Chargeback Fraud

How It Works, Common Types, & How to Prevent It

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In marketplaces, especially large ones, mistakes with transactions are bound to happen. A way that credit card companies and banks protect customers when these errors occur is by allowing them to file chargebacks. This allows customers to dispute and potentially reverse charges to their credit cards that they feel are unjustified.

However, some customers abuse this system by requesting chargebacks on transactions that they know were perfectly legitimate. This is known as chargeback fraud, and it’s becoming a huge problem as more people shop online with their credit cards.

This article will explain in more detail what chargeback fraud is and how it works, including how it differs from scenarios where there are legitimate reasons for filing chargebacks. You’ll also get some tips on how to prevent chargeback fraud from happening to your business.

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What is Chargeback Fraud?

Chargeback fraud is when a person knowingly makes a purchase with a credit card, then disputes the charge with their credit card provider. It’s a form of fraud because the customer is intentionally being deceptive, either about not authorizing a payment or about not receiving a product or service.

Chargeback fraud can be a form of first-party fraud (where the fraudster is committing fraud as themselves) or third party fraud (where the fraudster is committing fraud using fake identities).

Chargeback Fraud vs. Friendly Fraud

Friendly fraud is a specific type of chargeback fraud in which the actual cardholder intentionally requests an illegitimate chargeback. While cardholders can do this accidentally, friendly fraud is a case where they do it intentionally.

While chargeback fraud is any misuse of a chargeback system, friendly fraud is only when the cardholder themselves commit chargeback fraud. For example, if a criminal commits a chargeback with a stolen credit card, this is chargeback fraud, but not friendly fraud. If a cardholder initiates a fraudulent chargeback request themselves, it constitutes friendly fraud.

Is Chargeback Fraud Illegal?

Yes, when done intentionally, chargeback fraud is illegal.

When investigating chargeback fraud, it’s important to keep in mind that there are legitimate reasons for chargebacks that do not constitute fraud. Let’s explore those cases to understand the difference between chargeback fraud and legitimate chargebacks.

  • Technical Error: A chargeback is not processed due to a technical error by the merchant, the customer, or the payment processor.
  • Item Was Not Received: The customer never received the item.
  • Credit Was Not Processed: The refund credit was not properly processed, and therefore never received.

All of these constitute legitimate cases of chargebacks. However, not all chargebacks claimed are legitimate.

Chargeback fraud, in law, can sometimes be considered a form of payment card fraud or wire fraud. So can chargeback fraud result in jail time? Technically, yes, but usually only in extreme circumstances where it’s used to steal very high values or volumes of products and services.

Sometimes, a merchant may file a civil suit against a person who fraudulently files chargebacks. Again, though, this is likely only if they are losing enough volume or value in products or services for litigation to be worth it. There are other chargeback fraud consequences, though, such as:

  • Disqualification from filing legitimate item returns with a merchant
  • Suspension of a business relationship with a merchant
  • Loss of credit score
  • Suspension of banking privileges

How Chargeback Fraud Works

Credit card chargeback fraud is intentional abuse of the chargeback process put in place by banks and credit card companies. It usually involves a customer skipping dealing directly with a merchant to arrange a return and/or a refund, choosing instead to immediately involve their credit card company and bank in a disputed transaction.

The fraud chargeback process goes like this:

  1. A fraudster makes a legitimate purchase with their credit card.
  2. The fraudster contacts their credit card company or bank, without first dealing with the selling merchant, and claims that the purchase was fraudulent.
  3. The credit card company or bank cancels the charge, meaning the merchant loses the money from the sale and potentially also the product.

A variation is when someone initiates a legitimate return or chargeback, but then doesn’t abide by its conditions. For example, they may refuse to return the purchased item, or return it but then falsely claim they never got the refund for it. In these cases, if the person files a chargeback over not getting a refund, or keeps an item despite already having the chargeback for it processed, this can also count as chargeback fraud.

Types of Chargeback Fraud

Chargebacks fall into three general categories. Depending on a chargeback’s type, it can have a stronger or weaker association with fraud, and may be more or less justifiable from a customer’s standpoint.

Organizations looking to mitigate the impact of chargeback fraud will need to understand the different types of chargeback fraud occurring, and look at ways to prevent them from occurring.

Chargebacks from Criminal Fraud

Chargebacks from criminal fraud happen when a fraudster steals access to a credit card and uses it to make fraudulent purchases. This can include stealing the physical card, cloning its information onto a fake card, or compromising an account with the card’s information on file.

Though this chargeback type has a strong connection to fraud, it’s also very justifiable from a customer’s point of view because they are the victim, not the perpetrator. Usually, a merchant facing this type of chargeback will simply offer the legitimate cardholder a refund to avoid having to negotiate a chargeback. Thankfully, chargebacks from criminal fraud are relatively rare.

Chargebacks from Friendly Fraud

Friendly fraud and chargeback fraud happen when customers file chargebacks for purchases when they have no legitimate justification for doing so. While this can be done accidentally, when done intentionally, it constitutes fraud.

This form of chargeback fraud is called friendly fraud because - based on how it’s conducted - it is extremely difficult to distinguish when it’s accidental, and when it’s intentional.

Customers may intentionally commit chargeback fraud for a number of reasons:

  • They want to get a product or service for free
  • They think filing a chargeback will be easier than negotiating a return or refund
  • They know they’re not eligible for a refund, but want their money back anyway
  • They get “buyer’s remorse” despite their purchase not being defective or misrepresented

These are by far the most common categories of chargebacks. Unfortunately, due to the nature of these claims, it’s incredibly challenging to determine when friendly fraud is accidental versus deliberate. This is because it can be challenging to definitively prove whether a customer’s intent in filing a chargeback is malicious or not.

But both end up hurting businesses the same way: lost sales and inventory; chargeback fees, fines, or penalties; and reduced credit card provider trust.

Chargebacks from Merchant Error

Chargebacks from merchant error happen because of mistakes in the purchase or return processes. For example, a customer may: 

  • Accidentally pay more than what their purchase is worth
  • Be charged the wrong amount because the merchant makes an oversight
  • Not receive an order that was supposed to be delivered
  • Receive an order that’s defective or totally different from what they actually purchased 
  • Return an item but not receive the refund or credit they’re owed

These chargebacks have a weak connection to fraud because they’re usually legitimate and not caused by any malicious intent by the customer or a third party. Instead, they’re more often the result of faulty business practices (or, in rare cases, fraud) on the merchant’s part.

Still, many of these situations require the customer to provide proof: not only that there was a problem with the transaction, but also that the selling merchant was unavailable or unwilling to help resolve the issue. Failure to do so may signal fraud on the customer’s part.

Chargeback Fraud Prevention and Protection

Chargeback fraud is a bit different from other types of fraud because it doesn’t happen at the point of purchase. Instead, it happens after the purchase has already been made.

Some companies may fight chargeback fraud after it happens. But, again, most don’t have the resources to make going after individual fraudsters worthwhile. So how to prevent chargeback fraud starts with securing a marketplace’s purchase and return processes so that chargebacks don’t happen at all. Here are some ways to do that.

Implement Robust Credit Card Verification Systems

Avoiding chargebacks related to criminal fraud comes down to being able to determine if a credit card transaction is fraudulent before it goes through. That means using identity verification and fraud detection tools, including things like the Address Verification System, to make sure credit cards and their details are being used by their rightful owners. It’s much more efficient to block a fraudulent transaction before it happens than to negotiate a chargeback with a victimized customer afterwards.

Flag Unusual Transactions 

In some chargeback fraud cases, fraudsters will attempt to buy large quantities of items – or make repeated small quantity purchases – with the intention of filing chargebacks over them later. In the meantime, they often resell these items, allowing them to profit at a merchant’s expense if the chargebacks go through.

Even if these kinds of transactions are made legitimately (though they often aren’t), they can still be used to commit fraud. That’s why businesses should have tools for things like suspicious activity monitoring and link analysis to look for atypical shopping patterns and block them before they result in chargeback fraud.

Establish Clear Policies and Communications

Friendly fraud tends to happen for a few key reasons. One is that a customer doesn't recognize a charge on their credit card statement because a merchant doesn't describe themselves or the transaction very clearly. Another is that a merchant’s return process is ambiguous or convoluted, so a customer thinks filing a chargeback will be more convenient.

Therefore, a big part of avoiding friendly fraud is open communication with customers. Businesses should write billing descriptions to correspond exactly to the business’s name, and to the nature of the specific transaction if possible. 

They should also form clear return policies that are succinct, publicly accessible to users on the business website, and automatically attached to purchases. Finally, businesses should make methods of getting in contact with them available and obvious if customers have questions about orders.

Log Evidence of What Happened During a Transaction

Both friendly fraud and chargeback fraud happen when customers claim that something didn’t happen with a transaction when it actually did (or vice-versa). That’s why it’s important for businesses to create records of transactions: so they have evidence on their side in the case of a dispute.

A common example is to automatically send a receipt email to a customer after they make a purchase. Another is to hire a package tracking service that shows customers where their orders are in real time, and requires proof of delivery. These measures and others serve as chargeback fraud protection in case a customer claims they never made an order or never received it.

Consider Using a Chargeback Guarantee Solution

Some merchant service providers offer a fraud detection chargeback guarantee. This means that they take full responsibility for monitoring for behaviors that may be indicative of chargeback fraud. And if they miss something that leads to an illegitimate chargeback, then they pay the associated financial costs instead of the merchants.

This can be useful for smaller businesses, especially ones that can’t (or don’t want to) pay for a dedicated risk management team and so might be more vulnerable to chargeback fraud. For larger businesses, a model that might work better is paying microfees for checking only those transactions that a risk team identifies as suspicious.

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Guard Against Chargebacks to Reduce Chargeback Fraud with Unit21

We’ll reiterate that the best strategy for tackling chargeback fraud is to reduce the number of legitimate chargebacks a business has to deal with. That means combining credit card authorization technology, transaction monitoring, case management, and good customer service.

Unit21’s platform can provide many of the elements required for a successful chargeback fraud prevention system. Book a demo today to see how we can help.