September 18, 2005

Is Paypal your pal?

By: Amy Phillips

The U.S. government believes that all customers of Paypal’s online money transfer service are criminals until they prove otherwise, and Rich Kyanka has had some trouble proving he’s not a crook. Kyanka , the owner of the popular website Something Awful, wanted to help the victims of Hurricane Katrina, so on September 3 he announced a fundraising drive. Within nine hours, over $30,000 had been donated to his Paypal account. But when Kyanka tried to forward the money on to the Red Cross, he got a message saying that his account access had been “limited” because of “suspicious behavior.” Paypal would not let him access his money.

His suspicious activity consisted of having hundreds of different individuals send small amounts of money to his account in a short period of time, a pattern that is frequently associated with money laundering and other criminal behavior. Kyanka had received no warning that his account would be locked, and no one at Paypal bothered to ask him what the transactions were for or to investigate before suspending his account. He provided Paypal with copies of his driver’s license, social security card, and financial information, and still his account remained frozen. Moreover, Paypal’s right to freeze his money for any or no reason without notice was part of the fine print that every customer must approve before opening an account. Kyanka wrote several updates on his website railing against Paypal’s apparent belief “that every single one of their customers is a liar, a cheat, and a thief.” He asked why the FDIC and the government allow Paypal to “literally answer to nobody.”

Paypal was actually conceived as a way to transfer money without having to answer to anybody. Paypal’s founders, Peter Thiel and Max Levchin, wanted to free consumer monetary transactions from governmental control. Both students of Soviet history, they wanted to make it harder for governments to rob their citizens of their money and their rights by creating an extra-governmental way to transfer and exchange money not subject to the laws and regulations that banks are required to follow.

Unfortunately even in the free United States, the government didn’t like the idea of financial transactions beyond their control, and the banks didn’t like the idea of outside competition. The banks were first to lobby the government to regulate Paypal through the FDIC. They hoped that regulation would kill off Paypal and any other non-bank online financial service, protecting bank money transfers from competition.

While Paypal is not a bank and thus can’t be regulated by the FDIC, it is regulated by the Federal Reserve under Regulation E and by each state government as a money transfer provider. Under the PATRIOT Act, money laundering statutes, and anti-fraud laws, Paypal is required to prove to the Department of Justice that it is taking affirmative steps to prevent people from using Paypal to break the law. If it doesn’t suspend the accounts of users who behave in ways the feds might find suspicious, it can be prosecuted by the DOJ for facilitating criminal behavior.

The state of Louisiana was a major instigator of the policies that prevented Paypal relief from reaching state residents last week. In February 2002, Louisiana’s attorney general ordered Paypal to cease operations within the state until they obtained a state money transfer license. The terms of the license, which is designed to help the state prosecute fraud and money laundering, require Paypal to collect the kind of information it demanded from Kyanka about all transactions above a certain dollar amount. New York, California, Oregon, Illinois, and several other states subsequently threatened legal action. Each of the states has its own financial regulations, and Paypal must comply with all of them or face legal penalties.

Paypal didn’t suspend Kyanka’s account because Paypal considers him a potential criminal; Paypal suspended Kyanka’s account because the government considers him a potential criminal. Paypal spokesperson Amanda Pires said that Paypal’s internal fraud policies are designed to comply with the myriad regulations that state and federal governments impose on it. Still, Paypal has tried to remain true to its original vision of a no-strings-attached money transfer option, allowing most customers to open an account with only a name, an email address, and a credit card number. Only large-scale users like Kyanka are required by federal and state laws to legitimate their transactions.

Kyanka’s frustration stems from a sense that there is no alternative for those who want to avoid Paypal’s bureaucracy, and he’s right. Most of Paypal’s competitors have gone out of business because they couldn’t compete with existing options and still comply with the law. Online credit card accounts, wire transfers, and inter-bank transfers are cumbersome and require their smallest customers to provide detailed personal and financial information. The law requires such companies to “assume all [their] customers are guilty until they prove, beyond a shadow of a doubt, they’re innocent,” and Paypal is popular in part because it manages to shield most of its customers from those intrusive inquiries and keep fees remarkably low given the costs of complying with those regulations. But if Kyanka got his wish for Paypal to be further regulated by the government, more customers, not fewer, would find their transactions stymied by charges of “suspicious behavior.”

Amy Phillips is associate editor of Brainwash. Her website is