What is chargeback fraud and how do I prevent it?

Welcome to the wild world of chargeback fraud — where consumers become self-serving renegades and hard-working merchants transform into skilled detectives. This, my friends, is a tale of deceit, persistence, and the power of technology. As a merchant, you may be familiar with the infamous “friendly fraud” or “first-party fraud,” and let’s face it, there’s nothing friendly about it.

Join us as we embark on a journey through the winding maze of the chargeback process. You’ll encounter its crafty villains, understand their insidious tricks, and see first-hand the devastating impacts they can have on your coffers. But don’t worry, this story doesn’t end in gloom. You’ll uncover incredible strategies and tools to shield your business from these marauding scammers.

We’ll dive into the rising tide of this issue, linking it to our new normal of booming e-commerce and the unintended fallout of a global pandemic. And as we wade through this murky water, we’ll also spotlight the potential strain on your relationships with banks due to a high volume of chargebacks. So buckle up for a fascinating exploration.

Let’s not forget about the good guys either — the cutting-edge AI technologies that work tirelessly in the background, using data to predict and prevent these dastardly deeds. We’ll look at the potential legal repercussions that face these fraudsters — because justice does have a way of catching up, doesn’t it?

Be prepared for an in-depth exploration of how chargeback fraud works, the cost of defending your business, and how to effectively equip yourself in this ongoing battle. Remember, knowledge is power and in the words of a wise man, “By failing to prepare, you are preparing to fail.”

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As merchants scale up, the complexity and volume of transactions typically introduce a whole new set of risk factors.    It’s a case of more transactions, more problems. As the ecosystem evolves, so does the language used to describe the strategies merchants deploy to keep fraudsters at bay. Phrases like “fraud detection,” “fraud prevention” and “fraud protection” have often been tossed around interchangeably, creating a confusing web of jargon that does little to help merchants understand their own processes. In this article, we aim to explain why fraud detection is important and to pull the curtain back on these terms, offering clear, concise definitions, with particular focus on the most basic component, fraud detection.

Fraud analysis and prevention in ecommerce transactions

Fraud is a constant threat to ecommerce businesses, constantly evolving and adapting. For merchants, the cost of fraud can be staggering, resulting in lost revenue, damaged reputation and legal liabilities. As the number of ecommerce transactions grows, fraudsters become more sophisticated and find new ways to exploit vulnerabilities in the system. It’s crucial for merchants to understand the types of fraud they might encounter and how to protect themselves from financial losses. We put together some tips and insider information to help you protect your business from fraud while avoiding adding friction to the checkout experience.

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The vast majority of the orders that a risk analyst reviews falls into one or the other category. However, for a small subsection, the authorized cardholder and the likely fraudster are one and the same. This is known as friendly fraud, and it’s nearly impossible to detect in the card-not-present world. (And, according to Lexis Nexis, it’s a pain point for over a fifth of ecommerce merchants.)

Considering the extreme difficulty for merchants in detecting and preventing friendly fraud, we’ll delve into what it is about our current environment that allows for friendly fraud to exist and continue unfettered. Then, we’ll recommend some strategies for merchants to be proactive about mitigating potential cases of friendly fraud.

The post What is friendly fraud? Key signs and mitigating the effects of consumer abuse appeared first on Signifyd.

When an order arrives with a billing address different from the shipping address, the obvious questions are:

1. Is the package being shipped to the cardholder? (Does the real cardholder actually live at the address that the package is being shipped to?)
2. Is the package being shipped to anyone other than the cardholder? (Why?) So, can the billing and shipping address be different?

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Originally developed for use with mail and catalog orders, AVS is now commonly used by e-tailers, and other card-not-present merchants, as a method to verify the validity of an order they receive. An AVS check compares the billing address used in the transaction with the issuing bank’s address information on file for that cardholder. Depending on whether they match fully, partially, or not at all, the merchant can use that information in their decision on whether or not to accept or cancel the order.

As such, seeing a full AVS match on a transaction during order review offers a basic level of assurance for merchants that the order is not fraudulent. However, most merchants don’t understand how best to use AVS in Ecommerce Fraud Detection, nor their liability on transactions they accept where the AVS check returned a full match.

In this article, we’ll give a background on AVS and the details on how the service works, share who holds the liability for paying a merchant chargeback on a transaction with full AVS match, and how to use AVS in order review.

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However, as robust as data-driven models may be, there will almost always be a subset of orders where some manual review is necessary. Not all orders fit easily into “good” and “bad” categories, and those that don’t require further research to be correctly classified.

With that in mind, we’ve created a guide to help take fraud and risk analysts through the thought process around reviewing an order. Our goal is to illustrate not only our philosophy around order review, but the right questions to ask yourself as you review an order and how you should approach making your decision.

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To a consumer, the decision between purchasing online or in-store is simply a calculation of convenience, price and availability.

To a merchant however, a purchase online versus in-store are two very different scenarios, especially when it concerns liability for accepting a fraudulent transaction.

Let’s dive into an example that will help illustrate the difference for merchants. This will help you to understand who pays for credit card fraud and chargeback merchant rights.

John Smith is a video-game enthusiast, eagerly awaiting the release of a new game. Release day has finally come, and he heads down to his local store to purchase it, happy to discover that he can grab a copy in-store.

For the brick-and-mortar merchant, this is a card present (CP) transaction, meaning the cardholder, John Smith, is physically present with the card at the point of purchase. When a consumer makes an in-person transaction with a physical card, the merchant has the ability to not only inspect the card but to ask for identification (such as a driver’s licence) and obtain a signature from the consumer. In addition, merchants require a secure form of payment such as paying with a chip-enabled card. Chip-enabled cards generate unique transaction codes for each purchase, making the payment information much more secure. If the merchant follows proper procedure such as requiring a chip-enabled card for purchase and getting a signature, the merchant does not hold the liability on the transaction. Liability rests with the bank that issued the cardholder’s card, and if the purchase is later deemed to be fraudulent, the merchant is not responsible for refunding the customer. (However, if a merchant does not have a chip-enabled card reader, and accepts the transaction, they are held liable for that purchase, as they did not undertake the proper updated security procedures.)

Now, say John Smith ran to his local store only to discover the game was sold out, and he needed to order it online.

For the ecommerce merchant, this is a card not present (CNP) transaction, meaning that the cardholder is not physically present at the time of the order. Lacking the opportunity to examine the credit card for the merchant, protection is that much more difficult. Without the standard security measures such as checking identification and paying with a chip enabled card, an online transaction is deemed far less secure. Given the riskiness of accepting an online transaction, the liability of accepting a fraudulent transaction rests with the merchant themselves, and not the issuing bank. If a merchant accepts an order online that is later deemed fraudulent, it is the merchant’s responsibility to refund the customer. The cardholder’s issuing bank will collect on behalf of the cardholder.

Understanding this liability is essential for online merchants, many of whom are unaware of their responsibility to review their orders to weed out fraud that they are on the hook for.

It’s imperative that online Merchant Fraud Prevention measures be implemented to protect merchants from the costs of fraudulent transactions, for many reasons.

First, the total cost to the merchant for accepting one fraudulent transaction is often more than twice the cost of the transaction itself, since they cannot recover the original fraudulent shipment and must also refund the scammed customer.

Second, the merchant’s bank (known as the acquiring bank, with whom the merchant stores their money) heavily monitors their customers for fraud acceptance and may charge a fee for every merchant chargeback received – amplifying how important the question of who is responsible for chargebacks really is. And, should the merchant start to process a large volume of fraudulent transactions, an acquiring bank may not only raise card fees sharply, they may take steps to shut down an online merchant’s account.

To sum up, when it comes to credit card fraud, merchant responsibility is as follows:

Card present transactions occur in-store, where the merchant can review the identifying documents of the cardholder for legitimacy and take other security steps, like using a chip-enabled card terminal, to further confirm the validity of the purchase. If they follow the process correctly, they are not liable for fraudulent purchases. The cardholder’s issuing bank is.

Card not present transactions occur online (or other non-present channels, like mail), where the merchant is unable to confirm the identity and validity of the purchase in-person. The merchant is liable for the acceptance of any fraudulent order and the cardholder’s issuing bank will collect the customer’s refund from the merchant should a cardholder request a chargeback. If the merchant processes a large volume of fraudulent orders, and thus receives a large number of chargebacks relative to their orders, their acquiring bank will likely take steps to raise fees to penalize the merchant.

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When a customer disputes an order and files a chargeback, the merchant has an opportunity to contest that dispute. In order to dispute a chargeback and ultimately win, a merchant needs to participate in a series of defined steps created by the card associations with the issuing and acquiring banks, who act as mediators between the customer and the merchant. (A list of players in the payments ecosystem, like acquiring and issuing banks, payment processors etc.)

As consumer protections favor the customer, merchants often find themselves in an uphill battle to win a chargeback abuse dispute. In order to simply participate in challenging the chargeback automation, merchants must complete every stage of the process under increasingly tighter timeframes.

With that in mind, we’ve outlined the process, from start to finish, that any merchant will have to participate in to fight a chargeback fraud detection. Our goal is to shed light on ecommerce chargeback protection process and help merchants understand the intricacies involved.

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What is a chargeback?

In the U.S., a cardholder has the right to request a refund from their issuing bank for any transaction or purchase made with their credit card.

Specifically, under Regulation Z within The Truth in Lending Act, which covers credit cards, and Regulation E in The Electronic Fund Transfer Act, which covers debit cards, cardholders are afforded reversal rights, meaning that they are guaranteed a right to receive their money back on a purchase and reverse the charge.

Usually, the cardholder recovers their money from the merchant directly, in the form of a return or refund. (Note that while a merchant may hold a “no refund” policy, ultimately, if a consumer receives a product that is broken, different than described or generally displeased with the purchase these regulations mandate that a merchant must honor the consumer’s right to a refund.)

In the case that the cardholder is unable to receive a refund from the merchant, or the merchant refuses to do so, a cardholder has the ability to contact the bank that issued them their credit or debit card (called the issuing bank) and file a chargeback request to recover the debt.

Types of chargebacks

The first thing to know about chargebacks is that they’re not all the same. When the cardholder initiates a chargeback abuse, they are prompted to give a reason for doing so. The most common reasons are:

• Billing dispute: Merchants who make billing errors (either by billing too much or double billing their customers) will be at risk of a chargeback. While many merchants proactively correct any billing errors, billing issues unbeknownst to merchants that don’t result in a quick refund will likely result in a chargeback.
• Broken item: When a customer receives an item that they claimed was broken upon arrival or quickly breaks down after, the merchant may receive a broken item chargeback.
• Item not received: Item not received is the chargeback filed against a merchant when a customer reports that they never received the good that they paid for.
• Item significantly not as described: If a merchant ships a red t-shirt when a customer ordered a blue one, the merchant may receive an item significantly different than described chargeback.
• Transaction not recognized: This fraud-related chargeback is reported to merchants from customers who claim to not know why the transaction was reported on their card.
• Fraud, card not present: This more commonly reported fraud-related chargeback is levied against merchants when a consumer claims that their card information was stolen.

Most of these chargebacks are fairly self-explanatory, but they generally fall into three categories:

• Actual fraud: The most obvious reason for a chargeback is also the most common. A fraudster used a legitimate cardholder’s information, purchased an item from a merchant and the merchant shipped said order to the fraudster. The real cardholder, seeing this charge on their statement, files a chargeback request with their issuing bank against the charges on their credit or debit card. In cases of actual fraud, there is little that merchants can do other than refund the sale amount without the expectation of receiving their items back.
• Merchant error or negligence. The merchant either never shipped out the order or shipped out an item that was broken or different than described, and failed to provide good customer service to rectify the situation. When the authorized cardholder fails to receive the item they paid for, they file a chargeback on that transaction, requesting a refund.
• Friendly fraud: Friendly fraud (also called chargeback fraud) is an industry term for authorized cardholders who dispute seemingly legitimate charges to their credit cards. The authorized cardholder may file a chargeback on a legitimate charge for a few reasons: (1) they want to avoid paying for the order in question, (2) they may have forgotten they made the purchase, or (3) there may be another household member who made the purchase in their name, and they don’t recognize the transaction.

Ramifications of chargebacks

Because of the cost and time involved in the chargeback automation dispute process, card associations are extremely strict with merchants around what is acceptable for a chargeback. Most merchants are only able to reach a 1% chargeback rate on any form of payment (Visa, American Express, Mastercard, etc.) before being placed on a chargeback watchlist by that card association.

If a merchant incurs a chargeback rate greater than 1% of orders on a particular card association brand, (e.g. more than 1% of orders processed with Mastercard were chargebacks) that merchant has several detrimental penalties that they can incur.

The first and most painful are higher processing fees on all orders. For example, if a merchant’s normal processing fee for Visa was 3%, Visa could increase that fee to 3.5% or 4% to process all orders, cutting into the merchant’s profit margin.

Secondly, a merchant might lose the ability to fight chargebacks. If a merchant has suffered a high degree of chargebacks on American Express, AmEx might suspend that merchants ability to fight any chargebacks until the merchant brings down their chargeback rate.

Third, a merchant may be placed in a chargeback monitoring program, implemented by the card association to identify merchants with higher than normal chargeback rates. Merchants who land in a chargeback monitoring program may have restrictions placed on their merchant account and further fees levied as the card association attempts to help them reduce their chargeback rate.

Lastly and most seriously, if merchants fail to bring down their chargeback rate after several months, they might lose the ability to transact payments within a certain card association or even more seriously, might have their merchant account shut down by the acquiring bank, afraid of the losses they might incur by continuing to underwrite the merchant.

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