Auction Payment Sites: Who's Holding Your Money?

SAN FRANCISCO (05/26/2000) - If you deal with an unregulated escrow company, you may have nowhere to go with your complaints.

If you feel uneasy about sending a large check to a stranger for something you bought at an online auction, you're smart and not alone. Of the thousands of online fraud complaints fielded by the National Consumers League last year, 87 percent concerned Internet auctions.

Enter online escrow services--neutral third parties that are supposed to make online transactions safer by acting as an intermediary between buyer and seller. Online escrow services are particularly attractive if you're buying or selling an expensive or irreplaceable item and want some added security. But not all these services are created equal. As we discovered in our research, many of these outfits aren't licensed or regulated.

The authorities have started to take notice. California, one of the first states to address the licensing issue, passed a law that took effect January 1, holding Internet escrow companies to the same regulatory standards as their offline counterparts. The results so far have been modest: Only 2 of the 22 escrow companies known to be doing business in the state are licensed, and 3 others are in the process of getting licensed. The others have either refused to comply or haven't responded to the state's demands.

As of press time, neither California officials nor representatives from the National Consumers League had received any reports of fraudulent online escrow companies. Still, the potential for abuse is there.

But not all online escrow sites agree. "Their laws aren't a good fit for escrow companies outside of California, and I think they're overly strict," says Ken Thompson, president of SecureTrades.com, an escrow business based in Michigan.

"They're trying to apply a law written for real estate escrow companies in California to any Internet escrow company based outside California."

Current Efforts

Typically, online auction sites make some effort to protect their customers.

Auction giant eBay Inc. insures all transactions against fraud for $200. But you are not compensated for bigger losses, and if you buy a product that doesn't live up to your expectations, you could wind up stuck with it.

The time-tested strategy of paying with a credit card also has limitations.

Most individuals can't accept credit cards. Services like PayPal that allow individuals to accept credit cards don't require users to have any more than a usable e-mail address to receive payments into an account. This protects sellers, but not buyers. For instance, if someone offers to sell you a Ming vase collection, they could collect your payment anonymously and never deliver the goods.

The Escrow Option

Like traditional escrow services, an online escrow service helps manage the completion of a purchase between two parties who don't know one another. Where the offline services typically manage a relatively low volume of very expensive properties (such as homes), the online services help large numbers of buyers and sellers who use online auctions or classified ads to buy relatively low-cost items. And most online escrow companies operate at Internet speeds, using a number of automated processes to close the sale in a matter of hours, or a few days at the most.

Some services offer a money-back guarantee if the buyer doesn't come through with the money, or if the seller never ships the product. The services require both the buyer and seller to register for the service with a credit card, and the buyer usually pays for the product up front. The seller then either sends the product directly to the buyer, using a shipper like Federal Express that tracks shipments, or to the service itself. If the buyer finds the product to be as advertised, the escrow service pays the seller either by check or by direct deposit (less the service's transaction fees).

If the buyer never receives the product, or if it fails to meet the buyer's expectations, the escrow service helps the two parties negotiate a new deal, or it makes sure that the buyer gets a refund and returns the product in resellable condition. Either way, the escrow companies "guarantee" that neither the buyer nor the seller can defraud the other. Some services also say that they carry insurance policies to cover losses to either the buyer or the seller.

The sense of security the services offer does not come cheap. Typically, escrow companies charge a hefty 2.5 to 5 percent of the purchase price.

Escrow Watchers

Until recently, Internet escrow companies haven't been required to prove their own trustworthiness. Most didn't register with any state authority, submit to audits or financial inspections, subject their employees to thorough background checks, or even keep surety and fidelity bonds that protect a customer's cash in case an employee or manager steals it.

To address the potential risks to consumers, the California legislature amended the state's escrow laws. The new law makes it illegal to operate as an unlicensed escrow agent.

If any party in an escrow transaction--the buyer, the seller, or the escrow service--is based in California, the service needs a license. The benefit to consumers is clear: If a licensed business commits fraud, the California agency that oversees escrow companies can seize control of the business before more money is stolen. But they can do little about an unlicensed operation. "Once [a fraudulent business has] absconded with the money, the chances of you getting it back are negligible," says Julie Stewart, spokesperson for the California Department of Corporations.

Earlier this year, Louisa Broudy, an assistant commissioner at California's Department of Corporations, sent letters to more than 20 Internet escrow services asking them to either apply for a license (which would subject their operations to scrutiny) or stop offering their services to California shoppers.

So far, California has licensed only two escrow companies, IEscrow and Escrow.com. (At press time, three others were completing required employee background checks and paperwork.) That means most Internet escrow companies didn't comply or didn't respond to initial contact letters and have been sent a strongly worded Desist and Refrain Order, a stepping-stone to legal action.

"The message we want to get out is that [consumers] need to do their homework, and make sure that an escrow service they plan to do business with is properly licensed, whichever state it's in," says Department of Corporations representative Stewart.

Not For Everyone

So when should you even consider using an escrow service? If you're the buyer, you might want to employ one if the seller can't accept a credit card or if the value of the purchase is more than you are willing to risk losing. If you are the seller, you might deal with a service if you want some legal recourse in case the deal goes sour after you've shipped the goods.

Of course, before you use any online escrow business, call or e-mail the service and ask whether it's licensed to operate as an escrow service. And if you're not certain that an Internet escrow service is up to snuff, you can call the California Department of Corporations (203/576-6201) or the National Fraud Information Center (800/876-7060).

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