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Stock Analyst Update

EBay Walks a Fine Line in Combating Fraud

Shill bidding is the latest problem, but there's no reason to panic.

Online auction giant eBay (EBAY) was hit with some negative publicity Friday when a front-page story in The New York Times charged that rings of "shill bidders" have been unethically pumping up prices on the site. There's no reason to overreact, though, since the problem involves only a tiny fraction of eBay's millions of users, and the company has done a good job overall of fighting this kind of fraud.

Shill bidding occurs when a seller conspires to drive up the price of an item by making bids designed solely to get other people to bid higher. Sometimes this involves working with confederates who make the bids, but because nothing prevents eBay users from using more than one screen name, sellers themselves can make shill bids to drive up the price of their own items.

That's what happened in a high-profile case last month, when an abstract painting on eBay skyrocketed from $0.25 to a final bid of $135,805. The jump came when people began speculating that the painting might have been created by Richard Diebenkorn, an artist whose works have sold for as much as $3.9 million. But eBay voided the auction and suspended the seller, Kenneth Walton, when it discovered that he had bid on the painting himself, using a different screen name. Walton also admitted that he had made up the story accompanying the painting, misrepresenting himself as an innocent who knew nothing about art when in fact he had sold many paintings on eBay before.

Friday's Times story alleges that there are organized rings of shill bidders who bid up each others' items and post positive feedback for each other. Most of the Times' evidence is circumstantial, but it did turn up a couple of other instances where Walton bid on his own items. In one of these cases, Walton "sold" a CD to himself for $2 and then posted feedback calling himself "a really cool guy." Walton admitted to the Times that he had bid on his own items, but denied being part of any organized shill ring.

This type of problem has become more prevalent as the number of eBay users has mushroomed. EBay has had to walk a fine line between letting its users police each other, thus fostering a sense of community, and cracking down on blatant fraud by people who abuse the system. To its credit, it has responded swiftly to the accusations of shill bidding, kicking off users it deemed guilty of the practice, including Walton. It has also cracked down on sellers who don't deliver merchandise, by far the most common complaint. Considering that eBay averages about 27 complaints per million auctions, it's clear that fraud is hardly pervasive, and that most of the site's users are honest.

EBay has generally done a good job in convincing people that it's a safe place to buy and sell merchandise. It has weathered many storms, such as the site outages last summer that irked many users and sent eBay's stock price plunging. Though it undoubtedly has more work to do to combat this latest outbreak of fraud, there's no reason to doubt that eBay will come through just fine.

David Kathman does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.