Is eBay a SafeHarbor?[Fool on the Hill] June 14, 2000

An Investment Opinion

Is eBay a SafeHarbor?

By Bill Mann (TMF Otter)
June 14, 2000

Over the last month, online auctioneer eBay (Nasdaq: EBAY) has had a fairly rough time of it in the news. Reports of bidding fraud by some community members, along with a strange case involving a work by modern artist Richard Diebenkorn have caused regulatory authorities and even the FBI to investigate. EBay was assured by the FBI that it was not the target of the investigation, but nonetheless as the public face of anonymous buyers and sellers throughout the world, eBay still has both proximate and direct threats on its business.

Proximate because eBay's success is based, at its center, around trust. With 4 million items listed at any one time, eBay and its users should rightfully expect some fraud to take place. According to the Federal Trade Commission, there have been 10 people who were prosecuted for auction fraud on eBay (since these transactions are usually completed between parties in different states, sometimes using U.S. Mail, federal laws have some jurisdiction, countless more charges have been brought in each state). Should eBay's reputation as a company where people can reasonably expect protection against fraud be tarnished, customers or consumers will either choose to go elsewhere, or forego Internet auctions altogether. Even though eBay is a pretty neat service, it is not a necessity for most users. It's just really cool.

Direct threats because even though eBay serves neither as buyer or seller in any transaction, as the switchboard that receives commission for each sale it can be on the hook for legal actions, fines, or limitation of service in certain jurisdictions. This is and should be a big worry for eBay. The problem is that the company walks a tightrope, since providing too much policing on its site actually opens it up to increased liability. Still, eBay is not passive in its protective measures on the site, though complainants have been critical of the speed or appropriateness of its actions.

EBay claimed in 1999 that it receives around 27 complaints of fraud per 1,000,000 transactions. But in the last year it has had some high profile cases in New York and in Los Angeles in regard to fraudulent sales of computer equipment and sports memorabilia. The most recent problems have come in bids for coins and precious metals, one of the larger components of eBay sales.

The scam works like this: a seller places an item on eBay and then uses either alternate aliases or even other users, "the shills," to bid on the items in order to raise the price at which the item is eventually sold. The best practitioners of this count on making a buck or two extra in each transaction, a practice which will add up over thousands of transactions.

The buyer and seller on eBay should be aware of the fact that the company cannot possibly patrol all of the auctions going on. While the company offers insurance, feedback, and other protections, these are largely reactive in nature. However, other tools can and should be used by the buyer to take reasonable precautions. For example, the buyer should take a look at the feedback from any community members who have previously transacted with the seller (or vice versa, not all fraud is seller-centric). This is eBay's way of helping community members gain credibility where warranted, or lose it if they don't play by the rules. You can also look at the identities of the bidders on any item, and if you see a pattern of inter-bidding, where the same user names put bids on a seller's various auctions, you may be seeing the evidence of a shill scam.

EBay offers a program called SafeHarbor, with such programs as escrow accounts, insurance, external verification, investigations, and other protections. But eBay is quite limited in the types of actions it will take for items that are currently for sale. One problem eBay has is that competing sellers will often complain about items for sale, so it will not take action unless a complaint is registered by someone with a legal or financial stake in the matter. This would be the seller, the buyer, or another bidder, or someone with copyright or ownership of the item. Just this situation happened in the Diebenkorn situation, in which the seller acknowledged that he had bid on his own item to pump up the price.

Should eBay not take sufficient care to protect its community members it is risking a great deal in terms of future business. It is safe to say that the company is aware of this threat to its business. In fact, eBay has language responding to the threat of action against it due to fraud right in its most recent 10-Q. It reads, "We believe that government regulators have received a substantial number of consumer complaints about us which, while small as a percentage of our total transactions, are large in aggregate numbers."

Investors in eBay should be aware of the fine line upon it must tread, both in its U.S. and its overseas activities. Ebay's business is unlikely to be impacted by the actual fraud investigations, as the vast majority of users are aware of its inability to verify each item in advance of auction. What would be more damaging to eBay is if it is shown to be willfully negligent in taking sufficient action against abusers of the system.

Users of eBay's services should keep in mind that the company's policy is based in the concept of "caveat emptor," let the buyer beware. Still, users who feel they have been defrauded should contact the company, be aware of their rights under SafeHarbor, and argue for them vociferously. Failing direct resolution, complainants should consider using eBay's third party dispute resolution services, and also the Justice Department's Internet Fraud Center.

Fool on!
Bill Mann, TMFOtter on the Fool Discussion Boards

Related Sites:

  • EBay Safe Harbor Page
  • Justice Department's Internet Fraud Site
  • Federal Trade Commission on Internet Auction Fraud