Fraud crackdown cuts into card convenience

Not long after stating "your table is ready," restaurant host David Seymour has lately been forced to address a number of customers with a far less welcoming message: "Your credit card has been declined."

Each month, Mr. Seymour personally turns down an average of six credit cards. His colleagues report similar statistics.

The reasons may vary, says Seymour, but the change is clear. "The past six months there's been a big jump in declined cards," he says.

This shift is also playing out in retail stores across the country, experts say.

Increasingly, credit-card issuers are blocking purchases, leaving some consumers without a method of payment and causing others to rely on cash or another card to complete a purchase.

At the root of the trend: a growing effort by creditors to crack down on fraud. Last year, the credit-card industry lost $750 million to fraudulent purchases – a $160 million increase over 1997. But the percentage of all credit-card purchases lost to fraud has fallen significantly. (See chart, right.)

Many observers credit the downturn to issuers use of relatively new tools, including computer software called neural networks that block purchases that do not fit a cardholder's buying profile.

"Your individual spending patterns are learned by the network so that when you make a purchase outside of your spending pattern, a red flag goes up," says David Robertson, publisher of The Nilson Report, an Oxnard, Calif.-based credit-card research firm.

Attempted purchases are given a score of zero to 100 in less than a second. The higher the score, the more likely the purchase is fraudulent. Each credit-card company sets a number that, if exceeded, will cause a purchase to be blocked.

The software debuted about a decade ago, but has since become more refined, accumulating years of data on consumer buying habits and on incidents of fraud. More than half of credit cards on the MasterCard and Visa networks are under the umbrella of the technology.

"The level of sophistication of our systems has improved dramatically the past few years," says Skeet Rolling, director of Fraud Control Services, an information-security firm in Columbus, Ga., that sells neural-network software.

Combined with a new commitment to reduce fraud, the technology has likely led some top card companies to block more purchases, says Mike Cunningham, fraud executive for Chase card member services. "They're adding to their staff, making a larger investment, and referring more transactions at the point of sale," says Mr. Cunningham.

The efforts have yielded significant savings for the industry. "Over the last few years, losses to fraud are lower than a snake's belly," says Robertson. Now, for every $100 charged, card issuers lose only about 7 cents to fraud compared to 18 cents a decade ago.

But the security improvements have come at a cost. The system often blocks cards that belong to people who have done nothing wrong. And merchants say a small but growing number of consumers are bristling at the extra layer of bureaucracy now being imposed in the checkout line.

"All kinds of rules have gone forward over the year that end up hassling and turning off consumers," says Avivah Litan, a bank-industry analyst with the Gartner Group, a market-research firm in Stamford, Conn. "For now, it's a pretty clear savings for the banks, but it's getting annoying for consumers."

For many consumers, credit-card companies' vigilance often seems to be manifested at the most inconvenient times.

DeeAnn Finkel, a Boston resident, says her Chase MasterCard was blocked when she attempted to use it during a recent trip to Europe. Ms. Finkel was directed to call Chase. After answering a few basic questions, her card was reactivated. She now shares her itinerary with Chase before taking a vacation.

"Calling ahead is a good idea because it advises your credit-card company to anticipate certain behavior patterns," says Jim Donahue, spokesman for credit-card issuer MBNA.

Creditors become suspicious when charges are made in states or countries where cardholders have never been before – as was the case with Finkel. Fraud also is often suspected when cards are used to buy gasoline and then electronics or jewelry. At a gasoline station, a thief can swipe a stolen card at the pump to determine if it is active. If the card works, the criminal often buys other goods that can be sold and turned into cash. Large dollar amounts, a quick number of purchases in succession, and transactions at odd times of day also raise eyebrows.

Some merchants grouse that the new era of scrutiny is excessive. Rather than call the issuer directly, many simply tell customers that their card has been canceled and ask for another. "If a customer perceives it to be a negative experience, typically it's because the merchant doesn't want to go through the process," says Cunningham.

Apathy on the part of retailers also points to a significant stumbling block in the fight against fraud: Consumers and merchants rarely welcome measures that make the buying process more complex.

As a result, experts say credit-card companies are not likely go overboard with enforcement, nor even do all they can to reduce fraud. "If they eliminated all fraud, they'd be out of business. It's a question of choosing your degree of fraud," says Lewis Mandell, author of "Credit Card Industry: A History."

Convenience has been the guiding principle of the modern credit-card industry since its inception about a half century ago. Card issuers emphasize convenience even more now because of intense competition in the industry. "The issuer knows that if they make [the process] too onerous, they will lose business," says Mr. Mandell.

One example of overstepping customers' bounds of privacy may be collecting trip-itinerary information, even though consumers provide the information voluntarily. "Unless the issuer has a way of authenticating the caller with something like a password, consumers should think twice about [this]," says Mr. Rolling.

Credit-card companies traditionally operated with streamlined procedures, including easy application and payment processes. The emphasis on efficiency leaves the system open to significant errors, say some consumer advocates. Among them: frequent approval of applications lacking basic information such as a name or Social Security number.

Consumers are rarely liable for money fraudulently spent in their name (see story left), but might be paying for a lack of security in the form of more expensive goods and services.

"The banks are not absorbing the losses. We are as consumers, with higher merchandise prices," says Linda Foley, executive director of the Identity Theft Resource Center in San Diego.

Banks are losing more money each year to fraud primarily because people are relying more on plastic to make purchases.

Americans made about $26 billion in payments using credit or debit cards in 2000, but only wrote about $22 billion in checks, according to a recent study by the Federal Reserve.

While the number of credit cards issued to consumers over the past five years has remained relatively flat, debit-card use has boomed.

During the first half of 2002, Visa USA processed 3.04 billion debit-card transactions compared with 2.96 billion credit-card transactions. That is a startling statistic, say experts, given that there are twice as many credit cards as debit cards are now in circulation on the Visa system.

Other than the convenience of not having to carry much cash, consumers prefer debit cards because they help them manage their budgets better.

"It's more of a control issue," says Avivah Litan, a bank- industry analyst with the Gartner Group, a market-research firm in Stamford, Conn. "People like to control spending through their checking account rather than wracking up credit bills."

Those choosing between the two methods of payment, experts say, must factor in more than convenience.

Several banks have recently begun charging consumers a fee if they complete their debit-card purchase by entering a PIN (personal identification number) rather than penning their signature, even though both expenditures ultimately come out of consumers' checking accounts.

Indeed, 20 percent of the nation's 250 top banks use rewards or fees to persuade customers to use their signature for debit purchases, according to a recent survey by Jefferies and Co., a New York investment firm.

Banks encourage the use of signatures because they can typically charge retailers more for such transactions.

In terms of theft, consumers' liability depends on the issuer of the card. According to federal law, consumers are only liable for up to $50 of any fraudulent purchase made on their credit-card account, though banks rarely ask for the payment.

In the case of debit cards, protections are a bit looser. Liability is capped at $50 if the debit-card user notifies the bank within two days of learning that the card is missing. That number soars to $500 for consumers who wait up to 60 days.

In this case, as well, banks often assume the loss themselves. The industry has also voluntarily adopted a cap of $50 on consumers' liability for fraudulent, signature-based debit-card purchases.

The security of PIN numbers normally defends against fraudulent PIN-based purchases.

A daily limit on how much money consumers can withdraw from their checking account with a debit card – often $300 or $600 per day – offers another layer of protection if an unauthorized user finds out the account-holder's PIN.