Alice in Credit-Card Land: On Chargebacks

Interview with Andrew Greenstein

By: Sam Vaknin, Ph.D.

Also published by United Press International (UPI)


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My credit card was stolen in 1998, in a crowded film festival. I placed a phone call to the number provided by my bank. The same number was also published in my tourist guide and in the local daily press. I gave my details and asked to have my card cancelled, or at least blocked. I felt safe because I knew that, in a few minutes, my card number will pop up in a stop-list available to authorization centres worldwide. From that moment on, no thief will be able to fraudulently abuse my card, I thought as I reverted to my delicious lunch, sighing in relief.

But the danger was far from over.

Though rarely advised to do so, the best and safest thing is to call the authorization centre of the bank that issued the card - i.e., the issuing bank. That being a weekend, the number I called instead was a poor second. It belonged to a "volunteer" bank, which catered to the needs of all the issuers of a given type of card - "MasterCard", "Visa", or "American Express" in this case. Some travel service organizations (e.g., IAPA the International Air Passengers Association) provide a similar service.

Updating the stop-list is a low priority with the overworked weekend stuff of the "catering bank". Sometimes it takes hours before the list is updated. The "catering bank" sends a fax to the issuing bank, asking it to cancel the card. The details of all the issuing banks are available in special manuals. These are published by the clearing and payments associations of all the banks that issue a specific type of card. All the financial institutions that issue MasterCards, Eurocards and a few other minor cards in Europe are members of Europay International (EPI), for example.

Here lies the first snag: the catering bank often mistakes the identity of the issuer. Many issuers - especially branches of the same bank - are eponymous. Banks with identical names exist in Prague, Budapest, Frankfurt, London, Zagreb, or Vienna, for instance. In my case, they alerted the wrong bank in the wrong country. My card was never blocked. The thieves simply abused it to the limit.

Thus, going the indirect route (calling an intermediary bank instead of the issuing bank) translates into a delay which could prove monetarily crucial. By the time the fax is sent, it might be no longer necessary. To be on the safe side, standard credit card contracts in some countries apply coverage only one hour after the theft - when most of the damage has already been done. In the USA credit card liability in case of fraudulent transactions is limited to the first $50.

The cardholder can reclaim, in writing, fraudulent charges and money withdrawals. This ritualistic dispute procedure is called "chargeback". A chargeback is a transaction disputed within the payment system by the cardholder through the card issuer. It can also be initiated by the card-issuer on technical grounds, usually at the behest of the cardholder or if his account is overdrawn: wrong or no signature, wrong or no date, important details missing in the sales vouchers and so on. Despite the warnings carried on many a sales voucher ("No Refund No Cancellation") both refunds and cancellations occur daily.

The cardholder himself has no standing in the process and is confined to lodging a complaint with the issuer. The rules and regulations governing chargebacks are internal and inaccessible to him though they often result in debits and credits to his bank account. The issuer, at its discretion, may decide that issuing a chargeback is the best way to rectify the complaint.

The typical credit card transaction involves these steps:

  1. The cardholder presents his card to a merchant, the acceptor.
  1. The merchant may request an authorization for the transaction, either by electronic means (a Point of Sale / Electronic Fund Transfer apparatus) or by phone (voice authorization). A merchant is obliged to do so if the value of the transaction exceeds predefined thresholds. But there are other cases in which this might be a policy either required or recommended by issuers, card companies, or clearinghouses.
  1. If authorized, the merchant notes down the transaction authorization code and gives, or ships, the goods, or services to the cardholder. If the cardholder is present, he must sign the sale slip (voucher) and the merchant validates the signature by comparing it to the specimen at the back of the card. The transaction goes through only if the signatures match. The merchant then provides the cardholder with a receipt, normally with a copy of the signed voucher.
  1. The merchant collects all the transaction vouchers periodically and gives them to his bank (the "acquiring" bank).
  1. The acquiring bank credits the merchant's bank account with the difference between  the total amount of the transactions and the commissions and fees payable to the credit card company. Some banks pre-finance or re-finance credit card sales vouchers (receivables financing) - i.e., they lend against future credit card revenues.
  1. The acquiring bank forwards the slips or an electronic ledger to the payments system (VISA International, or Europay International) through its connection to the relevant network (VisaNet, in the case of Visa, for instance).
  1. The credit card company (Visa, MasterCard, Diners Club) credits the acquiring bank.
  1. The credit card company sends the transactions to the issuing bank and automatically debits it.
  1. The issuing bank automatically debits the cardholder's account. It issues monthly or transaction related statements to the cardholder.

In some countries - mainly in Central and Eastern Europe, the Middle East, Africa, and Asia - credit card companies sometimes work directly with their cardholders who pay the companies via money order or bank transfer. The cardholder is often required to provide a security to the credit card company and his spending limits are tightly supervised. Credit history, collateral, and background checks are rigorous. Even then, the majority of the cards issued are debit - rather than credit - cards.

Andrew Greenstein's Internet business - sold last year - did a great volume of credit card transactions and experienced chargebacks of between 0.5 to 3 percent. Despite its positive cashflow and good standing with the bank, it was fined by Visa, placed in its "Merchant Watch" list and forced to set aside $125,000 in a reserve account. Its fee per chargeback shot from nil to $25 on local cards and $50 per foreign chargeback.

Greenstein says:

"Over the years, I experienced bank re-negotiations, bank switches, used various online credit card processing software. I successfully negotiated our way out of additional reserve accounts, set up alternate merchant accounts with lower - sometimes virtually no - fees, and helped the company scale down its chargeback picture considerably. It was always frustrating though that even when we'd show Merchant Services & Visa dramatically reduced chargebacks, increased revenue, a large positive cashflow, years of success, letters from accountants, etc. - they'd continue to fine us over and over again, insisting that even 1.75% was 'too high for an Internet business'.

It always seemed as though they were doing it to profit - knowing full well that the company I ran had one of the rosiest chargeback pictures of all and one of the cleanest reputations around. Still, for years the company continued to suffer nicks and jabs at the whim of either Merchant Services or Visa. My years of experiences getting new accounts, changing accounts, offsetting reserves, and more - led me to create ChargebackPrevention.Com to help less knowledgeable merchants benefit from my years of 'education' in the field'."

Question: How bad is the problem of Internet credit card fraud?

Answer: Having no medium-wide statistics, I'd say that the amount of chargebacks/fraudulent orders is only increasing as more people take to the Internet and as more pranksters realize that the odds of "getting busted" are pretty low. Though frustrating to businesses, I believe that most reasonably-accomplished outfits can survive with a certain number of chargebacks even if it amounts to 3 or 4%. The problem arises when the "powers-that-be" add insult to injury by demanding a reserve account, or by arbitrarily "fining" merchants for being "bad boys." That's when Internet credit card fraud becomes a the seed that spawns a whole garden of trouble.

Question: Chargebacks allow consumers to protect themselves against fraud, faulty products, and breach of sales contracts. Would you say that consumers are abusing this protection? If so, how would you restructure the chargeback process to balance the rights and obligations of all parties?

Answer: Abuse exists in any scenario. If you ask most merchants, those few cases of torment when they knew they were being taken advantage of probably stuck in their memory and their response would be "yes, consumers are abusing this protection!".

Indeed, I can't help but recall those individual cases of obvious abuse. Still, I'd have to say that the number of people intentionally doing chargebacks to get money back is quite low. I also believe that the ONE thing Visa/MasterCard does right is to limit people in quality dispute chargebacks. When they see someone doing it excessively, they flag their account. I don't think there's a big problem of people doing it regularly, but there is a problem when consumers read articles like this one and realize, in the back of their minds, that they can chargeback. Then every slight problem with a merchant gets blown out of proportion and they try to get the product/service for free.

In my experience, however, quality dispute chargebacks are generally very easy to reverse or beat and ChargebackPrevention.Com spends a great deal of time on this - and offers many pages of information and even examples of successful rebuttal letters - teaching merchants how to diffuse this sort of chargeback.

In sum, I would say that while there are some abuses - this is the one area MC/VISA has "down pat" reasonably well. There are ways they could improve the tackling of fraud but I can't see many ways they can improve the treatment of quality disputes. Everything is well-mediated. Every once in a while you come across a grumpy anti-merchant sort of chargeback handler burnt out and tired of his or her job reviewing chargebacks all day. But such cases are few and far between. Take it from someone who has successfully reversed - or been involved in the reversal of -hundreds of these!

Question: What percentage of sales goes towards paying credit card-related expenditures: processing fees, chargebacks, fines, and reserve accounts (please explain each of these terms)?

Answer: Processing discount rates right now for phone/mail orders seem to have bottomed out around 2.2-2.3 percent depending on the variables involved. Many newer merchants pay as much as 2.57 and even 4 percent, though they can definitely negotiate a lower rate. Most merchants pay $10-$15 per chargeback but some pay as high as $25. A few merchants even pay a bogus $10-$15 fee per ticket retrieval request.

Thus, if you have a $50 sale and the customer has a gripe, you may be slapped with a $15 fee for the slip request, another $25 for the chargeback.. and then even if you reverse the chargeback - some banks charge another $25 to do it. If the customer does a second chargeback, that's another $25. So you can lose your $50 plus pay another $90 by the time you're done - in the worst case scenario with the worst merchant account conceivable!

Merchants can negotiate deals with no chargeback fees - though, generally, this increases the processing discount rate a bit - so merchants need to crunch numbers to figure out where they save the most money - with lower discount fees or with lower or no chargeback fees.

In sum, figure an average of 2.5% paid for processing discount rates, 15-40 cents per transaction (unless you negotiate a no fee per transaction deal), and $0-$25 per chargeback. Chargeback and reserve accounts happen only to "select" merchants, of course! But additional fees sometimes seen are:

        Extra charges if the merchant's batch isn't settled every 24 hours;

        Additional fees and/or augmented rates for international transactions;

        Specific per transaction fees for the type of software being used or to have "the privilege" of checking AVS or CVV2;

        Monthly statement fees - unless otherwise negotiated.

Question: Processing agents seem to benefit greatly from chargeback fees, reserve accounts, and related fines. Do they contribute to the proliferation of chargebacks? Wouldn't you say that the relationship between financial intermediaries (banks, processing agents, credit card companies) are incestuous and that the problem is structural?

Answer: In my opinion, though generally viewed as being noble and legitimate - it's one of the most corrupt businesses out there. I could never fully understand how a corporate entity is allowed to "fine" its customers. It's no wonder it's so difficult to get out of the "Merchant Watch Program". Visa certainly has no incentive to release the merchants on the list when they can get away with fining them $10,000 or more - almost at whim.

Reserve accounts at least make a little bit of sense for banks to protect themselves. But grabbing $100k or more from so many merchants and holding it for 6 months or longer -  can only be increasing bank profits ever so much. Some merchant representatives seem motivated to set reserve accounts and are probably paid based on some sort of incentive program. There appear to be employees at FirstData (which now has a virtual monopoly) who do nothing else but answer calls from merchants griping about reserve accounts - and it's very difficult (but, from our experience, not impossible) to get them to act in the merchant's favor.

In the case of the e-business I developed and owned for so many years, I found the "loss prevention" people to be vindictive and senseless with little concern for anything other than their own agenda. When one loss prevention agent was shown in detail by a team of accountants that the company only makes money, turns profits, has never failed to pay a chargeback, has a positive cash flow and so on - her response was simply: "We don't care about making money, we only care about loss prevention." And that was a management-level employee.

An even better example comes to mind. FirstData has the "right" to use the letterhead of any bank they represent and to act "on their behalf", so newer merchants tend to think they're dealing w/ their own merchant bank directly. But really the two interests couldn't be more contrary!

In one case, our corporate checking account had an open $100,000 line of credit. Yet FirstData - acting in the name of the bank's merchant services - declared after 2 years that a $100,000ish reserve was necessary to offset chargebacks. FirstData didn't know or realize that our bank gave us $100,000 worth of open credit even as FirstData's "mid-level risk loss prevention" department was telling us that we're a "risky business" and need to post $100,000 immediately to offset potential losses to the bank from chargebacks!

We had the President of our bank call FirstData directly and tell them not to hold any of the company's money; informing them what a great client we were and what a great banking relationship we had. FirstData uses that bank's letterhead and claims to represent it - but it refused to release our funds despite the explicit request of the bank whose merchant services they're contracted to represent!

Question: Give us one tip or technique on how to avoid chargebacks and describe the most widespread frauds.

Answer: Even though it adds a bit of time and expense, the one technique that works best - better than CVV2 verification or any other generic technique touted by MC/Visa - is to verbally verify each order. Just pick up the phone and call each customer. Internet frauds enjoy their anonymity and are scared senseless about actually playing their act out over the telephone. Most of them aren't "real" thieves in the sense that they would shoplift from retail stores or perpetrate fraud in a non-electronic scenario. You'll find out who is real and who is fraudulent if you pick up the phone and start calling the phone numbers on your incoming order forms. At ChargebackPrevention.Com, we teach users precisely what to look for, what to say, what questions to ask over the telephone, etc.

Question: Can you comment on the current antitrust investigation against Visa and MasterCard and its potential implications? Additionally, do you believe that the aggressive marketing drives of credit card issuers, involving little or no background checks, contribute to an increase in credit card fraud?

Answer: Sorry, no comment on this aspect!

Question: Can you compare the advantages and disadvantages of "card not present" and "card present" sales? Is e-commerce hobbled by some of the procedures and safeguards required by credit card companies and clearinghouses?

Answer: Obviously, "card present" transactions are safer for merchants. If only every computer terminal could have its own magnetic swiping device! I can't help but wonder if clearinghouses are just seeing e-commerce as a "whipping boy" - constantly crying wolf - telling merchants that they have too many chargebacks and hitting them with profitable fines.

Retailers usually don't have the same chargeback problems as E-tailers when it comes to fraud. But E-tailers generally don't have the same overhead that retailers do - so we're able to comfortably survive with 3, 4, 5 percent chargebacks. But clearing houses are too gung-ho in their search for "red flags." They simply need to stop applying the same flags to every business in every case.

A company that delivers information electronically is going to have more chargebacks than one who ships to a home address. But a company with a negative cashflow is going to be more of a risk than a company with a positive one. They should really evaluate companies more deeply before charging them with so many fines and fees. Most of the advice given by clearinghouses is generic and empty and that's one of the main reasons chargebackprevention.com came to be.

Telling everyone: ship to the billing address only, use AVS, and use CVV2  may be fine and dandy but  billing addresses don't apply to information-only merchants, AVS can cause problems of its own and CVV2 still confounds customers and loses legitimate sales when they fail to recite their credit card number by heart.

ChargebackPrevention.Com  tries to create more of a 'happy third way' between  reducing chargebacks and maintaining sales volume - something that the powers-that-be seem to care very little about. When they get chargebacks down, they reward themselves, they pat themselves on the back, they attribute it to their fines and strong-armed reserve accounts - without delving deeper. We try to teach the merchant to proactively avoid fraud, reserve accounts, and fines and to reactively deal with these issues effectively when they do occur.

Question: How will smart wallets, e-cash, PayPal and other debit/credit money substitutes affect the credit card industry?

Answer: I haven't seen much worth experimenting with. They require the customer to go through extra steps. So many online buyers are still "new to it". Some are making impulse purchases  and some are just barely convinced to buy. Requiring them to go sign up for an account with PayPal and so forth is asking for extra steps, instructions, and can pull them out of "the ether", or make them back away from sales.

Only the net-savvy really know about companies like Pay Pal and trust them. The typical occasional user about to make a purchase at your site is trusting enough to give you their information. Going over to PayPal adds another party, one they haven't even always heard of as often as you or I. I would never risk clientele by asking them to sign up.


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