Fighting first-party fraud

Companies spend significant time and money combatting fraud, but one of the most pervasive and costly forms is one that’s also difficult to prevent—because it happens right in the heart of the business. First-party fraud occurs when customers or employees misrepresent themselves or manipulate accounts for their own financial gain.

Frequently, the person whose information is used to perpetuate this type of fraud is a willing participant in the scheme. It can be as simple as a customer seeking credit who knowingly provides false or misleading information. Or it can be employment-related fraud, when an applicant is dishonest about a previous job title, past salary or employment history. Or it can involve more sophisticated schemes to induce otherwise good clients to use their accounts as a conduit for fraud. 

First-party fraud costs businesses an estimated $132 billion a year, but the impact can be far greater due to the expense and time involved in detection and mitigation. It poses a unique challenge for businesses because, unlike other financial crimes, the victim isn’t an individual but the organization itself.  

First-party fraud can cost businesses in many ways, including: 

• Bad debts—Businesses may experience higher levels of unpaid debt because of fraud in customer credit applications.  

• Chargebacks and refunds—Consumers increasingly contact card issuers directly to dispute charges, rather than the merchants, resulting in chargebacks on legitimate transactions. 

• Higher operational costs and diverted resources—Businesses must invest more in fraud detection and prevention. And they will need to dedicate staff to investigating and resolving fraudulent transactions, taking resources away from operations such as growth initiatives, product development and customer service. 

• Higher customer costs—To compensate for losses from first-party fraud, businesses may increase costs to all customers. 

• Reputational damage—Fraud can make customers lose faith in a company’s ability to protect consumer information and make sure transactions are secure. 

• Regulatory and legal consequences—Businesses that can’t stop fraud may face fines, litigation or other penalties. 

• Higher insurance premiums—Businesses with more fraud claims may face higher premiums. In addition, insurance companies divide the cost of claims among policyholders, so first-party fraud claims can drive up premiums for everyone. 

• Merchandise loss—Retailers who are the target of first-party fraud don’t receive payment for their products. 

To identify first-party fraud, businesses must accurately identify suspicious patterns and behaviors, which are often subtle anomalies within seemingly legitimate transactions. This can only be done only with a comprehensive review of customer data. 

Even then, detection can be challenging. First-party fraud can go unnoticed if businesses rely on individual data points and transaction habits. The fraud may mimic normal customer behavior and transactions. And businesses that aren’t careful about how they flag and review potential fraud run the risk of insulting, angering or alienating other customers, who aren’t engaging in fraud.

Indeed, some customers who participate in first-party fraud didn’t intend to when they set up their accounts or applied for credit. They are among the most difficult to identify because they began the process as legitimate customers. Others may be paid to use their own information to get credit on behalf of fraudsters. 

First-party fraud is becoming more difficult to spot as fraudsters become more sophisticated. For example, some are now using synthetic identities that combine stolen personal information and legitimate details. Other techniques include “loan stacking,” in which multiple credit lines are opened simultaneously.

These more sophisticated schemes are colliding with changing regulatory requirements. As businesses navigate data privacy laws, they may find it more difficult to gather the necessary information, balance the customer experience and security checks, and update prevention processes as regulations evolve. 

In addition to the cost of the fraud itself, first-party fraud comes with increased expense for prevention and improved technology. Businesses often may need to invest in advanced fraud detection systems, train employees, or hire outside experts or services to combat first-party fraud. The cost of these antifraud systems comes not just in their initial implementation, but also in their ongoing maintenance and updates. 

As businesses devise their strategies for combatting first-party fraud, they should consider how the measures they adopt will affect employees and customers. If they implement stricter fraud prevention measures, they may risk angering customers with verification processes that customers find time-consuming, annoying and inconvenient.

Similarly, fraud prevention can negatively affect corporate culture, creating a climate of distrust among employees, eroding morale, and even turning colleagues against each other. 

To reduce the cost of first-party fraud and avoid other negative impacts on your business, there is a range of helpful mitigation tactics: 

Conduct a fraud risk assessment—Analyze your business processes, systems and customer interactions to identify vulnerabilities that fraudsters can exploit. Evaluate the possibility of different types of fraud occurring and the potential financial and reputational damage they could cause. Focus your resources on the biggest risks first. 

Educate employees and customers—Train your employees to identify and report suspicious activity and teach them about common fraud tactics and prevention techniques. Provide customers with information about first-party fraud and how they can protect themselves. Offer tips on account security and encourage customers to report suspicious activity. 

Establish a fraud prevention strategy—Designate the people responsible for detecting and responding to this type of potential fraud. Define how they will implement and monitor the fraud prevention plan, and clearly establish what they should do if fraud is detected. Set measurable goals for reducing losses and improving detection. If necessary, seek guidance from experts who are trained to assess your specific risks.  

Use the best fraud prevention tools—Consider strengthening customer identification processes through technology, such as multifactor authentication, document verification, address verification and knowledge-based authentication. Behavioral analytics can identify potential fraud in customer behavior patterns, and real-time monitoring systems can detect suspicious transactions, such as those that involve large amounts, multiple purchases in a short period of time, or come from high-risk locations. Biometrics, such as fingerprint identification, can track devices and flag those that access multiple accounts. 

Embrace  “least privilege”—When possible, restrict employees’ access to the “least privilege” necessary to perform a job function, especially when it involves personally identifiable information or payment data.  

Increase the perception of detection—Frequently remind employees and other users that your systems are monitored for signs of potential fraud. 

Assess and review fraud prevention efforts—Analyze the data to identify trends and use the information to refine your fraud strategies. Conduct regular audits or periodic reviews by third parties to assess the effectiveness of your strategies and controls and identify areas of improvement. Adjust your plan as necessary based on your internal findings and changing fraud trends.

Maintain an anonymous whistleblower hotline—Make sure employees are aware of the hotline and the way to access it. Monitor and regularly review the calls or submissions and develop a system for investigating the reports. For the hotline to be effective, employees must believe that reports are heard, action is taken, and confidentiality is preserved. 

For more ideas on how to help protect your business from fraud, visit Capital One’s Treasury Management Solutions

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