February 22, 2000

The Role of Government in E-commerce

By Mark R. Stefanic


There are many irregularities in today’s e-commerce marketplace. This high level of transactional problems is alarming, but it is not surprising, given the relatively immature e-commerce market. Before we can fix the existing problems, it is important to understand what role the Federal Trade Commission (FTC) should play, and why the FTC must be involved. Further, a healthy e-commerce environment requires cooperative interaction between the FTC, vendors, customers, and market enablers. Ultimately, a frictionless Internet market with strong transactional integrity will benefit customers and businesses alike.

Defining the Problem

Security and privacy of consumer’s personal information is of paramount importance to healthy e-commerce. Security and privacy cannot be considered exclusively though, without regard to other important transaction risks such as; customer service, product/service delivery, warranties, guarantees and financial integrity. These ‘other’ attributes fall under the general classification of "Service". Security, Privacy and Service are intertwined. When all these attributes are in confluence, completed transactions will result in customer experience consistent with customer expectations. When customer experience does not reach customer expectations across all attributes, transactions will be abandoned and e-commerce irregularities will persist.

The desirable state of equilibrium, in which there exists a high level of e-commerce satisfaction, can only be achieved when vendors strive to meet all these transaction attributes. In a nascent market, such as the Internet, the market forces and communication links between customers and vendors are not mature enough to drive toward a healthy equilibrium. Thus it is incumbent upon the FTC, market enablers and vendors to expedite this process.

In order to enable e-commerce and create an environment conducive to the best of interests of the consumer and vendor, we must define the ideal e-commerce market equilibrium. Market equilibrium is achieved when customer transaction expectations are fulfilled.

We can express e-commerce market equilibrium as follows:
CTE = Customer Transaction Expectations
SP = Security and Privacy Protection
SVC = Satisfactory Customer Service (Product & Service Delivery, Guarantees, Warranties, Financial Integrity, Other)

Understanding the Consumer

Extensive data has been published that traces consumers’ reluctance to complete transactions over the Internet to the specific factors identified in this equation. The consumer’s unwillingness to complete a transaction is simply a lack of confidence in the process, driven, in a large part, by their inability to readily ascertain and evaluate these transaction issues. Current vendor disclosures available to consumers on web sites is either inadequate, incomprehensible, not credible, or ignored. Often, the consumer is frustrated trying to find and/or understand the attributes of interest.

Understanding The Consumer, cont’d.

The consumer, offering to purchase online with a credit card, is a AAA (highest quality) counter-party to the transaction. This AAA status is in terms of both the personal information conveyed and their ability to pay. The consumer has an implicit understanding of this notion. Conversely, given current disclosure practices, the consumer views the vendor as a less than equal counter-party. This information imbalance between the counter-parties decreases transaction liquidity.

The problem is particularly acute given the opaqueness of the Internet transaction. Historically, consumers have taken comfort in the tangible aspect of ‘bricks and mortar’ retailers. On the Internet, that same old-fashioned sense of security cannot always be gleaned from the site or the vendor’s name. This phenomena is exacerbated by the proliferation of new, unknown dot-com businesses.

Regulatory Focus

By entering into a transaction, the consumer provides information in a limitless number of forms. However, arbitrarily limiting the nature or type of information exchanged during a transaction places undue constraints on the principles of a free market.

From a regulatory standpoint, the focus should be on complete disclosure of vendor information practices to the consumer, rather than legislating particular standards of practice for vendors to follow. Concerning the consumer’s access to information collected and/or retained by a vendor, and given that the consumer is a AAA counter-party, ideally, the consumer should have absolute access to all of their information used by a vendor. This gives the consumer the opportunity to monitor the information disclosure and usage of vendors they transact with. To help protect consumers against unscrupulous vendors, regulatory efforts should focus on periodic audits of vendors. In addition, material changes to information collection and usage practices should be filed with the regulatory authority.

Setting disclosure standards for information collection and usage is necessary, but does not unilaterally create market equilibrium. Since mere disclosure by a vendor does not ensure compliance with their policies, an efficient market requires an assessment of the vendor’s ability to perform. The independent e-commerce rating agency’s assessment of SP and SVC, supported by research and analysis, combined with regulatory initiatives, balances the counter-party information exchange.

Role of the Rating Agency

The value information has with respect to transaction liquidity is demonstrated and readily observable in our capital markets. There, it can be seen that better counter-party information significantly improves liquidity and reduces transaction costs, promising similar opportunities in e-commerce. The stock market is argued to be almost perfectly efficient by top academic researchers. This status has been fostered by centralized, efficient exchanges and strong regulatory oversight by the Securities and Exchange Commission (SEC). However, this model is not as well suited to the Internet as that of the bond market. Like the Internet, bond purchasers make one-on-one transactions without the luxury of a centralized processing function. Still, transaction safety is achieved through the rating agencies.

The rating agencies remove information gaps by providing an assessment of transaction risk (rating) supported by thorough research and analysis. This independent rating process affects the pricing of the security issued, increases transaction liquidity, and drives market equilibrium. The rating process is an arms-length transaction between the rating agency and the securities issuer. The beneficiaries of this process are the issuer (seller) and the investor (buyer).

Role of the Rating Agency, cont’d.

Application of the rating agency model to the e-commerce industry will increase liquidity for e-commerce transactions. The Internet rating agency, through independent assessment of SP and SVC, reduces market irregularities, which increases transaction confidence and eliminates transactions lost to market imperfections.

The bond market rating agency is subject to regulation and oversight by the Securities Exchange Commission (SEC). An e-commerce rating agency could have a similar relationship to the Federal Trade Commission (FTC). The SEC also provides an enforcement function concerning securities issuers. However, the SEC does not provide research or an opinion, as this would compromise the objectiveness of their enforcement capability. This is where the value of the rating agency model becomes central to improved transaction liquidity. The independent e-commerce rating agency provides the same benefit to the e-commerce transaction.

Roadblocks to Regulation/Legislation

It will be difficult to establish global guidelines for fair information disclosure and practices given the differing needs various industries and/or companies may have regarding the nature and extent of personal information they must collect and retain. Some examples are offered below:

The travel/car rental/hospitality industry: For a variety of reasons, these vendors are required to collect and maintain more extensive information such as an individual’s driver license number. Also, the business model of this industry includes the extensive sharing of information through partnerships and promotional arrangements. Often, the consumer is the direct beneficiary of these arrangements in terms of better pricing and service, due to the decreased customer acquisition cost.

Information as payment: Vendors can offer to consumers, based on their tastes and preferences, better service and pricing in exchange for significant personal information. For example, a phone company may provide free long distance in exchange for a consumer providing demographic information, including income, and agreeing to listen to or view advertisements.

Outsourcing: A computer manufacturer or retailer may outsource the maintenance contracts and warranty work on their products, necessitating the transfer of personal information to a third party. This is especially true if these third party maintenance providers have differing disclosure practices. Additionally, these same third party vendors may sub-contract the work.

Banner Ads: Many e-commerce sites accept banner ads as a means of generating revenue. Some of these ad companies can and may track consumer information, which becomes personally identifiable. The obvious problem is, the ad company, as a lessee of site space may have policies differing from the site itself. The issue of when and who should disclose these practices becomes problematic, and is further complicated by the rate at which these purveyors may change.

Regulatory and legal framework: Vendors have exhibited extensive legal risk management, making every effort to protect their exposure to any potential shortcomings in their disclosure statements and practices. This legalese will serve to dilute the consumer’s ability to understand the vendor's practices and also defeats the regulatory intent.


As a direct result of the inherent ‘blindness’ of an Internet transaction, the regulatory and rating needs for e-commerce transaction safety are analogous to the capital markets. The SEC and rating agencies protect stock and bond market investors and, in doing so, ensure a highly liquid transaction environment. An independent e-commerce rating agency, in conjunction with the FTC, offers the Internet an expeditious path to riskless transactions.

The SEC, as a regulatory and enforcement body, does not, and cannot offer an assessment of quality, such as, the ability of a company to make their dividend or interest payment. Similarly, the FTC cannot offer the consumer an assessment of SP and SVC. The independent rating entity increases transaction liquidity and reduces transaction costs by synthesizing all data, operating and financial, and provides an informed valuation or rating. This bridging of the information gap between vendor and customer drives the market to a healthy equilibrium.

The core component missing in any existing or proposed disclosure regulation and legislation is the rating function. The correct rating model assesses all of the transaction components on a comprehensive basis. Merely setting a hurdle rate for stated practices and offering a ‘seal of approval’ is insufficient. Regarding e-commerce transactions, a web site’s true ability to deliver on their policies and practices is directly impacted by their financial and operational ability to maintain and support the infrastructure for their practices. For the rating entity to be effective, they must address the vendor’s ability to deliver on all aspects of the transaction.

Mark R. Stefanic
President and CEO
February 22,2000