Porn in the USA

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

Heartland Bank bills itself as a paragon of Midwestern values.

Chartered as a savings and loan in 1887, the bank is one of the oldest in Missouri and brags that no customer lost money during the Great Depression. With 13 offices in the metropolitan area, the Clayton-based bank has $539 million in assets and a commitment to the community. Heartland sponsors local Christmas parades and School Supplies or Shoes, a charity that outfits needy schoolchildren with crayons, pencils, glue and other necessities. Bank executives tout Heartland's commitment to the community on the bank's Web site: "Heartland has strong, long-standing ties to St. Louis," says president and CEO John J. Wuest. "Building on that history we hope to expand our business with entrepreneurial vision and energy, while serving the individual needs of our customers."

Heartland is owned by some of St. Louis' most prominent citizens, who purchased the then-failing thrift in 1985. The partners include brothers John and James McDonnell III, heirs to an aerospace fortune; real-estate tycoon Andrew S. Love Jr. (once a law partner at Bryan Cave); and Love's top lieutenant, Laurence A. Schiffer, who is president of Love Savings and Holding Co., Heartland's parent company. Love and Schiffer control the bank. Under their leadership, the bank has branched out from its core business and formed subsidiaries that lease office equipment, collect consumer debt and make loans to car buyers who can't get bank loans.

Founded in 1997, Heartland Payment Systems is now the largest privately held credit-card-processing company in the nation.
Founded in 1997, Heartland Payment Systems is now the largest privately held credit-card-processing company in the nation.
Xpics is defunct, but its owners are still in the Internet porn business, offering monthly memberships to pornographic Web sites through this home page.
Xpics is defunct, but its owners are still in the Internet porn business, offering monthly memberships to pornographic Web sites through this home page.

One of the bank's most successful subsidiaries has been Heartland Payment Systems, a credit-card-processing company born in 1997. HPS last year handled $7.8 billion in transactions for 32,900 merchants across the country, making it the nation's largest privately held credit-card processor. HPS president Robert Carr expects to hit $10 billion this year. "We are a huge processor, and we always planned on being huge," he says.

HPS outgrew the bank in 1999 and switched to a larger Ohio bank to provide the capital needed to back its credit-card transactions. Heartland Bank cashed in on HPS's success in May, when it sold the business to the subsidiary's managers. "That's really our business model on some of these investments: Get them started, get them up to speed and then sell our interest or sell the company in total," explains Heartland Bank senior vice president David Minton. Asked whether the bank's relationship with HPS proved profitable, Minton answers "Absolutely."

There is a dirty little secret behind this success story. Two years ago, HPS jumped headfirst into Internet pornography, a swamp most banks dread. With the full approval of the bank, HPS signed deals with online pornographers who raked in millions of dollars in less than a year, with the bank collecting a percentage. It was a chance to make a lot of fast money. As Carr once said, adult Internet business was the secret to HPS's growth.

But that growth came at a price to thousands of innocent credit-card holders. The Federal Trade Commission says HPS did business with pornographers who ripped off consumers by charging credit-card accounts without permission. In one instance, HPS handled nearly $40 million in transactions for a California pornographer the FTC says was the mastermind behind the largest case of credit-card fraud in U.S. history.

HPS says it had no idea that its porn clients were cheating anyone. But the company ignored numerous warning signs while it processed transactions for smut peddlers no other bank would stomach.


While Heartland was going into the credit-card business three years ago, Brian Shuster and Mario Carmona were on the brink of the big time. The two California natives had known each other since 1992, when Shuster hired Carmona to be his personal trainer. Not yet 30 years old, the men were ambitious.

Shuster, an entrepreneur since high school, had sold everything from candy bars to T-shirts. He had a passion for theater and appeared in several community productions in Fresno, where he grew up. While still a student at UCLA in the late 1980s, Shuster created a cartoon called Chaosthat drew comparisons to The Far Side -- like Gary Larson, Shuster had a dry sense of humor reflected by animals with human qualities that dominated his one-panel strip. Demand for Chaos skyrocketed after Larson retired. By 1995, Chaos appeared in 220 daily newspapers, including the St. Louis Post-Dispatch. Shuster was just 26 years old, supporting himself with comic strips he invented while blasting the Grateful Dead in his Los Angeles apartment. All he had to do was come up with the ideas and captions. He hired artists to draw the pictures.

But success in the cartoon world wasn't enough for Shuster, who dreamed of making it big on the then-fledgling Internet. With $85,000 in borrowed money, Shuster formed a company called World Wide Internet Networks, which signed up thousands of webmasters who agreed to run advertising solicited by World Wide, says Joe Jacobson, Shuster's attorney. But Shuster couldn't find any advertisers except online pornographers, whose business he rejected. "Brian said, "No, our policy is, we don't have adult ads,'" Jacobson says. "So he's got all these people willing to run the ads but no one willing to buy."

By 1996, Shuster was desperate. His borrowed money was just about gone, and he had nothing to show for it. And so he went into the online-porn business himself, taking on Carmona as an equal partner in a company called Xpics Publishing Inc. Meanwhile, Shuster abandoned Chaos. The reason was simple. "There was more money in Xpics," Jacobson explains.

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.

Xpics wasn't the only account that HPS landed from Charter Pacific. Carr says a former director at Charter Pacific convinced him HPS could turn a profit on porn. "She said, "If you did this business right, you could do this higher-risk business and do well and live by the rules,'" Carr recalls. And so Heartland opened its doors to smut and bet that it could do what Charter Pacific couldn't: reduce chargebacks for pornographers who were being forced to jump banks under pressure from Mastercard and Visa. Carr says HPS made no moral judgments. So long as the pornographers didn't violate obscenity laws, they were welcome.

HPS was soon besieged by Internet pornographers seeking accounts. "What we didn't realize, and the surprise to us, was, when we said we would consider these merchant types, they all came to us overnight," Carr recalls. "It was like a pack of mosquitoes. The word got out. And we didn't have caps (on transactions). The bank had enough capital. We basically wanted to have big volume." And HPS thought it had solved the chargeback challenge.

Shuster and Carmona contend HPS had a secret plan for eliminating chargebacks, which can be automatic for Internet businesses. They claim HPS told Visa that Xpics did some face-to-face transactions so that refund demands wouldn't immediately be classified as chargebacks. Carr says that's not true. "We honestly thought we could get them (chargeback rates) lower," he says. Visa did not respond to an inquiry from the Riverfront Times.

A chargeback is considered an involuntary refund. Less severe, at least in the eyes of Visa and Mastercard, is a retrieval, which means a cardholder who disputes a charge gets a refund within 14 days. Carr says HPS figured it could satisfy refund demands before they became chargebacks, thereby avoiding scrutiny from Visa and Mastercard. Money for refunds would come from a reserve account built from 5 percent of Xpics' transactions. HPS also had access to Xpics' checking accounts if the reserve account wasn't big enough.

The plan went haywire almost from the beginning. Carr expected some chargebacks from Xpics, but he wasn't prepared for 11,000 refund demands that hit Heartland headquarters in Clayton during the second month of the contract. "Think about 11,000 envelopes," Carr says. "Every one of them had to be answered" -- but not by HPS, which began forwarding the mail to Xpics. Shuster and Carmona were no better equipped to handle the flood than a company that had been in the card-processing business for barely one year. Refund requests went unanswered and became chargebacks. In many cases, the problem compounded itself when cardholders who had already disputed charges were billed for a second or even third month of unwanted service. Those second and third bills became additional chargebacks. In some cases, frustrated cardholders who couldn't cancel unwanted memberships canceled their credit cards. Mastercard last year fined HPS more than $140,000 for excessive Xpics chargebacks.

The matter ended up in court, with HPS suing Xpics (which is no longer in business) and Shuster and Carmona individually. HPS alleged breach of contract, arguing that Xpics was obligated to pay the Mastercard fine, as well as lost profits and outstanding chargeback costs. A St. Louis County jury on Nov. 2 awarded HPS $290,000, enough to cover the Mastercard fine and attorneys' fees, but not nearly what HPS demanded: an additional $1.9 million for unrealized profits and $101,000 for chargebacks that HPS says it ended up paying.

Xpics blames HPS for chargebacks, saying Heartland had agreed to handle customer-service inquiries and was so slow in notifying the company of refund demands that second and third bills went out before Xpics knew that initial charges had been disputed. HPS says Xpics had a threadbare customer-service department that couldn't handle refund demands. Carr recalls visiting Xpics headquarters in California in June 1998, about two months after HPS started processing cards for the company.

"These chargebacks were getting out of line," Carr recalls. "We were getting flooded with mail from irate cardholders. For the first time in our history, we were getting called by Visa saying we had a merchant who was breaking the rules. We went to their facility, and there weren't very many people there. We asked them (Xpics) how they could handle complaints when there wasn't anyone there to answer telephones." Carr says Shuster told him Xpics would hire more people. And HPS continued doing business with Xpics.


There was a more sinister explanation for the barrage of Xpics chargebacks than inadequate customer service. According to the Federal Trade Commission, Xpics was flat-out ripping off cardholders.

Less than two months after HPS opened the Xpics account, Visa investigator Alex Graham picked up on the scam when he saw an Xpics Web site that said a 30-day trial membership was free but that the company needed a credit-card number to verify the prospective member's age. "When he went into the Web site, it said "free, free, free' all over the place," Carr recalls. "Mr. Graham wanted that removed."

The FTC says Xpics immediately billed customers who provided card numbers thinking they wouldn't be charged if they canceled the service within 30 days. The FTC -- which sued Xpics in January 1999 for alleged violations of federal laws barring unfair and deceptive business practices -- also says Carmona and Shuster charged consumers who never visited the company's Web sites and made it impossible for cardholders to cancel trial memberships. In some cases, Xpics upgraded cardholders to more expensive memberships when they tried canceling by e-mail, according to the FTC. Cardholders who tried telephoning Xpics couldn't get through. It's not clear how Xpics got card numbers from cardholders who didn't visit the company's sites. Xpics settled the lawsuit in July without admitting any wrongdoing.

HPS, following standard procedure, had checked the Xpics site before opening the company's account. HPS's only suggestion was the removal of nudity from homepages so children wouldn't be inadvertently exposed to the likes of Wendy Wett, "goo gobblers" and the erotic adventures of teenage babysitters (Carr says HPS drew the line at bestiality and child porn). When Visa and Mastercard started asking questions about Xpics, HPS defended the pornographers, telling the credit-card companies that internal auditors didn't think the chargeback rates were excessive. Carr blamed dishonest cardholders, not Xpics, for chargebacks. He admits now that that was a mistake.

Although online casinos, cyberauctions and porn sites are particular problems, any kind of Internet merchant can be scammed by cardholders because refunds are automatic, even when goods are shipped. Expedia, an online travel agency owned by Microsoft, earlier this year announced that chargebacks would cost the company between $4 million and $6 million. In that case, investigators believe scammers used stolen card numbers to purchase airline tickets. Carr says he's seen cases in which cardholders have obtained refunds for hotel rooms they said they didn't use and bedroom furniture they claimed didn't arrive. "You can only do it several times per card, because eventually your bank is going to say, "Wait a minute. There's a problem here,'" Carr says. "They'll cancel your card if you do it too much." But there is nothing to prevent dishonest cardholders from getting new credit cards and pulling the same scam over and over again. "There is no blacklist of consumers in this business," Carr says. "Nobody can stop it." Shuster, who argues that credit-card companies should allow a higher chargeback rate for the Internet-porn industry, insists that's what happened to Xpics. "It's easy to do," he fumes. "There's no questions asked. Why not? Who wouldn't do it?"

As chargebacks mounted, Visa and Mastercard threatened six-figure fines. By mid-June 1998 -- less than three months after Xpics opened its account -- the number of chargebacks had exceeded 20,000 and would eventually top 90,000. Visa agreed to hold off with the fines if Xpics brought chargebacks under control by Aug. 1, 1998, but fines weren't HPS's only worry. Xpics' monthly transactions hit $6 million in May, and the bank would have to pay refunds if Shuster and Carmona went out of business. No one knew just how many chargebacks lay in the future. The chargeback process can take more than two months, which helps disguise high chargeback rates when companies are growing fast, as was the case with Xpics and other Internet pornographers HPS took on, Carr says. "You're taking month one's chargebacks against month three and four's processing volume," he explains. "If the numbers are ratcheting up pretty good, you can go quite a ways before you know there's a problem." It amounts, he says, to a Ponzi scheme of sorts.

Under its agreement with Xpics, HPS was supposed to withhold 5 percent of transactions to build up a $3 million reserve account to cover chargebacks. Worried that there wouldn't be enough money in the reserve, HPS began withholding 25 percent of Xpics transactions. Even that wouldn't be enough, Carr feared, and so HPS started withholding 100 percent of Xpics transactions in the middle of June 1998, leaving the pornographers with no cash flow. "The main reason was, we thought if Xpics closed their accounts or went out of business, Heartland Payment Systems would have to pay out millions," Carr says.

After four days of no money from HPS, Xpics stopped sending transactions to Heartland, triggering an immediate response from Carr. He called Shuster and asked why the money had stopped. By now, Xpics' main Web site was the 19th most-visited site on the Internet, right behind RealNetworks and just ahead of Amazon.com. Despite the chargebacks, Heartland still wanted the business.

During a June 18, 1998, telephone conversation with Shuster that lasted hours, Carr agreed to release $750,000 from Xpics' reserve account so the company could make payroll and pay webmasters for advertising. But Xpics never did process cards through HPS after Carr released the $750,000. Instead, Xpics sent its transactions to First Bank of Beverly Hills (which was eventually fined by Visa for excessive chargebacks). Carr didn't expect that. "I noticed you didn't process with us over the weekend," he told Shuster in an e-mail. "What does this mean?"

All told, HPS processed more than $17.9 million in credit-card transactions for Xpics over a span of 83 days. The pornographers ended up with most of it. "The bottom line is, we paid them $12 million in cash in 10 weeks," Carr says.

Carr admits HPS made mistakes with Xpics and other Internet pornographers. "These guys inoculated themselves by giving me this sob story -- which I bought into -- that there's so much consumer fraud," he says. "We were given this antidote, so we were expecting there to be a small problem. By the time we found out what was really happening, it was a pretty bad situation. Frankly, Visa was on top of it before us. We wanted to form our own opinion. And we did."

Two months after Xpics sent its business elsewhere, HPS demanded payment for chargebacks and threatened to report the company to the U.S. Secret Service or the FBI. Eventually HPS gave the FTC a list of adult Internet merchants it suspected had scammed consumers. "We believed that these people were defrauding consumers and felt it was our obligation as good citizens to do that," Carr explains.

Although HPS's relationship with Xpics lasted less than three months, it continued processing cards for several other X-rated Internet businesses. And troubles continued. HPS has at least two lawsuits pending against Internet pornographers in St. Louis County Circuit Court. The allegations are much the same as the one the bank made against Xpics: HPS was left owing money as a result of excessive chargebacks. Like Xpics, the pornographers blame HPS for problems.

Eagle Access, a Delaware corporation for which HPS maintained three accounts opened between April 15 and June 8, 1998, says Heartland wasn't prepared to handle the volume of transactions and refund requests. Clear Access and its successor company Internet Provider (both owned by the same Florida couple) make the same claim, adding that HPS shifted transactions from Clear Access to Internet Provider because of excessive chargebacks.

All told, Carr says, HPS maintained about 20 accounts for adult Internet merchants. All of them went sideways, he says, and HPS no longer accepts adult Internet clients. But HPS admits porn helped make it an industry leader. Under questioning by Xpics attorney Jacobson in the recently concluded St. Louis County civil lawsuit, HPS senior vice president Joan Herman testified that porn companies were HPS's biggest clients in 1998 and that the company got into the adult Internet business because it thought it could make a lot of money fast. She also said Carr once told her that porn was the secret to HPS's growth. Carr testified that porn paid for the infrastructure that made Heartland what it is today. "I don't mind the truth being told," Carr says. "It can be colored, which is obviously what Xpics did to try to prejudice the jury. It gave us the money to hire a big staff. We had to have a big staff to process all the chargebacks. We made gross income. You take all of our expenses out of it and all that, we actually lost money in 1998. We certainly learned a lot."

Heartland and HPS had no better teacher than Kenneth Taves.


Three years ago, Ken Taves had big dreams and a rocky history with the law. Today his dreams are dashed, but legal troubles remain. He's in prison in California, held for contempt of court until he tells where the money is. The feds say Taves engineered the largest credit-card scam in U.S. history. And most of the money went through Heartland Payment Systems.

No ordinary swindler, Taves pleaded guilty to a charge of being an accessory to murder in 1980. The victim -- who, Taves thought, had cheated him in a business deal -- was in the federal witness-protection program. Taves potentially faced a murder charge in the alleged murder-for-hire scheme, but the main witness against him died in a car accident, forcing prosecutors to accept a lesser plea. Taves was also a suspect in a 1988 murder investigation, according to the FTC, but was never charged.

Taves supported himself through a variety of businesses, but forays into such ventures as a printer-toner-supply distributorship didn't prove profitable. And so in 1997 -- the same year he pleaded guilty to federal check-counterfeiting charges -- Taves went into the Internet-porn business.

Taves ran Netfill, a California-based company that operated several porn sites. Like Xpics, Netfill contracted with Charter Pacific Bank to process its credit-card transactions. Taves, who had a bad credit history, used his wife, Teresa, to secure a merchant account and processing agreement with Charter Pacific. The Taves were soon rich and enjoying life in a Malibu mansion worth more than $2 million. They each got $1.7 million a year in salary. Their son, who was 15, was also on the payroll. The teenager was paid $48,000 a year, even though he had no job title or job description -- Teresa Taves recalls seeing him cleaning up the office once in a while.

Like Xpics, Netfill's chargeback rate was astronomical, given industry standards. In January 1998, Netfill had a 5.54 percent Visa chargeback rate. The rate exceeded 6 percent the next month. In March -- the third month of excessive chargebacks -- Visa notified Taves and Charter Pacific that Netfill needed to submit a written plan to reduce chargebacks within 15 days. Visa also warned Netfill that the high chargeback rate could result in the suspension of privileges to accept Visa cards.

Taves never did submit a chargeback-reduction plan. Instead, just a few weeks away from the four-month threshold that triggered fines, he went to HPS and opened accounts under the names N-Bill and Webtel, again using his wife's name because of his bad credit history. But Taves was in charge of the day-to-day operations, and HPS knew it. As Carr said on the witness stand in the Xpics case, "I've been to Ken Taves' office a few times." They certainly had plenty to talk about.

In November 1997, Taves bought 3.6 million credit-card numbers from Charter Pacific. The database, however, didn't include the names of cardholders, their addresses or the expiration dates of credit cards, information that is typically required by merchants and banks to prevent fraud.

Once Taves had the card numbers, he began charging accounts, even though cardholders hadn't ordered anything or visited pinkbeaver.com, muffpie.com or any other Web site he ran. Because Taves didn't have the software required to access credit-card systems, he contracted with a Los Angeles company called Automated Transaction Services, which essentially acted as a go-between for Taves and HPS. Once a month, Taves would e-mail batches of credit-card numbers to ATS, which would verify that accounts were open and had sufficient credit available, according to the FTC and David Goldfarb, ATS owner. Money from those accounts would then be deposited into Taves' account at Heartland, which received chargeback demands and was ultimately responsible for making good on any refund demands.

The FTC, which won a $37.5 million judgment against Taves in September, says 90 percent of $49.4 million in charges generated by his companies in less than a year were bogus -- an estimated 40 to 50 percent of cardholders who were charged didn't even own computers. Most of the money -- $38.7 million -- went through HPS, which continued doing business with Taves despite months of excessive chargebacks.

Visa was monitoring Taves' accounts at Heartland within two months after they were opened. In June, the credit-card company warned HPS that chargeback problems could result in fines. HPS argued that chargebacks weren't excessive, and Taves' accounts remained open while the chargebacks piled up. In August alone, HPS received 21,431 chargebacks for N-Bill, for which it charged Taves $321,465 in fees at the rate of $15 per chargeback. Visa chargebacks soared to nearly 10 percent of transactions in September. If chargebacks weren't brought under control within a month, Visa would fine the bank.

Heartland closed the N-Bill account on Oct. 1, just before fines kicked in. About the same time, however, the bank opened another account for Webtel, according to the FTC. Taves used a surrogate to sign the paperwork, but there was ample evidence he was in charge of both Webtel and N-Bill. On the Webtel account application, Taves listed pureskin.com as one of the company's Web sites. Pureskin.com was also an N-Bill Web site. FTC attorney Douglas Wolfe, who handled the case against Taves, says e-mails between HPS and ATS indicate the bank knew that Taves was in charge.

"Basically, all of the correspondence and electronic mail that went back and forth between Heartland and the defendants, a lot of it was exchanged with Mr. Taves directly," Wolfe says. "I think that there was certainly some correspondence from Mr. Goldfarb to Mr. Carr that indicated they were asking for a way to lessen Ken Taves' chargebacks. And this was in the middle of October 1998, and clearly, as of that point, every account except for the Webtel account was closed. You can draw your own conclusions from that. We at the FTC did not really follow up on that area directly, simply because we have no jurisdiction over banks."

Carr admits Heartland erred in opening new accounts for Taves. He says the bank learned too late just how many chargebacks Taves was racking up. "It was a mistake," he says. "We just didn't know. We shouldn't have done it. What can I say?"

Heartland didn't stop processing credit cards for Taves until Dec. 7, 1998. The end came after three card-issuing banks, concerned about fraud, contacted Mastercard after Webtel processed $4.7 million in transactions through HPS in the space of four days. Mastercard subsequently called HPS and convinced Carr to close the account, which put Taves out of business. The call from Mastercard was the first time HPS had any inkling that Taves wasn't on the up-and-up, Carr says. Mastercard eventually fined Heartland more than $500,000. By January, the FTC had launched an investigation.

All told, bank records show Charter Pacific and Heartland together refunded $7.3 million, or about 14 percent of transactions from Taves' companies. The FTC and Visa say that rate doesn't accurately reflect the number of bogus charges. Processing a chargeback typically costs a card-issuing bank at least $20, so if the disputed charge is less than the cost of the paperwork, the bank will sometimes issue a refund and eat the questioned charge without submitting a chargeback. Like Xpics, Taves charged $19.95 for monthly memberships, beating the $20 threshold by just a nickel. The FTC also says some cardholders discovered the charges too late to request refunds, others never noticed porn charges and some cardholders who thought they were getting a month of free service probably suffered in silence. "People may have gotten scammed by these companies, but they're somewhat embarrassed to admit it due to the nature of the entertainment that's being provided," says FTC lawyer Stephen Cohen, who handled the Xpics case.

The bottom line is, no one knows how many victims are out there. "The number of consumers that we know at least caught these and received chargebacks and credits was the vast minority compared to the number who appear to have gotten stung here," says Wolfe, who estimates that 700,000 cardholders got taken in the Taves case.

In January 1999, the FTC obtained a restraining order against Taves preventing him from getting back into the Internet-porn business. Meanwhile, a federal judge appointed a receiver to track down his assets and look for victims. The judge also ordered Taves to disclose his assets to the FTC. In February, federal prosecutors in Los Angeles charged Taves with making false statements to the FTC and criminal contempt for hiding $23.5 million in a Cayman Islands bank account. In addition to hiding bank accounts, the FTC says, Taves sold his Malibu home for more than $2 million and tried transferring the proceeds to a third party in an attempt to hide the money. Taves is now in prison on the pending charges.

Taves never disputed the FTC's contention that he'd broken the law. "In this case, the corporate defendants essentially concede that they engaged in unfair business practices in violation of the FTC Act," U.S. District Judge Audrey Collins said in a ruling in April of this year.

Robb Evans, the court-appointed receiver in the Taves case, has found millions of dollars in Taves' bank accounts in the Cayman Islands, Switzerland and Vanuatu, a small island nation in the South Pacific. Most of the money will likely end up in government coffers. Because it will probably be impossible to find all the victims, any portion of the $37.5 million judgment left over after cardholders are paid will go to the U.S. Treasury, Judge Collins ruled. Carr says HPS is owed about $1.5 million. A hearing on its claim is scheduled in California on Dec. 4.


Internet pornographers would not be able to scam anyone without the help of companies such as HPS, which continued to process credit-card transactions despite growing signs of trouble. HPS knew about excessive chargebacks at Charter Pacific before it opened accounts for Xpics and Taves. HPS kept accounts open despite high chargeback rates. HPS, overwhelmed itself with letters demanding refunds, knew the pornographers couldn't handle refund requests. And HPS opened new accounts for pornographers whose existing Heartland accounts were drawing attention from Visa and Mastercard as a result of excessive chargebacks.

Why did HPS continue doing business with pornographers despite so many signs of trouble? "It's a very good question," Carr admits. "They are masters. They are very, very smart people who spend their every waking moment trying to figure out how to beat the system."

Heartland's culpability in scamming consumers is "very much an open issue," says Evans, who blasts Charter Pacific and Heartland for doing business with Taves. "I would suggest it was never prudent for them to do so, because neither of these banks had any appropriate due diligence in opening these accounts," he says. "If I were in the shoes of either of those two banks, there would be two things I would be worried about. One would be me -- my charge to the court is to make the victims whole, and we are not finished with that process yet. The other would be a class-action (lawsuit). That would be a bad thing, because the money that would be recovered would go substantially to lawyers, not to victims."

Cohen, the FTC lawyer who sued Carmona and Shuster, chuckles a bit when asked whether Heartland bears any responsibility in the Xpics case. "I think that any credit-card processor who is getting a high level of chargebacks and doesn't take appropriate action is culpable," he says. Like Wolfe in the Taves case, Cohen says the FTC didn't investigate Heartland because the agency has no jurisdiction over banks.

The federal Office of Thrift Supervision, which does have jurisdiction, placed Heartland Bank under special monitoring in January, but it isn't clear whether the bank's dealings with Internet pornographers played any role. OTS concluded Heartland had engaged in unsafe banking practices, but the audit that led to the special monitoring isn't a public record. Besides calling on the bank to increase its capital, the supervisory agreement between the bank and OTS states that the Heartland must come up with a plan to monitor the activities of its subsidiaries. Carr says OTS supervision has nothing to do with HPS. The bank says the federal action resulted from a downturn in Fannie Mae and Freddie Mac stock and the failure of a subsidiary that tried collecting credit-card debt that had been written off as uncollectible by other banks.

Heartland Bank senior vice president David Minton insists HPS was operating on its own when it came to Internet porn, particularly in the Taves case. Minton says the bank wasn't aware that porn was an important part of HPS's growth. "It was never in the bank's mind a focus of the business," he says. The bank learned about the Taves fiasco only after the FTC launched an investigation, Minton says. "Our reaction was not very favorable, to say the least," Minton says. "We had a procedure in place, effectively, for merchants of a particular size to be approved by Heartland Bank before they proceeded. That procedure did not occur in this particular situation. The bank immediately said there should be absolutely no Internet-pornography business. I really do want to distance the bank from Heartland Payment Systems. I don't think we were a primary actor in this case. We were a conduit, to a certain extent." How much the bank's owners and outside directors knew of the extent of HPS's involvement in the porn business is unclear. The McDonnell brothers, who say they've had no say in the bank's operation, are currently locked in a court fight against Love and Schiffer for control of the bank.

Carr says Heartland Bank knew full well what HPS was doing. Senior bank officers had to approve every account involving more than $5 million a year in annual transactions, he says, and HPS got approval for Taves. In the Xpics case, one of the exhibits introduced at trial was a merchant-account agreement signed by Wuest, the CEO of Heartland Bank.

Although Heartland appears to have escaped serious punishment for its dalliance in the porn business, the FDIC -- which doesn't have jurisdiction over savings and loans like Heartland -- cracked down hard on Charter Pacific, which enabled Ken Taves' scam by selling him credit-card numbers and processing his transactions. In a cease-and-desist order issued in May, the FDIC ordered Charter Pacific to divest itself of its bank-card division by Sept. 30. In the meantime, the feds barred Charter Pacific from selling credit-card information for any purpose and ordered the bank to terminate the account of any merchant deemed high-risk by Visa or Mastercard. The FDIC also forced Charter Pacific to immediately terminate the account of any merchants with excessive chargebacks and deny new accounts to applicants who had previous accounts terminated by the bank.

Xpics is defunct, but Shuster and Carmona remain in the porn business. Their businesses include an Internet-porn company called Global Reach Inc., which appears to employ marketing practices similar to those of Xpics. Trial memberships are free, but Global Reach requires a credit-card number to verify age. Carr says Global Reach uses foreign banks to process its credit-card transactions as a result of pressure by Visa and Mastercard in the United States.

As part of its out-of-court settlement with the FTC, Shuster and Carmona agreed to spend $125,000 on Internet banner ads offering a refund to any Xpics customer who wanted one. Refund requests went to an independent claims administrator. Shuster says the administrator did not receive a single refund demand, showing that Xpics didn't do anything wrong. FTC attorney Cohen says he hasn't received a report from the administrator, so he can't confirm that there were no refund demands.

As for Ken Taves, he's charged with lying to the FTC and disobeying a court order, but he hasn't been charged with fraud or any other crime related to bilking credit-card holders. Carr can't understand why. "It's just amazing," he marvels. "They claim that 91 percent of his transactions were a crime. You can go out and steal $19.95 hundreds of thousands of times with no problem, but if you go steal $19.95 from a convenience store, you get how many years?"

Neither can Carr understand why more of Taves' victims haven't come forward. Either cardholders got ripped off or the banks that issued their credit cards did, but fewer than 10,000 victims have been identified by the receiver, according to court documents. No card-issuing bank has submitted a claim against Taves, Carr says. The simplest explanation, he says, is that cardholders simply overlooked the charges.

"It just blows me away," Carr says. "It's amazing how many cardholders don't look at their monthly bill; they just pay it. Being in the business, I make sure we check ours every month."

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