Accountants have an old saying, "If people can steal, they will steal." If it is possible for people to sneak in the back door of a movie theater without buying a ticket, half the audience will have no ticket.
The advent of the credit card brought with it a whole new field of scams. Credit cards can be stolen and forged. People can go "dumpster diving" for slips that reveal the cardholder's name, account number and expiration date (as a result of a "manual imprint," according to VISA jargon). Database theft can be done in person or via computer. Today's crook has a myriad of ways to make a quick grab for tons of money or merchandise before anyone even realizes a crime has been committed.
Playing fast and loose with merchant accounts certainly supplies the potential for all manner of fraudulent activities. A crook with a merchant account is like a kid in a candy store. A case in point is a recent Southern California federal indictment, where the defendants were alleged to have improperly billed some 900,000 credit card numbers for adult website access that the cardholders had never ordered. The group was alleged to have funneled about $23.5 million into Cayman Islands bank accounts. That's about 25 bucks per card.
Chargebacks are a problem currently plaguing the Internet world. They usually result from some kind of fraudulent or questionable activity. At one extreme is the previous example, which theoretically should result in 900,000 chargebacks with the banks left holding the bag for millions of dollars. At the other end lies the domestic chargeback that results from the missus finding a $29.95 charge on the VISA bill from an X-rated something-dot-com and confronting hubby with it. "Some hacker must have gotten our account number," he protests, perhaps correctly and perhaps not. Either way, it is a chargeback that the dot-com company is going to have to eat because, as explained in Part II of this series, there is no possible way - yet - of verifying it.
The fraud rate for e-tail businesses is reported to be little different from that in a "Face-To-Face Environment" (a word of art from the VISA Glossary) - reportedly less than 1/10th of one percent (0.08 - 0.09\\%). This really should be no surprise because, with proper security measures, chargebacks can be deflected by evidence of delivery to the same address that the credit card bill is sent. While other reports suggest that non-"Face-to-Face Transactions" have profoundly higher rates of fraud, there is little question that Web content transactions - where there is no physical "product" to sign for - are at substantially greater risks of fraud.
E-tailers obviously have a strong incentive to avoid fraud. Those victimized by a fraudulent transaction ship their products but will never be paid for them. The pressure to keep customers happy in the hopes that they will buy more stuff, combined with the pressure to keep chargebacks down, often results in the same kinds of customer service dilemmas encountered in brick-and-mortar businesses. For example, a guy in Biloxi claims that the triple-action dildo he purchased online was damaged in transit. No problem; a replacement is on the way. A company similarly deals with a complaint that the blow-up doll headed for Boise was lost in transit. And if a dispute cannot be resolved, sometimes it is better to simply give the customer a credit or replacement product than to deal with a chargeback. With appropriate anti-fraud and customer-service mechanisms in place, e-tailers should not have a problem. Consultants are available for those with questions.
But the potential for merchants to engage in fraud also exists. The alleged Southern California scamsters described above probably could have accomplished the same result by billing card members for non-existent product shipments. Mail-order scams existed long before the Internet, after all.
However, compared to the problems associated with e-tailers, the broad problems associated with what is now called "videotext" are colossal. This is not new, either. The same problems existed with what is called "audiotext." Originally called "Dial-A-Porn" by its detractors, audiotext started with "976" and "900" numbers. When the so-called "Helms Amendment" was enacted, billing such services through the telephone companies became prohibited. According to the Helms Amendment, the only legal way to now propagate adult audiotext services is to have the caller provide a valid credit card before being plugged in. The resulting chargeback problem is, as you might imagine, substantial.
"Videotext" has been the subject of a great deal of news coverage in this magazine. Both it and audiotext share the common problem that no product is ever physically "delivered." Chargebacks are therefore indefensible by the merchant, as explained last month. Moreover, the incidence of chargebacks is exacerbated by the fact that videotext merchants often do not deploy appropriate anti-fraud techniques and, worse yet, often engage in chargeback-generating behavior such as automatic renewals.
It is no surprise that the credit card systems have not taken these problems sitting down. Remember, they want happy cardholders. That is why, even though federal law caps a cardholder's liability at $50 for unauthorized charges that take place before the card is reported lost or stolen, card issuers very often waive even that small fee. "What a nice bank," the cardholder thinks, perhaps not even aware of the $50 limit, "It didn't make me pay for anything that was charged up on my stolen card. I think I'll buy everything with my Modern National Bank VISA card now." On the other hand, cardholders are not happy to find unauthorized charges for $19.95 worth of Internet pornography on their bills. And it is only worse when several months of repeat charges accrue before anyone notices them. So, despite the fact that a cardholder can invariably have an audiotext or videotext charge removed from his or her card without penalty, (1) it is a nuisance and, (2) not everybody reads their cardholder agreement so carefully as to know their rights. Cardholders can feel that they have been imposed upon, that their privacy has been invaded and that the card issuer has caused them a nuisance. Maybe next time they will charge things on American Express instead of VISA, or the other way around.
The result of all of this is what this industry is so painfully learning these days: The credit card industry is doing much to combat fraud in general - and chargebacks in particular. That is why merchant accounts are not carelessly issued.
When business owners apply for a merchant account from an ISO, they will be presented with an application form. The application form includes many questions, some of which are very personal. Inaccurate responses can cause revocation of one's merchant processing privileges and placement in the dreaded terminated merchant file.
Many merchants had their processing privileges yanked during the mid-'90s because aggressive sales personnel from the ISOs simply said, "Just sign the form, I will fill it out for you." Nice guy, right? Wrong! The sales people from the ISO presumably were working on commissions and, therefore, were very enthusiastic about having their customers' applications approved. Years later, when this package of merchant accounts was being sold from one ISO to another - for the second time - someone culled through the package and found that a number of merchants had misrepresented what they were doing; they were in the adult-video mail order business, not in a brick-and-mortar sales operation. The acquiring bank did what it was entitled to do under the merchant-processing agreement, which was to disconnect the merchant-processing rights, suck almost limitless amounts of money out of the merchant's bank account for "chargeback reserves," and put the merchant on the "Terminated Merchant File" (as will be explained in next month's article). The moral of the story, of course, is to be absolutely sure that the application is completed with unqualified accuracy.
Next time, the nuts and bolts of all this.
(Clyde DeWitt is a partner in the Los Angeles, California law firm of Weston, Garrou & DeWitt. He can be reached through AVN Online's offices, at his office at 12121 Wilshire Boulevard, Suite 900 Los Angeles, CA 90025 or over the Internet at [email protected]. Readers are considered a valuable source of court decisions, legal gossip and information from around the country, all of which is received with interest. Books, pro and con, are encouraged to be submitted for review, but they will not be returned. This column does not constitute legal advice but, rather, serves to inform readers of legal news, developments in cases and editorial comment about legal developments and trends. Readers who believe anything reported in this column might impact them should contact their personal attorneys.)
