Isn't the obvious solution to also reverse the transfer from Bank B to Bank C? If multi-hop transfers are treated as irreversible, then it creates an incentive for fraudulent sellers to collect all payments through multiple hops. If instead fraudulent transactions may be reversed at the first payment processor, the payment processor then has a financial incentive to make sure that they only pass through valid transactions.
In an analogous situation, suppose I go to a physical store and buy a TV, only to find that it doesn't turn on. I have the right to return it to the same store that I bought it from, and to receive a full refund. Nobody at that store manufactured or designed the TV, so why should they take the financial hit for a broken TV? Except that without that financial incentive, the store has little reason to bargain with their suppliers about defective merchandise, and the supplier has little incentive to fix a defective product.
> If instead fraudulent transactions may be reversed at the first payment processor, the payment processor then has a financial incentive to make sure that they only pass through valid transactions.
Yes, but it's only one of the incentives they're facing. Another one is to provide useful and convenient service to its customers.
Try to think more about the example I provided. The account in bank A is victim's, while accounts in banks B and C are owned by the fraudster. The transfer from A to B is fraudulent, but the transfer from B to C is perfectly legitimate as far as B bank knows: the name on the destination account in bank C might even be exactly the same as in bank B, so why would bank B have any suspicions? At best, it could reject incoming transfer from bank A if it had suspicions (which, by the way, why would it have?). Would you want to be a customer of a bank that can just reject incoming transfers, so that you have trouble getting paid?
Finally, consider that bank C might then allow the fraudster to withdraw the proceeds in cash. Bank C might be foreign, and B communicates with it through SWIFT, and might simply refuse reversing the transaction, or again might already have sent the funds to bank D in yet another country. The point is that you cannot treat regular financial transactions as reversible either. They might be reversible sometimes, especially if everyone involved acts in good faith, but there is no guarantee.
> In an analogous situation, suppose I go to a physical store and buy a TV, only to find that it doesn't turn on. I have the right to return it to the same store that I bought it from, and to receive a full refund.
That's not really an analogous situation. Here's what would be closer: imagine you order a specialty TV online from China. The retailer A orders a company B that manages it warehouse to pack it on a truck of company C that specializes in LTL, which then ships it to company D which coalesces LTL freight into packed containers, then puts on containers owned by a shipping company E, which ships them across the Pacific to port authority F, then we have a shipping company in G in states, another truck company H to ship it to train yard H that gets it to LTL company I's warehouse, which then is passed on to courier company J, an independent subcontractor K of which finally gets it to your front door. Then your TV doesn't work, and you want to return it.
Will you try to unravel the chain back the same way it arrived? Are you going to find the subcontractor K, and have him ship it back to courier company J, to send it back to the LTL company K etc? No, you'll go straight for the original retailer. Similarly, with financial fraud, you'd need to go straight for the fraudster.
> Isn't the obvious solution to also reverse the transfer from Bank B to Bank C? If multi-hop transfers are treated as irreversible, then it creates an incentive for fraudulent sellers to collect all payments through multiple hops.
Well ... some kinds of transferring wealth are legally harder to reverse after the first transfer.
In the United States, an old-fashioned way of moving money between people, the "check", has behavior specified in Uniform Commercial Code Article 3, Negotiable Instruments.
Article 3 is worth a read; it has filled in a lot of gaps for me about the bare-minimum legal requirements associated with activities like writing a check, post-dating a check, negotiating a check, stopping payment, etc. (In practice banks may do more than the minimum for customer service but it's interesting to understand the basics).
One of my favorite parts is the "holder in due course" rule ("§ 3-202. NEGOTIATION SUBJECT TO RESCISSION.")
If a check gets endorsed a couple of times and a new person takes it in good faith, then that new person is a holder in due course. Some remarkable things happen: even if the check has gotten a stop payment or has otherwise been dishonored, a holder in due course now has the right to the money promised by the check.
I wondered why the law would set up such a convoluted way of making certain payments irreversible. My dad explained:
"""[A] a widely accepted legal framework for negotiable instruments was critical to trade in the era before electronic payments. The problem is convenience - how can a buyer safely pay for goods or services without carrying around a lot of cash? The holder in due course rule basically lets the buyer's bank rely on the form of the negotiable instrument (including a genuine signature) without risking a claim for wrongful payment based on other facts about the sale it can't know."""
So -- can someone take advantage of this behavior to turn a dubiously valid check into an irreversibly one, and get the money?
Yeah! Totally! There's a guy named Robert Triffin who is, like, famous for buying dodgy checks at below their value, cashing them, and suing to get his money when the payor refuses to pay up. I don't have firsthand info about this, I just read news articles, but I think he gets a decent ROI. (See e.g. http://appellatelaw-nj.com/the-first-triffin-case-of-2011/
P.S. Some of my other favorite things about this instrument in the UCC:
* a signature is any mark you intend to be your signature (§ 3-401);
* a check can be written with almost any text and in almost any format on whatever you want (§ 3-104);
* checks can go stale six months after the datestamp but banks can choose to honor them anyway (§ 4-404);
* writing a future date on a check doesn't legally prevent it from being cashed unless you also tell your bank about the postdating in the same way you would make a stop payment order ( § 3-113, § 4-401 )
* If you have a dispute with someone about how much money they owe you for a service, and they give you a check, you can cash the check and write "without prejudice" to indicate that you aren't agreeing that this is the correct amount owed but you do want their money (§1-308). UNLESS the payor has written on the check "a conspicuous statement to the effect that the instrument was tendered as full satisfaction of the claim" (§ 3-311), in which case cashing that check discharges your claim. Which all frankly seems like a mess.
In an analogous situation, suppose I go to a physical store and buy a TV, only to find that it doesn't turn on. I have the right to return it to the same store that I bought it from, and to receive a full refund. Nobody at that store manufactured or designed the TV, so why should they take the financial hit for a broken TV? Except that without that financial incentive, the store has little reason to bargain with their suppliers about defective merchandise, and the supplier has little incentive to fix a defective product.