PayPal Causes a Stir Inside the Card Associations

  While questions about PayPal's intentions to increase its automated clearing house volume at the expense of credit cards are certain to cause a stir among card executives, PayPal is by no means a stranger to controversy in the credit card world.
  Last year PayPal's status as a payments aggregator became a hot topic of debate at MasterCard International and Visa U.S.A. At issue was PayPal's compliance with rules governing MasterCard/Visa merchants. Although PayPal offers card acceptance to micro merchants, it is itself a MasterCard/Visa merchant.
  The ensuing flap was over concerns that PayPal was in violation of rules to deter fraud and other wrongful behavior that can lead to high chargeback rates. MasterCard/Visa rules state that merchants must route all card receipts through their acquiring bank and verify the legitimacy of the merchant. The latter can be costly and time-consuming for aggregators like PayPal that service small, entrepreneurial merchants.
  PayPal got its start promoting an application to transfer money securely between Palm Pilot hand-held computers. The idea was the brainchild of Chief Technology Officer Max A. Levchin, a cryptology expert searching for funding to launch a company dedicated to creating an encryption standard for mobile transactions.
  Levchin partnered with Peter A. Thiel, who ran a large hedge fund, and PayPal was born in October 1999 with Thiel as chairman and chief executive. PayPal's Palm Pilot application attracted 10,000 users by year's end. In early 2000, eBay users discovered PayPal, and volume has been exploding ever since.
  Although MasterCard and Visa decline to reveal the specific past rule violations by PayPal, PayPal is now in full compliance, according to Debra Rossi, executive vice president, business Internet services for San Francisco-based Wells Fargo & Co., PayPal's merchant acquirer. Until last year, Wells Fargo owned an equity stake in eBay's Billpoint payment service. EBay bought out Wells Fargo's interest when it purchased PayPal last October.
  "PayPal understands where they needed to come into compliance and has made those changes," says Rossi without being more specific. "Once an aggregator understands where their operating practices may pose a risk to the system they are willing to change."
  MasterCard and Visa, both of which have stepped up monitoring of high-risk aggregators ("More Costs for Adult-Content Sites," Card Watch, December, 2002), have since notified members to set a deadline for all merchants, aggregators and independent sales organizations to be in compliance with their operating rules. "The rules are not new, nor have they changed," says MasterCard in a prepared statement. "If an entity does not comply, MasterCard may terminate its relationship with that entity."
  Given the volume PayPal generates, it is certain Wells Fargo will see to it PayPal remains in full compliance at all times. "The rules are in place for good reason and exceptions can't be made," says Rossi. "Still, an aggregator's business can be tough for some to understand."
  Indeed, a Visa executive told those attending a session about the new monitoring requirements at last September's Electronic Transactions Association conference in Seattle that she had spent a large amount of her time in the preceding months at PayPal simply learning the company's business.