Swiping Back At Credit-Card Fraud

Bogus transactions are falling overall, but e-tailers are still feeling the pain

Every other week, it seems, another bank, credit-card company, or data-processing outfit announces a security breach of personal financial data. On June 17, MasterCard International Inc. disclosed that one of the companies that processes transactions for it and other card companies had been infiltrated. In all, information on more than 40 million accounts was exposed to fraud. With criminals freely trading card numbers, Social Security numbers, and mothers' maiden names, you might think credit-card fraud was going through the roof.

Well, not exactly. In fact, overall credit-card fraud has been falling for more than a decade as retailers and card issuers get better at rooting out bogus transactions. Matters aren't quite as peachy online. E-tail credit-card fraud is triple the rate of the brick-and-mortar world, according to The Nilson Report, a card-industry publication. "Internet fraud is a problem that's not going to decline for the next several years," says Robert Lynch, vice-president of eFunds Corp.'s (EFD ) retail sales group, which sells fraud-prevention technology to e-tailers.

Still, if the brick-and-mortar world is any guide, e-tailers should be able to fight back. In 1992 fraudulent credit-card transactions peaked at 15.7 cents of each $100 in sales, according to Nilson. By last year such fraud had fallen to 4.7 cents per $100 of sales. Even absolute levels are down: Although the value of credit-card transactions has risen nearly 50% in the past five years, fraud fell from $1.13 billion in 1999 to $1.05 billion in 2004.

Indeed, banks and credit-card companies have spent hundreds of millions on technologies that help identify illegal card use. Security features, such as the multidigit number found on the back of cards, are one weapon in this ongoing war. The industry has also turned to sophisticated technology that instantly analyzes cardholders' spending to spot unusual activity. As a result, issuers are able to detect many phony transactions before authorizing payment.

Now, Internet retailing -- which accounts for 11% of the value of card transactions -- is creating new opportunities for criminals. That helps explain why an estimated 14 cents of every $100 in online credit-card transactions are bogus. With stolen card numbers or ones generated by sophisticated computer programs, organized crime groups inundate e-tailers with hundreds of bogus charges. To avoid suspicion, they have the goods shipped to fronts in the U.S., who forward the parcels overseas. In another scam, called "triangulation," crooks sell an item in an online auction. Once they receive payment from the buyer, they use a stolen card number to buy that item from another online retailer, who ships directly to the consumer.

In the past couple of years, however, bigger e-tailers such as Amazon.com Inc. (AMZN ) and eBay Inc. (EBAY ) have gotten more aggressive, adding staffers to combat fraud and sophisticated technology to screen for it. In addition, they have shared information on the problem and worked more closely with credit-card associations, banks, and agencies such as the FBI. That has prompted fraudsters to switch to smaller retailers, who can't afford those defenses and who don't work closely together. "So much for the Internet leveling the playing field," says Avivah Litan, an analyst at research firm Gartner Inc.

Unlike their brick and mortar counterparts, online merchants generally are liable for bogus charges since there is no physical card to check. So it's not surprising that in their efforts to weed out fraudulent transactions, some are being overcautious and blocking legitimate sales as well.

Xavier Kris, U.S. operations chief of British fraud-prevention firm Retail Decisions PLC, estimates that 6% to 8% of legitimate online sales are rejected for fear they are fraudulent. In low-margin businesses that need as much sales volume as they can muster, that caution quickly becomes a big drain on profits.

Internet fraud is clearly a challenge that e-tailers can't afford to ignore. With fraud rates that are far higher than those of traditional retailers, they will have to put more muscle into their fight than many seem willing to do at the moment.

By Robert Berner and Adrienne Carter in Chicago, with bureau reports

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