Lawsuits Highlight PayPal's Growing Pains

Users say company is poorly managing its rapid expansion

Two class-action suits have been filed against PayPal Inc. in the past two months, accusing the online payment processor of having inaccessible customer service and a trigger-happy antifraud system that locks customers out of their own accounts with little recourse.

The lawsuits highlight customer grievances against the fast-growing company that have recently shown up by the thousands in postings on at least five PayPal complaint Web sites.

The most recent suit, filed in San Francisco Federal Court March 13, alleges that Palo Alto, Calif.-based PayPal's two-tiered customer service practices violate the Electronic Funds Transfer Act, which requires companies to provide a phone number for customers to inquire about their transfers.

PayPal does offer a toll phone line for users who hold free accounts and a toll-free number for paying customers. But the lawsuit charges that the toll number is hard to find and subjects users to long waits and frequent hang-ups, pushing many nonpaying customers to seek help through the PayPal Web site and self-help links.

Those users make up about 80% of PayPal's customer base but only 10% of the transactions, according to a spokesperson for the company.

But the free account holders are important because they're needed to expand PayPal's buying and selling network of small-scale traders, said Avivah Litan, research director at Gartner Inc. in Stamford, Conn.

"Our case is the accessibility to PayPal to its own customers who try to alert PayPal that someone's withdrawing money out of their checking or credit card account. But the first problem they have is they can't figure out how to contact PayPal by telephone to report it," said Eric Gibbs, a partner at Girard Gibbs & De Bartolomeo LLC, the San Francisco-based law firm that filed the suit.

The case also addresses questions regarding whether accounts are being properly frozen, as well as the difficulties people have getting their money out of the frozen accounts, which is the basis for another class-action suit filed in February by Oakland, Calif.-based Jacoby & Meyers LLP at Santa Clara County Superior Court in San Jose.

The Jacoby & Meyers suit alleges that PayPal's "phenomenal" increase in users, combined with its lack of operating experience, has led to serious flaws in its fraud detection and prevention systems. PayPal now boasts 15 million members, up from 10,000 members in 2000. The company currently performs $10 million in transactions per day.

PayPal hasn't yet responded to either of the cases, but company spokesman Vincent Sollitto said the lawsuits are without merit. Sollitto said that the company has hired 200 additional customer service representatives for its processing center in Omaha. He also pointed to PayPal's e-mail notification process and no-risk guarantee for transactions between PayPal members with addresses verified by the company.

Sollitto said the company "encourages all customers to contact PayPal via its Web site for more efficient response," and he acknowledged that the toll phone line for free account holders may require "a wait time." But he said that any customer is free to use the number to contact the company.

Playing by the Rules

PayPal's fraud detection is based on rules-based fraud screens. The problem is that these screens:



subtle patterns quickly.


experienced by the site using the system; they can't detect larger trends or see across merchant sites to identify potential fraud attacks.


making them too complicated to maintain.


to be updated regularly.

Source: CyberSource Corp., Mountain View, Calif.

Copyright © 2002 IDG Communications, Inc.

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