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The Consumer Financial Protection Bureau is appealing to the U.S. Supreme Court over the Fifth Circuit’s ruling that their funding structure is unconstitutional, with an initial hearing on January 6. If the Supreme Court upholds the decision in April, it could lead to a reversal of many rules imposed by the financial watchdog.
Retailers and financial institutions must work together by using end-to-end data sharing and automated technology to provide a more accurate picture of how fraud occurs and to protect consumers, banks and businesses, especially as the Consumer Financial Protection Bureau (CFPB) is in legal turmoil.
Related: The 5 Most Common Small Business Fraud Scenarios
While payment disputes can arise between cardholders and merchants, the best way to handle these disputes is controversial.
The problem is presented as a zero-sum competition where the needs of retailers must be weighed against the rights of cardholders. Conventional wisdom says that anything that benefits merchants should come at the expense of cardholders and vice versa.
Regulatory pressure from agencies like the CFPB has largely ignored the merchant perspective in favor of expanding cardholder protections. Unfortunately, this focus has consequences that lead to increased costs for merchants and financial institutions caught in the middle of it all.
Fortunately, technology allows us to build a collaborative solution that benefits all parties in the transaction process without putting the needs of one over the other. With the Supreme Court considering the CFPB’s certiorari petition regarding the Fifth Circuit Court of Appeals deeming their funding structure unconstitutional, there is a possibility that the Supreme Court could uphold the Fifth Circuit’s ruling, leading to to a reversal of the regulations imposed by the financial watchdog. and major disruption for banks and businesses.
Related: 9 Crucial Tips to Protect Your Small Business from Credit Card Fraud
Table of Contents
The need for cardholder protection
It is clear that there are good arguments for prioritizing consumer protection.
When the CFPB was founded in 2011, its stated purpose was to protect consumers from abusive and predatory financial practices. This was seen as a necessary backlash in a post-2008 environment.
Protecting consumers against fraud and abuse is the right thing to do. It also helps provide a solid foundation for the market as a whole. If consumers are confident in their protection, they will be more willing to transact online.
Cardholders have the right to ask their issuing bank to intervene by filing a chargeback, essentially a forced chargeback. This fundamental guarantee has underpinned much of the growth of the online market over the past two decades. Without it, you could argue that far fewer people would confidently shop online.
For cases of true fraud, payment disputes should be easy to resolve and require minimal effort from cardholders. Adding excessive friction or awkward obstacles would have downstream ramifications for the entire e-commerce industry.
The problem is that cardholders are more comfortable with the dispute process and have learned ways to abuse the system.
The problem of chargeback abuse
Many of the chargebacks filed by cardholders this year are based on invalid claims.
Consumers are increasingly seeing chargebacks as the first way to resolve a problem with an online merchant. Card issuers have made it really easy to dispute a charge, so it’s often faster for consumers to contact their bank than the merchant if they’re unhappy. In fact, it’s so simple that many chargebacks are accidentally initiated by cardholders simply looking for information about a transaction.
This has led to an explosion of friendly fraud cases costing merchants billions of dollars annually. A recent survey found that friendly fraud was the most common method merchants faced in 2021, rising from fifth place in 2019.
Related: Think You Can’t Win Against Chargebacks? Think again.
The current system also puts a heavy burden on traders who want to defend against friendly fraud. The lack of standardization and cumbersome requirements of many acquirers are in part designed to deter sellers from responding to disputes.
The real cost of fraud on LexisNexis study estimates that merchants end up losing $3.60 for every dollar of direct fraud costs. This multiplier is due in part to the resources merchants need to manage chargebacks effectively.
The need for trade rights
The current chargeback system was codified long before e-commerce or online banking was a concern. While the chargeback process has been updated several times over the years, the underlying logic has remained largely unchanged.
Under the current system, the burden of disputes is overwhelmingly on merchants, and filing a response is generally difficult. Most banks still require paper documents and provide little guidance on format or other requirements. This may be, at least to some extent, by design.
When a merchant provides conclusive evidence that the transaction was legitimate, both banks must review and process the case. If the case is decided in favor of the merchant, the cardholder can escalate the dispute. This is a manual, time-consuming process. The current system would break if most sellers responded to most cases.
This “strategic dysfunction” has prevented many traders from defending themselves against illegitimate disputes, but it cannot be the final solution. As friendly fraud becomes more common, it should be easier, not harder, for traders to fight back.
Related: How This New Accounting Feature Can Save Businesses from Fraud and Financial Mishaps
The “merchant vs. cardholder” fallacy.
Common wisdom states that by placing too much emphasis on consumer protection, we are asking merchants to accept chargebacks and friendly fraud as a cost of doing business. This places a financial burden on sellers that is invariably passed on to customers.
By contrast, trying to empower merchants without reexamining the foundations of the dispute process could put consumers at risk. The system can become overloaded and dishonest sellers can re-victimize cardholders with legitimate claims.
The way forward is not to protect one side at the expense of the other. Instead, it is to develop strategies that meet the needs of merchants, cardholders and banks.
A technological roadmap
Modern banks are increasingly behaving like software companies, but payment disputes are still largely handled on rails from the twentieth century. Collaborative solutions and end-to-end data sharing can better inform chargeback decisions, streamline operational bottlenecks, reduce friendly fraud, and protect cardholders.
Here’s an example: As artificial intelligence and machine learning play a greater role in fraud prevention, accurate data to train these systems becomes increasingly valuable. By discouraging sellers from responding to disputes, institutions lose critical data that can be used to prevent fraud.
If acquiring banks encouraged their merchants to respond to all cases, even just to confirm actual fraud, it would give institutions a much more accurate picture of the actual fraud. The current solution relies heavily on raw chargeback data, which includes “criminal” fraud by third parties and “friendly” fraud by own parties.
If more merchants responded to payment disputes, banks would be much better at identifying and preventing fraudulent transactions. There would be fewer cases of criminal fraud and fewer false denials, which would benefit everyone.
The added caseload can be streamlined through modernization. Instead of relying on disparate, non-standard paper documents, technology could enable vendors to send raw data in a globally standardized format. This would enable all parties to use automation, minimize errors and reduce the number of employees required to handle disputes.
In addition, chargebacks can be further reduced by making more data available to issuing banks when handling disputes. A significant number of chargebacks are filed accidentally. Cardholders call their bank to inquire about a charge, and with little to no information about the transaction, the bank’s only option is to initiate a chargeback.
Currently, two technologies – Verifi Order Insight and Ethoca Consumer Clarity – enable merchants to share data with banks in the event of a cardholder investigation. They have proven the benefits of data, but the programs are costly and difficult for merchants to implement.
More data sharing should be the goal by default.
Out with the old, in with the new
Striking a balance through technology is a “win-win” that benefits cardholders, banks and merchants alike. It should be the goal of all parties, including regulators like CFPB, to advocate for technological solutions to our current problems.
The change won’t be easy and we won’t see results overnight, but the value of building a better, more viable system outweighs the cost. The more we focus on solutions that meet the needs of merchants, banks and consumers, the easier it will be to resolve the remaining conflicts.
The current system is not sustainable. It’s time to try new ideas.
