Merchant fraud victimizes consumers and financial institutions. Techniques to scam banks and cardholders continually evolve, requiring ongoing evaluation of prevention tactics by the financial services industry to minimize the impact.
Prevalent Forms of Merchant Fraud
include:
Transaction Laundering (Factoring)
A fraudulent company engages in merchant fraud by processing payment card transactions through the merchant account of a real business. The real business processing the transactions generally is categorized with a low-risk merchant code.
Certain industries are labeled as high-risk – operating under more stringent regulations with substantially higher transaction costs (e.g., subscription payment models, gambling sites). Laundering payments through a low-risk merchant account allows maximum proceeds while avoiding regulatory limitations.
Bust-Out Fraud
Fraudsters open bogus merchant accounts allowing them to accept credit card payments. They set up an online store, selling non-existent goods to cardholders who assume it’s a legitimate business.
The fraudster pockets the funds then transfers them to a different account. Oftentimes, they quickly use the cardholder’s account information to make multiple, fraudulent purchases.
By the time the cardholder realizes what has occurred, the scammer has “busted out” – shutting down the bogus shop and vanishing.
Triangulation Fraud
Triangulation Fraud, a form of merchant fraud, occurs when a cardholder unknowingly places an order from a fraudulent online storefront, leading to a series of deceptive actions by scammers to exploit both the cardholder and unsuspecting legitimate merchants.
The cardholder places an order from a fraudulent, fake storefront that is offering goods at exceptionally low prices.
The scammer accepts payment for the order (while gaining access to the cardholder’s account information).
To avoid or delay detection, the scammer orders the item from a legitimate merchant – using credit card information stolen from a previous victim. They have it shipped to the cardholder who placed the order, while pocketing their money.
Four Parties Involved in Triangluation Fraud:
- Innocent Buyer: The innocent buyer is an individual who unknowingly participates in the fraud. They come across a sales listing for a desirable item, often at an unusually low price, and proceed to make a purchase using their credit card information.
- Victim of Credit Card Theft: The victim of credit card theft is someone whose credit card information has been stolen. The scammer uses this stolen information to make fraudulent purchases.
- Legitimate Merchant: The legitimate merchant is an actual online retailer or eCommerce website. The scammer, posing as a buyer, places an order with the legitimate merchant using the stolen credit card information. The merchant processes the order and ships the item to the innocent buyer’s shipping address, unaware of the fraudulent nature of the transaction.
- Scammer/Middleman: The scammer acts as a secret middleman in the merchant fraud scheme. They set up a fake storefront or pose as a legitimate merchant, accepting orders from innocent buyers. Using the stolen credit card information, they fulfill the orders placed by the innocent buyers, pocketing the money provided by the buyers. The scammer’s role is to facilitate the fraudulent transactions and remain undetected
Business Model Swap
A common tactic used in merchant fraud involves a bad actor opening a seemingly legitimate business and initially representing it as a low- to moderate-risk payment model or operation. This deceptive strategy aims to gain approval for a merchant account from the acquiring institution. Once the merchant account has been established, the business shifts to a high-risk model or category without the knowledge of the acquiring institution.
Identity Swap
To circumvent AML (anti-money laundering) compliance programs, a fraudster opens a merchant account for an online store. The store may be “legitimate” in that they actually sell items.
But, the store may also process payments from illicit parties for non-existent goods listed on the site. In reality, these payments are for illegal activity (e.g., drug-related, human trafficking, or other organized crime activities).
Identity swap is also be used by businesses that are prohibited from opening merchant accounts – to avoid watch list detection, evade taxes, or by merchants in countries under economic sanctions. Although it may be for a legitimate business enterprise, the merchant account is set up with fraudulent identities.
This is distinct from transaction laundering, in that the fake merchant is trying to launder funds acquired from illegal activities.
Merchant Fraud Prevention
Due diligence is at the core of merchant fraud prevention. And the onus lies not only with acquiring banks, but also vendors and legitimate merchants. The importance of the Know Your Customer (KYC) and Know Your Business (KYB) tenets cannot be understated in the current global economy.
Account Origination
Ideally, credit card processors would be able to identify fraudulent merchants at the time of acquisition. Due diligence at merchant onboarding remains the most effective way to prevent financial crime. Deploying advanced technology powered by accurate, timely data arms acquiring banks with the tools they need to minimize opening fraudulent accounts.
Verifying and validating business information during account creation helps prevent fraudulent entities from gaining an account before they perform any transactions.
Relationship Monitoring
Even with flawless origination execution, the risk for merchant fraud remains high. Regularly reviewing merchant activity is key to catching merchants that have facilitated account swaps or factoring and identifying potential merchant fraud.
The direct and indirect costs of merchant fraud-related chargebacks, reputation risk, resources consumption, and regulatory penalties and fines can be incalculable. According to the Global anti-money laundering and sanctions survey, global regulators levied $14 billion in fines and penalties for anti-money laundering non-compliance in 2020.
In aggregate, impact on the bottom line is inevitable. The increased costs will eventually be passed on to merchants and consumers, potentially reducing wallet share and limiting a financial institution’s competitive edge.
Zoot’s Merchant Acquisition & Monitoring solution is your key to unlocking comprehensive, real-time insights into your merchant accounts. This powerful tool offers unprecedented rules management capabilities, allowing you to quickly detect and circumnavigate potential risks to both new and existing merchant relationships.
Mitigate financial losses before they occur by streamlining risk analysis and investigations with Zoot’s advanced case management. This enhanced agility empowers financial institutions to stay one step ahead, safeguarding their business against potential threats.With Zoot, you can:
- Ensure compliance: Measure and maintain your merchants’ card association compliance effectively.
- Maximize profitability: Calculate the profitability of your existing merchants and forecast potential profitability of new merchants.
- Prevent Merchant Fraud: Predict and prevent collusive or fraud-targeted activities to secure your business.
- Risk Assessment: Evaluate the likelihood of merchant bankruptcy to mitigate potential losses.
- Improve Customer Retention: Manage and improve merchant satisfaction by determining and addressing attrition risks.
Zoot’s solution is designed to support your financial institution’s growth strategy. Seamlessly acquire, onboard, and manage new merchant accounts while delivering an exceptional customer experience to your existing merchant partners.
Take action now, leverage the benefits of Zoot’s Merchant Acquisition & Monitoring solution, and take your financial institution to new heights. Secure your business’s future, maximize profitability, and ensure unparalleled customer satisfaction with Zoot.
