/usr/staff/cc/misc [65] cat credit.desc
From cca.ucsf.edu!ucsfcgl!ucbvax!tut.cis.ohio-state.edu!rutgers!dptg!lznv!ziegle
Article 2226 of misc.consumers:
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>From: ziegler@lznv.ATT.COM (J.ZIEGLER)
Newsgroups: misc.consumers
Subject: Credit Card 101 Part 1 of 6 - The Players
Keywords: Credit Debit Charge Banks
Message-ID: <1656@lznv.ATT.COM>
Date: 25 Sep 89 20:13:50 GMT
Distribution: usa
Organization: AT&T ISL Lincroft NJ USA
Lines: 197


Part one in a series of postings about the workings of the credit
card industry.

DEFINITIONS
-----------

First some terms, along with the meanings they have in the industry:

Cardholder - an individual to whom a credit card is issued.  Typically,
    this individual is also responsible for payment of all charges made
    to that card.  Corporate cards are an exception to this rule.

Card Issuer - an institution that issues credit cards to cardholders.
    This institution is also responsible for billing the cardholder for
    charges.  Often abbreviated to "Issuer".

Card Accepter - an individual, organization, or corporation that
    accepts credit cards as payment for merchandise or services.  Often
    abbreviated "Accepter" or "merchant".

Acquirer - an organization that collects (acquires) credit
    authorization requests from Card Accepters and provides guarantees
    of payment.  Normally, this will be by agreement with the Issuer of
    the card in question.

Many issuers are also acquirers.  Some issuers allow other acquirers to
provide authorizations for them, under pre-agreed conditions.  Other
issuers provide all their own authorizations.


TYPES OF CARDS
----- -- -----

The industry typically divides up cards by the business of the issuer.
So there are bank cards (VISA, Master Card, Discover), Petroleum Cards
(SUN Oil, Exxon, etc.), and Travel and Entertainment (T&E) cards
(American Express, Diners' Club, Carte Blanche).  Other cards are
typically lumped together as "Private Label" cards.  That would include
department store cards, telephone cards, and the like.  Most private
label cards are only accepted by the issuer.  People are starting to
divide the telephone cards into a separate class, but it hasn't
received widespread acceptance.  (This is just a matter of terminology,
and doesn't affect anything important.)

Cards are also divided by how they are billed.  Thus there are credit
cards (VISA, MC, Discover, most department store cards), charge cards
(American Express, AT&T, many petroleum cards) and debit cards.  Credit
cards invoke a loan of money by the issuer to the cardholder under
pre-arranged terms and conditions.  Charge cards are simply a payment
convenience, and their total balance is due when billed.  When a debit
card is used, the amount is taken directly from the cardholder's
account with the issuer.  Terminology is loose - often people use
"credit card" to encompass credit cards and charge cards.

A recent phenomenon is third-party debit cards.  These cards are issued
by an organization with which the cardholder has no account
relationship.  Instead, the cardholder provides the card issuer with
the information necessary to debit the cardholder's checking account
directly through an Automated Clearing House (ACH), the same way a
check would be cleared.  This is sort of like direct deposit of
paychecks, in reverse.  ACHs love third-party debit cards.  Banks hate
them.

Another recent addition is affinity cards.  These cards are valid
credit cards from their issuer, but carry the logo of a third party, and
the third party benefits from their use.  There is an incredible
variety of affinity cards, ranging from airlines to colleges to
professional sports teams.


HOW THEY MAKE MONEY
--- ---- ---- -----

Issuers of credit cards make money from cardholder fees and from
interest paid on outstanding balances.  Not all issuers charge fees.
Even those that do, make most of their money on the interest.  They
really LIKE people who pay the minimum each month.

Issuers of charge cards make money from cardholder fees.  Some charge
cards actually run at a loss for the company, particularly those that
are free.  The primary purpose of such cards is to stimulate business.

Issuers of debit cards may make money on transaction fees.  Not all
debit card transactions have fees.  Most debit cards exist to stimulate
business for the bank and to offload tellers and back-room
departments.  To date, third-party debit cards exist solely to
stimulate business.  Providers of such cards make no direct money from
their use.

Acquirers make money from transaction charges and discount fees.
Unlike the charges and fees mentioned above, these fees are paid by the
accepter, not (directly) by the cardholder.  (Technically, it is not
legal for the merchants to pass these charges directly to the
consumer.  Some petroleum stations have gotten away with giving a
discount for cash, and it has survived court challenges so far.)
Transaction charges are typically in pennies per transaction, and are
sensitive to the type of communication used for the authorization.
Discount fees are a percentage of the purchase price and are sensitive
to volume and compliance to rules.  One way to encourage merchants to
follow certain procedures or to upgrade to new equipment is to offer a
lower discount fee.

Until fairly recently, the only motivation for accepters was to expand
their business by accepting cards.  Reduction of fraud was enough
reason for many merchants to pay authorization fees, but in many cases,
it isn't worth the cost.  (That is, it is cheaper to pay the fraud than
to prevent it.)  Recently, electronic settlement has provided merchants
with an added benefit by reducing float on charged purchases.
Merchants can now get their accounts credited much faster than before,
which helps cash flow.

Companies that issue charge cards are real keen on float reduction.
The sooner they can bill you, the sooner they get their money.  Credit
card companies are also interested in float reduction, since the sooner
they bill, the sooner they can start charging interest.  Debit cards
typically involve little or no float.

Affinity cards usually pay a percentage of purchases to the affinity
organization.  Although it may seem obvious to take this money from the
discount fee, this doesn't work since the issuer is not always the
acquirer.  The money for this usually comes from the interest paid on
outstanding balances.  Essentially, the bank is giving a share of its
profits to an organization in turn for the organization promoting use
of its credit card.  The affinity organization is free to use its cut
any way it wishes.  An airline will typically put it into the frequent
flyer program (and credit miles to your account).  A college may put
the money into the general fund or into a scholarship fund.  Lord only
knows what a sports team does with the money!


THE PLAYERS AND THEIR ROLES
--- ------- --- ----- -----

American Express (AMEX) is a charge card issuer and acquirer.  (Their
other businesses are not important to this discussion.)  All AMEX
purchases are authorized by AMEX.  They make most of their money from
the discount fees, which is why they have the highest discount fee in
the industry.  That's one reason why AMEX isn't accepted in as many
places as VISA and MC, and a reason why many merchants will prefer
another card to an AMEX card.  The control AMEX has over authorization
allows them to provide what they consider to be better cardholder
("cardmember" to them) services.

VISA is a non-profit corporation (SURPRISE!) that is best described as
a purchasing and marketing coalition of its member banks.  VISA issues
no credit cards itself - all VISA cards are issued by member banks.
VISA does not set terms and conditions for its member banks - the banks
can do pretty much as they please in signing cardholders.  All VISA
charges are ultimately approved by the card issuer, regardless of where
the purchase was made.  Many smaller banks share their account
databases with larger banks, third parties, or VISA itself, so that the
bank doesn't have to provide authorization facilities itself.

Master Card (MC) is very much like VISA.  There are some differences
that are important to those in the industry, but from the consumers
standpoint they operate pretty much the same.

Discover cards are issued by a bank owned by Sears.  All Discover
purchases are authorized by Sears.

Most petroleum cards, if they are even authorized, are authorized by
the petroleum company itself.  There are exceptions.  Fraud on
petroleum cards is so low that the main reason for authorization is to
achieve the float reduction of electronic settlement.


THE BUSINESS RELATIONSHIPS
--- -------- -------------

Card acceptors generally sign up with a local acquirer for
authorization and settlement of all credit cards.  This acquirer may or
may not be a card issuer, but certainly will not have issued all the
cards that the merchant can accept.  The accepter does not generally
call one place for VISA and a different place for MC, for example.  At
one time, this was necessary, but more and more acquirers are connected
to all networks and are offering a broader range of services.

Acquirers generally are connected to many issuers, and pay transaction
charges and discount fees to those issuers for authorizations.  Thus,
the acquirer is actually making money on the difference between fees
paid and fees billed.  Most acquirers gather together transactions from
many accepters, allowing them to get volume discounts on fees.  Since
the accepters individually have lower volume and are not eligible for
those discounts, there is a markup that the acquirer can get away
with.  Acquirers also, of course, provide the convenience of a single
contact.

Most large banks are issuers and acquirers.  Things get real
interesting when it's time to settle up.  Some small banks are only
issuers.  There are third parties that are only acquirers.

In future episodes, I'll explain how standards help all this chaos work
together, and give details about how the authorization process happens.

                Joe Ziegler
                att!lznv!ziegler


From cca.ucsf.edu!ucsfcgl!ucbvax!ucsd!rutgers!dptg!lznv!ziegler Fri Sep 29 22:25
Article 2263 of misc.consumers:
Path: wet!cca.ucsf.edu!ucsfcgl!ucbvax!ucsd!rutgers!dptg!lznv!ziegler
>From: ziegler@lznv.ATT.COM (J.ZIEGLER)
Newsgroups: misc.consumers
Subject: Credit Card 101, Part 2 of 6 - Standards
Keywords: credit, debit, banks, standards
Message-ID: <1658@lznv.ATT.COM>
Date: 26 Sep 89 21:24:11 GMT
Distribution: usa
Organization: AT&T ISL Lincroft NJ USA
Lines: 208


This is part two in a planned six-part series about the credit card
industry.  It would be best if you read part one before reading
this part.  Enjoy.

DEFINITIONS
-----------

Some more new terms that are used in this posting.

ABA - American Bankers Association

ACH - Automated Clearing House - an organization that mechanically and
    electronically processes checks.

ANSI - American National Standards Institute

Embossing - creating raised letters and numbers on the face of the
    card.

Encoding - recording data on the magnetic stripe on the back of the
    card.

Imprinting - using the embossed information to make an impression on a
    charge slip.

Interchange - sending authorization requests from one host (the
    acquirer) to another (the issuer) for approval.

ISO - International Standards Organization

NACHA - National Automated Clearing House Association

PAN - Personal Account Number.  The account number associated with a
    credit, debit or charge card.  This is usually the same as the
    number on the card.

PIN - Personal Identification Number.  A number associated with the
    card, that is supposedly know only to the cardholder and the card
    issuer.  This number is used for verification of cardholder
    identity.


THE ORGANIZATIONS
--- -------------

ISO sets standards for plastic cards and for data interchange, among
other things.  ISO standards generally allow for national expansion.
Typically, a national standards organization, like ANSI, will take an
ISO standard and develop a national standard from it.  National
standards are generally subsets of the ISO standard, with extensions as
allowed in the original ISO standard.  Many credit card standards
originated in the United States, and were generalized and adopted by
ISO later.

The ANSI committees that deal with credit card standards are sponsored
by the ABA.  Most members of these committees work for banks and other
financial institutions, or for vendors who supply banks and financial
institutions.  Working committees report to governing committees.

All standards go through a formal comment and review procedure before
they are officially adopted.


PHYSICAL STANDARDS
-------- ---------

ANSI X4.13, "American National Standard for Financial Services -
Financial Transaction Cards" defines the size, shape, and other
physical characteristics of credit cards.  Most of it is of interest
only to mechanical engineers.  It defines the location and size of the
magnetic stripe, signature panel, and embossing area.  This standard
also includes the Luhn formula used to generate the check digit for the
PAN, and gives the first cut at identifying card type from the account
number.  (This part was expanded later in other standards.)  Also, this
standard identifies the character sets that can be used for embossing a
card.

Three character sets are allowed - OCR-A as defined in ANSI X3.17,
OCR-B as defined in ANSI X3.49, and Farrington 7B, which is defined in
the appendix of ANSI X4.13 itself.  Almost all the cards I have use
Farrington 7B, but Sears uses OCR-A.  (Sears also uses the optional,
smaller card size as, allowed in the standard.)  These character sets
are intended to be used with optical character readers (hence the OCR),
and large issuers have some pretty impressive equipment to read those
slips.


ENCODING STANDARDS
-------- ---------

ANSI X4.16, "American National Standard for Financial Services -
Financial Transaction Cards - Magnetic Stripe Encoding" defines the
physical, chemical, and magnetic characteristics of the magnetic stripe
on the card.  The standard defines a minimum and maximum size for the
stripe, and the location of the three defined encoding tracks.  (Some
cards have a fourth, proprietary track.)

Track 1 is encoded at 210 bits per inch, and uses a 6-bit coding of a
64-element character set of numerics, alphabet (one case only), and
some special characters.  Track 1 can hold up to 79 characters, six
of which are reserved control characters.  Included in these six
characters is a Longitudinal Redundancy Check (LRC) character, so that
a card reader can detect most read failures.  Data encoded on track 1
include PAN, country code, full name, expiration date, and
"discretionary data".  Discretionary data is anything the issuer wants
it to be.  Track 1 was originally intended for use by airlines, but
many Automatic Teller Machines (ATMs) are now using it to personalize
prompts with your name and your language of choice.  Some credit
authorization applications are starting to use track 1 as well.

Track 2 is encoded at 75 bits per inch, and uses a 4-bit coding of the
ten digits.  Three of the remaining characters are reserved as
delimiters, two are reserved for device control, and one is left
undefined.  In practice, the device control characters are never used,
either.  Track 2 can hold up to 40 characters, including an LRC.  Data
encoded on track 2 include PAN, country code (optional), expiration
date, and discretionary data.  In practice, the country code is hardly
ever used by United States issuers.  Later revisions of this standard
added a qualification code that defines the type of the card (debit,
credit, etc.) and limitations on its use.  AMEX includes an issue date
in the discretionary data.  Track 2 was originally intended for credit
authorization applications.  Nowadays, most ATMs use track 2 as well.
Thus, many ATM cards have a "PIN offset" encoded in the discretionary
data.  The PIN offset is usually derived by running the PIN through an
encryption algorithm (maybe DES, maybe proprietary) with a secret key.
This allows ATMs to verify your PIN when the host is offline, generally
allowing restricted account access.

Track 3 uses the same density and coding scheme as track 1.  The
contents of track 3 are defined in ANSI X9.1, "American National
Standard - Magnetic Stripe Data Content for Track 3".  There is a
slight contradiction in this standard, in that it allows up to 107
characters to be encoded on track 3, while X4.16 only gives enough
physical room for 105 characters.  Actually, there is over a quarter of
an inch on each end of the card unused, so there really is room for the
data.  In practice, nobody ever uses that many characters, anyway.
The original intent was for track 3 to be a read/write track (tracks 1
and 2 are intended to be read-only) for use by ATMs.  It contains
information needed to maintain account balances on the card itself.  As
far as I know, nobody is actually using track 3 for this purpose
anymore, because it is very easy to defraud.


COMMUNICATION STANDARDS
------------- ---------

Formats for interchange of messages between hosts (acquirer to issuer)
is defined by ANSI X9.2, which I helped define.  Financial message
authentication is described by ANSI X9.9.  PIN management and security
is described by ANSI X9.8.  There is a committee working on formats of
messages from accepter to acquirer.  ISO has re-convened the
international committee on host message interchange (TC68/SC5/WG1), and
ANSI may need to re-convene the X9.2 committee after the ISO committee
finishes.  These standards are still evolving, and are less specific
than the older standards mentioned above.  This makes them somewhat
less useful, but is a natural result of the dramatic progress in the
industry.

ISO maintains a registry of card numbers and the issuers to which they
are assigned.  Given a card that follows standards (Not all of them
do.) and the register, you can tell who issued the card based on the
first six digits (in most cases).  This identifies not just VISA,
MasterCard, etc., but also which member bank actually issued the card.


DE FACTO INDUSTRY STANDARDS
-- ----- -------- ---------

Most ATMs use IBM synchronous protocols, and many networks are
migrating toward SNA.  There are exceptions, of course.  Message
formats used for ATMs vary with the manufacturer, but a message set
originally defined by Diebold is fairly widely accepted.

Many large department stores and supermarkets (those that take cards)
run their credit authorization through their cash register controllers,
which communicate using synchronous IBM protocols.

Standalone Point-of-Sale (POS) devices, such as you would find at most
smaller stores (i.e. not at department stores), restaurants and hotels
use a dial-up asynchronous protocol devised by VISA.  There are two
generations of this protocol, with the second generation just beginning
to get widespread acceptance.

Many petroleum applications use multipoint private lines and a polled
asynchronous protocol known as TINET.  This protocol was developed by
Texas Instruments for a terminal of the same name, the Texas
Instruments Network E(something) Terminal.  The private lines reduce
response time, but cost a lot more money than dial-up.

NACHA establishes standards for message interchange between ACHs, and
between ACHs and banks, for clearing checks.  This is important to this
discussion due to the emergence of third-party debit cards, as
discussed in part 1 of this series.  The issuers of third-party debit
cards are connecting to ACHs, using the standard messages, and clearing
POS purchases as though they were checks.  This puts the third parties
at an advantage over the banks, because they can achieve the same
results as a bank debit card without the federal and state legal
restrictions imposed on banks.

In the next installment, I'll describe how an authorization happens, as
well as how the settlement process gets the bill to you and your money
to the merchant.  After that I'll describe various methods of fraud,
and how issuers, acquirers, and accepters protect themselves.  Stay
tuned.

                Joe Ziegler
                att!lznv!ziegler


From cca.ucsf.edu!ucsfcgl!ucbvax!tut.cis.ohio-state.edu!rutgers!dptg!lznv!ziegle
Article 2307 of misc.consumers:
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>From: ziegler@lznv.ATT.COM (J.ZIEGLER)
Newsgroups: misc.consumers
Subject: Credit Card 101, Part 3 - Authorization and Settlement
Keywords: credit, banks, authorization
Message-ID: <1661@lznv.ATT.COM>
Date: 27 Sep 89 21:56:38 GMT
Distribution: usa
Organization: AT&T ISL Lincroft NJ USA
Lines: 282


Here's part 3 in my six-part series on the credit card industry.
This part discusses how authorization and settlement work.  This is
a long one.  It will help if you have read parts 1 and 2, since I
had to leave out a lot of overlap to keep this from getting
ridiculous.  Enjoy.


THE ACCEPTER
--- --------

An important fact to note is that a card accepter does not have to get
approval for any purchases using credit or charge cards.  Of course, a
merchant is usually interested in actually getting money, and so must
participate in some form of settlement process (see below).  Usually,
the most acceptable (to a merchant) forms of settlement are tied (by
the acquirer) to authorization processes.  However, a merchant could
simply accept all cards without any validation, and eat any fraud that
results.

A merchant typically makes a business arrangement with a local bank or
some other acquirer for authorization and settlement services.  The
acquirer assigns a merchant identifier to that merchant, which will
uniquely identify the location of the transaction.  (This facilitates
compliance with federal regulations requiring that credit card bills
identify where each purchase was made.)  The acquirer also establishes
procedures for the merchant to follow.  The procedures will vary by
type of the merchant business, geographic location, volume of
transactions, and types of cards accepted.

If the merchant follows the procedures given by the acquirer and a
transaction is approved, the merchant is guaranteed payment whether the
card in question is good or bad.  The purpose of authorization is to
shift financial liability from the acceptor to the acquirer.

There are two basic tools used - bulletins and online checks.
Bulletins may be hardcopy, or may be downloaded into a local controller
of some form.  Online checks could be done via a voice call, a
standalone terminal, or software and/or hardware integrated into the
cash register.

A low-volume, high-ticket application (a jewelry store) would probably
do all its authorizations with voice calls, or may have a stand-alone
terminal.  A high-volume, low-ticket application (a fast-food chain)
will probably do most of its authorizations locally against a bulletin
downloaded into the cash register controller.  Applications in between
typically merge the two - things below a certain amount (the "floor
limit") are locally authorized after a lookup in the bulletin, while
things over the floor limit are authorized online.

Usually a lot of effort is taken to use the least expensive tools that
are required by the expected risk of fraud.  Typically, communication
costs for authorizations make up the biggest single item in the overall
cost of providing credit cards.

Large accepters are always a special case.  Airlines are usually
directly connected, host-to-host, to issuers and/or acquirers, and
authorize everything online.  Likewise for many petroleum companies and
large department stores.  Some large chains use different approaches at
different locations, either as a result of franchising oddities or due
to volume differences between locations.  A lot of experimentation is
still going on as well - this is not a mature market.

For voice authorizations, the merchant ID, PAN, expiration date, and
purchase amount are required for an approval.  Some applications also
require the name on the card, but this is not strictly necessary.  For
data authorizations, the merchant ID, PAN, PIN (if collected),
expiration date, and purchase amount are required.  Typically, the
"discretionary data" from track 2 is sent as well, but this is not
strictly necessary.  In applications that do not transmit the PIN with
the authorization, it is the responsibility of the merchant to verify
identity.  Usually, this should be done by checking the signature on
the card against the signature on the form.  Merchants don't often
follow this procedure, and they take a risk in not doing so.

In most applications, the amount of the purchase is known at the time
of the authorization request.  For hotels, car rentals, and some
petroleum applications, an estimated amount is used for the
authorization.  After the transaction is complete (e.g. after the gas
is pumped or at check-out time), another transaction may be sent to
advise of the actual amount of the transaction.  More on this later.


THE ACQUIRER
--- --------

The acquirer gathers authorization requests from accepters and returns
approvals.  If the acquirer is an issuer as well, "on us" transactions
will typically be turned around locally.  As before, the acquirer does
not have to forward any requests on to the actual issuer.  However,
acquirers are not willing to take the financial risks associated with
generating local approvals.  Thus most transactions are sent on to the
issuers (interchanged).  The purpose of interchange is to shift
financial liability from the acquirer to the issuer.

Typically, an acquirer connects to many issuers, and negotiates
different business arrangements with each one of them.  But the
acquirer generally provides a uniform interface to the accepter.  Thus,
the interchange rules are sometimes less stringent than those imposed
on the accepter.  Also, most issuers will trust acquirers to with
responsibilities they would never trust to accepters.  The acquirer can
therefore perform some front-end screening on the transactions, and
turn some of them around locally without going back to the issuer.

The first screening by the acquirer would be a "sanity" test, for valid
merchant ID, valid Luhn check on PAN, expiration date not past, amount
field within reason for type of merchant, etc.  After that, a floor
limit check will be done.  Issuers generally give acquirers higher
floor limits than acquirers give accepters, and floor limits may vary
by type of merchant.  Next, a "negative file" check would be done
against a file of known bad cards.  (This is essentially the same as
the bulletin.)  Then a "velocity file" check may be done.  A velocity
file keeps track of card usage, and limits are often imposed on both
number of uses and total amount charged within a given time period.
Sometimes multiple time periods are used, and it can get fairly
complicated.

Transactions that pass all the checks, and are within the authority
vested in the acquirer by the issuer, are approved by the acquirer.
(Note that, under the business arrangement, financial liability still
resides with the issuer.)  An "advice" transaction is sometimes sent to
the issuer (perhaps at a later time), to tell the issuer that the
transaction took place.

Transactions that "fail" one or more checks are denied by the acquirer
(if the cause was due to form, such as bad PAN) or sent to the issuer
for further checking.  (Note that "failure" here can mean that it's
beyond the acquirer's authority, not necessarily that the card is bad.)
Some systems nowadays will periodically take transactions that would
otherwise be approved locally, and send them to the issuer anyway.
This serves as a check on the screening software and as a
countermeasure against fraudulent users who know the limits.

Transactions that go to the issuer are routed according to the first
six digits of the PAN, according to the ISO registry mentioned in an
earlier section.  Actually, it's a bit more complicated than that,
since there can be multiple layers of acquirers, and some issuers or
acquirers will "stand in" for other issuers when there are hardware or
communication failures, but the general principal is the same at each
point.


THE ISSUER
--- ------

An issuer receiving an interchanged transaction will often perform many
of the same tests on it that the acquirer performs.  Some of the tests
may be eliminated if the acquirer is trusted to do them correctly.
This is the only point where a velocity file can actually detect all
usage of a card.  This is also the only point where a "positive file"
lookup against the actual account can be done, since only the issuer
has the account relationship with the cardholder.  If a PIN is used in
the transaction, only the issuer can provide true PIN verification -
acquirers may be able to do only "PIN offset" checking, as described in
a previous section.  This is one reason why PINs have not become
popular on credit and charge cards.

An account typically has a credit limit associated with it.  An
approved authorization request usually places a "hold" against the
credit limit.  If the sum of outstanding holds plus the actual
outstanding balance on the account, plus the amount of the current
transaction, is greater than the credit limit, the transaction is
(usually) denied.  Often in such a case the issuer will send back a
"call me" response to the merchant.  The merchant will then call the
issuer's number, and the operator may even want to talk to the
cardholder.  The credit limit could be extended on the spot, or
artificially high holds (from hotels or car rental companies) could be
overlooked so that the transaction can be approved.

The difference between the credit limit and the sum of holds and
outstanding balance is often referred to as the "open to buy" amount.
Once a hold is placed on an account, it is kept there until the actual
the transaction in question is settled (see below), in which case the
amount goes from a hold to a billed amount, with no impact on the open
to buy amount, theoretically.  For authorizations of an estimated
amount, the actual settled amount will be less than or equal to the
approved amount.  (If not, the settlement can be denied, and the
merchant must initiate a new transaction to get the money.)
Theoretically, in such a case, the full hold is removed and the actual
amount is added to the outstanding balance, resulting in a possible
increase in the open to buy amount.

In practice, older systems were not capable of matching settlements to
authorizations, and holds were simply expired based on the time it
would take most transactions to clear.  Newer systems are starting to
get more sophisticated, and can do a reasonable job of matching
authorizations for actual amounts with the settlements.  Some of them
still don't match estimated amounts well, with varying effects.  In
some cases, the difference between actual and estimated will remain as
a hold for some period of time.  In other cases, both the authorization
and the settlement will go against the account, reducing the open to
buy by up to twice the actual amount, until the hold expires.  These
problems are getting better as the software gets more sophisticated.

Some issuers are also starting to use much more sophisticated usage
checks as well.  They will not only detect number of uses and amount
over time, but also types of merchandise bought, or other patterns to
buying behavior.  Most of this stuff is new, and is used for fraud
prevention.  I expect this to be the biggest effort in authorization
software for the next few years.

American Express does things completely differently.  There are no
credit limits on AMEX cards.  Instead, AMEX relies entirely on usage
patterns, payment history, and financial data about cardmembers to
determine whether or not to automatically approve a transaction.  AMEX
also has a policy that a cardmember will never be denied by a machine.
Thus, if the computer determines that a transaction is too risky, the
merchant will receive a "call me" message.  The operator will then get
details of the transaction from the merchant, and may talk to the
cardmember as well, if cardmember identity is in question or a large
amount is requested.  To verify cardmember identity, the cardmember
will be asked about personal information from the original application,
or about recent usage history.  The questions are not the same each
time.  If an unusually large amount is requested, the cardmember may be
asked for additional financial data, particularly anything relating to
a change in financial status (like a new job or a promotion).  People
who are paranoid about Big Brother and computer databases should not
use AMEX cards.


SETTLEMENT
----------

So far, no money has changed hands, only financial liability.  The
purpose of settlement is to shift the financial liability back to the
cardholder, and to shift the cardholder's money to the merchant.
Theoretically, all authorization information can be simply discarded
once an approval is received by a merchant.  Of course, contested
charges, chargebacks, merchant credits, and proper processing of holds
require that the information stay around.  Still, it is important to
realize that an authorization transaction has no direct financial
consequences.  It only establishes who is responsible for the financial
consequences to follow.

Traditionally, a merchant would take the charge slips to the bank that
was that merchant's acquirer, and "deposit" them into the merchant
account.  The acquirer would take the slips, sort them by issuer, and
send them to the issuing banks, receiving credits by wire once they
arrived and were processed.  The issuer would receive the slips,
microfilm them (to save the transaction information, as required by
federal and state laws) charge them against the cardholder's accounts,
send credits by wire to the acquirer, and send out the bill to the
cardholder.  Problem is, this took time.  Merchants generally had to
wait a couple of weeks for the money to be available in their accounts,
and issuers often suffered from float on the billables of about 45
days.

Therefore, nowadays many issuers and acquirers are moving to on-line
settlement of transactions.  This is often called "draft capture" in
the industry.  There are two ways this is done - one based on the host
and one based on the terminal at the merchant's premises.  In the
host-based case, the terminal generally only keeps counts and totals,
while the acquirer host keeps all the transaction details.
Periodically, the acquirer host and the terminal communicate, and
verify that they both agree on the data.  In the terminal-based case,
the terminal remembers all the important transaction information, and
periodically calls the acquirer host and replays it all for several
transactions.  In either case, once the settlement is complete the
merchant account is credited.  The acquirer then sends the settlement
information electronically to the issuers, and is credited by wire
immediately (or nearly so).  The issuer can bill directly to the
cardholder account, and float can be reduced to an average of 15 days.

The problem is, what to do with the paper?  Current regulations in many
states require that it be saved, but there is no need for it to be sent
to the issuer.  Also, for contested charges, a paper trail is much more
likely to stand up in court, and much better to use for fraud
investigations.  Currently, the paper usually ends up back at the
issuer, as before, but it doesn't need to be processed, just
microfilmed and stored.

Much of the market still uses paper settlement methods.  Online
settlement will replace virtually all of this within the next 5 to 10
years, because of its many benefits.

This was pretty long, but there is a lot of information, and I skimmed
over a lot of details.  Future installments should be shorter.  Coming
up next is a discussion of fraud and security, and then a special
discussion of debit cards.  Hang on, we're halfway through this!

                Joe Ziegler
                att!lznv!ziegler


From cca.ucsf.edu!ucsfcgl!ucbvax!agate!shelby!rutgers!dptg!lznv!ziegler Fri Sep
Article 2355 of misc.consumers:
Path: wet!cca.ucsf.edu!ucsfcgl!ucbvax!agate!shelby!rutgers!dptg!lznv!ziegler
>From: ziegler@lznv.ATT.COM (J.ZIEGLER)
Newsgroups: misc.consumers
Subject: Credit Card 101, Part 4 of 6 - Fraud and Security
Keywords: credit cards, ATM, bank, security, fraud
Message-ID: <1662@lznv.ATT.COM>
Date: 28 Sep 89 21:23:44 GMT
Distribution: usa
Organization: AT&T ISL Lincroft NJ USA
Lines: 240


This is part four of a planned six-part series on the credit card
industry.  It will be helpful if you have read parts one through
three, as I use a lot of terminology here that was introduced
earlier.  Enjoy.


WARNING
-------

This installment describes various methods of perpetrating fraud
against credit and charge card issuers, acquirers, and cardholders.
Legal penalties for using these methods to commit fraud are severe.
The reason for sharing this information is so that consumers will be
aware of the importance of security and be aware of the procedures used
by financial institutions to protect against fraud.  Neither I nor my
employer advocate use of the fraudulent methods described herein.

All the information here is publicly available from other sources.
Unnecessary detail is purposely not included, particularly as it
applies to detection and prevention of fraud.


CARDHOLDER FRAUD
---------- -----

The most common type of fraud against credit cards is cardholders
falsifying applications to get higher credit limits than they can
afford to pay, or to get multiple cards that they cannot afford to pay
off.  Sometimes this is done with intent to defraud, but most often it
is done out of desperation or sheer financial ineptitude.  Those who
intend to defraud generally use the multiple-card approach.  They give
false names and financial data on several (sometimes as many as
hundreds) of applications.  Often, the address of a vacant house that
the crook has access to is given, making it difficult to track the
crook's real identity.  Once cards start showing up, the crook uses
them for cash advances or charges merchandise that is easy to sell,
like consumer electronics.  The crook will run all the cards up to the
limit immediately, and will generally move on by the time the bills
start arriving.  This type of fraud is not applicable to debit cards,
since they require an available account balance equal to or greater
than any purchases or withdrawals.

Protecting against this type of fraud, either intentional or otherwise,
is exactly the purpose of credit bureaus such as TRW.  Issuers have
become more aware of the need for careful screening of applications,
and are using better techniques for detecting similar applications sent
to multiple issuers.  More sophisticated velocity file screening can
also be used to detect possibly fraudulent usage patterns.  Since this
is a method of fraud that can be used to gain really large amounts of
money, it is a high priority with issuers' security departments.

A variant of this scheme is much like check kiting.  Can you use your
VISA to pay your MasterCard?  Well, you might be able to manage it, but
if you're doing it with intent to defraud, you can be prosecuted.
Kiting schemes typically don't last long, have a low payoff, and are
very easy to detect.

Another type of cardholder fraud is simply contesting legitimate
charges.  Most often, retrieving the documents gives pretty convincing
proof.  Frequently, a family member will be found to have used the card
without the cardholder's permission.  Such cases are usually pretty
easy to resolve.  In the case of an ATM card, cameras are often placed
at ATMs (sometimes hidden) to record users of the machine.  The camera
is usually tied to the ATM, so that a single retrieval stamp can be
placed on the film and the ATM log.  If a withdrawal is contested, the
bank can then retrieve the picture of the person standing at the
machine, and conclusively tie that picture to the transaction.

A type of cardholder fraud that is endemic only to ATMs is making false
deposits.  You could, theoretically, tell the ATM that you are
depositing a large amount of money, and put in an empty envelope.  Most
banks will not let you withdraw amounts deposited into an ATM until the
deposit has been verified, but some will allow part of the deposit to
be withdrawn.  Typically, you can't get away with much.  If you have
any money actually in your account, the bank has easy, legal recourse
to seize those funds.  Most banks have no sense of humor about such
things, and will remove ATM card privileges after the first offense.


THIRD-PARTY FRAUD
----------- -----

The simplest way for a third party to commit fraud is for them to get
their hands on a legitimate card.  There is a large black market for
credit cards obtained from hold-ups, break-ins and muggings.  Perhaps
one of the cruelest methods of getting a card is a "Good Samaritan"
scam.  In such a scam, credit cards are stolen by pick-pockets,
purse-snatchers, etc.  That same day, someone looks up your number in
the phone book and calls you up.  "I just found your wallet.  All the
money is gone, but the credit cards and your driver's license are still
here.  It just happens that I'll be in your neighborhood next Wednesday
and I'll drop it off then."  Since the cards are found, you don't
report them stolen, and the crooks get until next Wednesday before
you're even suspicious.  If such a thing happens to you, ask if you can
come and pick the cards up immediately.  A true good samaritan won't
mind, but a crook will stall you.  If you can't get your hands on the
cards immediately, report them as stolen.  Most issuers will be able to
get you a new card by next Wednesday, anyway.

Often stolen cards will be used for a time exactly as is.  The best
tool for preventing this is verification of the signature, but this is
ineffective because most merchants don't consistently check signatures
and some people don't even sign their cards.  (I guess these people
figure that all purse snatchers are accomplished forgers as well.)
Many cards will eventually be modified as the various security schemes
start catching up.

It is a very easy matter, for example, to re-encode a different number
on the magnetic stripe.  Since the card still looks fine, a merchant
will accept it and run it through the POS terminal, completely ignorant
of the fact that the number read off the back is not the same as that
on the front.  Although the number on the front would fail a negative
file check, the number on the back is one that hasn't been reported
yet.  A card can be re-encoded almost any number of times, as long as
you can keep coming up with new valid PANs.  To protect against this,
some merchants purposely avoid using the magnetic stripe.  Others have
terminals that display the number read from the stripe, so the cashier
can compare it to the number on the card.  Some issuers are
experimenting with special encoding schemes, to make re-encoding
difficult, but most of these schemes would require replacing the entire
embedded base of POS terminals.  An interesting approach I've seen
(it's probably patented) uses a laser to burn off the parts of the
magnetic stripe where zeroes are encoded, leaving only the ones.  This
severely limits the changes you can make to the card number.  Some
issuers use the "discretionary data" field to encode data unique to the
card, that a crook would not be able to guess, to combat this type of
fraud.

Since an ATM doesn't have a human looking at the card, it is
especially susceptible to re-encoding fraud.  A crook could get a
number from a discarded receipt and encode it on a white card blank,
which is easy to obtain legally.  Many people use PINs that are easy to
guess, and the crook has an easy job of it.  Most ATMs will not give
you your card back if you don't enter a correct PIN, and will only give
you a few tries to get it right, to prevent this type of fraud.
Velocity file checks are also important in detecting this.  You should
always take your ATM receipts with you, pick a non-obvious PIN, and
make sure that nobody sees you enter it.

One place that a crook can get valid PANs to encode on credit cards is
from dumpsters outside of stores and restaurants.  The credit slip
typically is a multipart form, with one copy for you, one for the
merchant, and one for the issuer (ultimately).  If carbon paper is
used, and the carbons are discarded intact, it's pretty easy to read
the numbers off of them.  Carbonless paper and forms that either rip
the carbons in half or attach them to the cardholder copy automatically
are used to prevent this.

There are a lot of scams for getting people to tell their credit card
numbers over the phone.  Never give your card number to anyone unless
you are buying something from them, and make sure that it is a
legitimate business you are buying from.  "Incredible deal!!  Diamond
jewelry at half price!!  Call now with your VISA number, and we'll rush
you your necklace!!"  When you don't get the necklace for four weeks,
you might start to wonder.  When you get your credit card bill, you'll
stop wondering.

There are other, more sophisticated ways to modify a credit card.  If
you're skillful, you can change the embossing on the card and even the
signature on the back.  For most purposes, these techniques are more
trouble than they're worth, since it's not difficult to come up with a
new stolen card, or fake ID to match the existing card.


MERCHANT FRAUD
-------- -----

There are many urban rumors of merchants imprinting a card multiple
times while the cardholder isn't looking, and then running through a
bunch of charges after the cardholder leaves.  I don't know of any case
where this is an official policy of a merchant, but this is certainly
one technique a dishonest cashier could use.  The cashier can then take
home a bunch of merchandise charged to your account.  Although some
people are afraid of this happening in a restaurant, where a waiter
takes your card away for a while, it's actually less likely there,
since there isn't anything the waiter can charge against your card and
take home.

A merchant could also make copies of charge slips, to sell the PANs to
other crooks.  (See above for use of PANs.)  Most credit card
investigation departments are sensitive to this possibility, and catch
on real fast if it's happening just by looking at usage history of
cards with fraudulent charges.

A merchant is also in a position to create many false charges against
bogus numbers, to attempt to defraud the acquirer or issuer.  These
schemes are usually not too effective, since acquirers generally
respond very quickly to an unusual number of fraudulent transactions by
tightening restrictions on the merchant.


ACQUIRER AND ISSUER FRAUD
-------- --- ------ -----

The place to make really big bucks in fraud is at the acquirer or
issuer, since this is where you can get access to large amounts of
money.  Fortunately, it's also fairly easy to control things here with
audit procedures and dual control.  People working in the back offices,
processing credit slips, bills, etc. have a big opportunity to "lose"
things, introduce false things, artificially delay things, and
temporarily divert things.  Most of the control is standard banking
stuff, and has been proven effective for decades, so this isn't a big
problem.  A bigger potential problem to the consumer is the possibility
of an employee at the issuer or acquirer selling PANs to crooks.  This
would be very hard to track down, and could compromise a large part of
the card base.  I know of no cases where this has happened.

Programmers, in particular, are very dangerous because they know where
the data is, how to get it, and what to do with it.  In most shops,
development is done on completely separate facilities from the
production system.  Certification and installation are done by
non-developers, and developers are not allowed any access to the
production facilities.  Operations and maintenance staff are monitored
very carefully as well, since they typically have access to the entire
system as part of their jobs.

Another type of fraud that is possible here is diversion of materials,
such as printed, but not embossed or encoded, card blanks.  Such
materials are typically controlled using processes similar to those
used at U.S. mints.  Since most of the cards issued in the United
States are actually manufactured by only a handful of companies, it's
not too hard to keep things under control.

There are many types of fraud that can be perpetrated by tapping data
communication lines, and using protocol analyzers or computers to
intercept or introduce data.  These types of fraud are not widespread,
mainly because of the need for physical access and because
sophisticated computer techniques are required.  There are message
authentication, encryption, and key management techniques that are
available to combat this type of fraud, but currently these techniques
are far more costly than the minimal fraud they could prevent.  About
the only such security technique that is in widespread use is
encryption of PINs.

The next episode will be devoted to debit cards, and the final episode
will talk about the networks that make all this magic happen.

                Joe Ziegler
                att!lznv!ziegler


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