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Current Efforts: Tried but Not True

Typically, online auction sites make some effort to protect their customers. Auction giant EBay insures all transactions against fraud for up to $200, and Amazon.com Auctions covers certain transactions for up to $1000. But neither site compensates for bigger losses, and if you buy a product that doesn't meet your expectations, you could be stuck with it.

Auction sites have taken other measures to safeguard transactions, such as implementing internal rating systems that record reports of auction participants' past behavior. But earlier this year, some sellers reportedly beat EBay's system by selling low-priced items to increase their reliability ratings. Once they had high ratings, the same people sold a high-priced item, which was never delivered. EBay spokesperson Kevin Pursglove says that the company received reports of high-priced items that had not been shipped, but he has not confirmed that the incidents were intentional or scams.

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 their Ming vase collection, they could collect your payment anonymously and never deliver the goods. In such a case, you'd have a tough time getting your money back.

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 property (like 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 lot of automated processes to close the purchase or 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 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 find the product to be as advertised, the escrow service pays the seller by check or direct deposit (less the service's transaction fees).

If the buyer never receives the product, or if it doesn't meet their expectations, the escrow service helps the two parties negotiate a new deal or makes sure that the buyer gets a refund and returns the product in resellable condition. Either way, the escrow companies "guarantee" that both the buyer and seller will satisfactorily complete their purchase. Some services also say they carry insurance policies to cover losses to either the buyer or seller.

That sense of security doesn't come cheap. Typically, escrow services charge a hefty 2.5 to 5 percent of the purchase price.

Looking Over Escrow's Shoulder

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 state legislature amended the state's escrow laws. The new law makes it illegal to operate as an unlicensed escrow agent.

If any of the parties in an escrow transaction--the buyer, seller, or 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. Victims "have no recourse," says Julie Stewart, spokesperson for the Department of Corporations. "Once [a fraudulent business has] absconded with the money, the chances of you getting it back are negligible."

Earlier this year, Assistant Commissioner Broudy 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. "Companies that are aware they're being regulated . . . are less likely to violate any laws that would be harmful to consumers," she says.

So far, California has licensed only 2 escrow companies, IEscrow and Escrow.com. (At press time, 3 others were in the process of completing the necessary paperwork and employee background checks.) At press time, 19 Internet escrow companies either refused to 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 Department of Corporations has given the companies a "reasonable amount of time" to comply with the new rules, says Stewart. In the meantime, she says, "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."