Academic journal article Economic Perspectives

An Examination of the Fraud Liability Shift in Consumer Card-Based Payment Systems

Academic journal article Economic Perspectives

An Examination of the Fraud Liability Shift in Consumer Card-Based Payment Systems

Article excerpt

Introduction and summary

In the absence of a significant (and right now unforeseeable) shift in the retail payments landscape in the United States, consumers will continue to reach consistently (and often) for their debit and credit cards. They will use these cards when paying for goods and services in face-to-face, Internet, mail order, and telephone order transactions. Likewise, criminals will continue to use tried-and-true tactics and will develop innovative methods to perpetrate payment card fraud.

At the intersection of consumers conducting legitimate card transactions and fraudsters pursuing their illegal ends is a tangled web of public laws and private card network rules. These laws and rules allocate fraud risk among the consumers, card issuers, and merchants participating in card-based payment systems. In theory, one would hope that these laws and rules for payment card transactions are thoughtfully designed to encourage behavior that minimizes fraud losses to the system as a whole. In reality, systemwide fraud reduction is often not the principal objective behind particular public laws or private rules affecting fraud liability allocation. Consequently, these laws and rules may fail to promote efficient fraud avoidance; indeed, in some instances, they may actually discourage fraud avoidance.

Defining the issue

The first step in evaluating the efficiency of fraud liability allocation rules in current card-based payment systems is to define the issue. Doing so requires an understanding of the difference between identity theft and common payment card fraud, as well as an understanding of the workings of the card-based payment systems at issue.

Identity theft versus fraud

News stories abound about identity theft resulting from dumpster divers absconding with old bank statements and criminals rifling through mail and intercepting credit card offers. Further, email accounts are barraged with phishing attempts and other web-based schemes craftily designed to lure consumers into revealing personal identification information that can be used for nefarious purposes. Typically, the fraudsters intend to use the ill-gotten fruits of their snooping to impersonate their victims and access their credit or asset accounts. This is identity theft, and it is an increasingly pervasive problem in the United States and throughout the world. During 2007, Consumer Sentinel, a network that collects information about consumer fraud and identity theft from the Federal Trade Commission and over 125 other organizations, recorded 258,427 identity theft complaints. (1)

Identity theft is distinguishable from common financial fraud. Identity theft is generally defined as "the use of personal identifying information to commit some form of fraud." (2) In contrast, fraud is simply "[a] knowing misrepresentation of the truth ... to induce another to act to his or her detriment." (3) As noted in the definition of identity theft, fraud is typically the end goal of identity theft. However, often fraud is committed without antecedent theft of Social Security numbers or other assumption of identity. Along with the cases of identity theft reported in 2007, 555,472 cases of non-identity-theft-related fraud were reported during the same year. (4) Given that card-based payment systems (and other payment systems, for that matter) seek to prevent monetary fraud perpetrated through the system regardless of how the information used to perpetrate the fraud was obtained, here I focus on the broader category of payments fraud--whether or not it is precipitated by identity theft. There is no need to steal another person's identity to perpetrate simple payment card fraud--all the perpetrator needs to do is obtain a person's payment card or payment card information?

Distinguishing fraud from identity theft is important to the discussion that follows for two reasons. First, fraud is broader and more pervasive than identity theft. …

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