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Something didn’t smell right. Years of nabbing spies, kidnappers and other bad guys had taught Robert Chestnut a thing or two about scam artists. A former federal prosecutor-turned-bloodhound for online auctioneer San Jose, Calif.-based eBay Inc., Chestnut could sniff out petty thievery a mile away. And from the look of a tip he got in January, that’s exactly what was going on. First clue: The guy selling digital cameras on the site at $1,000 a pop was demanding wire payments, akin to cash. Would-be buyers told eBay they were getting nervous about purchasing the cameras. Then Chestnut discovered the guy was hawking goods under a fake name. That’s all it took. Chestnut ordered customer support to shut down the seller’s account and alert affected bidders to the likely hoax. He also contacted Western Union, and, by day’s end, all money transfers to the seller had been blocked. There was a time, not so long ago, when eBay might have looked the other way. That was in the mid-1990s, when the company was still a fledgling startup, staking a claim in a lawless virtual frontier. Like any settler, eBay made up the rules as it went along. The strategy was simple: Host a virtual yard sale, charge a nominal commission — and then back off. Bidders and sellers would work everything out among themselves — what to sell, what to pay, how to pay for it, and how to settle disputes. “It was ingrained in our culture to make a small number of rules and then get out of the way,” says chief executive officer Margaret “Meg” Whitman. But when traffic on the site mushroomed in the late 1990s — from 2.2 million customers in 1998 to a whopping 42.4 million last year — eBay had to rethink that strategy. While the spike in users boosted the company’s balance sheet (earnings grew by 87 percent from 2000 to 2001), the site’s popularity also brought an influx of less-than-honest bidders and sellers. Major consumer industries and key regulators suddenly paid attention to eBay and grew increasingly alarmed at some of the items up for auction. To protect its profits and ward off costly lawsuits, eBay switched from a “hands-off” to a “hands-on” legal strategy. Now the company polices the site constantly, snitches on ne’er-do-wells, and tries its best to placate overzealous regulators. The activist approach is smart business. eBay has flourished on the notion of community and it knows that, in order to succeed, it can’t lose its users’ trust. After all, barely a week goes by without that confidence being put to the test, whether it’s controversy over the appropriateness of selling fragments of the destroyed World Trade Center, or the airline industry’s objections to what it deems to be the unauthorized sale of frequent-flier miles. But by mediating these skirmishes, eBay has opened up a potential Pandora’s box of legal woes; while trust is important to how it conducts its business, keeping that trust by patrolling the site poses some risk. In fact, eBay might be better off doing nothing. Under traditional legal doctrine, companies that take protective, but insufficient, steps to ward off crime open themselves up to the argument that their troubleshooting didn’t go far enough. So by monitoring the site’s activity, eBay can potentially be held liable for the crimes it doesn’t catch. The company, of course, begs to differ, pointing to two Internet-era laws — the Communications Decency Act and the Digital Millennium Copyright Act — that shield Web businesses from liability for certain activities that take place on their sites. EBay insists that, under the protection afforded by these laws, if it doesn’t catch wrongdoing on its site, it isn’t ultimately liable. The final responsibility for soured deals or contraband sales rests with its users. For now, critics charge that eBay is trying to have it both ways: acknowledging the need to keep the site safe yet wanting a free pass for shady stuff it doesn’t detect. So far, the company has beaten back some key challenges in U.S. courts on this issue. One suit was brought in Los Angeles federal court by the maker of a documentary about Charles Manson angry over the sale of pirated copies of the film. (As of press time, the filmmaker hadn’t filed an appeal.) Another was launched by buyers of what turned out to be fake sports memorabilia; eBay won summary judgment. Yet eBay’s ability to maintain this winning streak is far from assured, particularly as the company sets its sights on China and other promising markets where the laws are even murkier — and the regulators even more unpredictable. As Jane Winn, a visiting professor at the University of California, Berkeley’s Boalt Hall School of Law and an e-commerce expert, puts it: “EBay is in a very vulnerable position. There’s no clear regulatory framework, [so] eBay is trying to get out in front of everybody with a plausible story.” Chestnut is hardly your typical Silicon Valley sleuth. Three years ago, he was in his 11th year as an Assistant U.S. Attorney in the Eastern District of Virginia, newly married, and ready to make a beeline for the private sector. Late at night he would scour the Internet, looking for companies that could use a seasoned ex-prosecutor — not exactly an obvious pick. Between searches, Chestnut would bid on eBay for rare Polaroid equipment for his professional photography sideline. Months passed before it dawned on him that an online auction site might be a hotbed of criminal activity. The way deputy GC Chestnut, now 43, tells it, that night he e-mailed his r�sum� to [email protected] and went to bed, never thinking it would lead anywhere. By the next afternoon, he’d forgotten all about it. Michael Jacobson hadn’t. The next day, Jacobson, the newly ensconced general counsel of eBay, and his sole deputy, Bradley Handler, arrived at work to find that the answer to a critical need had just landed in their laps. Chestnut, it turned out, had guessed right. Jacobson had already concluded that a veteran prosecutor — someone who knew investigations and, more importantly, those who run them — was exactly what the company needed. Weeks earlier, eBay had made the 180-degree shift in its legal strategy and decided to start policing its site. Business had exploded and so, too, had the carping. Video game makers, among them Sony Corp. and Nintendo Co. Ltd., were particularly upset. Games they had developed but never released were trading on eBay. Faced with a David-and-Goliath battle with the video game manufacturers, eBay retreated. It took several months for Jacobson to convince the company’s executive team that the time had come to start paying close attention to who was selling what, but he had one key backer from the start: CEO Whitman. Though she supported the shift, Whitman said she knew that Jacobson was going out on a limb: “If you were purely a lawyer, without a business head on your shoulders, you would never have recommended that.” To be sure, being proactive was a matter of survival. The deep-pocketed video game industry was mad and ready to do battle. By backing down, eBay “could buy more time,” explains Winn, the Boalt professor, “and put on the back burner the question of whether or not they were going to get hit on assumption of duty.” Chestnut was not the company’s only unusual hire. Jacobson was not your typical dot-commer, either. At 44, he was older and far more risk-averse than the Gen-Xers then flooding the Valley. A corporate securities specialist, he was considered a lifer at Palo Alto, Calif.’s Cooley Godward, the firm he joined straight out of Stanford Law School. Former colleagues describe him as a “lawyer’s lawyer” — not a wine-and-dine type who jumped on the Internet bandwagon. Read: He wasn’t a big rainmaker. He was, instead, the go-to guy for legal arcana, the “big brain in a chair,” as one partner described him. His messy office is still legendary at the firm. He’s also storied for another quirk. Like John Cage, the fictional lawyer in television’s “Ally McBeal” who walks barefoot in the office to relieve stress, Jacobson had his own way of decompressing. He’d skip, in the middle of the night, up and down Cooley Godward’s halls or do jumping jacks while on conference calls. It was, Jacobson says sheepishly, his way of burning off excess energy. Looking back, some former partners speculate that Jacobson was frustrated at Cooley. “He thought he had more to offer the world [than being Cooley's resident brainiac],” says Alan Mendelson, a corporate partner who is now in the Menlo Park, Calif., office of Los Angeles’ Latham & Watkins. At the time, Jacobson’s colleagues were baffled by his move. “Internet auctions? You’ve got to be kidding,” thought Gregg Alton, a former Cooley Godward associate who is now general counsel of Gilead Sciences Inc., when he heard the news. Many others thought Jacobson was getting a raw deal on compensation: With a base salary of $150,000, he would be taking a pay cut, and his options didn’t look so promising either. Some tried to talk him out of it. But Jacobson wasn’t listening. “Mike did a lot of research and said, �No, this company is a winner,’” recalls Alton. No kidding. For Jacobson, it’s been a sweet ride. On top of $256,600 in annual pay (in 2000), he’s cashed in about $33 million in stock since the company’s wildly successful IPO in 1998. Now silenced, the naysayers just shake their heads, amused by their own nearsightedness but delighted, too, at Jacobson’s good fortune. At eBay, it didn’t take Jacobson long to make his presence known. His first feat — turning the company into an active steward of its site — ushered in a string of strategic hires. First came Chestnut. He was soon followed by Jay Monahan, who was then overseeing The Walt Disney Co.’s antipiracy initiatives, and who is now in charge of eBay’s intellectual property and litigation portfolios. Next through the door was Jay Clemens, an in-house lawyer at Hewlett-Packard Co. whose domain at eBay covers its international operations. With the growth to 31 lawyers worldwide has come an increase in legal costs for eBay. Jacobson won’t divulge numbers, but notes that legal expenses at Internet companies have run as high as 5 percent of gross revenue and says that he’d like to bring eBay’s closer to corporate America’s standard of about half a percent (or, at eBay, roughly $3.7 million). Jacobson describes his job as part sage, part blind man with a walking stick, never quite sure of what lies ahead. His top deputies echo that sentiment. “A lot of things that we were doing or that I wanted to do were going to exceed the law once it all shook out,” says Monahan. Jacobson and his crew knew they were entering dangerous territory once the company had adopted its revamped legal strategy. They understood that critics would view eBay’s initiatives as mere window-dressing, aimed at shielding the business from responsibility for transgressions on its site. But they felt that they had two powerful weapons in their arsenal: the Communications Decency Act, which protects Internet service providers from online defamation by third parties, and the Digital Millennium Copyright Act, which extended those protections to copyright claims. Because courts had not yet tackled either law to any significant degree, eBay was operating in a legal gray area that Monahan describes as “terrifying.” The way eBay sees it, Congress was attempting to strike a balance in passing the laws. Internet service providers (and, in attorney Monahan’s opinion, those akin to ISPs, such as eBay), IP rights holders, and consumers should all shoulder some responsibility for online dealings. “Otherwise,” says Monahan, “[the government will have too much oversight and] we’ll never get to run our business.” But above all, he continues, legislators wanted to encourage ISPs and related businesses to take proactive steps to keep scofflaws away without fear of reprisals. As such, the whole assumption of duty notion doesn’t apply to the Internet, argues Monahan. “It seems to be in everybody’s best interest for us to have the freedom to voluntarily and proactively look for certain types of [illegal] content on the site,” says Monahan. At the same time, he acknowledges that eBay is walking a fine line. “There is a point where somebody like an ISP could be so involved with activity on its site that the right thing to do is hold them responsible for it,” he says. Where exactly the line gets drawn between eBay’s responsibility and that of its users or third parties is unclear. It didn’t take long for plaintiffs lawyers to seek clarity. Their attacks are premised on one central argument: that eBay is more than just an Internet service provider or a gateway between users and the Internet, and, hence, doesn’t enjoy the same protections as, say, ISP America Online Inc. EBay, they argue, is essentially an auctioneer and, just like Sotheby’s Holdings Inc., is potentially liable for goods sold under its auspices. Officially, eBay calls itself a “marketplace” and assiduously steers clear of the “auction house” moniker. In interviews, however, even its in-house lawyers refer to the company as an auction site. It’s an admission plaintiffs lawyers would love to hear in court. (EBay also owns two nonvirtual auction houses, San Francisco�based Butterfields Auctioneers Corp. and Auburn, Ind.�based Kruse Inc.) The first challenge to eBay’s position was filed in August 1999 by Randall Stoner, a San Francisco lawyer who sued eBay over the sale of bootleg recordings of live music. In his San Francisco superior court case, Stoner argued that eBay was not simply an Internet service provider; that by providing bidders with updates on auctions and offering billing and other services, the company was serving a business role that wasn’t protected by the CDA. In November 2000 the case was tossed out on summary judgment. In his ruling, Judge Stuart Pollak ruled that the CDA protected eBay and that requiring the company to monitor every nook and cranny of the site and to hold it liable for anything missed could force it out of business. But Pollak noted, without elaborating, that exceptions to eBay’s immunity could exist. The decision in Stoner v. eBaywas cited in two similar cases that followed — a veritable trifecta that has Jacobson and his team oozing confidence these days, at least as far as eBay’s U.S. operations go. But the confidence might be premature. One of the three cases is ongoing, and eBay recently suffered a setback when California filed an amicus brief objecting to the company’s immunity claims. In Gentry v. eBay, buyers of bogus sports memorabilia sued the company in April 2000 on the grounds that eBay essentially acted as a dealer and should be held accountable for the fraud. EBay responded with its blanket immunity defense and got the class action dismissed on summary judgment grounds several months later. Unlike the two cases that preceded it, Gentry is now on appeal. “The CDA is a poorly written law [that is] so broad you could drive a truck through that immunity claim,” says James Krause, the San Diego plaintiffs’ lawyer who filed the case. Late last year, his case got a big boost when California Attorney General Bill Lockyer filed an amicus brief opposing eBay’s broad immunity claim. In the state’s filing, Lockyer calls eBay’s interpretation of the CDA “breathtaking.” Congress, he argues, “did not create a blanket immunity for interactive computer service providers: They continue to be responsible as ‘distributors’ for disseminating material they know or have reason to know to be false, fraudulent, defamatory, obscene, unlawful, or otherwise objectionable.” California’s stance caught eBay off guard. The state’s suggested limit on the CDA’s scope, says Monahan, “has not been followed by any court that has looked at the [CDA].” Oral arguments in Gentry haven’t been set as of press time. For eBay, the battles fought at home have provided some comfort as it looks ahead. But as observers and even the company’s lawyers are quick to note, the same skirmishes it faced in the United States are likely to be replayed abroad, where the Internet itself is still a novelty and the laws governing it are practically nonexistent. The stakes are huge. Though it is already the world’s largest online auction site and enjoys little competition in the U.S., the company faces legal challenges and fierce competition abroad, notably from online portal and auctioneer Yahoo Inc. For eBay, staying ahead means protecting its brand and steering clear of any liability for what happens on its site. Already, the company is running into rough patches. In Europe, German courts have issued seven injunctions against eBay for fake designer watches sold on the site. And there are some countries, such as Italy, with difficult regulatory environments. In an effort to ward off challenges abroad, eBay is taking the same approach that has served it well at home: It’s meeting with foreign regulators, trying to educate them about the business, and pledging to abide by every country’s rules. eBay is also scouting for local legal talent. When in-house lawyer Clemens first joined the company, he says, he sent off letters to blue-chip law firms abroad (he won’t say which ones) and didn’t get much response. But he says that, now that they know that eBay isn’t a fly-by-night operation, he’s flooded with calls from some of the same firms that shunned the company. The problem is, Clemens says, that there aren’t many Internet-savvy firms abroad. “It’s been a struggle,” he says, “[to find] the right person, who has insight into the Internet, our business, and what that really means in terms of the regulatory climate.” Looking to Asia, eBay is confronting the rampant piracy of name brands in some countries in the region. In one odd instance, eBay has sued an elderly Taiwanese woman who claims to have gotten the idea for her site, www.ebay.co.tw, from a fortune-teller; in attorney Monahan’s eyes, the case is a clear violation of eBay’s trademark that, nonetheless, could take years to make its way through local courts. Will overseas markets finally end eBay’s winning streak? The auction’s still open. In any event, notes Professor Winn, “the U.S. was the easy market.” Related charts: On eBay’s Docket eBay Inc.’s Vitals

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