Chargebacks, VAMP, And Racketeering For The Duopsony (Part 1)

You’ve undoubtedly had a charge on your credit card statement that was hard to decipher.

Perhaps you squinted real hard to parse the merchant’s name and even called the listed number to figure out what the charge was for.

Or maybe you’re the other 99.999999% of card-owning Americans and you said “I ain’t paying for this,” and you clicked a button in your bank portal and immediately had the disputed funds credited back to your account.

Don’t get us wrong, there are legitimate reasons to charge back unauthorized transactions.

But today’s chargeback has become:

1. A guaranteed loser for merchants, even if they’re in the right
2. A free-money windfall for the duopolies 

There once was a time when you would call the issuing bank and they would bring in the merchant to amicably resolve the issue. 

Not anymore, baby.

To show you how ridiculous this all is we tapped Jason Kafer, founder of Payments Therapist, and one of the few that understand this industry at its core.

We need to begin with the basics.

A chargeback is a mechanism the card schemes codified to protect cardholders from, for lack of better terms, fraud and misrepresentation.

Fraud is somewhat obvious: someone stole your credit card and started buying things you never approved.

Misrepresentation is a little more complicated. 

A more straightforward example of misrepresentation would be that you ordered a sweater in size Medium, received a size Large, and the merchant isn’t permitting a refund despite clear return policies that entitle you to a refund.

Towards the ambiguous end of the spectrum: you hired a contractor to paint your house, the contractor painted your house, you didn’t like it – who knows why – so you charge back the whole job. 

In reality the biggest risk for a large volume of chargebacks are affiliate programs, as Jason points out in his own article. 

All of these chargeback scenarios have reason codes that are intended to highlight the basis for the chargeback. 

While this may have been well intentioned when it started – and certainly helped the card duopolies build their standing, so don’t mistake it for charity – it’s become yet another example of the entire payments ecosystem cornholing the poor merchant.

The issuing banks, who represent the cardholder, make so much money on interchange that they bend over backwards to keep cardholders.

It’s common for banks to instantly issue a provisional credit to the cardholders account, particularly in an ecommerce transaction

Jason Kafer

That’s because the issuing bank doesn’t want to be on the hook for any amounts owed to the merchant and broadly markets zero fraud liability to prospective cardholders. 

Go look how easy it is to initiate a dispute on your own banking platform.

Here’s what happens when a chargeback is filed.

The cardholder issues a dispute. The issuing bank, which represents the cardholder, sends the dispute to the acquiring bank, which represents the merchant.

The merchant/acquiring bank must submit satisfactory evidence to the issuing bank per the card scheme’s dispute guidelines. 

The issuing bank then reviews the evidence. 

If they don’t find the evidence satisfactory, they deny the dispute, at which point the next step is Arbitration.

Let’s stop here for a second.

In combing through chargeback data, we’ve seen fewer than 4% of disputes resolved in the merchant’s favor on the first pass.

And this is for high integrity MCCs, like medical, where the services were clearly rendered.

Why so low?

Because the issuing banks set the acceptance rules. 

Just because the merchant submits the precise data called for by the card schemes doesn’t mean the issuing bank has to accept dick. 

Off to the bank’s offshore contractor whose mantra is “reject immediately and dare them to fight us.”

For instance, in an ecommerce transaction the use of 3-D Secure (think Apple Pay) is supposed to provide enough security that the issuer can’t refute the merchant’s chargeback, shifting liability to the issuer… but that’s only if you, you know, follow the networks’ rule books. 

Which nobody does.

Including the networks themselves. 

Arbitration, fortunately, does involve the card networks, so if the submitted evidence meets the card scheme’s requirements there’s a higher probability that the dispute will be ruled in the merchant’s favor.

But guess what?

Arbitration costs $500 for the merchant, and $500 for the cardholder (issuing bank). 

And no, you don’t get that money back.

How many transactions are worth spending $500 for a chance at the slot machine?

You’re talking about transactions in the thousands or tens of thousands of dollars before the math will pencil.

Frankly, the Arbitration process should mirror English Rule, where the loser pays the winner’s fees in addition to their own. 

Jason has seen some real abuses of the system.

Try this one on for size.

A cardholder spends big money on a bar tab. 

After he’s unquestionably consumed all the liquor and sobering up the next day, he looks in his bank account and realizes he’s spent way more money than he had.

And rent is due.

So naturally he issues a chargeback.

Cuz ‘Merica. 

The cardholder gets the money back – almost instantly – and then he spends the money on rent.

Of course the merchant’s getting boned, and they rightfully submit evidence to counter the dispute: video footage, receipt signature, the works. 

Well, the issuing bank looks at the cardholder’s balance and realizes that if they award the funds back to the merchant, the cardholder will have a negative balance and get hit with an overdraft fee.

Can’t lose a cardholder now: we make way too much money on interchange for that.

So the issuing bank rejects the evidence knowing that the odds of the merchant going to Arbitration are slim-to-none.

Here’s another one.

An Amex cardholder goes to the bar and the Amex is declined at checkout. 

The cardholder calls Amex and Amex gives the merchant a 6-digit voice authorization code that allows for a forced settlement through the terminal, meaning that the merchant will get a settlement in their bank without a corresponding Amex authorization.

The merchant gets their money so they’re happy.

The cardholder does this month after month, clearly indicating that he doesn’t have the funds to be at the bar, but when did financial prudency ever stop Americans from spending money?

One day the merchant notices that tens of thousands of dollars have been withdrawn from his bank account by Amex.

Why?

The Amex cardholder was behind on bills, and Amex – by virtue of sending the bar authorization codes which are NOT processed as EMV transactions – realized that they could simply issue a chargeback and recoup all monies spent by the cardholder within the past 540 days (Amex has now capped this to 120 days, but of course they set the rules).

Is it legalized theft?

Not according to chargeback “rules”.

But in the court of morality?

100%.

Outside of the direct costs of each chargeback, here’s why chargebacks matter: 

If a merchant receives a high percentage of chargebacks, the card schemes can prevent the merchant from processing in the future.

Mastercard puts these merchants on the MATCH list, and Visa’s list is called TMF.

According to Jason, nearly everyone just takes Mastercard’s MATCH list as the source of truth.

The intent of these lists is to prevent bad actors from remaining in business and fleecing more cardholders.

And being on the lists is expensive.

While Visa is changing their high risk program (future article on VAMP incoming) here’s how the networks have viewed chargebacks in broad strokes.

1. Merchants are flagged if they have a high percentage chargebacks (0.9% of transactions) AND a high number of chargebacks (75 per month) 
2. If a merchant surpassed these thresholds for long enough then the merchant would need to submit to the card schemes a plan for how they will lower their chargebacks
3. The merchant has three months to correct the behavior otherwise they roll into a new tier where they’ll be charged $50 per chargeback and $10K per month
4. If that’s not corrected in three months, the fees increase to $100 per chargeback and $25K per month
5. If that’s not corrected in three more months, the fees again increase to $50K per month for a quarter, and then $75K per month for three more months
6. If you can’t get yourself together at this point, onto the blacklists you go

In reality, most merchants never make it this far. The sponsoring bank is on the hook and is supposed to be diligently overseeing their acquiring programs, and having merchants make it to the MATCH list just invites extra scrutiny.

Jason clarifies that the networks choose to do a minimum number of bank audits annually, and they’re painful. If you’re a bank who has chargeback issues, guess who’s making it to the top of the audit list?

Sounds like being on the MATCH list is bad, right? Can’t process card payments anymore, which is definitely inconvenient. 

But you know how duopolies think: never let a crisis go to waste.

Especially when you control everything.

Enter RDR, or Rapid Dispute Resolution.

If you don’t know about RDR, you’re going to love this.

Imagine you’re a merchant that operates in a gray legal area, like nutraceuticals. 

You get a lot of chargebacks. So much so, that you’re at risk of getting placed on the MATCH or TMF lists.

But your acquiring bank wants to keep you off that list because they’re making a killing on your account, classifying you as a “high risk” merchant and probably clearing 500 bps of margin on every dollar through your business.

You obviously want to stay in business and are generally in a line of commerce that’s highly profitable (nutraceuticals are a 40% margin business, for example).

Under RDR, your acquiring bank will work directly with the issuing bank of a cardholder that issues a chargeback to settle the matter off Visa and Mastercard’s radar, so you can keep accepting cards.

This protocol, called the Chargeback Dispute Resolution Network (CDRN), was invented by Ethoca and Verifi, and for $45 a merchant could relinquish the disputed amount but would avoid the black eye of a chargeback.

And if you went to those links you probably noticed that Ethoca is now owned by Mastercard, and Verifi now owned by Visa.

Chargebacks = bad.

But pay $45 and the networks are happy to look the other way.

See, the card duopolies don’t actually care about stopping “scumbags and evil-doers” from conducting business and hurting cardholders: they care about being duopolies.

The idea that transactions were being handled outside their networks was a risk, so they shut it down via acquisitions.

And of course it just happens to be great business for the duopolies that cardholders can continue spending at “scumbag” merchants.

Total coincidence, we’re sure.

But at least the card duopolies are incredibly consistent in their arbitrary positions on matters concerning their own rules. 

Visa’s VAMP will change this, but you’ll have to wait for our subsequent article to hear our thoughts on the impact of that program.