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Fraud Busters

Although most Americans have yet to encounter any of these portable payment and identification devices, the technologies are proliferating throughout the rest of the world. Smart cards were introduced more than a decade ago, and in the past few years they have gained real momentum; more than 685 million smart cards were shipped last year alone, 60 percent of them going to Europe and 30 percent to Asia, according to Gartner Group, a market research firm in Stamford, CT. “My colleagues from the States think it’s hilarious,” says Clare Hirst, a London-based analyst with Gartner. “They come over here and say, you’ve got chip cards for everything.’”

Most of the smart cards in Europe are postage stamp-size SIMs, or subscriber identity modules, that give a mobile- phone owner the option of requiring a password for placing calls. These cards, which large numbers of Europeans have been using for a decade, not only store identity data but also hold phone numbers, address lists, and other personal information. Users can pop their cards into new phones, retain all their collected data, and begin charging calls to their own accounts. Due to the far lower incidence of telephone fraud in the United States, U.S. phone companies have been policing scams only after they have happened. Thus, Americans are just starting to gain experience with chip card technology already familiar to Europeans.

Europeans have deep-seated reasons for their devotion to stopping fraud and their rapid adoption of smart cards. Because government-owned telecommunications companies have precluded a competitive business environment in Europe, even local calls are expensive. “There is no such thing as a free local call in Europe,” says Pattinson, of SchlumbergerSema. To reduce telecommunications costs, European merchants process credit card transactions in batches rather than individually in real time, the standard practice in the United States. By the time European merchants check authorization, the thieves have made their getaway. It’s simple for store clerks and waiters to “clone” credit cards: they quickly skim the data from magnetic-stripe credit cards and transfer the information to new cards for use somewhere else. This procedure makes it easier for thieves using stolen or cloned cards.

Smart cards go a long way toward thwarting such popular crimes, and they save European retailers a bundle: because the money is in memory, there is no need for costly phone-based verification. Before the introduction of smart cards in Europe, card cloning and theft resulted in fraud rates as much as 10 times higher than those in the United States, says MasterCard’s Merschen. Key features of today’s smart cards were invented in France in the mid-1970s to combat this very problem. “It’s easy to hack into a card with a mag stripe,” says Peter Buhler, manager of IBM’s Secure Systems Research Group in Zrich, Switzerland. “Smart card chips are resistant to tampering.”

Europe is now going one step further. The Europay-MasterCard-Visa global consortium, or EMV, has set a series of deadlines by which all banks in Europe and many parts of Asia and Latin America must issue smart cards to their customers. By 2005 the switch to smart cards should be complete in many countries. Though its edict lacks the force of law, the consortium can use strong financial incentives and punishments to impose nearly universal acceptance. “EMV has said it will no longer absorb the cost of fraud in those regions,” says Gartner’s Hirst. “So if they don’t comply, the banks and merchants will have to take on the cost of the fraud themselves.”

This liability transfer is “the ultimate enforcement measure,” says Visa’s Knox, who notes that there will be “real financial consequences for those who fail to adopt smart cards.” The cost of moving so many banks and merchants to smart cards is expected to total billions of dollars, but in much of the world, the antifraud benefit is expected to justify the expense, she says. In the United States, however, where fraud rates are so much lower, the savings reaped from reducing fraud would not justify a comparable action, Knox adds.

Yet the United States could very well be forced to join the global conversion, Gartner’s Hirst predicts. “If fraud isn’t as easy in other regions, the crime will shift to the U.S.,” she says, “or it will look high in comparison.” ActivCard’s MacBeth agrees. “If the rest of the world deploys smart cards, and that eliminates much of the fraud elsewhere,” he says, “the criminals will focus on the United States, and we could become the last bastion of magnetic-stripe fraud.” This, he says, would force the United States to replace its infrastructure. “We wouldn’t have much of a choice.”

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