Terrorism Could Have A Devastating Impact On An Innocent Bystander: PayPal
By Yochi J. Dreazen
PAYPAL, THE SPUNKY online money-transferring service, has survived the
high-tech collapse and intense competition from better-funded rivals, including
a bruising battle with Internet-auction giant eBay Inc., to become one of the
rare success stories of the post-dot-com age.
But can it survive the government's continuing war on terrorism?
PayPal Inc., based in sleepy Mountain View, Calif., has in the past three
years built a profitable business that allows individuals to make electronic
payments to one another or to online merchants through e-mail, a system that
has proved especially useful on auction sites like eBay. The company, which has
17 million registered users and says it adds 28,000 more per day, had revenue
of $104 million last year. EBay, eager to keep that money for itself, launched
an electronic-payment service of its own called Billpoint, but the initiative
never matched PayPal's popularity. In July, eBay finally threw in the towel and
agreed to buy PayPal in an all-stock deal valued at $1.4 billion.
Now, however, PayPal has another challenge to face from a different arena: the
federal crackdown on money laundering and transferring that followed last
year's terrorist attacks in New York and Washington.
In October 2001, Congress hurriedly passed the USA Patriot Act. The act
expanded the scope of the nation's money-laundering rules and instituted an
array of new penalties, in some cases raising penalties to $1 million from
$100,000. One of the legislation's main goals was to make it harder for
terrorists to launder money or quickly transfer it from account to account
without attracting suspicion or attention.
For PayPal, whose entire business model revolves around making it easy for
users to send money to each other over the Internet, the act has the potential
to force the company to radically and quickly reconfigure the ways it does
business, at potentially great cost. While no links between PayPal and
terrorists have been found, as the biggest online money-transfer operation out
there, PayPal could be hard hit by the Patriot Act.
"Like all financial-services companies, PayPal was created to do good and make
things easier and more convenient for consumers," says Don Temple, who is an
anti-money-laundering specialist for Mantas Inc., which sells
online-transaction tracking and security software. "Unfortunately, those are
just the qualities that terrorists and money launderers look for when they want
to hide money and take advantage of the system."
PayPal contends that the very nature of its business -- electronic
transactions -- makes it easier for the company to comply with the increased
government regulation than it is for traditional financial-services firms.
"The ability to maintain extensive records and quickly provide information to
law enforcement has been a hallmark of our business from the beginning," says
spokesman Vincent Sollitto. "Some of the provisions that might mean big changes
for Old Economy financial institutions are already second nature to us."
The unique set of challenges the act poses began to come into focus in April,
when the Treasury Department unveiled a new set of rules that extended its
provisions for banks and securities firms to credit-card companies, mutual
funds and wire-transfer firms. The regulations required the firms to implement
comprehensive money-laundering compliance programs. Among the provisions,
companies were required to designate a special compliance officer, train
employees to detect money laundering, commission independent audits, and
establish policies and procedures to identify risks and minimize opportunities
for abuse. The act also requires companies to file copies of their plans with
the Treasury Department.
Lawyers who specialize in financial-services regulations note that the act's
record-keeping provisions are so extensive and cumbersome that even large,
established financial-services institutions are having trouble complying with
them. The challenges of complying will be even greater for a small and
still-growing company like PayPal, they say.
"For a small company these are incredible burdens from a paperwork standpoint
and from a standpoint of trying to stay in business and not run afoul of the
law while at the same time continuing to grow the company," says Janice Meyer,
a partner in the litigation group at the law firm Dewey Ballantine in New York.
"It's really asking quite a lot of them."
PayPal officials concede that the act could have an impact on its daily
operations, and that complying with the new money-laundering rules, depending
how far they go, could be costly.
PayPal already has appointed a compliance officer and is training all of its
new hires on the requirements of the act and the company's procedures against
money laundering.
But in an initial public offering prospectus the company filed with the
Securities and Exchange Commission earlier this year, PayPal said the Patriot
Act posed several threats to its business model and daily operations. The
filing noted that even unwittingly breaking the new law could lead to a
lawsuit, large fine or government prosecution, and said more regulation was
likely. "We cannot predict how such regulation would affect us," the filing
said. "Complying with such regulation could be expensive or require us to
change the way we operate our business."
The officials point out that the company -- which uses sophisticated
proprietary fraud-detection software programs -- is well-suited to comply with
the act's requirements because it keeps records of every transaction that
occurs across its network and closely monitors the activities of its users.
They say its electronic transactions offer a digital paper trail that details
when money was sent, who received it and the amounts. The company won't detail
its exact procedures, but in general it tracks the number of transactions
originating from or ending up in a single account, as well as the size of the
amounts being transferred. PayPal subjects transactions to increasing amounts
of scrutiny based on the size of the transaction.
PayPal officials also note that since the average size of a transaction is
just $57, larger transactions of the types terrorists or criminals might use
are already subjected to intensive additional scrutiny. For example, PayPal
requires customers wishing to send more than $2,000 using a credit card to also
register and confirm a valid bank account. In addition, the officials say, the
company files reports to the Treasury Department about any suspicious
transactions for amounts greater than $2,000. The officials also say that the
3% processing fee it charges would make sending thousands of dollars
prohibitively expensive.
However, more rules are indeed on their way. The Treasury Department is
expected to issue rules this fall that will set minimum standards financial
institutions must meet to determine the identities of their customers. The new
rules will require companies like PayPal to verify the identity of its
customers carefully, keep records on what documents were used as part of the
verification process, and continually consult lists of known or suspected
terrorists to see if new customers are on any government watch lists.
In its filing, PayPal said it had already had rules to deal with those three
requirements, but acknowledged that if the expected Treasury regulations take a
different or more stringent form, the company could have to substantially
modify its policies or add new ones accordingly.
Currently, the company begins by assuming that the banks and credit cards used
by new subscribers of its service have already verified that the people with
accounts and cards are who they say they are. PayPal then subjects new
subcribers to additional security and verification measures, like depositing
two random amounts between 1 and 99 cents into the customer bank account tied
to the PayPal account. Before using the account, the customer must contact his
or her bank to find out these amounts, and then relay that to PayPal. The
company expects it won't be required to change its verification process under
the new rules.
The last area where the act could force PayPal to change the way it does
business involves overseas accounts, which are of particular concern to federal
law-enforcement officials. The Patriot Act already requires companies to check
all transactions and accounts of residents of foreign countries on a special
Treasury Department money-laundering watch list. Under the new rules, though,
the companies could have to obtain more detailed information on overseas
accounts, maintain extensive records and file regular reports with the
government about any transactions from foreign countries on the watch list.
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10:00 PM- - 10 00 PM EDT 10-20-02
PayPal officials have some of that information, in part because they have
already had to comply with weaker versions of the provision.
Mr. Sollitto declined to speculate on the exact form the new Treasury
regulations are likely to take and what changes PayPal is planning, but said
the company was bracing itself for their release.
"Anytime the government is in a position to add new requirements to
businesses, it's a concern," he says. "The challenge is to make sure that the
goal of the law and the regulations are met while still allowing individuals
and entities to engage in lawful activity."
Another headache that has spurred PayPal to change its practices is the
controversial area of Internet gambling.
In July, PayPal said it received a subpoena from the office of New York State
Attorney General Elliot Spitzer asking for information about the online
gambling payments that occur over PayPal's network. Mr. Spitzer contended it
was illegal under state law for a company like PayPal to facilitate online
gambling in New York.
The company settled the matter with Mr. Spitzer a month later by voluntarily
agreeing to a deal that will bar New York state residents from using the
service to transfer money to accounts with casinos, and by paying some $200,000
in penalties and reimbursing the state for the cost of the investigation.
Gambling Web sites like Lucky Nugget and Aces High have long offered sizeable
bonuses to gamblers making deposits with PayPal accounts, and hundreds of
gambling sites mention PayPal as their payment methods of choice because it
charges far lower fees than conventional credit-card companies.
EBay executives have said they'll terminate PayPal's business arrangements
with Internet-gambling firms when the merger closes. The $4 billion-per-year
Internet gambling market has been a lucrative revenue stream for PayPal,
accounting for $117 million, or 8%, of the payments the company handled in the
second quarter of this year. PayPal charged "high risk" merchants like Internet
casinos a higher transaction fee than it charged other customers, making the
business even more profitable. EBay executives had estimated that the gambling
business would have accounted for between 10% and 15% of PayPal's business next
year.
PayPal also has agreed to back draft legislation sponsored by Rep. Jim Leach
(R., Iowa) that would ban the use of checks, credit cards and electronic-fund
transfers for Internet gambling. PayPal officials say the company's new stance
has alienated some longtime users of the site, but say they want to finally
have legal clarity about Internet gambling. While no states have laws
explicitly prohibiting placing a bet with an offshore casino from a home
computer, using a credit card or service like PayPal to actually pay for that
bet could be illegal depending on a court's interpretation of the federal laws
that ban using telephones to bet across state lines.
"When something is of murky legality a company is stuck between customer
desire to do what they think is legal and the law-enforcement folks who may
have a different view," Mr. Sollitto says. "When something is clearly illegal
it makes it easier for company to ban something without drawing the ire of our
own customers. We just need to know what we're expected to do."
---
Mr. Dreazen is a staff reporter in The Wall Street Journal's Washington
bureau. He can be reached at [email protected].
(END) DOW JONES NEWS 10-20-02
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posted on November 1, 2002 09:31:48 AM new
The answer is yes!! I don't think that eBay went into this deal with a blindfold on. The article states that the average transfer is $57.00. These transfers are not going to make any waves. As long as they are flagging the high ticket ones it won't be a big prolem.
posted on November 1, 2002 02:49:51 PM new
"In July, eBay finally threw in the towel and agreed to buy PayPal in an all-stock deal valued at $1.4 billion. "
Wow, that actually sounds like eBay "lost" the war against Paypal. From my perspective, I'd call that -winning-.
