5 Steps to Keep First-Party Fraud From Impacting Your Bottom Line
What if we told you the fastest-growing fraud threat facing the market isn’t committed by professional fraudsters? What if your customers themselves are responsible for more than 60% of all chargebacks?
It’s true. First-party fraud, or fraud committed by an authorized user, is a bad problem already, but it’s getting worse every year.
First-party fraud is a costly post-transactional threat of which every merchant needs to be aware. It’s also a threat for which you need to strategize and plan to defeat. That raises the question: what is first-party fraud, exactly? And, more importantly, what can you do to stop it?
Let’s find out.
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What is First-Party Fraud?
- First-Party Fraud
First-party fraud occurs when an individual receives goods or services after promising to make a future payment for those items. However, the buyer has no intention to do so. Examples include applying for a loan that the borrower won’t pay back or filing a false chargeback claim.
[noun]/fərst • pär • dē • frôd/
Put simply: a first-party fraud attack refers to any fraudulent activity perpetrated by a consumer rather than by a third-party fraudster.
To illustrate, imagine that an individual takes out a loan they have no intention to pay back. The plan is to later claim that they did not request the loan and pocket the cash. Or, maybe a user buys an expensive item on their own credit card, but has no intention to actually pay for it. In this case, the plan is to simply claim the transaction was unauthorized and request a chargeback. These are both examples of first-party fraud.
What makes first-party fraud distinct from third-party fraud is that the “fraud” lies in the false claim, rather than the transaction. By all accounts, a transaction is legitimate until the moment the fraudster claims it is not.
First-party fraud costs merchants $89 billion per year as of 2022.
Again, take chargeback misuse for example. This practice is also known as friendly fraud, and involves a cardholder filing an invalid dispute against a credit card transaction. But, until the moment the cardholder initiates a dispute, the transaction is effectively valid.
Another unique thing about first-party fraud is that it’s not always intentional. It can be committed willfully; however, it’s more often due to a mistake or misunderstanding by the perpetrator, as we’ll see later.
How Does First-Party Fraud Affect Businesses?
First-party fraud wreaks havoc in the eCommerce space, in particular. This is because it’s tough to spot — and even harder to stop — when the merchant and cardholder never have any face-to-face interaction.
First-party fraud isn’t merely expensive for you as a merchant. It can also be extremely damaging to your reputation, too. To illustrate, here are some of the ways first-party fraud involving chargebacks can negatively impact your businesses:
Now that we have a solid understanding of how first-party fraud affects businesses, let’s discuss how those merchants might be targeted.
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Most Common First-Party Fraud Scams
Like third-party (or “criminal”) fraud, there’s not just one unique source for first-party fraud. There’s an entire family tree of different but related fraud schemes. The complicity of the “legitimate” (i.e. authorized) user is the uniting thread.
First-party fraud can manifest via several scenarios, all of which can be extremely easy to miss. But, awareness of the various scams out there is a decisive first step toward fraud prevention. Here are some examples of common first-party scams:
How First-Party Fraud Happens
So, there are a lot of different tactics and scenarios that can fall under the mantle of first-party fraud. Perhaps the cleanest way to segment all of these is dividing them into three main categories: unintentional, opportunistic, and organized.
Unintentional First-Party Fraud
The vast majority of first-party fraud is actually committed by otherwise legitimate cardholders. These are situations in which the buyer is not entitled to a chargeback. However, they may want to get their money back, and simply misunderstand the difference between refund requests and chargebacks.
Unintentional first-party fraud might happen because the customer:
- is displeased or confused.
- didn’t understand the merchant’s return policy.
- didn’t recognize the merchant’s billing details on their statement.
Generally, these cases are not malicious. The buyer simply just doesn’t understand what they’ve done, and how it can impact you.
Opportunistic First-Party Fraud
Like we mentioned above, most first-party fraud is actually committed by otherwise legitimate cardholders. Sometimes, though, when the opportunity presents itself, the cardholder may indulge the urge to take advantage of the situation.
Opportunistic first-party fraud could happen because:
- the customer didn’t like the items or services purchased.
- a family member made the purchase without permission.
- the customer felt that requesting a refund was too much work.
- the customer wanted to get something for free.
It’s important to note that opportunistic first-party fraud isn’t always malicious. That said, it is always damaging to the merchant involved.
Organized First-Party Fraud
Of course, not all first-party attacks are so innocent. There are cases in which a fraudster initiates a purchase already planning to commit first-party fraud. This would be the cyber-shoplifting we mentioned earlier.
Again, though, we’re touching on the difficulty of really digging into first-party fraud, as the more benign practice of wardrobing technically falls under this mantle, too. Both cyber shoplifting and wardrobing are deliberate first-party fraud, but the ramifications of both are very different.
That’s really the issue.
First-party fraud represents a decided “gray area” in the fraud management space. As a result, banks and merchants are hard-pressed to identify these attacks. Knowing what to look out for is a crucial step to not only resolve current issues within your best practices, but also to help you prevent future first-party attacks.
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Top 5 First-Party Fraud Red Flags
Experts have identified a number of specific red flags to help spot third-party fraud. By themselves, none of these warning signs necessarily point to a problem; large purchases, for example, aren’t indicative of a full-scale fraud issue. But, at the same time, you must recognize the signs that warrant further investigation.
While it’s a bit harder to identify the signs of first-party fraud… they’re still there. You just need to know where to look.
Below, we’ve picked out five of the most common signs of chargeback abuse as a way to illustrate how this can work.
Red Flag #1 | The Cardholder Has Done This Before
According to our research, 81% of cardholders freely admit to filing a chargeback out of convenience. Furthermore, 40% of consumers who commit first-party fraud will do it again in 60 days. If a cardholder gets away with first-party fraud and sees no consequences, they might be incentivized to try it again.
Enabling blacklists and other chargeback prevention tools can drastically reduce the likelihood of being hit by the same scam twice.
Red Flag #2 | The Cardholder Ordered Multiples of the Same Item
Consumers will often order multiples of the same item if they really like it. Clothing is an excellent example of this; everyone has a favorite shirt they’d like to have in several colors. However, there comes a point when merchants should be wary of repeat purchases made for one particular item. This could be a case of wardrobing. It could even be a sign of mule activity or deliberate cyber shoplifting, as the buyer might request chargebacks on those purchases, then warehouse the goods to resell later.
Avoid return fraud and other scams by keeping meticulous records for every transaction. If something looks suspicious, there could be a reason.
Red Flag #3 | The Cardholder Uses Other Aliases
Suppose the cardholder has made purchases from multiple accounts, ships to various addresses, or sets multiple active users on one account. It might be wise to investigate each purchase and keep an eye on them thereafter. If the customer requests returns and wants them shipped to a different address, this could indicate address fraud. Whatever the case, it’s best to practice caution.
If your customer creates multiple accounts, disable payments until the cardholder selects a primary account and address. Always keep a record of purchases and activity, too.
Red Flag #4 | The Cardholder is Spending Large
No merchant wants to reject a large sale. However, let’s say the cardholder has never made a purchase from you before, but then drops $10,000 on your site in the middle of the night, from a foreign location. This should be a clear fraud red flag. Smart merchants know these are precisely the types of transactions that often lead to fraud and chargebacks.
Earmark EVERY major purchase as potential fraud, even if you are familiar with the cardholder. Timestamps and transaction details will come in handy if you are hit with a chargeback for the amount spent.
Red Flag #5 | They Fit the Profile
First-party fraudsters tend to be younger, more tech-savvy men who live in urban environments and who don't have a lot of money. These factors alone don’t mark any one individual out for fraud. However, when taken together with the above factors, these statistics could be an important indicator.
When investigating a suspicious transaction, take the customer’s profile into consideration. You should never assume fraud based on a customer’s circumstances. But, if more than one factor is present, the profile then becomes a red flag.
5 Steps to Stop First-Party Fraud
We should clarify this point up front: you may be able to stop some first-party fraud. Your options are limited when it comes to ongoing first-party fraud prevention, though.
First-party fraud schemes are generally post-transactional. A transaction seems legitimate right up until the second the cardholder accepts a fronted bill, returns wardrobed goods, or files a friendly fraud chargeback. So, how can you really fight back?
Here are a few steps to help you get started:
#1 | Define the Problem
You have to know the difference between first-party fraud vs. third-party fraud. Look at the signs, and know precisely which schemes are being deployed to hurt your business.
You can’t work with the cardholder to confirm what’s happening, as the cardholder is also the perpetrator. Instead, you must examine your data closely and trust your internal decisioning processes. You need to build out this capacity or work with a third party who can conduct data analysis on your behalf. Once you have this system in place, identifying which type of fraud you’re dealing with gets much easier.
#2 | Identify Bad Transactions
Once you have a strategy in place for first-party fraud detection, you are better equipped to handle it. Categorizing the incident accordingly will help you prepare your official response. If you can prove the incident was fraud, you should compile any evidence, restrict the user’s account, and contact the bank as quickly as possible. In the case of friendly fraud, for instance, you might have all the ammunition you need to prepare a winning representment.
#3 | Deploy Solutions
As we established, your ability to “prevent” first-party fraud is limited. However, the data you generate from identifying bad transactions and responses could be an incredible asset to help here.
Looking at chargebacks again, we see that analyzing historical data regarding past disputes and representments could help you block suspicious transactions. It will also help you prepare stronger cases and recover more revenue in the long term.
#4 | Adjust Over Time
Another benefit of implementing effective first-party fraud solutions is that, over time, you can evaluate and see what is—and is not—working for you.
The strategy you implement might seem rational at first. But, as time goes on, you could discover that you’re not getting the results you expect. If you make adjustments accordingly, you can see better results for recovering first-party fraud losses.
#5 | Ask for Help
As they say, “prevention is the best medicine.” That’s true for third-party threats, as well as first-party fraud schemes. What if you are too busy, understaffed, or overloaded to manage that on your own, though?
With more than a decade in chargeback management and recovery, the experts at Chargebacks911 have the advanced tools and industry knowledge to help you prepare a winning fraud prevention strategy. Contact us today for your free demo.
What is first- vs. third-party fraud?
First-party fraud is committed by an otherwise legitimate cardholder or customer, either on an individual basis or in a combined effort with another fraudster.
Third-party fraud, on the other hand, is committed by a practiced fraudster unrelated to either the customer or the merchant. This type of attack revolves around using stolen customer credentials to defraud a merchant or organization.
What is indicative of first-party fraud?
First-party fraud fraud is generally either unintentional, meaning the cardholder didn’t realize what they were doing, or it is deliberate. Deliberate first-party fraud can be further broken down into opportunistic attacks, meaning the cardholder sees an opportunity to recoup funds from a merchant that has displeased them in some way. Or, it can be an organized attempt to deliberately defraud a merchant or organization on a post-transactional basis.
Is first-party fraud serious?
Yes, it is a huge problem. First-party fraud costs merchants upward of $89 billion per year, and is responsible for up to 60% of all chargebacks.
What are the three types of fraud?
We can segment fraud into first-party, second-party, and third-party fraud.
First-party fraud is post-transactional fraud committed by the cardholder. Second-party fraud is committed by a party working along with the cardholder, either pre- or post-transaction. Third-party fraud is fraud committed by a person unrelated to the cardholder, who uses their credit credentials to commit transactional fraud.
How do I stop first-party fraud?
You must examine your data closely and trust your internal decisioning processes. You need to build out this capacity or work with a third party who can conduct data analysis on your behalf. Once you have this system in place, identifying which type of fraud you’re dealing with gets much easier.