By Bob Sullivan Technology correspondent
updated 3/8/2004 5:58:22 PM ET 2004-03-08T22:58:22

Online payment processor said Monday it would clarify the rights of consumers hit by fraud as part of a settlement with the New York state Attorney General's Office over its handling of such cases.

Separately, parent company eBay revealed in its annual report that its PayPal unit was being scrutinized by the Federal Trade Commission and a number of state officials for the way it handles consumer disputes.

In addition to changing its user agreement, PayPal agreed to pay $150,000 in penalties and legal costs to New York state, which alleged the Web site misrepresented consumer rights in its user agreement, in violation of New York's General Business Law.

The attorney general's office alleged that the company misled consumers about their rights under the Fair Credit Reporting Act, which allows credit card users to dispute charges when they don't receive goods they've paid for.

The site claimed users enjoyed full credit card refund rights, called "chargebacks" in the industry. But in practice, many consumers who were stiffed by auction sellers -- who took their credit card payments but never delivered the goods -- also were unable to get refunds from credit card firms.

PayPal admitted no wrongdoing, but a spokeswoman said the company was eager to make its user agreement as clear as possible.

"We're happy to put this whole matter behind us,  which is why we signed the settlement," said PayPal's Amada Pires. "While we don't believe we've done anything wrong ... we're happy to clarify the points."

The settlement follows an investigation last year which revealed that consumers who faced PayPal fraud were being treated differently based on which credit card they'd used for the transaction. Discover and American Express users often found they couldn't get refunds, while Mastercard and Visa users could.

Discover and American Express have already signed separate agreements with the New York State Attorney General's Office, and now permit PayPal chargebacks. American Express paid $85,000 in penalties and expenses. Susan Korchak, a spokeswoman for American Express, said the company changed its PayPal chargeback policy in April 2003, in response to consumer dissatisfaction with PayPal's dispute process. A spokeswoman for Discover card said that company made a similar policy change in August.

PayPal, with 40 million customer accounts, is easily the largest online payment firm, and handled $12.2 billion in transactions last year. But the firm has long been criticized for the way it handles consumer complaints. In February 2002, the firm was slapped with a class-action lawsuit over the practice of "freezing" consumer accounts that are involved in disputed transaction. The suit alleges that PayPal regularly locks up entire user accounts -- closing off access to all funds -- even when disputes amount to a tiny fraction of the balance. The lawsuit is still pending, Pires said.

In its annual report, eBay acknowledges that PayPal's practice has also drawn the attention of government agencies.

“As a result of customer complaints, PayPal has ... received inquiries regarding its restriction and disclosure practices from the Federal Trade Commission and the attorneys general of a number of states,” eBay said in the report, released Friday.

"If PayPal’s processes are found to violate federal or state law on consumer protection and unfair business practices, it could be subject to an enforcement action or fines."

Pires said the FTC's interest in the freezing issued was "very old news" that had been revealed in previous corporate filings.

"The issue is one year old," she said. "There is no formal FTC investigation."  The company is in an ongoing dialog with the FTC, she said, and had already made changes to its procedures based on input from the agency.

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