PayPal, which has 40 million customers worldwide, had specifically stated that it provided the same rights and protections of a traditional credit card transaction, said Attorney General Eliot Spitzer. But consumers were often denied those rights, he said.
PayPal creates accounts for buyers and sellers using the Internet, including PayPal's parent, eBay, the Internet auction site.
PayPal lets buyers and sellers exchange money through e-mail. Buyers make payments online through credit cards and bank accounts, and PayPal relays the funds to sellers' accounts. Basic usage is free, but sellers who use added features must pay fees based on the amount transferred. About 60 percent of PayPal's business comes from eBay users.
Besides the penalties, PayPal will pay New York state the investigation costs. The online payment service also will clearly describe consumer rights including conditions or limitations on their rights and refund policies.
Without the agreement, consumers using their credit cards through "e-payment" systems like PayPal would lose their protections under the federal Fair Credit Billing Act and similar state laws.
For example, consumers who didn't receive merchandise purchased through PayPal were often denied reimbursement from either PayPal or American Express or Discover credit cards.
The credit card firms agreed to properly credit consumers in an agreement with Spitzer late last year.
"Protecting consumer rights in online transactions is the best way to establish and maintain confidence in electronic commerce," Spitzer said. "As with any new industry, it is essential that consumers making e-payments receive full disclosure of their rights and liabilities."
"While we thought the (wording) was sufficient, he felt it needed to be clarified," said PayPal spokeswoman Amanda Pires. "We are not acknowledging the accuracy of the allegations."
PayPal has clarified that it will investigate any claims about a deal as long as the complaint is made within 30 days of the purchase. That differs from the 60 days credit cards allow. Pires said she's unsure how long the investigations typically take. The "disputed funds" are frozen until an investigation is resolved, she said.
Spitzer spokeswoman Christine Pritchard said consumers complained they were being bounced between PayPal and their credit card companies and there was no prompt action.
PayPal can differ from a traditional credit card in another way. Although PayPal purchases made with credit cards are protected by the credit cards' reimbursement policies, PayPal purchases made through savings or other PayPal accounts are reimbursed only up to $500, Pires said.
EBay bought PayPal for $1.5 billion in late 2002 and has continued the service's rapid growth. PayPal opened 17 million more accounts last year, giving the service about 40 million customers as of Dec. 31.
PayPal handled transactions totaling $12.2 billion last year, processing an average of 629,000 payments each day, according to eBay.
Although its service is widely popular, PayPal also has irritated many customers by freezing accounts flagged for suspicious activity. PayPal says it needs to be able to freeze accounts to combat fraud, but the practice has triggered several class-action lawsuits alleging violations of various consumer protection laws.
Persistent customer complaints also have triggered inquiries about PayPal's account restrictions from the Federal Trade Commission and the attorneys general from "a number of states," according to eBay's annual report filed Monday with the Securities and Exchange Commission.
By Michael Gormley and Michael Liedtke