Friendly Fraud and the Failure of Chargeback Protections

Chargebacks were originally designed to protect consumers. Today, it’s ironic that merchants often need protection against this very system put in place to protect consumers. A chargeback is the return of funds to the consumer, by the bank, to settle a debt. In the event of a filed chargeback, the bank then forcibly removes funds from the merchant’s bank account to “repay” the consumer.  

Chargebacks have long been a hindrance to e-commerce companies, sparking a rise in fraudulent behavior among consumers who attempt to defraud a company for their own monetary gain. While the payments sector grapples with bad actors, innocent consumers often get caught in the crossfire. 

Friendly fraud — also known as chargeback fraud — occurs when a customer files a chargeback instead of attempting to obtain a refund from the merchant. In some cases, such as when the goods were not received or not as described, the request for a refund is genuine. The very same cases may drive buyers to take shortcuts in their desire to avoid the archaic, tedious processes often associated with recourse. As friendly and malicious fraudsters adopt the same methods of getting a refund, attempting to distinguish between them is futile. 

Defining friendly fraud 

Friendly fraud is an honest mistake by a consumer, most commonly involving genuine forgetfulness or unknown purchases by family members. On the other hand, the desire to steal from the merchant fuels chargeback fraud with malicious intent. 

Chargebacks were introduced to protect consumers who operate in good faith. In the event that a scammy merchant has successfully convinced a buyer into paying for goods or services, chargebacks ensure that the buyer is not out of pocket should the goods arrive faulty, are counterfeit, or do not arrive at all, as is sometimes the case.

Eventually, this trust in customers was abused, and fraudsters found that they could fool the bank into issuing a chargeback on the basis that they didn’t receive goods or their card was used by someone else. In this case, the buyer receives money from the bank (which then charges the merchant) and keeps the goods. 

Financial identification: discretion and security

Chargebacks were introduced when e-commerce was an undeveloped concept. Purchases were made in traditional brick-and-mortar stores and credit cards were kept in physical purses and wallets. Unfortunately, what was once an industry that thrived off good faith now fosters fraudulent activity. Credit card information stored on numerous online accounts, apps and devices only heightens the potential for merchants to scam buyers.

The Truth in Lending Act, the foundation of the chargeback, was drafted back in the 1960s. Consider how commerce and consumer habits have been revolutionized in the last decade, not to mention the last six decades. This archaic act has failed to stymie chargeback fraud, thus proving that outdated regulation cannot be effective when the entire shopping landscape itself has changed. However, it’s not solely the legal regulations that have become outdated. 

The core issue: outdated payments systems 

Banks and outdated payments systems are the problem. In theory, the issuer of the chargeback thoroughly investigates every claim a cardholder files. In reality, banks are being overtaxed by the rapid rise in overall chargebacks, lacking resources such as time, money and modern verification systems to meet the influx of claims. This squeeze on the issuer means claims are not sufficiently reviewed and little evidence is required to submit the chargeback to a merchant’s bank. This inability to verify the legitimacy of each chargeback creates a twofold problem: While merchants are getting hit with more unnecessary fees and damage to their credibility, banks are essentially showing consumers that filing a chargeback has no repercussions. 

The issue at the root of the chargeback predicament is that people still have to expose their financial information to pay for goods and services online. This giant loophole creates more opportunities to commit fraud.

What is being done?

It’s evident that both parties need to be protected. Online payment system companies such as PayPal and Stripe have endeavored to make e-commerce safer for everyone involved. Stripe even introduced a chargeback protection service in June 2019, promising to “reimburse the disputed amount and waive dispute fees.” This benefits both the consumer and the merchant. The consumer gets their payment, and in the merchant’s case, the service especially useful in trying to stabilize cash flow. Having money removed from an account before the opportunity to dispute the fraud makes it impossible to obtain smooth cash flow. 

Technically, merchants have the right to challenge chargeback claims, however, disputing a chargeback is a complicated and time-intensive process, and the odds of a merchant succeeding in getting a chargeback reversed are very low. With the damage already done and regardless of whether the case was friendly fraud or chargeback fraud, in the eyes of the bank, the merchant is guilty until proven innocent. 

The merchant must shoulder the burden of validating the original transaction, and what’s more, there is nothing merchants can do to stop bad-acting cardholders from repeating this behavior. As financial information has been disclosed, scammers can easily hack into these centralized databases and access someone else’s card details. The exposure of this information and the storing of financial details makes it too easy to keep conning buyers. Significant security breaches have occurred time and time again — the Marriott hotel’s breach, in which hackers gained access to the personal information of an estimated 500 million customers, is just one of the scariest in recent years. 

However, a potential alternative solution does exist. With cryptocurrency payments, financial information is secure, meaning there is no risk of the buyer being frauded via identity theft, for example. The inherent immutability of blockchain technology means transactions are final for the merchant, eliminating chargeback fraud. Furthermore, the ability to instantly record information could spell the end of fraud by improving security, making hacking and faking almost impossible. The opportunity to record information on a tamper-proof ledger could eradicate issues that have burdened merchants and customers alike for years. 

There is a catch, however — neither the bank, the merchant nor the buyer can solely remedy the issue on their own. Creating an entirely new landscape for payments based on security that does not require chargebacks is the next step toward fostering mutual trust across a fragmented industry. 

The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.