Fraud Risk Management: A Practical Guide to Reducing Fraud Rates in Your Organization

Fraud is costing businesses more than ever. In 2023 alone, global losses due to fraud reached $485.6 billion, with organizations losing an average of 5% of their annual revenue to fraudulent activities. More concerning, nearly one-third of fraud cases succeed due to inadequate internal controls.

If you're reading this, you're likely concerned about fraud risk at your organization—and you should be. But here's the good news: with the right fraud risk management approach, you can significantly reduce your exposure and protect your business from devastating losses.

This guide walks you through the COSO/ACFE fraud risk management framework—the industry standard used by organizations worldwide—and shows you exactly how to implement it to combat payment fraud, friendly fraud, and refund abuse in retail operations.

What is Fraud Risk Management?

Fraud risk management is the systematic practice of identifying, analyzing, and mitigating the potential for fraud within your organization. It's about creating a continuous cycle of improvement where each element reinforces the others.

The framework consists of four interconnected components:

Prevention stops fraud before it starts by building systems that make fraud difficult to execute. For retail operations, this means implementing payment verification systems, transaction limits, and automated fraud scoring at checkout. Prevention also includes velocity checks that stop fraudsters from testing multiple stolen cards rapidly, and authentication requirements that verify customers are who they claim to be.

Detection identifies fraud while it's happening or shortly after, before significant damage occurs. The goal isn't just to catch fraud eventually—it's to spot unusual patterns and anomalies quickly enough to limit losses. This requires real-time monitoring systems that flag suspicious transactions, analytics that identify coordinated fraud rings, and alerts that trigger when customers exhibit high-risk behaviors like excessive returns or chargebacks.

Response ensures you take appropriate action when fraud is detected. For payment fraud, this might mean immediately declining the transaction and blocking the payment method. For friendly fraud, it means gathering evidence to fight illegitimate chargebacks. For refund abuse, it involves account suspension and recovery of lost merchandise or funds. The response should match the severity—systematic fraud rings warrant aggressive action including law enforcement involvement, while isolated incidents might be handled through account restrictions.

Recovery and Learning closes the loop by turning every fraud incident into an opportunity to strengthen your defenses. This means analyzing what detection rules the fraudster bypassed, what new techniques they used, and how similar attempts can be blocked in the future. Organizations that feed learnings back into their prevention and detection systems become increasingly resistant to fraud over time. Each fraud attempt that succeeds reveals a vulnerability you can fix; each attempt that fails confirms your defenses are working.

These four components work together as a cycle: prevention reduces incidents, detection catches what prevention missed, response stops the damage and gathers intelligence, and recovery feeds lessons back into better prevention and detection.

Why Fraud Risk Management Matters More Than Ever

The fraud landscape has evolved dramatically. Fraudsters now use artificial intelligence, machine learning, and sophisticated techniques to exploit vulnerabilities. The shift to e-commerce, contactless payments, and digital wallets has created new attack vectors for card testing, account takeovers, and refund fraud at scale.

The impacts extend beyond immediate financial losses. Chargebacks from friendly fraud count against your merchant account, and excessive chargeback rates can result in higher processing fees or termination of your payment processing relationship. Refund abuse directly impacts your bottom line while tying up inventory. Payment fraud creates operational overhead as you dispute chargebacks and investigate suspicious orders.

Organizations with strong fraud risk management programs protect their revenue, maintain healthy payment processor relationships, and reduce operational drag from fraud investigations.

The Five Principles of Fraud Risk Management

The COSO/ACFE framework organizes fraud risk management into five core principles. Think of these as the foundation of your program—each principle must be present and functioning for the system to work effectively.

Principle 1: Fraud Risk Governance

Establish clear ownership and accountability for fraud risk management. Designate who owns fraud prevention for payment transactions, who monitors refund patterns, and who investigates suspected friendly fraud. Make it clear that fraud risk isn't just the responsibility of loss prevention—operations, customer service, and e-commerce teams all play a role.

Document your organization's fraud risk appetite—how much friction you're willing to add to the checkout process, what false positive rate you'll accept, and which fraud types pose the greatest threat to your business. Not every transaction requires the same level of scrutiny. Understanding your risk appetite helps you balance fraud prevention with customer experience.

For retail operations, governance also means establishing clear policies for handling borderline cases. When do you decline an order that seems suspicious but might be legitimate? When do you restrict an account with a high return rate? Having documented decision frameworks ensures consistent treatment and reduces second-guessing.

Principle 2: Fraud Risk Assessment

Conduct regular, systematic assessments to identify specific fraud schemes that could affect your retail operations. Get specific about the threats you face:

Payment Fraud Schemes: Card testing attacks where fraudsters use your checkout to validate stolen card numbers. Account takeovers where criminals gain access to legitimate customer accounts and make fraudulent purchases. Stolen card transactions where fraudsters use compromised payment information to buy high-value, easily resold items.

Friendly Fraud Schemes: Customers who falsely claim they never received items despite delivery confirmation. Buyers who claim items were defective or not as described to obtain refunds while keeping merchandise. Customers who dispute legitimate charges through their bank to avoid paying.

Refund Abuse Schemes: Serial returners who buy items, use them, and return them repeatedly. Customers who swap original items for damaged ones before returning. Refund fraud rings that exploit your return policy across multiple accounts or locations. Receipt fraud where customers return stolen merchandise using fake or found receipts.

Assess both the likelihood and potential impact of each fraud type you identify. Use a simple matrix approach: plot each risk based on how frequently you see it and how much damage it causes. This helps you prioritize where to focus your prevention efforts.

Evaluate your existing controls against these identified risks. Where do your payment verification systems work well? Where are your refund policies vulnerable to abuse? Where do you lack visibility into customer behavior patterns? This honest assessment shows you where to invest in additional protection.

Principle 3: Fraud Control Activities

Design and implement specific control activities to address your assessed fraud risks. Controls fall into two categories: preventive controls that stop fraud from happening, and detective controls that identify fraud quickly when it does occur.

Payment Fraud Prevention:

• AVS (Address Verification Service) and CVV checks that validate cardholder information matches

• 3D Secure authentication that adds an additional verification layer for card-not-present transactions

• Device fingerprinting that identifies when multiple accounts or transactions come from the same device

• Velocity limits that block excessive transaction attempts in short timeframes

• Automated fraud scoring that evaluates multiple risk signals and accepts, declines, or flags orders for review

• Payment tokenization that reduces exposure of actual card data

Friendly Fraud Prevention:

• Delivery confirmation requirements for high-value orders, including signature on delivery

• Clear order confirmation emails with detailed item descriptions and terms

• Proactive shipping updates that document the delivery chain

• Chargeback alerts that notify you immediately when disputes are filed, giving you time to respond

• Compelling evidence packages that document legitimate transactions to fight illegitimate chargebacks

Refund Abuse Prevention:

• Return authorization systems that screen refund requests before accepting returns

• Receipt validation that verifies purchases actually occurred at your business

• Return frequency tracking that identifies serial returners

• Item condition verification before processing refunds

• Refund method restrictions (refund to original payment method only)

• Account-level return limits based on purchase history

Detective Controls:

• Transaction monitoring that flags orders with unusual characteristics (high value, rush shipping, mismatched addresses)

• Pattern analysis that identifies customers with excessive returns, chargebacks, or refund requests

• Fraud ring detection that links related accounts through shared payment methods, addresses, or devices

• Anomaly detection that spots transactions that deviate from typical customer behavior

• Real-time alerts for high-risk activities that require immediate review

The key is layering multiple controls. If AVS fails but device fingerprinting is clean and the customer has good purchase history, you might still accept the order. If multiple signals indicate risk, you decline or hold for review. This layered approach reduces false positives while catching actual fraud.

Principle 4: Fraud Investigation and Corrective Action

When fraud is detected, respond swiftly and systematically. For payment fraud, immediately decline the transaction or cancel the order if it hasn't shipped. Block the payment method and device fingerprint to prevent future attempts. If the order already shipped, work with your payment processor to document the fraud and minimize liability.

For friendly fraud, gather all available evidence immediately. Pull order records, shipping confirmations, delivery signatures, customer communication history, and any photos or documentation from the transaction. Submit this evidence package to fight the chargeback. Track which customers file multiple disputes and restrict their accounts accordingly.

For refund abuse, investigate the full scope of the customer's activity. How many returns have they made? What's their return rate compared to average customers? Are there patterns in what they return or when? Check for links to other accounts through payment methods, addresses, or devices. Based on what you find, take graduated action from warning the customer, to requiring manager approval for future returns, to suspending return privileges or closing the account entirely.

Document every fraud incident with key details: the fraud type, how it was detected, what the loss amount was, what evidence you collected, and what action you took. This documentation serves multiple purposes—it supports your chargeback disputes, justifies account restrictions if customers complain, and provides data for analyzing fraud trends.

Use each investigation as a learning opportunity. What control failed or didn't exist? What red flags appeared in retrospect? What new fraud technique did you encounter? Document these insights and translate them into control improvements. If you discover fraudsters are exploiting your guest checkout to avoid account-level tracking, that insight might lead to implementing device fingerprinting or requiring account creation for high-value orders.

Principle 5: Monitoring and Continuous Improvement

Establish ongoing monitoring of your fraud risk management program. Track key metrics that tell you whether your program is working:

Fraud Rate Metrics:

• Payment fraud rate (fraudulent transactions as percentage of total transactions)

• Chargeback rate (chargebacks per total transactions)

• Refund abuse rate (abusive returns as percentage of total returns)

• Fraud loss amount (total dollar value lost to fraud)

• Fraud prevention rate (fraud attempts blocked before completion)

Operational Efficiency Metrics:

• False positive rate (legitimate orders incorrectly flagged or declined)

• Time to detection (how quickly fraud is identified)

• Review queue size (how many orders await manual review)

• Chargeback win rate (percentage of disputes you successfully fight)

• Average fraud investigation time

These metrics reveal whether your controls are too loose (high fraud rates) or too tight (high false positive rates). They show whether you're detecting fraud quickly enough and whether your processes are efficient.

Review your fraud patterns monthly. Are you seeing new fraud techniques? Have attack patterns shifted? Are certain products or channels experiencing more fraud? Use these insights to adjust your fraud rules and detection thresholds.

Test your controls periodically to ensure they're operating as designed. Run test transactions to verify fraud rules trigger correctly. Audit your review queue to confirm orders are being handled consistently. Check that return authorization systems are actually blocking high-risk returns.

Stay informed about emerging fraud trends in retail. Subscribe to fraud intelligence services, participate in retail loss prevention groups, and monitor industry reports. Fraudsters share techniques across retailers—what hits your competitors today may target you tomorrow.

Recognizing Fraud: Warning Signs That Demand Attention

Training your team to spot fraud patterns enables faster detection and response. Here are the key warning signs for each major fraud type:

Payment Fraud Indicators:

• Orders with billing and shipping addresses in different countries or states

• Multiple orders using different cards but shipping to the same address

• Rush shipping requests combined with high order values

• Orders with unusual quantities of high-resale items (electronics, gift cards, luxury goods)

• Multiple failed payment attempts followed by a successful transaction

• Email addresses that don't match the billing address location

• New accounts making large first purchases

• Orders just below your automatic review threshold

Friendly Fraud Warning Signs:

• Customers with multiple chargebacks across different orders

• "Item not received" disputes despite delivery confirmation with signature

• Chargebacks filed long after the delivery date

• Customers who file disputes immediately after delivery without contacting you first

• Patterns of chargebacks on specific high-value items

• Customers who frequently report items as damaged or not as described

Refund Abuse Red Flags:

• Return rates significantly higher than average customers (2x-3x or more)

• Consistent pattern of buying items before major events and returning them after

• Returns of worn, used, or damaged items claimed as defective

• Multiple returns lacking original tags or packaging

• Receipt patterns that don't match purchase records

• Customers who return items and immediately repurchase similar items at sale prices

• Returns clustered near the end of your return window

• Same customer returning high-value items across multiple locations

• Returns that always seem to be just under the refund limit that requires additional approval

Don't rely on any single indicator—fraud detection works best when you consider multiple signals together. A new account isn't suspicious by itself, but a new account making a large purchase with rush shipping to a freight forwarder deserves immediate scrutiny.

Building Your Fraud Risk Management Program: A Practical Roadmap

Implementing the five principles doesn't require a massive upfront investment. Start with a focused approach that builds momentum through quick wins and gradual expansion.

Months 1-2: Foundation and Assessment

Begin by pulling your fraud data for the past 6-12 months. How much did you lose to payment fraud? What's your chargeback rate? What percentage of returns are suspicious? Understanding your baseline helps you prioritize and measure improvement.

Conduct your initial fraud risk assessment focused on payment fraud, friendly fraud, and refund abuse. Interview your customer service team, payment operations staff, and fulfillment team. They know where the problems are. Review declined orders—are you declining legitimate customers? Review approved orders that turned out to be fraud—what signals did you miss?

Document your findings: the specific fraud schemes you're facing, how often they occur, what your losses are, and what controls currently exist. Rank fraud types by their impact on your business.

Months 3-4: Quick Win Controls

Implement controls for your highest-impact fraud types. If payment fraud is your biggest loss, start there with AVS/CVV verification and basic fraud scoring. If refund abuse is killing you, implement return frequency tracking and authorization requirements for high-risk returns.

Establish clear procedures for handling flagged orders. Who reviews them? What information do they check? When do they approve versus decline? Document the decision process so multiple team members can handle reviews consistently.

Set up basic monitoring dashboards tracking your key fraud metrics. Even simple weekly reports showing fraud rates, chargeback counts, and high-risk customer lists provide visibility you need to manage the problem.

Months 5-6: Technology and Process Enhancement

Deploy fraud detection technology matched to your priority risks. For payment fraud, this might be a fraud scoring solution that evaluates transactions in real-time. For refund abuse, this might be return analytics software that tracks customer return behavior. Choose tools that integrate with your payment gateway, e-commerce platform, or point-of-sale system.

Enhance your evidence collection processes for fighting friendly fraud. Create templates for chargeback response packages. Ensure your shipping process captures delivery confirmation properly. Set up systems to save all customer communications automatically.

Refine your refund policies to reduce abuse while maintaining legitimate customer service. This might mean requiring original receipts, limiting return windows on certain items, or flagging serial returners for additional verification.

Months 7-12: Monitoring and Refinement

Establish regular monitoring and reporting rhythms. Weekly reviews of fraud metrics with operational teams, monthly reviews with management. Use these reviews to discuss what you're learning and what adjustments you're making.

Refine your controls based on real-world performance. Are you generating too many false positives that frustrate good customers? Are you missing fraud that gets through? Adjust your fraud scoring thresholds, add new data points to your analysis, or modify your review procedures based on results.

Begin planning for your annual fraud risk assessment refresh. What's changed in your business? Are you selling new products that attract different fraud? Have you expanded to new markets with different fraud patterns? Update your assessment accordingly.

Beyond Year 1: Continuous Evolution

Fraud risk management becomes part of how you operate. New payment methods launch with fraud controls built in. Fraud metrics are reviewed alongside other operational metrics. Controls are tested and updated regularly. Each fraud incident generates insights that strengthen your defenses.

Turning Fraud Incidents Into Stronger Defenses

Every fraud incident—whether it results in losses or is stopped before damage occurs—contains valuable intelligence. Organizations that learn effectively from fraud build increasingly robust defenses over time.

When fraud occurs, conduct a post-incident review once the immediate response is complete. Gather your payment operations, customer service, and fraud prevention teams. Ask these questions:

What specific techniques did the fraudster use? For payment fraud, this might be using stolen cards with matching AVS information or exploiting guest checkout. For refund fraud, this might be buying items on sale and returning at full price or swapping worn items for new ones. Understanding the mechanics helps you identify similar attempts in the future.

What warning signs existed that we missed or didn't act on? Often, the indicators were there but weren't recognized or weren't significant enough to trigger action. Maybe the customer had a high return rate but not quite high enough to flag. Maybe device fingerprinting showed similarities to known fraud accounts but not an exact match. Identifying missed signals helps you refine detection capabilities.

Which controls failed, and why? Controls fail for different reasons. Maybe your fraud scoring tool didn't weight certain risk factors heavily enough. Maybe your return authorization system wasn't checking the right criteria. Maybe you have controls but staff aren't following procedures. Understanding the failure mode guides corrective action.

What would have detected this fraud earlier? Working backward from the incident, identify the data points or behavioral indicators that, if monitored, would have flagged the fraud sooner. These become candidates for new detection rules or manual review triggers.

Document these insights and translate them into concrete actions: new fraud rules, adjusted scoring weights, enhanced review procedures, or additional data points to monitor. Track implementation of these improvements to ensure learning leads to actual change.

Share relevant insights across your organization. If the e-commerce team discovers a new payment fraud technique, the retail stores need to know about it. If customer service identifies a refund fraud pattern, the returns processing team needs that information. Collaborative defense makes everyone stronger.

Common Implementation Challenges and How to Address Them

Most organizations encounter similar obstacles when building fraud risk management programs. Anticipating these challenges helps you navigate them successfully.

Challenge: "Our fraud prevention creates too much friction—customers abandon carts when we require additional verification"

This tension between security and conversion is real, but manageable. Use risk-based approaches that apply strong controls only to high-risk transactions. The majority of legitimate customers won't experience additional friction. When you do add verification steps, make them as smooth as possible—3D Secure 2.0 creates less friction than older authentication methods. Monitor both fraud rates and conversion rates to find the right balance, and don't assume every security measure kills conversion. Sometimes customers appreciate knowing you're protecting them.

Challenge: "We can't fight every chargeback—it takes too much time and our win rate is low"

You're right that you can't fight every chargeback economically. But you should fight the ones that matter. Focus on high-value chargebacks and obvious friendly fraud cases where you have strong evidence. Even if you only win 30-40% of disputes, that's revenue you've recovered. More importantly, customers who successfully commit friendly fraud will do it again. Fighting their chargebacks sends a signal that you're not an easy target and may deter repeat attempts. Also, consider chargeback alert services that give you a chance to refund before the chargeback hits your account—the refund costs the same but doesn't count against your chargeback ratio.

Challenge: "Our return policy is very liberal—it's part of our customer service promise. How do we prevent abuse without changing the policy?"

You don't need to change your return policy for all customers to address abuse from a small percentage. Implement tiered approaches: most customers get your generous return policy unchanged, but customers who exceed normal return patterns trigger additional requirements like manager approval, restocking fees, or receipt verification. Track return rates at the customer level and set thresholds that catch clear abuse while leaving normal returners alone. You can maintain your customer-friendly policy while protecting against systematic abuse.

Challenge: "Fraudsters keep finding new ways around our controls"

This is the nature of fraud—it evolves constantly. The answer isn't perfect prevention (impossible), but rapid adaptation. Establish monitoring that detects when fraud patterns change. Build flexibility into your controls so you can adjust fraud rules quickly. Maintain connections with industry groups and your fraud detection vendors to learn about emerging fraud types before they hit you. Accept that some fraud will occur, but commit to learning from it and adapting faster than the fraudsters evolve.

Challenge: "We're a smaller retailer with limited resources for fraud tools"

Many fraud prevention capabilities don't require expensive enterprise software. Start with what your payment processor offers—most provide basic fraud screening tools. Use free or low-cost features like AVS and CVV checks. Implement manual review procedures for high-value orders. Track return patterns in spreadsheets if you don't have sophisticated analytics. Build expertise through free resources from payment networks and retail associations. As you prevent fraud and document the savings, use those results to justify investment in better tools.

Taking Action: Your Next Steps

The organizations that succeed with fraud risk management share a common trait: they start. They don't wait for perfect information or unlimited budgets. They begin with focused action on their highest-cost fraud, learn from the results, and build momentum over time.

Start by understanding your current fraud landscape—pull your loss data, talk to your teams, and identify where fraud hits you hardest. Then implement controls for your biggest vulnerabilities first. As you see results, expand your program gradually.

Your fraud losses are happening today. The question isn't whether you can afford to invest in fraud prevention—it's whether you can afford not to.

Get Expert Help

Building an effective fraud risk management program requires both strategic thinking and operational expertise. If you need guidance on assessing your fraud risks, implementing fraud detection systems, or optimizing your payment and refund controls, Guzco specializes in helping retail organizations reduce fraud losses while maintaining excellent customer experiences.

Contact us to discuss your specific fraud challenges and learn how we can help you build systems that protect your revenue without creating unnecessary friction for legitimate customers.