Friendly Fraud: Legitimate Dispute or Regrettable Boots?

Can we talk about chargebacks? When a cardholder contacts a financial institution about a non-authorized transaction – also known as a dispute – it triggers a costly, multi-step back-office procedure referred to as a chargeback. Processors can charge as much as $35 for a chargeback only to inform the institution that the merchant denied the refund for which it already credited its cardholder. 

Insult meet injury. 

According to Lisa Fisher, PRI Director of Brand Partnerships, chargebacks were designed to protect users from unfair merchant practices and identity theft, but they’re increasingly being misused by consumers. In fact, according to PayPal, 72% of shoppers consider filing a chargeback as a valid alternative to requesting a refund from a retailer. The practice known as friendly or first-party fraud is different from actual fraud, where someone obtains a customer’s card number through nefarious means and uses it to buy things. Merchants are becoming much savvier at avoiding chargebacks due to first-party fraud, but FIs are still playing catch-up and are often the ones left holding the bag. 

To understand how often it happens, just look at the merchant first-party fraud stats from PayPal. 

“In one 2023 survey of more than 300 retailers, nearly 75% of retailers – from small businesses to enterprises – experienced a 19% average increase in friendly fraud, with more than 50% of respondents saying that friendly fraud is a significant or moderate concern for their business. The same survey found that most consumers are unaware of what happens behind the scenes when they file a chargeback. One report found 72% of shoppers considered filing a chargeback a valid alternative to requesting a refund from a retailer, and more than 50% admitted to filing a chargeback without contacting the merchant first.” 

Fisher points out that the word dispute is defined as a disagreement, argument or debate, but that is not the way the typical FI handles dispute interactions with their customers. Wary of going sideways against Reg E, the usual practice is to automatically credit the customer’s account with little to no argument and try to sort it out with the merchant later. 

“Let’s ask ourselves is there any debate about the facts of the transaction or is the cardholder automatically credited the purchase amount, the chargeback processed, and the amount eventually written off to the ‘Losses’ GL? It’s important to know that Reg E does not restrict conversations, questions or gentle pushback on the cardholder,” she said. 

Friendly Fraud vs. True Fraud 

True fraud, also known as identity theft, starts with a card stolen, compromised or skimmed from the authorized user. Once the theft is discovered, the card is closed, and a new card issued. This situation is truly no fault of the cardholder, and it’s why Reg E was initiated back in the 1970s. But consumers use their cards much differently now than in the 1970s, including for transactions with online merchants that are even more prone to disputes and chargebacks.   

Friendly Fraud  

While some inaccurate disputes are indeed innocent errors, many can be categorized as first-party or friendly fraud. According to PayPal, first-party fraud can occur for several reasons, such as: 

• The customer made the purchase by mistake or ordered the wrong item.
• The customer did not remember making a purchase once they saw their bill.
•  A known family member or friend used the customer’s card without permission.
•  The customer suffered from buyer’s remorse.

“For example, what if I ordered a pair of red alligator boots online but decided I didn’t love them in proportion to what they cost after they arrive at my door?” Fisher said. “Theoretically, I can call my bank and tell them I see a transaction I didn’t initiate. They credit the transaction to my account and process a chargeback dispute, which the merchant will likely deny using concrete proof that I received the boots I ordered. In the meantime, I’ve abused my financial institution knowing that I’ll probably receive a full refund for little effort and get to keep the boots too!” 

If FIs review their dispute recovery percentage, they will probably discover it’s quite low. Merchants with deep pockets are investing in advanced processes to ensure friendly fraud is the financial institution’s loss, not theirs. Merchants have several ways to produce “compelling evidence” that the bank’s cardholder did, in fact, authorize the purchase, which include: 

• Delivery confirmation receipt email – from UPS, USPS, FedEx, etc.
• Photograph of the package on the porch. (Loss of merchandise by a porch pirate is not a dispute, it’s an unfortunate circumstance).
• A signed contract – hello, VRBO disputes!
•  Sales receipt. Even without a signature, it has a date/time stamp. 

The type of document isn’t as important as its function. Card issuers must be able to determine the validity of the transaction based on whatever document the merchant chooses to share as compelling evidence. 

Mastercard and Visa 3D Secure Authentication 

Visa and Mastercard employ 3-D Secure protocol to protect eCommerce transactions by providing an additional layer of identity verification before authorization. 3-D Secure (3DS) enables the exchange of data between the merchant, card issuer and, when necessary, the consumer, to validate that the transaction is being initiated by the rightful owner of the account. Data points such as device biometrics, device channel, IP Address and order history preclude the need for every shopper to actively authenticate with a password. 

When 3-D Secure is used during a transaction, that sale is not eligible for a chargeback involving any of the following reason codes: 

• No cardholder authorization
• Questionable merchant activity
• Cardholder does not recognize – potential fraud 

So, if your customer is pushing back on a 3D Secure verified transaction, be sure that you’re asking the right questions. 

Three tips to reduce chargebacks are: 

1. Review front-line procedures for accepting disputes without conversation and questions with the cardholder.
2. Ensure any time a dispute is accepted that is not a true merchant error/failure, the cardholder is required to have the card reissued.
3. Consider tracking fraudulent use losses separately from dispute refunds.

 “Stop being a pushover and stop calling everything fraud,” Fisher said. “First-party fraud is properly called customer service refunds. Educate your frontline employees on how to have probing conversations with your customers about chargebacks and when it’s appropriate and even necessary to say no.” 

Resources 

These Are the Biggest Fraud Risks Banks Will Face in 2024 – The Financial Brand

Strategies to Navigate the Surge in Friendly Fraud – PayPal US 

Profit Resources specializes in identifying profitability improvement areas for financial institutions through revenue growth, cost control, streamlining processes, and effective use of technology. Contact us to learn more about our personalized approach to strategic planning to propel growth and improve profitability.