The Fraud Squad

Whether it's done by customers, employees or organized criminals, fraud takes a bite out of business's bottom line. Here's what CSOs can do about it.

Many fraud-detection tools use link analysis or neural networks to reveal the hidden connections between pieces of information that, in combination, may indicate fraud. Credit card companies rely on these kinds of tools to help spot suspicious transactions. One of the most famous such products is the Falcon Fraud Manager from HNC software (a subsidiary of Fair, Isaac & Co.). Falcon is a neural network system used by 85 percent of U.S. credit card issuers. It pools large volumes of historical purchasing data about cardholders and analyzes it to establish transaction and spending patterns so that exceptions to those patterns can be discerned. The software looks at how each customer spends against how risky that spending is. Using a mathematical algorithm, it computes the likelihood that a transaction is fraudulent on a scale from 1 to 999. For example, if a consumer historically uses her card once a week to purchase gas and groceries in a New Jersey ZIP code, a transaction posted for a gas purchase in Ohio would trigger a slightly elevated fraud score. Conversely, a big-ticket Ohio purchase of an easily liquidated item like jewelry would produce a much higher score. Each card issuer determines the threshold at which it will initiate a fraud responsefor example, requesting the sales clerk to check the cardholder's ID or referring the case to a fraud analyst.

Technology has made a huge difference in fraud detection for companies like MasterCard, according to DeLuca. "Before, cards would run seven, 10 or even 30 days before a customer got their statement and realized they didn't make a transaction," he says. "Globally, fraud as a percentage of our transactions is down in 2002 compared with 2001."Getting the Drop on FraudThe challenges of fraud are unending. Fraudsters are constantly alert for new and ingenious techniques. "As we get up every morning to go to our jobs," says Sargent, "they're getting up to go to theirs. And their job is to steal money from us." Given the broad spectrum of ways to conceal fraudulent acts across an enterprise, CSOs need to take high-level steps to strengthen corporate defenses.

The first is to be proactive rather than reactive. Frazzini recommends that CSOs get involved in industry groups and fraud-buster organizations to pick up best practices that they can bring back and share within their company. One such group is the Financial Services Roundtable, a Washington, D.C., trade association for the banking, insurance and securities industries that has a technology unit known as Bits. Within Bits is a fraud working group where member companies can share experiences and glean advice. In addition, the Association of Certified Fraud Examiners runs seminars and offers continuing education for fraud examiners.