Porn in the USA

Internet smut peddlers reaped millions from unsuspecting credit-card holders. Their partner in slime was right here in the heartland.

Shuster and Carmona's company maintained several X-rated Web sites that were advertised on other sexually oriented Web sites. Webmasters were paid about 2 cents for every person who clicked on an advertisement that sent the Web-surfer to an Xpics site, where customers could sign up for memberships that allowed access to tens of thousands of pornographic images. The first month of porn was advertised as free. After that, members who didn't cancel were billed $19.95 a month.

Until the fall of 1997, Xpics was a fairly low-key operation. Then Xpics started paying webmasters 18 cents for every person who clicked on an ad. By early 1998, business was booming. Shuster and Carmona set their annual pay at $1.25 million apiece on the basis of projections showing that Xpics would reach $100 million in annual sales. But Xpics couldn't do it alone.

The company needed a bank to process its credit-card transactions, and finding a bank willing to take on transactions for an Internet-porn company wasn't easy. Banks assume risk when they process credit cards, especially when consumers dispute charges and demand refunds. If a merchant doesn't make good on refund demands, the bank that processed the transaction is on the hook. And refunds -- or chargebacks -- for transactions conducted over the Internet are virtually automatic if a cardholder disputes a charge, because no one physically swipes a credit card or signs a receipt. In essence, a cardholder need only say "I didn't do it" to get a refund.

Fewer than 1 percent of sales conducted over the Internet result in chargebacks, according to the credit-card companies. When chargeback rates reach 2.5 percent, Visa and Mastercard start investigating, because such rates are a red flag for fraud. After the fourth month of excessive chargebacks, card companies can fine banks that process the transactions at the rate of at least $25 per chargeback, plus a $5,000 administrative fee. Visa and Mastercard can also terminate credit-card-processing rights for banks and merchants with excessive chargeback rates.

Because of the likelihood of chargebacks and the risk involved, few banks are willing to handle accounts for Internet pornographers. One exception is Charter Pacific Bank of Agoura Hills, Calif., which has long specialized in processing transactions for X-rated businesses. The bank started with dial-a-porn transactions in 1988. The business proved lucrative. In 1991, the bank posted a $1.3 million profit in the midst of a downturn in the California economy that had other banks struggling. Nearly half of Charter Pacific's income came from processing credit-card transactions from merchants, mostly X-rated ones, who charged by the minute for telephone calls. Porn helped make Charter Pacific one of the most profitable community banks in the nation that year.

But there was a downside. By 1993, the Federal Deposit Insurance Corp. was looking into excessive chargebacks from Charter Pacific's dial-a-porn clients. Regulators thought the chargebacks might signal an unsafe banking practice. Scrutiny from the feds didn't stop Charter Pacific's romance with pornographers, which blossomed with the advent of the Internet. Potential profits were huge, and Charter Pacific welcomed business from Xpics and other adult Internet companies.

By 1998, Charter Pacific, unlike most banks, was earning most of its profits by processing credit cards as opposed to making loans. About one-third of its merchant accounts belonged to Internet pornographers.

In early 1998, Xpics was well on its way to becoming one of the world's largest cyberporn companies. But success brought problems. For one thing, Charter Pacific had capped the company's credit-card transactions at $2 million to help limit the bank's risk. Xpics, which was signing up 1,000 members a day at $19.95 a pop, was bumping up against that limit. Equally troubling were inquiries by Visa and Mastercard, which were concerned about chargebacks. By March 1998, the credit-card companies were threatening fines.

With the pressure mounting at Charter Pacific, Xpics switched to HPS. Heartland welcomed the business, even though the chargebacks at Charter Pacific were no secret in the banking industry. Because the Xpics account was high-risk and high-volume, Carr needed direct approval from a senior bank officer before opening it. "Can you check this one first?" Carr wrote on a Post-It note attached to the account application. "It is THE priority No. 1."


The Xpics account marked the beginning of HPS's foray into porn, which became the largest portion of its credit-card-processing business in 1998.

With few banks willing to process cards for Internet pornographers, HPS was in a position to demand a premium fee. In the case of Xpics, which projected $72 million in annual transactions on its account-application form, HPS charged 3.5 percent, plus 30 cents per transaction. Transactions, which came in the form of $19.95 monthly memberships, would number in the millions, according to Xpics projections. By comparison, HPS typically charged small retail merchants 1.5 percent, plus 20 cents per transaction.

HPS also charged Xpics $15 for every chargeback, but Heartland wasn't looking to get rich that way: If the chargeback rate got too high, Visa and Mastercard could fine HPS and force it to close the Xpics account. The pornographers could only stay in business if they had a bank that would process transactions and keep the credit-card companies at bay. As Carr notes, banks are everything in the Internet-porn biz. "The people who survive in that business are people who have relationships with banks that will process their credit cards," he says.

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