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The Recession Is Sending Rates of Friendly Fraud Up, Processors Say

(January 28, 2009) With the recession throwing more and more people out of work by the day, payments processors are reporting that their merchants are experiencing sharp increases in e-commerce chargebacks stemming from so-called friendly fraud. This is the fraud that results when a consumer repudiates a transaction as unauthorized in hopes of escaping liability for payment.


First Atlantic Commerce Ltd., an e-commerce transaction gateway in Bermuda that serves sellers of digital content, said this week that its merchants have seen a steady rise in chargebacks related to such repudiation since October, when the U.S. economy, already weak, took a decided turn for the worse. Andrea Wilson, chief executive of FAC, tells Digital Transactions News by e-mail that the combination of rising chargebacks and falling sales volumes is pushing more merchants above the allowable thresholds the card networks set for chargebacks as a proportion of card volume. "Banks that never had merchants on the global chargeback monitoring program are now getting notification from Visa and MasterCard," she says. Merchants, she adds, "are being fined for a situation they have absolutely no control over."


Merchants that exceed these chargeback thresholds are asked to present a plan to bring their chargebacks down within a certain period of time. Failure to control chargebacks can result in fines for acquirers, which pass them on to merchants.


The friendly fraud problem appears to be especially acute for merchants that traffic in games, music, and other digital downloads. Proof of delivery in such sales can be hard to establish, making it difficult to defend against a chargeback, and making it all the more tempting for strapped consumers to repudiate a purchase. The problem becomes even more acute given the typical lag time between the date of a transaction and when the statement arrives. During this time, a buyer in recent months may have been more likely to have lost a job, suffered a pay reduction, or seen an investment position wiped out.


Vindicia Inc., an e-commerce processor in Redwood City, Calif.., that specializes in handling transactions for digital goods, says it too has seen a larger-than-usual bulge in friendly fraud recently. Such increases are not unusual in the weeks before and after the holidays as some consumers repudiate transactions in an effort to free up credit lines for more purchases, says Sanjay Sarathy, senior vice president of marketing at Vindicia. But the recent jump, he says, has been exceptional. While the problem is hard to quantify, "we believe the economic recession has exacerbated this trend and we are starting to see that with some of our merchants whose friendly fraud volume is above normal," he tells Digital Transactions News.


Vindicia is only starting to see this trend now because it can take as many as 90 days to challenge a chargeback, get it investigated, and get a result indicating whether it stemmed from real fraud or a case of a customer getting cold feet. Overall, online merchants challenged half of all fraud-coded chargebacks in 2008, up from 47% in 2007, according to research conducted by CyberSource Inc., a Mountain View, Calif.-based payments-gateway and risk-management provider. Of the chargebacks they represented last year, merchants won 44%, CyberSource says.


While that may seem encouraging, some processors argue merchants should do more to protect themselves against friendly fraud now that signs indicate the recession isn't likely to lift any time soon. FAC's Wilson, for example, urges merchants to adopt the online authentication systems created by Visa and MasterCard. These technologies, called Verified by Visa and SecureCode, ask the consumer to authenticate himself at checkout by entering a secret code presumably known only to him. Under rules that differ somewhat between the two networks, merchants that adopt the authentication systems can be protected

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