Officials in four states recently sent inquiries to eBay about Billpoint, questioning whether its service should be regulated under the states' money transmitter laws, eBay reported in its annual report, filed earlier this week with the U.S. Securities and Exchange Commission. eBay is working with the states to answer their questions, the company reported.
"We will register Billpoint if it is determined that such registration is necessary," the company said in the report. "The cost and complexity of Billpoint's business may increase if certain regulations are deemed to apply to its business."
eBay representatives did not return calls seeking comment.
Although they've largely avoided problems thus far, online payment services such as PayPal and Billpoint may have to walk through a regulatory minefield.
States that license money transmitters typically require companies to formally apply for the service and pay a nominal fee based on the amount of transactions they've done within a state or the number of locations they have. States also typically require companies to put forth a surety bond--a kind of insurance--to guarantee transactions.
But PayPal and Billpoint could face stricter requirements if states rule that they are operating banks. Already, several states, including New York and California, have questioned whether PayPal is operating an illegal bank. And there's a growing sense among bankers that online payment companies should be regulated like banks, said Steve Schutze, director of eStrategies at the American Bankers Association.
State typically require banks to keep much higher reserves of cash on hand than they do money transmitters to guarantee transactions and to keep closer tabs on transactions. Banks also have to comply with regulations governing security, privacy and customer disputes.
"If they're not regulated then are they going to voluntarily abide by all these things?" Schutze asked. "I'm not saying that PayPal's not doing these things, but who's looking over their shoulder to be sure they are?"
In recent months, a growing number of states have begun to update their laws to cover online payment services. State authorities have the power to shut down online payment services in their state or to fine those that offer the services without a license.
The most popular online payment service, PayPal has already received inquiries from a number of state banking and financial services regulators. Last month, Louisiana, which updated its money transmitter law last fall, asked PayPal tooffering its service to the state's residents. The state later withdrew the request, and PayPal received a money transmitter license from Louisiana this week.
"We're trying not to be unreasonably hard on those folks," said Doris Gunn, deputy commissioner with the Louisiana Office of Financial Institutions. "Our goal is to get all of those licensed that are required to be licensed."
The issue has become more urgent for states and online payment companies since a federal anti-terrorism act was signed into law last fall after the September terrorist attacks. The law could assess heavy penalties on financial services companies that have failed to register under state laws.
"The applicability and interpretation of the Act's provisions to Billpoint is not clear, but should the Act apply to Billpoint, the penalties for noncompliance are severe and, if triggered, would have a material adverse effect on our business," eBay said in its annual report.
eBayWells Fargo's stake in Billpoint last month for $43.5 million. Wells Fargo had owned a stake in Billpoint since March 2000.
Billpoint faces similar questions in Louisiana to the ones PayPal faced. The company is also responding to inquiries from Oregon, Illinois and California.
Oregon has been in discussions with eBay since August about whether Billpoint should be registered as a money transmitter there, said Jim Krueger, a program manager at the state's Division of Finance and Corporate Securities. The issue is still under discussion, he said.
"It's always difficult to get your arms around Internet issues," Krueger said.
PayPal has insisted that it is not a bank and shouldn't have to comply with banking regulations. But the company faces two class-actionfrom customers who say the company has illegitimately restricted their access to their accounts. In many cases, customers say they have been unable to access their accounts for months, something that might be prohibited under banking regulations.
Threat to the bottom line
Having to comply with state regulations could hurt the bottom lines of online payments companies--and of online auction giant eBay. Processing payments is not a particularly profitable business, noted Steve Weinstein, a financial analyst with Pacific Crest Securities. PayPal, for instance, has never posted a net profit. And Billpoint's revenue is only a small piece of eBay's overall business.
But online payment services have become an important part of the online auction business. They've allowed sellers to cheaply accept credit cards, speeding transactions and increasing security. If payment services charged higher rates to cover their regulatory costs, many sellers might stop using the services.
Chris Penny, a financial analyst who covers PayPal for Friedman Billings & Ramsey, said it is unlikely that online payment companies would have to raise rates if they were forced to get money transmitter licenses. But regulators could still cause problems for the companies if they were to force them to get banking licenses or threaten to shut down their services.
"This is kind of unsettling for investors right now," Penny said. "I think investors want to see a clear and concise answer to this situation."