eBay's got a PayPal problem

February 24, 2012: 12:07 PM ET

As long as eBay has been struggling to right itself, Paypal has been surging. Now, it may be in jeopardy too.

By Janet Morrissey, contributor

ebayFORTUNE -- Through all eBay's struggles, PayPal has always been a bright spot. The online payment system, acquired in 2002, provided eBay with growing profits and, at times, a much-needed good story to tell investors. Founded in 2000 by tech stars, including Peter Thiel and Elon Musk, the company offered merchants and consumers an easy way to transfer money. To its credit, eBay generally left PayPal alone as it transformed itself from a company offering simple online money transfers into a digital currency powerhouse forging deals with retailers and pushing into mobile payments.

Now, interference by its parent is threatening to tarnish PayPal's good name. It may even stymie CEO John Donohoe's effort to finally turn around eBay (EBAY). At issue is a mundane-sounding decision to send out notices to sellers informing them that all payments they receive through PayPal for items sold on eBay will now be put on hold for up to 21 days. The company says the policy is aimed at protecting buyers from bogus sellers and to stem potential losses it incurs from its buyer protection program.

First introduced in 2008, the policy only applied to a small number of sellers, mostly those with a history of complaints. Last Fall, eBay started rolling out the rule to virtually all of its members. That move has confused and outraged thousands of sellers -- especially ones that have used the site for years, building sterling profiles along the way. "They're treating me like a criminal," says Madeleine Calabro, an Avila Beach, California, resident who has been buying and selling on eBay since 2003, garnering 100% positive feedback. Indeed, the PayPal website forum has more than 600 pages of posts from angry sellers protesting the hold. Also a flurry of surly websites -- letssuepaypal.com, paypalsucks.com, and screw-paypal.com, among others -- have popped up in response.

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Critics contend the new hold policy has little to do with scammers and everything with fattening revenues. The delay, they claim, could allow PayPal to collect interest on eBay sellers' payments. Worse yet, eBay could potentially even make short-term, small-scale market investments with little risk. Any loss from one particular account, could be repaid with funds from the next account once the 21 day waiting period is up. PayPal -- seemingly lending credence to such fears -- adjusted the wording on its user policy to specifically state "you will not receive interest or other earnings on the funds that PayPal handles as your agent and places in Pooled Accounts."

That has customers angry. "It is unfair and I considerate it illegal," says Doug Black, a Thomasville, N.C., resident who has been selling on eBay since January 2008 and had 100% positive feedback on more than 600 sales when he got notice of the changes. Shortly after, he was approved for an eBay debit card. "If I'm such a bad risk, how did I get an eBay debit card?" he asks. Black stopped using the site, filing complaints with the Better Business Bureau, the Attorney General of North Carolina, the N.C. Banking Commission, and the California Attorney General.

Vexing sellers even more is the fact that PayPal takes its 2.9% plus 30 cents fee and eBay takes its 9% fee right away instead of waiting 21 days. Even shipping fees, which are normally covered by the buyer, are put on hold, and eBay goes into the seller's personal bank account to cover the shipping costs – a move that has caused some surprised sellers to be slapped with bank overdraft fees. "I closed my PayPal account immediately after my last payment was released," says Lisa Holman, a Miamisburg, Ohio resident who had been selling for four years. "I will never sell on ebay again and I have vowed not to buy on eBay," she adds.

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Ebay spokesman Amanda Miller says the policy is being applied to sellers who "pose a higher than average risk of future transaction problems," but declined to explain why customers, who had been selling for years without complaint, were suddenly considered risks. Miller confirmed "all PayPal balances are stored in an interest-bearing bank account." She declined to say how much money eBay earned on sellers' money, except to say it was "not material to our business." She also did not respond to questions asking if any of the money was invested in other instruments.

That leaves eBay -- and Paypal — under an avalanche of angry sellers who are threatening to close their accounts. Ignored, the problem could become a bruising "Netflix" (NFLX) moment — a reference to the tone-deaf miscalculation the video streaming company made last year when it introduced a price hike that caused subscribers to abandon the company in droves and the stock to lose more than 60% of its value. "I have hoped that this was eBay's Netflix moment," says Calabro, who has stopped selling until the hold is lifted from her account. She's also opting to use credit cards, rather than PayPal, when buying items from other online sites, and is urging friends to do the same. "They haven't taken into account that eBay's sellers were also eBay's most dedicated buyers. When they crush us as sellers, they crush our desire to buy there too."

Corrections: A previous version of this story incorrectly stated that PayPal's fee was 3.35%. The fee is actually 2.9% plus 30 cents. PayPal's policy was first implement in 2008, not 2009 as previously reported. The story has been corrected with the correct figure and date. Fortune regrets the error.

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