Defending Consumer Rights: The Power and Pitfalls of Chargebacks in the Battle Against Credit Card Fraud

Credit card fraud is certainly not a recent development or even one confined to the twentieth century. In 1899, transportation companies issued credit cards that allowed passengers to travel by private carriage and pay the tab later. According to the Library of Congress, the first reported case of credit card fraud happened when a farmer threw away a transportation credit card offered to him, having no interest in such shenanigans. In the end, the farmer was stuck with a $27 bill (worth over $700 today) for private carriage rides he never took.¹ Lesson learned.

Seventy-five years later, The Fair Credit Billing Act of 1974 was enacted by the government to protect credit card holders and limit their liability from unfair billing practices, such as unauthorized charges as a result of theft, charges for products that may have been lost, stolen, or damaged en route, or any charge that may be in error. One critical regulation within this bill affords consumers the right to dispute questionable credit card charges and request a refund from their credit card issuer. This process is known as a chargeback.²

Chargebacks play a vital role in protecting consumer interests. However, the payments industry today is in a crisis when it comes to chargebacks due to criminal fraud, as well as first-party abuse and misuse, which impose unnecessary and significant financial burdens on all stakeholders involved, including consumers, banks, and merchants.

The Statistics

The Federal Trade Commission (FTC) reported that identity theft related to card payments in 2022 culminated in a loss of $8.8 billion for consumers, a 30% increase from the previous year.³ A 2023 credit card fraud report by Security.org revealed that 65% of Americans, roughly 151 million people, have experienced credit card fraud, up from 58% the year before.⁴

This financial burden, however, is not confined to consumers. The payments industry as a whole is expected to sustain damages exceeding $206 billion in 2023, much of which is a result of first-party fraud, otherwise known as “friendly fraud.”⁵

Despite this negative trend, 2.64 billion people worldwide are engaging in eCommerce in 2023, one-third of the global population.⁶ Consequently, there will be a corresponding increase in card-not-present (CNP) charges. The projected losses from CNP fraud in 2023 are expected to account for 73% of all card payment fraud losses.⁷

Friendly Fraud

Friendly fraud, also known as first-party or chargeback fraud, most commonly takes place when a customer uses a credit or debit card to make a purchase and later disputes the charge with their bank, even though there is no justifiable reason for doing so. Friendly fraud can range from accidental misuse to outright abuse.

First-party misuse occurs when consumers inadvertently or innocently misunderstand the details of a legitimate transaction. In such cases, the disputed transaction is a valid purchase made by the consumer or an authorized card user. However, the cardholder might forget about the purchase, fail to recognize the company’s name on the statement, or have other reasons to question the validity of the charge. Alternatively, some consumers may intentionally bypass disputing the charge with the retailer they purchased the goods or services from and opt to initiate the chargeback process with their card issuer to save time or avoid direct interactions with the retailer.

Chargeback abuse, on the other hand, is an intentional attempt to defraud the merchant. This could occur when consumers intentionally file a chargeback on a genuine transaction, even though they received the product and there was nothing wrong with it, with the intention of keeping the item and the money they paid for it. In some cases, these fraudsters may attempt to “double dip” by seeking a refund from the merchant while simultaneously filing a chargeback with their bank, effectively obtaining two refunds for a single transaction.

Chargeback Reasons

One of the primary tools allowing consumers to recover money lost to fraudsters or malicious merchants is the chargeback process, which can be used for a number of reasons. The following lists the primary reasons - both legitimate and illegitimate - consumers file chargebacks with their financial institutions:

1. Non-delivery of goods or services within the specified timeframe.
2. Receipt of damaged or defective items.
3. The merchant charged the incorrect amount.
4. Instances of outright criminal fraud, where a consumer’s card information is stolen and misused for unauthorized purchases.
5. “Buyer’s remorse,” an example of “friendly fraud.”
6. Occurrences of family fraud, where a family member makes a purchase without the cardholder’s knowledge.
7. Falling victim to affiliate marketing scams, where fraudulent ads or webpages use legitimate company branding to promote nonexistent products or services.
8. Seeking an easy way out of a subscription service, the consumer forgot about, regrets, or no longer desires.
9. Misleading product descriptions that lead to dissatisfaction.

Engaging in “cyber shoplifting,” where consumers exploit the chargeback process by disregarding return policies, refusing to wait for merchant refunds, or attempting to obtain items for free by making purchases and then disputing the transactions with their bank.

Burden of Proof

In a transaction dispute, the burden of proof typically lies with the merchants, and for good reason, what proof could a consumer provide if they don’t recognize a charge or don’t receive a product they ordered? As a result, card network rules are followed by both card issuers and merchants. This governance requires a specific process to assess and determine the validity of the chargeback claim, maintaining the consumer’s satisfaction as a priority. When it comes to safeguarding consumers, even merchants on the other side of a claim agree that for customers to continue to spend money, they must know their purchases are safe and secure.

The process for contesting a chargeback in the event the merchant believes it’s first-party fraud or “friendly fraud” is arduous by design for this very reason. For example, if the merchant provides evidence during the investigation, it is examined by the respective financial institutions. Should the cardholder disagree with the verdict - even if the evidence provided by the merchant remedies the claim - the consumer, per the rules and guidelines that govern their card rights, may file again or simply continue the dispute. When this happens, should the merchant continue to fight the case, they must pay up to $500 to proceed.

As painful as this can be for merchants, the fact is that more often than not, chargebacks are filed by consumers who innocently fail to recognize a charge on their billing statement or reach out to their bank out of convenience - not realizing the negative consequences in store for the merchant. These are not consumers attempting to steal money from the merchant or get something for free; these are right-doing citizens who are just confused about what exactly chargebacks are supposed to be used for and, more importantly, what happens to the retailer when they call their bank instead.

Fortunately, consumers receive a refund once they report their dispute to their bank, oftentimes immediately. This is an important part of the process and doubles in helping promote consumer confidence and continued spending (and even perhaps overspending). But for merchants who fund this transaction reversal to the consumer in near real-time with no advance notice, reaching a final verdict on a chargeback case can take about 90 days and require a few rounds of exchanged information. If the consumer loses the claim, the refund they received when they initiated the chargeback may be reversed (in some cases, the bank may take the loss in favor of less friction, depending on the transaction amount). However, the consumer still maintains the right to contest the transaction and rectify the issue for conditions where a different reason for a chargeback exists.

In the event that a chargeback is reversed and money is returned to the merchant for a valid purchase - in other words, the consumer agrees the claim was filed in error - the merchant is still assessed a chargeback penalty fee. Additionally, the merchant must devote time and resources if they wish to challenge the consumer’s dispute, knowing that even if they succeed, they will never remove the permanent, negative reputational demerit nor be reimbursed for any penalties or fees they were assessed through the process.

The Consequences

It seems banks have unintentionally made the chargeback process even more appealing to consumers by listening to their wants and needs and striving for a friction-free experience, similar to expectations driving the popularity of one-click sales. Today, banks touted for having the best service and most innovative customer experience have made it almost too convenient to reverse a transaction.

Misuse and abuse of the chargeback process lead to unforeseen consequences for cardholders. When consumers abuse the chargeback option, retailers may respond by blacklisting them or preventing future purchases. If a cardholder files a chargeback, thinking it’s a faster and easier solution than directly resolving the issue with the merchant, and the merchant ultimately wins the dispute, the consumer might forfeit the chance to reclaim the funds that could have been recovered by directly addressing the matter with the merchant from the outset.

Furthermore, repeatedly filing unjustified chargebacks can brand a consumer as a liability, leading the card issuer to close their account. Much can be said for the need for data sharing on this front, and among the regulatory debates over restrictions imposed to protect consumers, these same debates are ironically restricting the exchange of empirical intelligence that ultimately trickles down to the consumer in the form of increased costs, tighter policies and ultimately, inflation.

The Way Forward

Research has proven that 80% of chargebacks could be prevented if customers took their dispute to the merchant first.⁸ Friendly fraud affects all stakeholders in the transaction, but merchants experience substantial financial losses. Resolving each $1 of fraud dispute costs merchants $3.75,9 which is then compounded by revenue losses from voided sales, unreturned items, chargeback fees, and lost customers. Banks issue chargebacks to satisfy their customers and comply with regulations, incurring significant financial penalties and losses for card issuers. And consumers ultimately face higher costs and stricter policies from merchants due to the consequences of excessive chargebacks.

Effective collaboration between merchants and card issuers, as well as educating consumers on the chargeback process, is essential. Retailers prioritize customer retention and are open to finding mutually satisfactory resolutions, while financial institutions can play a crucial role in chargeback reduction by encouraging customers to communicate with merchants before resorting to chargebacks. By fostering three-way communication, merchants, banks, and consumers can jointly mitigate the negative consequences of chargebacks and work towards better protection for all parties involved.

References: 

1. McKenna, F. (2022, July 24). The story of the very first case of credit card fraud. Frank on Fraud. frankonfraud.com/fraud-trends/first-credit-card-fraud-case-was-in-1899/.
2. DeNicola, L. (2022, March 21). What is the Fair Credit Billing Act?. Experian. experian.com/blogs/ask-experian/what-is-the-fair-credit-billing-act/.
3. Ritchie, John Newman & Amy, and Simon Fondrie-Teitler and Amritha Jayanti. “New FTC Data Show Consumers Reported Losing Nearly $8.8 Billion to Scams in 2022.” Federal Trade Commission, 23 Feb. 2023, ftc.gov/news-events/news/press-releases/2023/02/new-ftc-data-show-consumers-reported-losing-nearly-88-billion-scams-2022.
4. 2023 credit card fraud report. Security.org. (2023, May 22). security.org/digital-safety/credit-card-fraud-report/.
5. Dan Berthiaume; Senior Editor. “Study: Total e-Commerce Fraud in 2023 Will Exceed $200 Billion.” Chain Store Age, 25 Jan. 2023, chainstoreage.com/study-total-e-commerce-fraud-2023-will-exceed-200-billion.
6. Arsenteva, Viktoria. “Key E-Commerce Statistics You Need to Know for 2023 and Beyond.” Lira Agency ® Official - PPC Growth Hacking Agency, 19 July 2023, lira.agency/blog/ecommerce-statistics.
7. Lebow, Sara. “Card-Not-Present Fraud to Make up 73% of Card Payment Fraud.” Insider Intelligence, Insider Intelligence, 23 Jan. 2023, insiderintelligence.com/content/card-not-present-fraud-payment.
8. Lebow, Sara. “Card-Not-Present Fraud to Make up 73% of Card Payment Fraud.” Insider Intelligence, Insider Intelligence, 23 Jan. 2023, insiderintelligence.com/content/card-not-present-fraud-payment.