he approaching holiday season is the busiest time of year for merhants. Shopping is at its peak, and so is returns fraud. Thieves, taking advantage of the anonymity of holiday shopper crowds and the lesser-trained eye of seasonal workers, come out in force and employ increasingly sophisticated scams.

Although returns fraud is a huge problem for merchants, it presents a significant opportunity for ISOs and merchant level salespeople (MLSs) to differentiate themselves from the competition by showing an in-depth knowledge of the important issues facing their customers and of the solutions available.

Returns fraud cost the industry $16 billion in 2003, the last year such figures were available, according to King Rogers of KingRogers International, a security and loss prevention consulting firm. "And that was trending up significantly," he said. The 2003 figures showed a 23% increase in returns fraud over 2002.

"An estimated 9% of all returns are fraudulent, an assault of staggering proportions," said Patty Colby, Senior Director of VeriFone's North America Corporate Strategy Development.

VeriFone has partnered with The Return Exchange Inc., a VeriFone Value Add Provider that offers fraud and abuse-detection solutions to retailers. ISOs and MLSs earn a fee for merchants who are willing to purchase the service.

"ISOs have the ability to educate and solve a merchant problem and create the 'stickiness' with the merchant that reduces attrition," Colby said.

The Return Exchange's Verify-1 return authorization system is a SQL Server database that stores customers' IDs and payment information when they return items. The system then compares variables such as return frequency, dollar amounts and timing against the retailer's own return policy rules to identify customers whose buying patterns make them look like "return" abusers.

Although 9% of all returns are fraudulent, only 1% of all consumers are responsible for fraudulent or abusive behavior, The Return Exchange reports. If merchants can track and reject the fraudulent returns, they can afford to offer the 99% of consumers who don't regularly return merchandise a more liberal return policy.

This is important to merchants squeezed on the one side by skyrocketing return rates and on the other by legitimate customers annoyed by less flexible return policies. A 2004 Harris Poll found that 91% of consumers interviewed considered return policies and processes important to their decisions about where to make purchases. Retailers can train employees to recognize fraud and make judgments manually, on a case-by-case basis, said Joseph LaRocca, Vice President of Loss Prevention at the National Retail Federation (NRF), or they can use software solutions.

"Merchants must constantly be analyzing their returns to determine what the best solutions for them may be," he said. "There is, unfortunately, no one-size-fits-all policy."

LaRocca also noted that merchants with high employee turnover or with multiple locations may find manual detection of returns fraud an ineffective and labor intensive effort. POS software systems, either created in-house or by outside vendors, are very effective in curtailing fraud, he said.

According to The Return Exchange, instituting a return tracking system decreases returns fraud even before a single return is denied, perhaps because criminals are leery of providing identification that may be tracked.

"Fraudsters gravitate to the merchants with liberal return policies," Rogers said. "Criminals seek the path of least resistance. I think if retailers really looked at what returns fraud means to their bottom line, you'd see some really vigorous attempts to combat the problem. I imagine the hue and cry from the stockholders would get pretty loud if they knew the actual hit to the bottom line."

Although some merchants would like to see a central repository of customers with excessive returns so they can spot return abusers across multiple chains, The Return Exchange's Verify-1 segregates each particular retailer's customers.

If The Return Exchange allowed clients to see information gleaned from other retailers about fraudulent behavior, they would be subject to different and more intensive regulations, including some involving the Fair Credit Reporting Act.

Additionally, The Return Exchange has faced opposition from consumer advocates who worry that there is potential for privacy violations or "blacklisting" consumers for making too many returns.

Sen. Charles Schumer (NY) even asked the Federal Trade Commission to investigate the practice. He proposed legislation to require stores that limit returns to clearly warn shoppers before they make purchases.

Consumer advocates want consumers to know the specific threshold of allowable returns, but according to The Return Exchange no specific amount of returns are banned. The pattern of a potential return abuser is based on a complicated and highly customized algorithm.

Furthermore, The Return Exchange argues that these concerns are overblown. Its solution rejects only 0.001% of the reviewed returns, and those consumers can contest the rejection by calling the company's 800 number. Fully 75% of consumers never make a return at all, the company said.

NRF is currently developing the Retail Loss Prevention Intelligence Network (RLPIN), a national Web portal and database to which retailers report significant incidents of retail crime. The association will unveil RLPIN next month.

"A central compilation of this data will enable us to work collaboratively with local law enforcement to recognize retail theft rings, spot trends and assist retailers in controlling theft damage," LaRocca said.

RLPIN should prove to be a handy way for law enforcement to track organized retail theft or to track down the source of stolen goods when they are recovered. This first phase of RLPIN, however, will not deal with returns fraud.

Returns fraud takes more forms than the average retail employee can keep up with. "Retailers tend to focus their attention on unreceipted refunds," Rogers said. "But the potential for fraud with receipts is enormous."

Following is a look at the most common types of returns fraud:

Renting/Wardrobing

"The largest scam is called 'renting/wardrobing' and is basically a result of a 'short-term purchase' where goods are purchased and utilized for a short time and then returned immediately after their use," Colby said.

"Think of a trendy watch worn for a job interview or a flat screen TV used to watch the Super Bowl. Unfortunately, the widespread notion that this behavior is basically acceptable has exacerbated its effects."

Nearly 51% of all returns fraud falls into this category, The Return Exchange reports.

"Every category of retailer faces this kind of thing at one time or another," LaRocca said. "But retailers with designer goods, or seasonal items: prom dresses, Halloween costumes, special event clothes, see this kind of fraud most frequently." Even electronics are "rented"; camcorders and digital cameras are frequently purchased the day before graduation and returned the day after, for example.

Shoplisting

"Another growing scam is called 'shoplisting' and involves obtaining a receipt and taking it into a store, picking up a few of the items on the receipt and then returning them for full value," Colby said. "The retailer in this instance is basically 'buying back' their stolen merchandise."

"Shoplifters can sell the goods online or at flea markets and get maybe $0.50 on the dollar," LaRocca said. "If they sell to a fence1, they probably get $0.25 to the dollar. Or, they can return the stolen items to the store and get full retail. Depending on where they are, they could get 108% because the retailer will refund sales taxes that were never actually paid."

In the past, receipts were obtained in the parking lot or found in discarded shopping bags, but as home computing and printing technology improves, the problem grows. "We've seen cases where people were actually sitting in their car in the retailer's parking lot making receipts on their laptop," Rogers said. "It's not a new problem, but it constantly takes new twists."

Shoplisting has become big business: You can even find Web sites that sell authentic receipts, presumably to those who illegally acquire particular items that they want to exchange for cash. There is also a growing black market for journal tape, the paper that runs through the register. Thieves copy a legitimate receipt over and over again onto journal tape and return as many of the items on the receipt as they can get their hands on.

Price Arbitrage

Price arbitrage occurs when thieves buy name-brand items and then return counterfeits. Today's counterfeits so closely resemble the actual items they are mimicking that retailers are often tricked into taking them back at the store for a full refund.

Another arbitrage scam is to buy two items and then return the cheaper item as though it was the higher priced item. For example, thieves can buy a $50 watch and a $100 watch. They then put the $50 watch in the $100 watch case and return it for a $100 refund. Most retail employees aren't familiar enough with the look of every item and are easily fooled by such scams.

A third arbitrage scam appeals to those who are hesitant to shoplift but are not shy about duplicating or replicating receipts. Thieves obtain, for example, a Macy's receipt for a $100 dress then buy the dress at a discount merchandiser for $75 and return it to Macy's for a full $100 refund.

Employee Returns Fraud

Software solutions that use a driver's license or other identification also deter employee returns fraud such as when employees enter a bogus return and then pocket the cash.

Despite merchants' best efforts, in 2004 52% of all merchants rated their own internal processes for detecting and avoiding returns fraud either little or not at all effective, Rogers said. ISOs and MLSs that offer a solution to a frustrating and costly problem, or even provide a little understanding and sympathy, will really stand out in a competitive field.