Is Friendly Fraud a Legitimate Dispute?

Chargebacks — designed to protect users from unfair merchant practices and identity theft — are increasingly being misused by consumers.

Nearly three-fourths of shoppers consider filing a chargeback as a valid alternative to requesting a refund from a seller, according to PayPal. This practice, known as friendly or first-party fraud, differs from actual fraud, where someone obtains a customer’s card number through nefarious means and uses it to make purchases. While merchants are becoming savvier at avoiding chargebacks due to first-party fraud, banks are still playing catch-up and often bear the financial burden.

Most consumers are unaware of what happens behind the scenes when they file a chargeback; more than half of shoppers have admitted to filing a chargeback without contacting the merchant first.

The word dispute is defined as a disagreement, argument or debate, but this is not how typical banks handle dispute interactions with their customers. Wary of violating Regulation E, which oversees the handling of electronic fund transfers, the usual practice is to automatically credit a customer’s account with little to no argument, then sort it out with the merchant. Fisher emphasizes that Reg E does not restrict conversations, questions or gentle pushback on the cardholder.

Friendly Fraud vs. True Fraud
True fraud, or identity theft, starts with a card being stolen, compromised or skimmed from an authorized user. Once the theft is discovered, the card is closed and a new card is issued. This situation is truly no fault of the cardholder and is why Reg E was initiated in the 1970s. Consumers now use their cards much differently than in the 1970s, including for transactions with online merchants that are more prone to disputes and chargebacks.

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:

• Customers making a purchase by mistake or ordering the wrong item.
• A customers did not remember making a purchase once they saw their bill.
• A known family member or friend using the customer’s card without permission.
• A customer suffering from buyer’s remorse.

For example, if someone orders a pair of red alligator boots online but decides they don’t love them after they arrive, they might call their bank and claim they see a transaction they didn’t initiate. The bank credits the transaction to their account and processes a chargeback dispute, which the merchant will likely deny using concrete proof that the boots were received. In the meantime, the customer has abused their bank, knowing they’ll probably receive a full refund with little effort and get to keep the boots too.

If banks review their dispute recovery percentage, they will likely discover it’s quite low. Merchants with deep pockets are investing in advanced processes to ensure friendly fraud is the bank’s loss, not theirs. Merchants have several ways to produce compelling evidence that the bank’s cardholder did authorize a purchase, including:

• A delivery confirmation receipt email from UPS, USPS, FedEx, etc.
• A photograph of the package on the porch.
• A signed contract.
• A sales receipt with 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.

Secure Authentication
Visa pioneered the original 3D secure (3DS) protocol to protect eCommerce transactions by providing another layer of identity verification before authorization. The system enables the exchange of data between the merchant, card issuer and, when necessary, the consumer to validate that a transaction is being initiated by the rightful owner of the account. Data points such as device biometrics, device channel, IP addresses and order histories preclude the need for every shopper to actively authenticate with a password.

When 3DS  is used during a transaction, that sale is ineligible for a chargeback involving any of the following reason codes:

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

If your customer is pushing back on a 3DS-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 that 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.