posted on December 20, 2001 11:35:24 AM new
Aggressive anti-fraud tactics at the first widely used online payment company are spurring a consumer backlash.
Editor's note: A clarification </letters/corrections/index.html> to this story was published on May 18, 2001.
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By Damien Cave
Feb. 23, 2001 | Stoney Brody wishes he had never discovered PayPal. At first, he was enthusiastic about the e-mail payment system: <http://www.paypal.com/> PayPal made it easier to collect money from his online clients, who pay Brody to invest in gold on their behalf. The drawling Texan once even considered himself quite a fan, convincing more than 200 other people to join the network.
But Brody's devotion turned to disgust last November when PayPal started freezing access to deposits to his account. PayPal, unlike credit card companies, "didn't even bother calling" to discuss the questionable charges, Brody says. Instead, all he received was a form letter stating that PayPal had handcuffed the cash in order to investigate "possibly fraudulent funds."
Then, in February, came the real deal breaker. PayPal refused to release deposits totaling over $20,000 even after Brody sent verification information proving that his customers used their own credit cards (rather than stolen ones) to secure PayPal acounts. At that point, Brody contacted the FBI and decided to sue, not just to recover the cash in his account, but also for $400,000 worth of lost business.
"It's a poorly run company with low-grade standards," he says. "Let's face it: Banks don't make these kinds of mistakes."
PayPal representatives declined to comment specifically on Brody's case, citing privacy concerns. But Brody's outrage is anything but unique. PayPal may be a phenomenon -- the preferred payment method on eBay, a darling of the financial press and the inspiration for copycat services like Citibank's C2it -- but among a growing number of the service's 6.5 million users, backlash is brewing. AuctionWatch <http://www.auctionwatch.com/> message boards buzz with tales of locked accounts, unjustified chargebacks, wrecked reputations and financial ruin. Many of the people who helped put PayPal on the map -- the small-time buyers and sellers of everything from Beanie Babies to Victorian greeting cards -- now spend their time trying to form class-action lawsuits or advising others to stay away.
PayPal representatives admit that its anti-fraud techniques are aggressive, and acknowledge that mistakes have been made. But they argue that aggressive tactics are warranted. Credit card fraud is at least three to four times more common online, say industry analysts, who point to problems with identity verification as the cause. The Palo Alto, Calif., company has already suffered attacks from Russian, Nigerian and Indonesian gangsters, and executives say that more attacks are never far away. Unless users bear more of the burden -- whether in the form of charge-backs or closed accounts, says Peter Thiel, a PayPal founder -- the "tsunami of fraud" will overwhelm the entire company.
But how many mistakes and how much risk should consumers expect to endure? When David Chaum, a U.C.-Berkeley cryptographer, first came up with the concept of e-cash in the early '80s, he expected banks to grab the idea and make digital cash legitimate and irreversible, just like tangible bills and coins. Digital cash would be the new cash. PayPal's approach -- mimicking credit card payment systems by limiting transactions to those people who have joined the PayPal network -- only arose after it became clear that the big banks didn't want to get involved. And while PayPal's usership numbers seem to prove that there's a demand for such a service, the lack of bank-backed support could threaten to injure the very consumers who have made it popular.
PayPal thrives in what many consider a dangerous form of legal limbo. Though it looks more and more like a bank with each passing week -- offering money market accounts and as of this month, credit cards -- PayPal remains outside the strictures of banking laws. Consumer accounts have neither the protection of federal insurance systems like FDIC nor the assurance of regulatory oversight. Even agencies such as the Federal Trade Commission and Better Business Bureau, which have recently started familiarizing themselves with several e-payment providers, appear to have limited power. Since PayPal is privately held, they don't even have the outright authority to scrutinize the company's finances. As one FTC lawyer put it, "if they filed for bankruptcy tomorrow, no one knows what would happen to their accounts."
Ultimately, no company that processes $7 million in transactions every day, as PayPal claims to do, deserves a free ride, says Ken Thomas, a finance professor at the Wharton School of Business. Because PayPal essentially works like a bank -- thriving in an industry where "any type of activity involving payments is heavily regulated simply because issues of public confidence are involved," he says -- they should be treated as a bank. Changing the laws, or persuading PayPal to buy a bank charter may be difficult, slow and expensive but until then, Thiel and his 575 employees aren't just asking that users endure a few technical difficulties. They're asking for nothing less than blind, pre-Depression trust.
"This is banking circa 1928," says Tom McGrath, managing partner of Bank Earnings International (BEI), a banking consulting company. "It's backwards. They could take all these customers' dollars and misapply them, so the money isn't available when the person wants it. They could be insolvent and no one would ever know.
