS AND INTERCHANGE: SOME HAVE IT, SOME DON’T

In the U.S., the wire transfer, ACH, and checking open loop systems operate without
interchange—that is, there is no network-defined transfer of value between the
“sending” and “receiving” banks to such transactions. Card network transactions do
bear interchange. The sometimes dramatic difference in economics that results is
fueling a number of different alternative payment schemes.

The economics of exception processing are critically important to the payments

industry. An exception item may occur simply because of a processing error (for
example, a check shredded in a sorter). It may, in the case of a pull transaction,
bounce. Or it may be the result of a customer inquiry or dispute. Typically, the
cost of handling these exception items is much higher than the cost of handling
a standard transaction. The efficiency with which a provider manages the
exception process may significantly define the overall economics of the product
for that provider. In recent years, providers have been increasingly aggressive in
pricing exception transactions to end parties. In some cases, the revenue from an
exception transaction far exceeds the cost of the transaction, and contributes
significantly to the profitability of the product. This is the case, for example,
with bounced check fees, card overlimit fees, and, in most cases, overdraft fees.

RISK, FLOAT
Risk Pays Whenever a provider—for example, a credit card issuer or a payments
services provider—proactively assumes risk that another party would otherwise bear,
it is apt to be well compensated. A provider that assumes risk but does not manage it
well, or (worst case!) does not understand that it is assuming risk, is apt to have a
short business life.
What is Float? (Part 1 of 2) Float is the value earned from money held over a period
of time. It is a benefit to a party that holds funds for a period of time before needing to
pay them out. It is a cost to a party that needs to pay out funds prior to receiving them.

Risk Management
All payments transactions are subject to risk. Some risks, notably that of fraud, have
a very high public profile. But there are many types of risk, and all parties to a payments
transaction bear some portion of the risk.

OPEN LOOP SYSTEMS AND THE CHAIN OF LIABILITY

In open loop systems, intermediaries and the network assume certain liabilities for
the actions of their customers, as well as for their own actions. The nature of these
liabilities is determined by the operating rules of the payments system. In the ACH
 system, for example, the originating bank of an ACH debit transaction warrants that
its customer has properly obtained the consumer’s consent for the debit to his or her
account. If the consumer successfully disputes a transaction, the originating bank
must reimburse the consumer’s bank. The originating bank will, of course, try to
recoup this from its customer—but if unsuccessful, the bank is left “holding the
bag.” Similarly, in the card networks, if a customer initiates a dispute that
(according to the rules) requires a transaction to be reversed, the acquiring bank is
ultimately responsible to the network for the obligation of its merchant customer.
As shown in the consumer and merchant example in the table below, there are many
types of payments fraud risk, some specific to certain payments systems and others
which are more general. Some payments systems, such as the card systems, have very
high levels of system-defined fraud management. Others, such as checking and ACH,
leave more of the fraud risk management to intermediaries and end parties.

Some of the primary categories of payments risks that require management:

Credit risk. A credit card issuer bears obvious credit risk: the cardholder may
simply fail to repay his or her loan balance. But there are other types of credit
risk inherent in payments. Whenever a bank, for example, extends an overdraft
rather than bouncing a pull payment (be it a debit card, check, or ACH debit), it
incurs credit risk. Less obviously, a bank on the “send” side of a pull transaction
(a card acquiring bank, or a check deposit bank) incurs credit risk because it is
assuming financial responsibility for the actions of its customer.
Fraud risk. As shown in the consumer and merchant example in the table
below, there are many types of payments fraud risk, some specific to certain
payments systems and others which are more general. Some payments systems,
such as the card systems, have very high levels of system-defined fraud
management. Others, such as checking and ACH, leave more of the fraud risk
management to intermediaries and end parties.
Operations risk. Occurs when one party to a transaction either fails to do what
is expected or does something in error. A wide range of situations fall into this
category: missed deadlines, incorrectly formatted files, machines that fail to
start or operate correctly (e.g., check sorters jamming), etc. An operational error
can have extremely serious financial consequences if, as a result, a party to the
transaction ends up holding funds that it is obligated (by rules) to pass on to
another party. Each payments system has a combination of rules and working
practices by which intermediaries in the system try to help each other recover
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any one who might take the pains to investigate would discover that
he is not reading the paper. The score or more of others are
occupied in their drink, jest and song.
Felton has regained his composure and lights a cigarette with a
steady hand.
“Are you aware, Senor Van Zandt, that at one word from me my
men would cut you to pieces?” he sneers.
“I know that one such word will mean your instant death,” is the
stern response.
“Well, I shall not utter it,” says Felton, coolly. “I am competent to
take care of myself. A moment ago you called me a coward. I will
prove to you that I am not. You seek satisfaction?”
A bitter smile flits over Van Zandt’s face. “Satisfaction!” he
murmurs. “Ay, I demand satisfaction for two years of utter misery
and, by heavens, I shall have it!”
“You shall! I swear it!”
“Ah! And when?”
“At once. This is my only opportunity to accommodate you at
present, as I am ordered to Cienfuegos to-morrow. Come, I will wait
for you without.” So saying, Felton turns on his heel.
Van Zandt regards him with a look in which suspicion is mingled
with a trace of admiration for his sang froid.
“You will attempt no treachery?” he says, sternly.
“I tell you, sir, I am not a coward,” answers Felton, haughtily.
“That he is not,” mutters the soldier with the scarred forehead,
and he adds, as if addressing the newspaper in his hand: “This is a
devilish unfortunate affair. I must have a hand in it. Hello! Was not
that a woman’s scream?” He rises and, throwing open the door
leading to the rear of the cafe, steps out upon the veranda. An
instant later he dashes the door shut with an ejaculation of
amazement.
 Standing at the further end of the veranda, terror depicted in her
colorless cheeks, is Louise Hathaway. A dozen feet from her is one of
the troopers, who has strolled out upon the veranda, and, while
much the worse for liquor, has plainly insulted the American girl.
When the new-comer arrives on the scene, he sees the caballero
wiping the blood from a long, deep scratch across his rage-contorted
face. Between insulter and insulted Cyrus Felton interposes a feeble
barrier.
With a muttered malediction the baffled Spaniard turns and re-
enters the cafe, followed by the scarred soldier, whose timely arrival
has doubtless saved Miss Hathaway from further affront.
“Jove! I shall have my hands full for a few minutes,” that individual
soliloquizes. “Ah, one moment,” as Van Zandt attempts to brush by
him. “You have some friends out here, senor.”
“Well?” demands Van Zandt, with a stare.
“Get them away at once, or these devils in here may make it hot
for them.”
“I do not understand.”
“You have no time to listen to a lengthy explanation. Do as I
direct. Send your friends to the consul’s and have them avoid the
main road. There is a path through the garden, and beyond that a
trail down the hillside to the beach. It is but a mile to the consul’s
residence by that route. They’ll be safe at the consul’s.”
All this is delivered in low, rapid tones and as Van Zandt moves
away the soldier turns and sees the drunken cavalier standing within
a few feet of him, a malicious smile upon his evil face. “Hello! What
the devil are you playing the spy for?” cries he of the scar, and
passes on with the muttered thought: “I wonder if the chap
understands English.”
When Van Zandt rejoins Mr. Felton and Louise he finds the old
man as white as death and his head sunk upon his breast, while
Miss Hathaway is in a semi-hysterical condition.
 “I’m so glad you have returned,” says the latter, as she comes
forward to greet him and she tells him of the encounter with the
Spaniard.
“The scoundrel!” grits Van Zandt, starting toward the cafe. But he
remembers that he has more serious business on hand than
thrashing a drunken trooper, and he turns gravely to his
companions:
“Miss Hathaway, and you, Mr. Felton, I must ask you to proceed
immediately to the residence of the American consul. I have a little
matter that demands my presence here for another half-hour, and
meanwhile it will not be safe for you to remain. Nor will it be well to
go by the main road. The city is in the hands of a mob. The
scoundrel who insulted you is a fair example. I was warned by one
of the men within—an Englishman, I should judge from his voice and
manner.”
Mr. Felton and Miss Hathaway regard Van Zandt apprehensively,
and Louise wonders at the pallor of his face and the strange look in
his eyes.
“You know where the residence of the consul is. You must follow
yonder path through the garden, and strike the trail down the
hillside to the sea; it is only a short walk. I will rejoin you there
within the hour—if I live,” says Van Zandt, with a significance not
understood by his auditors.
Without a word Cyrus Felton rises and, followed by Miss
Hathaway, starts off through the garden in the direction indicated by
Van Zandt’s outstretched arm.
While all this has taken place Ralph Felton has been leaning in the
doorway at the front of the cafe. He looks up when Sanchez, the
besotted subaltern, comes in from his encounter with the American
girl, and signals to him.
“Sanchez, I have a little affair of honor to settle within the hour,”
he says. “If I do not return, you are second in command. You
understand?”
 “Is it ‘a la mort’?” inquires Sanchez.
Felton nods and turns away, and Sanchez goes back into the cafe
in season to hear the last words of the warning extended to Van
Zandt by the soldier with the scar.
Felton lights another cigarette and awaits indifferently the
appearance of his implacable foe.
“I am ready, sir,” says a stern voice at his elbow.
“And I have been ready for some minutes. Come.” And Felton
leads the way across the road and into a path to the woods.
The soldier with the scar walks out into the dooryard and watches
the disappearing figures. “That duel must not take place,” he says.
“But how on earth am I to prevent it? Hello! What’s this?”
His attention is attracted by an ejaculation within the cafe. Two
men are whispering by the window next the entrance.
“What deviltry is this?” he scowls, bending his head. And as he
listens the scowl deepens on his face, and his fingers clutch at his
pistol stock. “By heavens! I must prevent that duel now,” he mutters.
Simultaneous with a command given to the half-intoxicated
Sanchez, he of the scar hears the sound of a shot over in the woods.
“Treachery!” he exclaims, and bounds away in the direction of the
report.

Felton and Van Zandt proceed silently into the thicket. A short
distance from the entrance to the woods is a cleared spot.
“This will probably suit our purpose,” remarks Felton, and, coolly,
he measures off ten paces.
“That will be distance enough, will it not?” he asks. Van Zandt
nods.
“Will you give the word, Mr. Van Zandt?”
 “As you please. We will fire at the word ‘Three.’” Both men draw
their revolvers.
“One moment,” interrupts Felton. “In the event of a second fire?”
“There will be no second fire,” is the grim rejoinder. “I shall kill you
with the first.”
“And I will endeavor not to waste mine. Well, sir, I am waiting.”
“One!” Two arms are raised, and not a tremor in either.
“Two!” The pistols click.
The word “Three” is trembling on Van Zandt’s lips, when a shot
rings out from the thicket. Felton clasps his hand to his abdomen,
with an exclamation of pain, sways a moment and pitches headlong
to the earth.
The bushes part and a woman, heavily veiled, steps forth,
smoking pistol in hand and walks to where Felton lies.
She looks upon the body for a moment in silence, and hisses:
“You cowardly hound! Your end is fitting!” Then, throwing back
her veil, she reveals the face of Isabel Harding.
“I have saved you, Phillip,” she says, with a calmness that is very
near madness.
“You have cheated me of my vengeance,” he replies, looking
gloomily upon the body of her victim.
“My wrongs called for greater vengeance than yours,” cries the
woman, her eyes glittering feverishly and her voice breaking
hysterically. “I followed him here. I saw through the cafe window
your meeting with him, and I exulted that I was in time—in time to
save the man I loved! Phillip! Phillip,” sobs Isabel, sinking on one
knee beside him, “I told you that some day you would realize how
much I loved you!”
But Van Zandt, with a shudder and expression of utter aversion,
turns away.
 “Ah, I see I am too late,” remarks a quiet voice, and Van Zandt
looks up to see the friendly soldier with the scar.
“To the consul’s if you would save the American girl,” says the
latter. “I’ll look after these obsequies. Come, be off,” as Van Zandt
stares at him in surprise. “A plot is afoot, headed by that precious
Lieut. Sanchez, and you have no time to lose.”
“But the consul—”
“The consul was at his office in the city two hours ago, and is
doubtless there yet. Ah, you are too late.” The clatter of departing
hoof-beats is borne upon their ears. “No; you can reach the consul’s
ahead of them, by the short-cut down the hillside. Here! Take my
revolver! You may need more than one. And mind, don’t waste any
ammunition,” shouts the soldier, as Van Zandt dashes off.
Then he turns to the scene of the tragedy. He kneels beside
Felton’s body and makes a brief examination. Then he straightens
up.
“Go!” he says sternly, to Mrs. Harding. “Your work is done!”
She stares at him a moment, with her glittering eyes; then, with a
little shudder, tosses the revolver into the bushes, turns and walks
slowly away.
The caballero watches her out of sight and again turns to the body
of the Spanish captain.
“Humph!” he grunts, as he lifts the limp form from the ground.
“He is worth a dozen dead men, or my name isn’t John Barker.”
 CHAPTER LIV.

AT BAY IN THE CONSUL’S HOUSE.

“There is something very odd in Mr. Van Zandt’s actions,” remarks

Miss Hathaway, as she and Mr. Felton follow the winding trail down
the hillside to the sea. The latter offers no explanation. He has aged
fearfully in the last half-hour, and it is now a bowed, feeble, old man
whom his companion more than once has to assist over the
obstacles in their rough path.
“To the consul’s. To the consul’s,” is all he says, and the journey is
finished in silence.
The residence of William Atwood, United States consul, is situated
about two hundred yards back from the shore, about a half a mile
below the mole at Santiago. The nearest neighbor is a quarter of a
mile away, toward the city. It is a plain, square, two-storied
structure. A broad veranda fronts both stories and ivy very nearly
conceals three of the walls of the building. An innovation, to the
Cuban view absurd, is an electric door bell, put in by the consul
himself. It is this bell that Mr. Felton presses, with the remark: “I
begin to feel at home already.”
The summons are answered by a porter who tells them that the
consul is gone.
 “Gone? Gone where?” demands Mr. Felton, with a start of
uneasiness that is inexplicable to Miss Hathaway.
The consul is at the city. Where, quien sabe? Probably at his office
in the city.
“We can do nothing except await his return or the arrival of Mr.
Van Zandt,” Louise says, as they step into the hall.
At the right of the entrance is the library. On the desk is pen and
paper, and here Cyrus Felton seats himself and writes, while Louise
stands in the doorway and watches him with troubled eyes.
Suddenly she hears the sound of footsteps hurrying up the walk.
The door is thrown open, and Van Zandt, breathing hard from the
exertion of his run, stands before her.
“Thank God, you are safe!” he cries, fervently.
“What danger threatens?” asks Louise, laying one hand upon Van
Zandt’s arm.
For answer he leads the way out upon the veranda. “Look!” he
says; and Miss Hathaway beholds the Semiramis, resting quietly
upon the still bosom of the bay.
“We must reach that yacht, or I fear we may not leave Cuba
alive!” he tells her.
Louise gazes at him in questioning dismay.
“Ah, there comes the enemy,” says Van Zandt, pointing up the
beach toward the city. A small troop of horsemen is approaching at a
lively canter.
“What is all this mystery? Why do you fear those men?” asks
Louise, as they re-enter the house.
“It is not for myself that I tremble,” replies Van Zandt, who is
critically examining his pistols.
“Then it is I whom they seek. Your silence answers yes,” says
Louise quietly. She is very white, but her voice does not tremble.
Like a true heroine she has grown calm in the face of danger.
“By heaven!” Van Zandt bursts forth; “my life stands between you
and those Spanish devils, and gladly do I place it there. As for you,”
turning to Cyrus Felton, who has risen from the library table and
stands near them, “I would not lift a finger to save your worthless
existence. For the wrongs which I have suffered, for the misery
which you and your son have caused me, I meant to have exacted a
bitter reparation, but fate has otherwise decreed. Ah, you know me!”
“Spare me your reproaches,” says the old man, lifting his hand in
protest. “I know you. You are Ernest Stanley. What I have dreaded,
yet for nearly a year expected, has come at last. My sin has found
me out.”
“Ah, that it has. But you are safe from my hands now, and maybe
from that of the law before this day is ended. Out of the way, unless
you wish your miserable life cut short by a Spanish bullet. Miss
Hathaway, I must ask you to step into the library, as our visitors
have arrived.” And, throwing open the door, Van Zandt stands upon
the threshold, waiting.
Lieutenant Sanchez and his men rein their horses within a dozen
paces of the house. The leader dismounts and comes leisurely up
the walk, apparently oblivious of the presence of Van Zandt, whose
watchful eyes are covering every movement of the scoundrelly band.
“One moment,” commands the American, holding up his hand. But
the Spaniard pays not the slightest attention.
“Halt!”
This time Sanchez pauses and strokes his mustachios with
exasperating calmness. “I would advise the senor to make no
opposition if he values his life,” he says.
“What is your errand here?”
“The American senorita, to whom I am indebted for this token.”
Sanchez indicates the long, dull-red scratch upon his unamiable
visage. “I have no time or inclination to parley with you, senor. Out
of the way, or I shall order my men to fire upon you.” The troopers
half-raise their carbines.
Van Zandt tears down a worn edition of the stars and stripes that
decks the wall above his head, and as he throws it across his breast
and shoulder his voice rings out defiantly:
“Fire upon the American flag, if you dare!”
The answer is a volley that splinters the woodwork about him and
brings down the glass above the door in a shower. Van Zandt feels a
sharp twinge in his left arm, and with an exclamation of rage and
pain he lifts his revolver and fires.
Lieutenant Sanchez falls dead in his tracks and there is an instant
scattering out of range on the part of his followers.
As Van Zandt closes the door and slips the bolt he turns to see
Cyrus Felton lying upon the floor, a stream of blood flowing from a
wound in his side.
“Fool! I cautioned him to keep out of range,” he exclaims, as he
bends over the old man.
“Is he badly hurt?” asks the voice of Louise.
“I fear so. We must retreat upstairs, as we may expect an assault
at any instant. Quick!”
As Louise ascends to the floor above, Van Zandt follows with his
unconscious burden. In the rear room is a sofa, and upon this Mr.
Felton is laid.
“I have but a few minutes to live. Forgive me,” he gasps.
“God may forgive you,” replies Van Zandt, turning bitterly away.
Louise takes his hand in hers.
“Surely, Mr. Van Zandt, you can forgive the past in this awful
moment,” she says, softly. “Remember, he was a father and he loved
his son.”
 At the contact of that little hand Van Zandt feels a thrill creep over
him.
“You know now who I am,” he says, dully. The blue eyes meet the
dark ones unwaveringly.
“I know that I believe in your innocence and that I trust you,” is
the quiet response. “Listen, he is speaking again.” They bend their
heads to catch the sinking man’s last words.
“In my—coat—papers,” gasps Mr. Felton, with his fast-glazing eyes
fixed on Van Zandt. “They—will—clear—your—name,” he finishes
and sinks back, exhausted by his effort.
“Cyrus Felton,” says Van Zandt, gravely, “if any forgiveness of mine
will afford you an iota of comfort on your journey to the other world,
it is yours.”
The dying man acknowledges the absolution with a glance. An
instant later his spirit passes to his Maker, to be judged by his deeds
in this world of sorrow and sin, of hope and happiness.

Again the Cafe de Almendras. The boisterous troopers are gone

and in their place a dozen or so quiet-appearing men in civilian dress
are grouped about the tables, drinking little and talking less.
It has been a noisy day, the patron tells a tall man with black eyes
and fierce mustachios, who lounges in the doorway and sweeps the
street with his keen gaze.
But the tall man heeds not the chatter of the patron; his gaze is
fixed curiously upon an approaching soldier, who bears across his
shoulder the limp form of a man in the uniform of a Spanish captain.
The face of the latter is hidden.
Barker brushes by into the cafe with the body of Ralph Felton, and
meets the contemptuous glance of the tall man with a searching
look that the latter does not fancy.
 “Ho, there, patron! A room and a doctor at once!” orders the
detective, and he gives the patron a handful of coin and effectually
silences his grumbling protest about making a hospital of the place.
Having deposited his burden above stairs, Barker returns to the
drinking-room and astonishes the tall man with the black eyes by
tapping him on the shoulder and remarking:
“I think I have met you before.”
“The mischief you have!” is the curt rejoinder.
“Now I am sure of it,” grins Barker. “Your voice has not changed,
but your mustachios do not fit you. Pardon me,” he adds, just in
season to prevent an outbreak, “I am indebted to you for this slash,”
indicating the scar across his forehead, “but I do not lay up any hard
feelings. I’ll call it quits if you will lend some friends of mine a
helping hand. I have got my hands full upstairs. Listen.” Barker
briefly recounts the episodes narrated in the previous chapter.
As the tall man listens his brow grows black as night, and when
the tale is finished his voice rings through the cafe in a sharp
command:
“Haste, my comrades! To the American consul’s to save my
friends!”
The quiet-appearing civilians about the tables leap to their feet as
one man, and, leaving the unpaid patron standing in hopeless
astonishment amid the ruins of the glassware he has dropped, the
little band sweeps out of the cafe.
“There will be music at the consul’s this afternoon, unless I am
greatly mistaken,” mutters Barker, as he looks down the dust-veiled
road. “And now for my patient. If he dies with his secret unrevealed
I’ll never forgive him!”
 CHAPTER LV.

A SIGNAL FROM MACEDONIA.

Van Zandt and Louise stand, hand in hand, gazing sorrowfully

upon all that is mortal of Cyrus Felton. A crash is heard below, as the
front door is burst from its hinges.
Van Zandt leaps to the head of the staircase just as the feet of a
brace of ruffians are on the lower step. Twice cracks his revolver and
his aim is true. One of the Spaniards falls and the second drops back
with a cry of pain. Then, as Van Zandt throws himself to one side,
there is a flash of fire below, and the bullets whistle harmlessly by.
As he judges, there is no immediate second rush by the attacking
party, so he proceeds to examine his surroundings and the result is
far from satisfactory. There is no serious danger of the besiegers
attempting to carry the staircase by storm. The Spaniard is not
lacking in courage, but it requires a considerable amount of sand to
lead the way to certain death. But the room to which they have
retreated was not built for a fortress and he realizes that the end
must come when the enemy will gain access to the second floor—by
the veranda or by the rear entrance to the building.
Suddenly his eyes rest upon a ladder at the other end of the short
hallway.
 “Quick!” he whispers to Louise, as he points the way to temporary
safety.
A minute later and they are on the roof of the building, the ladder
pulled up, and the scuttle fastened down. Over them floats, from the
flagstaff, the glorious banner of their native land, and above that
bends a sky of heaven’s deepest blue.
“Fairly outwitted!” says Van Zandt. Suddenly he feels a weakness
come over him and he sinks upon the sun-baked roof. Then for the
first time Louise notices that he is wounded, and she kneels beside
him with a very white face.
“It is nothing,” he reassures her. With her assistance he removes
his coat, tears open the left sleeve of his shirt and discloses a bullet
hole in the fleshy part of the arm. It looks more serious than it really
is and Louise feels an inclination to faint. But she resists it and
proceeds to bind up the still bleeding wound with strips torn from
her own silken petticoat. The golden head is very close to the brown
one, and as the fair surgeon bends to tie a knot, the soft sweep of
her hair steals away all of Van Zandt’s well-guarded reserve, and his
right arm encircles her in a passionate embrace.
“I love you! I love you!” he whispers.
And Miss Hathaway, being a sensible young woman, who knows
what she wants, does not remark upon the “suddenness” of the
declaration of love, but presses her red lips to his and tells Phillip
that she has loved him ever since she knew him.
But the lovers are brought back to earth by a chorus of yells and
picturesque profanity sufficient to supply the captain of a whaling
bark for an entire voyage.
“They have discovered our retreat,” whispers Van Zandt, as he lifts
the scuttle and listens to the tumult below. But he drops it as a
bullet crashes through a few inches from his head, and moves out of
such dangerous range. Then, as his eyes rest upon the flag above
him an idea seizes him—a veritable inspiration. He steps to the flag-
staff, detaches the halyards and the stars and stripes come fluttering
down to his feet.
“What are you doing with the flag?” asks Louise.
“Giving utterance to the old Macedonian cry,” he calls back, and up
goes old glory again, this time with the union jack down. “Pray that
my crew may see the signal,” he adds, fervently. And Providence
assists his effort, for a puff of wind streams the flag straight out
upon the breeze.
Capt. Beals is on the bridge of the Semiramis at this moment,
looking toward the shore, and his curiosity is excited.
He sweeps the roof top with one glance through his powerful
glance and then issues a command that echoes to the farthest
corners of the Semiramis.
A few moments later Van Zandt sees two boats cut shoreward
through the blue waters of the bay as fast as muscle can send them.
“Thank heaven!” he exclaims, as his heart bounds within him, and
he proceeds to hug Louise in a manner that vastly entertains Capt.
Beals, who is still an interested though distant spectator. And if the
bluff old sea dog could have made himself heard he would have
shouted a warning, for he discerns what Van Zandt cannot see—a
ladder placed against the side wall of the consul’s house and three
men ascending it, while back a short distance, with carbines raised,
stand the rest of the scoundrelly horde.
The attack bids fair to be successful, but suddenly rings out the
cry of “Santiago!” and the little band of patriots from the Cafe de
Almendras dashes upon the scene.
The Spaniards now have all the fighting they can attend to. Van
Zandt and Louise watch from the rooftop the progress of the battle
royal. The fight is won. No quarter is given, and those of the
Spaniards who have the ability to flee are in full retreat, and as they
disappear down the beach they shout:
“El Terredo! El Terredo!”
 Van Zandt sees a strange transformation in the appearance of the
leader of the rescuing party. During a hand-to-hand struggle with
one of the troopers his fierce mustachios have been knocked off, and
it is a handsome, beardless youth, with flashing black eyes, who
looks about him and remarks: “Well, my merry men, the victory is
ours, but where are the Americans?”
“Coming,” sings out Van Zandt, from the upper air. “We will be
with you in a minute.” And as he turns to Louise that young lady
proceeds to faint in his arms. It is a logical reaction from the strain
which she has borne with wonderful fortitude.
By this time the boats from the Semiramis have arrived, and in
them enough fighting Yankees to handle twice their number of
Spanish soldiery. A ladder is placed against the consul’s house and
the besieged are assisted to earth, one unconscious and the other
with an arm tied up.
While revivifying operations are under way Van Zandt hears a
startled exclamation at his elbow. It comes from El Terredo, who is
gazing upon the marble countenance of Miss Hathaway with
astonished and troubled eyes.
Without replying to Van Zandt’s questioning look, El Terredo picks
up his mustachios from the sand and again affixes them to his face.
Then he turns calmly to Van Zandt.
“The third of your party? I was told there was an old gentleman.”
“He is dead. Killed at the first fire,” Van Zandt tells him, and he
leads the way into the house.
As the two men look upon the body, which has not been disturbed
by the troopers, El Terredo shudders, and murmurs: “My God, what
does all this mean?”
“It means much to me,” replies Van Zandt, gravely, as he takes
from the dead man’s person a packet of papers.
Without speaking El Terredo steps to the sofa and assists Van
Zandt to bear the remains from the house.
 The body is laid in the bow of one of the boats, reverently
covered, and preparations are made for the return to the Semiramis.
When all but himself and the rescuing party from the cafe have
embarked Van Zandt turns to El Terredo, who, with folded arms, is
gazing abstractedly toward the law-and-order deserted city. “You are
going with us, are you not?” he asks.
“No; I shall remain here.”
“Your safety lies with yonder yacht.”
“Safety? Ah, senor, somewhere on this isle is one dearer to me
than personal security.” And the young man turns away to hide his
emotion.
“But you can gain nothing by remaining here now. The survivors
of the late scrimmage have recognized you and in half an hour the
whole town will be at your heels. Aboard my yacht you will be safe
and I will gladly land you at any point on the island you may
designate. Besides, the papers—”
“Say no more, senor,” exclaims El Terredo, extending his hand. “I
accept your generous offer.”
Dismissing his faithful followers, with the assurance that he will be
with them again ere many days, the revolutionary leader steps into
one of the waiting boats.
As they are about to push off a soldier whose horse is flecked with
foam comes dashing down the beach, and as he leaps from his well-
nigh broken steed, he calls out cheerily:
“Got room for one more?”
“Ah! My friend of the cafe,” cries Van Zandt. “You are very
welcome, senor.”
“And just in time,” remarks John Barker, detective, as with a hearty
thwack he sends his horse riderless down the beach and clambers
into the boat.
 CHAPTER LVI.

THE FATE OF THE SEMIRAMIS.

“And now, what?”

The boats have reached the Semiramis. Louise Hathaway has
been tenderly assisted to the deck by Van Zandt, followed by
Navarro and Barker, and the dead form of Cyrus Felton has been
reverently conveyed aboard.
A sort of council of war is being held on the quarter-deck of the
yacht, participated in by Van Zandt, Navarro and Capt. Beals. The
master of the Semiramis looks inquiringly at the insurgent leader as
he utters the words quoted above.
“For me personally there is but one course,” replies Navarro. “I
must land somewhere in the night and make my way to Gen.
Masso’s camp. That will not be a difficult matter. It is your own
situation that I am considering. The American man-of-war, is she still
in the harbor?”
Capt. Beals shakes his head. “She sailed an hour ago for Key
West, for supplies and instructions. She will not return for at least
two days.”
Navarro’s face grows grave. “Then you are not safe from
molestation even in this vessel and under that flag,” he says,
pointing to the red, white and blue floating from the masthead.
“Without a man-of-war to protect you, the Spaniards, knowing that
El Terredo is aboard, will search your yacht, possibly confiscate her
and subject you to no end of annoyance, even though they should
not find El Terredo. They respect no flag, no emblem, no rules of
civilized nations, unless they are absolutely compelled to by superior
force. You saw how they treated the American flag above the
consul’s own residence. There are now three Spanish gunboats in
the harbor. Within the hour I fear your yacht will be surrounded.”
“Then there is but one thing to do,” promptly replies Van Zandt.
“Capt. Beals, have steam got up at once and weigh anchor. We will
follow the America to Key West.”
There is silence on the quarter-deck for a few moments. Miss
Hathaway has retired to her former stateroom immediately upon
setting foot upon the yacht, and Barker is intently watching the
shore from the bridge. For the time being Van Zandt and Navarro are
alone. Suddenly the former breaks the silence.
“You are not a Cuban,” he says. “Why are you enlisted with the
nondescript army of the insurrectionists?”
Navarro flushes at the word nondescript, but does not reply at
once. Finally he says quietly: “No, I am not a Cuban. I am, like
yourself, an American. But my ancestors were Cuban, back more
than six generations. Until ten months ago,” continues Navarro, in a
less-impassioned tone, “I was a careless, happy-go-lucky American
youth, without any specific aim in life. But when the Cuban
insurrection broke out, I was consumed with an overmastering
desire to help free Cuba from the accursed yoke of Spain. I have
sacrificed everything to that end, and now I am known to the
Spaniards as ‘El Terredo,’ the terror. I believe I have been of some
service to the struggling natives, and so I shall continue until Cuba is
free, or–”
Navarro does not complete the sentence. While he was speaking
the smoke has been pouring out of the chimneys of the yacht in
steadily increasing volume, and now the clank of the steam windlass
announces that the vessel is getting under way. Without replying to
Navarro’s words, Van Zandt hastens below to inform Miss Hathaway
of the destination of the yacht. Capt. Beals has taken his station on
the bridge and the graceful vessel steams slowly toward the narrow
entrance to the harbor of Santiago.
Navarro watches intently the three Spanish warships by which the
Semiramis must pass within half a mile. As the yacht draws nearer,
the watcher notes with anxiety a boat hastily putting out from the
government wharf and evidently making for the flagship of the fleet,
the Infanta Isabel. He communicates his discovery to Van Zandt,
who has returned from below, with the comment: “They are
evidently notifying the cruiser to have her stop this vessel. Rather
than that she fire on the yacht and endanger the lives of those on
board, including the young lady, you must surrender me. Then they
may permit you to go unmolested.”
“No man leaves this ship for a Spanish prison or the garrote,”
replies Van Zandt, his eyes burning with excitement, “as long as
there is a timber of her afloat. It is less than six miles to the
entrance to the harbor, and once outside we can snap our fingers at
a whole fleet of Spanish cruisers. Besides, with all the various craft
scattered about the harbor, they will not dare to fire on us.”
Navarro shakes his head skeptically, but does not reply. The boat
has reached the side of the war vessel. The Semiramis is now nearly
abreast of the latter and distant less than half a mile. Suddenly a
puff of smoke rises from the forward deck of the Spaniard, followed
by the sharp crack of a rifle.
“There! She has signaled you to heave to,” remarks Navarro. “As I
told you, you must surrender me.”
“This is my answer,” replies the owner of the Semiramis, drawing
his revolver and firing two shots in the air. Then to Capt. Beals on
the bridge he sings out: “Full speed ahead!”
Smoke is now pouring from the stacks of the warship, and it is
evident that she is preparing to pursue the American yacht, but she
does not, as Navarro predicted, fire on the latter. Before the cruiser
gets well under way the Semiramis is within four miles of the
channel that marks the entrance to the harbor.
Van Zandt smiles at Navarro. “We will lead him a merry race if he
thinks to catch the Semiramis,” he remarks. “This yacht can go two
miles to his one. And if he hasn’t improved in his marksmanship I
will risk his guns. Ah, there goes the first one!”
The Spaniard has succeeded in getting within range of the yacht
without endangering any of the other craft, and the roar of his
forward gun is heard as Van Zandt speaks.
“An eighth of a mile to windward,” observes the latter, as he
watches the solid shot skip over the water. “He can’t race and shoot,
too.”
Evidently the pursuer has come to the same conclusion, for he
fires no more guns, but doggedly plows the placid waters of the
harbor after the great black yacht.
And now the latter is less than half a mile from the cleft in the
precipitous coast line. Capt. Beals has slowed down the engines and
the yacht is picking her way by the reefs that guard the channel.
“Ship ahoy!” suddenly rings out from the lookout forward. All eyes
are turned ahead. A steamer, inward bound, has just come into view
in the channel.
“Permit me,” Navarro takes the glasses and focuses them upon the
stranger. “It is the Spanish dispatch boat Pizarro,” he says. “When
the cruiser recognizes her she will doubtless signal her to intercept
the yacht, and in the narrow channel she can make serious trouble, I
fear.”
The report of another cannon, followed by two more in quick
succession, shows that the man-of-war has indeed recognized her
compatriot almost as soon as the American. An answering gun from
the dispatch boat also shows that she has heard and understands.
 Capt. Beals looks inquiringly at Van Zandt. “We must continue
straight on and take our chances in the channel with that craft,” the
latter says. Then to Navarro: “Do you know what her armament is?”
“Oh, she is not a fighting ship. She has no armament, merely one
gun for saluting purposes, and her crew cannot number over fifty.”
“Then we are all right. If she gets in our way she must take the
consequences.”
But the dispatch boat evidently does not intend that the American
shall pass. She has taken a position in the narrowest part of the
channel and lies stationary, presenting her broadside to the
oncoming yacht.
“Signal that we propose to pass to port,” Van Zandt says to Capt.
Beals, “and if the Spaniard gets in our course run him down.”
Capt. Beals nods and a second later the hoarse whistle of the
Semiramis echoes over the waters. The signal is answered with a
rifle shot from the Spaniard’s forward deck and the dispatch boat
moves forward two lengths, so that she lies fair and square in the
announced course of the yacht.
But there are no signs of slackening on the part of the latter, and
her black hull looks threatening indeed to the officers of the dispatch
boat.
Caramba! Surely she will not run down the royal vessel! Yet it
looks very like it! But they will not dare! Still—the Spanish
commander hesitates no longer. He signals his vessel to back at full
speed.
Too late!
The Pizarro has moved less than half a length when the American
yacht crashes into her. There is a grinding shock that brings Louise
Hathaway in terror to the deck of the Semiramis, and then the yacht
continues on her course, apparently unharmed. Van Zandt catches a
glimpse of a great jagged hole in the bow of the Spaniard, into
which the water is pouring in a cataract; of a panic-stricken crew
rushing frantically for the boats; and then he turns to Miss
Hathaway. It is nothing, he assures her tenderly; a slight collision,
but the yacht is all right and perhaps she had better return to her
stateroom for the present. Later on—and Louise smiles, a little sadly,
but permits Van Zandt to conduct her to the saloon.
Capt. Beals is awaiting Van Zandt as the latter bounds up the
steps a minute later. “We are badly stove forward,” he reports, “and
are making water quite rapidly. With the steam pumps going, we
may keep afloat three or four hours, but the yacht is doomed.”
Van Zandt is so startled at the news that for a moment he is
speechless. His eyes rove back to the Spanish warship, and then at
the nearly perpendicular cliffs by which the Semiramis is steaming.
He looks for the dispatch boat, but it is not in sight. “The
Spaniard?” he inquires, mechanically.
“Gone to the bottom,” laconically replies the captain.
“Then there is no hope for us but to keep on and try to land by
the boats somewhere on the coast,” Van Zandt says. “The Spaniards
will treat us all as enemies, now that we have sunk one of their
boats. How long can we keep up this speed?”
“Perhaps an hour, perhaps more. The water will put out the fires.”
“Well, have the boats quietly prepared and keep within reach of
land. Do you think the Spaniards will continue the pursuit?”
“Undoubtedly. They will stop only to pick up the crew of the
Pizarro, and then will keep on after us. If there was some little bay
near here where we could beach the yacht, but there isn’t.”
The noble craft continues to plow the waves and her injured bow
still tosses the foam on either side, but her speed is sensibly
diminishing. All on board have recognized the fact that the yacht is
doomed, but there is no confusion, no manifest anxiety. The boats
have been prepared and each member of the crew has secured in a
little package his most valued possessions. On the quarter-deck Van
Zandt, Navarro, Barker and Louise Hathaway are silently watching
the Spanish warship. The latter is gaining now, for the Semiramis is
steadily settling.
Navarro, his hat drawn over his eyes and his coat wrapped about
him so that his countenance is partially veiled, has carefully avoided
Louise. When she returns to the deck he walks over to where John
Barker is leaning against the rail and remarks in Spanish:
“If you do not desire to be shot as a deserter I should advise you
to borrow a suit of clothes from our friend, the owner of the yacht.”
The detective starts. “I guess you’re right,” he replies in English,
and turns to Van Zandt. Five minutes later he emerges from the
cabin attired in a fashionable suit of gray.
“The water is within two inches of the boilers,” reports the
engineer, and Van Zandt sighs heavily.
“Well,” he says, “we may as well take to the boats. Come.” He
leads Louise to the steamer’s launch.
“And he?” Louise points to where the body of Cyrus Felton lies,
covered by its winding sheet of canvas.
“He will go down with the Semiramis. He could have no nobler
tomb.”
Boom! The roar of the Spanish gun is the salute the people of the
Semiramis hear as the boats pull away from the doomed yacht. The
cruiser is within range and though her commander must be aware
that the American vessel is sinking he is firing on her.
“The coward!” grits Van Zandt. “But the Semiramis will not strike
her flag. She sinks with the stars and stripes flying.”
“Pull hard!” shouts Capt. Beals. “Pull hard! She’s going down!”
 CHAPTER LVII.

AN INTERNATIONAL EPISODE.

“Ashley, we will give you something to write about,” remarks Capt.

Meade, as the America steams out of the harbor of Santiago.
“What’s that, captain? A thrilling description of a voyage from
Santiago de Cuba to Key West?”
The commander of the cruiser smiles good-naturedly. “More
excitement than that, and something that will cause the little
senorita to cling frantically to your arm.”
“Ah, then, you may open the ball at once.”
“Not yet; not for an hour. In short, we are going to burn some
powder by and by. A little target practice, and if you have never seen
anything of the sort you will be rather interested.”
“Confound his target practice,” Jack mutters disgustedly, as Capt.
Meade bustles away. “The only powder-burning I want to see is the
shelling of the dingy old city of Santiago by the Spanish fleet.”
But Ashley’s temporary annoyance is soon forgotten in the
pleasure of assisting Juanita up and down the steep ladders, of
explaining the machinery, the guns, the great searchlight and the
thousand and one interesting features of the cruiser.
 The target practice, he also finds, is a decidedly interesting affair,
after all, which conclusion may have been influenced by the manifest
delight of his sweetheart over the novel experience.
But the last gun is fired, the buoy mark is demolished, and, within
forty-eight hours, Capt. Meade tells Jack, the America will be lying at
anchor in the harbor of Key West.
“And she will return to Santiago, when?” the correspondent
inquires. “I must be back at the finish, if the insurgents capture the
city and it is shelled by the Spanish fleet.”
Capt. Meade shakes his head. “That depends on instructions
received at Key West. I suppose though, that the cruiser would be
ordered directly back to Santiago after coaling.”
Just then the captain is summoned to the bridge, where it is
evident that some unusual occurrence is engrossing the attention of
the officers.
Jack observes that the captain has his glass turned toward the
northwest, and he also looks in that direction. Trails of black smoke
low down on the horizon, evidently from two steamers, are all that
reward his gaze, but he notices that the course of the America has
been changed and that her speed has been materially accelerated.
“What is in the wind?” he inquires, casually, of the youthful
ensign.
“That’s just what we’re going to find out,” is the reply, and Ashley
follows Capt. Meade to the bridge.
“Nothing special that we know of,” is that official’s response to
Jack’s query as to the cause of the change of course. “Some
stranger, probably a Spanish gunboat, is in pursuit of another
steamer, and as it is not much out of our course I concluded to run
up nearer the scene.”
The white cruiser is now rushing along at a speed that reminds
Jack of his first memorable trip upon her, and is rapidly reducing the