By Ruth Simon 

Troubles tied to a payroll processor sent hundreds of small businesses scrambling for funds this month, triggered an FBI investigation and cast a spotlight on a critical but lightly regulated industry.

About $30 million destined for paychecks and related tax payments went missing on Sept. 4 because of problems tied to MyPayrollHR, based in Clifton Park, N.Y. Workers at firms that used MyPayrollHR saw funds yanked back out of their bank accounts -- in some cases twice -- after another firm discovered the money backing the deposits wasn't available.

Roughly 8,000 employees at nearly 400 companies across the country were affected, according to Nacha, the organization that oversees the ACH Network, which was used to move money from one bank account to another. Banks report that funds have been returned to roughly 90% of those affected, a Nacha spokeswoman said.

Law-enforcement officials said they are looking into allegations of criminal conduct at MyPayrollHR and related companies. In a tweet issued Sept. 13, the Federal Bureau of Investigation's Albany, N.Y., office said it was investigating MyPayrollHR and asked potential victims to fill out a questionnaire. The FBI searched the home of MyPayrollHR owner Michael Mann on Monday, an FBI spokeswoman said. "It's going to be a complicated case," said the spokeswoman, who declined to answer specific questions.

An attorney for Mr. Mann said his client was cooperating with investigators and would continue to do so. "Michael Mann has voluntarily and proactively met with and is cooperating with the U.S. attorney's office in order to fully address the consequences of recent events," said the attorney, Michael Koenig. He didn't respond to detailed questions.

The situation has raised questions about the actions of other parties involved in the transactions, including the firms that move money electronically.

James LaFlamme said he advanced about $100,000 to replace missed paychecks for the roughly 60 employees of his two Vienna, Va., businesses. Mr. LaFlamme said he immediately filed a fraud claim with SunTrust Banks Inc. after $14,000 of his own pay was withdrawn from two personal bank accounts.

While Mr. LaFlamme said he still isn't sure when the bank will reverse those withdrawals, he said many of his employees had money returned to their accounts Friday. Some of those employees came to the office Monday with checks to repay the advances.

"We were able to scrape enough cash together to make the last payroll this past Friday, but if all the money doesn't come back to the employees, then there could be a problem with payroll coming up," Mr. LaFlamme said.

A SunTrust spokesman said the bank couldn't discuss specific customers but is working with clients.

There appear to be several failures in how the matter was handled, said Romeo Chicco, president of the Independent Payroll Providers Association, a trade group. "To say it's just the payroll industry or the payroll service would not be correct," he said.

The payroll-processing industry is sprawling and lightly regulated, with thousands of competitors. They include the publicly traded Automatic Data Processing Inc. and Paychex Inc. as well as smaller players including MyPayrollHR.

From the outside, the movement of funds from employer to employee appears to be a seamless process. But there is a lag between the time money appears to have moved into an account and when it is actually there. "It's not like a wire [transfer] where it is there in an instant, " said Frank Fiorille, vice president of risk management, compliance and data analytics at Paychex.

This month's incident with MyPayrollHR involved $26 million destined for workers and $4 million in tax payments. The system broke down when funds pulled from employers' accounts couldn't be accessed by third-party processors, even though the money appeared to be there.

Pioneer Bancorp Inc. in Albany, the payroll company's bank, said in a Securities and Exchange Commission filing that it "recently became aware of potentially fraudulent activity...by an established business customer." Pioneer said it is working with law-enforcement authorities. A Pioneer spokesman declined to provide additional comment.

Cachet Financial Services, one of the firms that manage the flow of payroll funds through the ACH system, said it was unable to access $26 million from MyPayrollHR's bank.

Cachet's attorney Wendy Slavkin said the file containing instructions for how to handle money collected from MyPayrollHR customers was manipulated. Money that should have moved into Cachet's holding account instead moved into a different account at Pioneer Bank under the control of MyPayrollHR, she said. The second account, where the money had been moved, was frozen, she said. Ms. Slavkin said the company believes that some payroll deposits were actually made to fraudulent accounts in the names of employees who didn't exist.

As a consequence, Cachet reversed the paycheck deposits. Many employee accounts were debited twice because Cachet discovered an error in its initial instructions and submitted a new set of orders, Ms. Slavkin said.

"Based on the information we have, Cachet's reversals of the payroll deposits appear to be in violation of Nacha rules," Nacha said in a statement. Payroll deposits can be reversed only in very limited circumstances, the nonprofit group said, such as when an employee is overpaid. "Cachet should not have done it at all," Nacha said.

Ms. Slavkin said Cachet has instructed banks to return the money to employee accounts. "When all is said and done, we remain the victim," she said. A Cachet spokeswoman said the firm was following industry standards and the company's own fraud protocol in reversing the transactions. The spokeswoman said 8,214 employees were affected by the reversals.

Mike Walls, the owner of a home-care agency and an assisted-living facility in Lake Jackson, Texas, said he took out a $50,000 line of credit to deal with any short-term problems.

Mr. Walls said he wrote checks to five of his 75 employees so that they could pay urgent bills and provided workers with letters they could show landlords or creditors. All except two employees have had their money returned, Mr. Walls said Monday.

"I can deal with this as a business owner, but my employees are profoundly affected," he said. "The snowball that could come from this is so scary."

Write to Ruth Simon at ruth.simon@wsj.com

(END) Dow Jones Newswires

September 18, 2019 09:17 ET (13:17 GMT)