Sex sells, doesn't it?

Tales of financial chaos at the heart of an online porn empire.

Published December 1, 1999 5:00PM (EST)

Conventional wisdom says there is no business quite as foolproof as selling X-rated photos and their multimedia derivatives on the Web. For several years the media overplayed a public fascination with online pornography, with pundits fretting that the only thing people were using the then-nascent Net for was smut. Having a dismally low opinion of our fellow citizens, we assumed that the demand for porn, the more hardcore the better, must be nearly insatiable.

And yet, while we assume that the computer in the next house is filled with steamy images downloaded through the Net, there's no Bill Gates of online porn. Heck, there isn't even a Hugh Hefner of online porn. The business of selling nude photo spreads is a shadowy one. Few operators of "adult sites" -- as porn sites are called by professional pornographers -- are willing to talk about their business.

Some people involved in the adult industry are so reluctant to speak to the press that they refer calls to their lawyers before they even know what they're about. Cybernet Ventures, the developer of an age verification and payment system called Adult Check, connects reporters directly with the company's general counsel, Tim Umvereit. After he's convinced that you're not under the misimpression that Cybernet Ventures actually operates any porn sites of its own, Umvereit will happily talk to you. But he won't say much, instead descending to good-humored but nearly comic depths of obfuscation.

Yes, Umvereit will tell you, there are some really big players in online porn. But he doesn't really know who they are. He might know some of them socially. But he can't really be sure.

Pornography is one of the biggest industries (the drug business being the obvious first-place winner) whose products few admit to consuming and hardly anyone fesses up to producing.

The one big exception in online porn was Seth Warshavsky -- a Seattle pornographer who, ever since his company, Internet Entertainment Group (IEG), acquired its infamous honeymoon video of starlet Pamela Anderson and rocker Tommy Lee, has been the public face of online porn.

In a December 1997 Wired Magazine profile titled "Sex Sells," Warshavsky outlined his simple theory of online porn. "You really never lose," the buzz-cut, 26-year-old Seattle businessman told Wired. "It's cheaper to produce than mainstream content, and it's easier to sell."

Since then, the arc of Warshavsky's career has been chronicled in dozens of magazine articles. Warshavsky told Wired that his sites took in $20 million in 1997. By January 1999, Warshavsky was telling the San Jose Mercury News that his Net ventures brought $44 million in revenues in 1998 -- and $15 million in profit.

Of course, hard and fast numbers in the online porn business are notoriously elusive.
Mark Tiarra, for instance, runs several adult sites himself, consults for several other companies and is president of United Adult Sites, a trade organization for the industry, so you might expect him to have as clear an idea as anybody of how big the industry is. But although at first he confidently says that adult sites take in a total of $500 million to $1 billion in subscription fees a year, within five minutes he is explaining how one of his clients -- a company whose name he won't divulge -- takes in $40 million in subscription revenue a month. Hey, Mark, isn't that $480 million a year right there?

This year, Warshavsky made the press rounds announcing plans to take his company public. But IEG never actually filed for an IPO, so there has never been an easy way to check Warshavsky's revenue claims; instead, many observers simply took this seeming millionaire at his word.

And why not? It certainly sounded plausible. If we assume that there are millions of porn consumers staring lustily at their glowing monitors, why not also a gaggle of porn millionaires making a living off them?

In October, however, IEG filed a lawsuit that took a bit of the shine off the porn industry's alleged profits. The company sued two former employees and its former staff counsel; Warshavsky claimed the three had stolen data and were planning to compete with him. That lawsuit has now been settled, but it seems to have boomeranged on Warshavsky.

A Washington Post story about the lawsuit brought out information that painted a much less rosy picture of the economics of online porn. Former employees accused IEG and Warshavsky of inflated revenue reports and fraudulent billings. The case ultimately raises the question: How well does online vice really sell?

Warshavsky disputes the accusations, but the accounts of former employees show a company that seemed to have manufactured much of its revenue by systematically overcharging customers -- and yet had cash-flow problems so bad that IEG payroll checks sometimes bounced.

The three onetime associates sued by IEG -- chief operating officer Bert Reitsma, editor Evan Wright and onetime counsel Eric Blank -- secured a pile of affidavits from former employees alleging that IEG created revenue by overcharging customers who had given IEG their credit cards for access to, IEG's flagship porn site, and other sites in the company's network. According to the affidavits, which were sent to Salon Technology by an anonymous source, the former employees say that IEG billed customers several times over and reactivated closed accounts. (Salon Technology was not able to reach all those who signed affidavits, but did speak with six former IEG employees.)

In one affidavit, Ron Chao, IEG's chief technical officer from June through August 1999, says that Warshavsky several times asked him to program the company's computer systems to double-bill customers. "Shortly before I left," Chao wrote in his affidavit, "Seth demanded that I cause the billing system to generate between $400,000 to $2 million on various occasions." Chao's affidavit also asserts that Warshavsky told him that improperly charged money should never be returned to customers unless they called to complain.

Several former IEG customer-service representatives signed affidavits saying that in the course of their work, they saw accounts that were charged several times and regularly received complaints from customers who said that their accounts had been reactivated without their permission.

These ex-employees suggest maneuvers like this may have added substantial amounts to IEG's bottom line. One customer-service representative, John Zicari, wrote in an affidavit: "In July of 1999, almost every account I came across in was billed two or three times and some were billed as many as a dozen times in a single day."

Even counting bills that might have been improper, the money rolling in from online pornography doesn't seem to approach Warshavsky's figures.

Two former IEG accountants, Jason Yankow and James Trujillo, say in affidavits filed in connection with the lawsuit that the company's online revenues were generally $30,000 to $35,000 a day, though in some days in August they saw revenues spike upward to between $60,000 and $100,000 a day. Yankow says in his affidavit that he was told that the revenues jumped because the company's billing system had been programmed to accept cancelled credit cards. Trujillo confirmed his account in an interview.

Another former IEG accountant pegs IEG's online revenues at an even lower number. After credit card processing charges, he said that IEG generally took in about $65,000 to $95,000 a week, and that those numbers fell 35 to 40 percent last summer. The accountant said that the drop could have resulted from users getting tired of stale content, but could also have resulted from changes in billing practices. Chao was chief technical officer of IEG at the time and, by his own account and that of other former employees, he refused to execute Warshavsky's requests to double-bill customers.

Reitsma, the former chief operating officer, told the Washington Post that revenues for IEG during his tenure were just $700,000 to $900,000 a month. Salon Technology could not reach Reitsma for comment.

Warshavsky calls his accusers "criminals" and says the attention his lawsuit has drawn is the result of envy. "I'm a young guy, I'm a successful guy and people want to take potshots."

He claims that IEG's online revenues are substantially higher than the numbers quoted in the affidavits and denies that he ever ordered accounts to be overcharged. By Warshavsky's account, there were only two incidents of improper charges. Though he admits that they involved "several thousand" customers, he says that incorrect charges were reversed. According to Warshavsky, one of the two incidents involved, a site for which IEG handled some billing functions but did not manage or own.

However, Matt Fischer, a customer-service supervisor who gave an affidavit in the lawsuit, says that in the time he was at IEG -- January 1998 to August 1999 -- there were six or seven occasions on which calls to customer service jumped from an average of 300 to 900 a day. Another former customer-service employee, Megan Riley, confirmed that there was a wave of complaints about, but said that the problems were not isolated to that site.

Warshavsky discounts the stories of his former customer-service employees. "What you have are $7-an-hour telephone operators who don't understand the billing systems," said Warshavsky. "It's like talking to the pizza delivery person at Domino's." (In fact, IEG's operators earned more like $10 an hour, say several former employees.)

According to Warshavsky, any revenue spikes were the result of batch processing of credit cards. Fischer, however, said in his affidavit and confirmed in an interview that at the times when calls to customer service increased, the majority of the calls -- 75 percent -- involved customers complaining that their closed accounts had been re-activated and billed again.

Warshavsky maintains that IEG documents back up his account of the company's revenues. He said also that an outside audit, commissioned by IEG, proved that there were only two incidents of overcharging. He offered to provide those documents, but only under a nondisclosure agreement that would give IEG the right to approve any use of the information that came from the documents; Salon Technology did not agree to those terms.

Is it possible to go broke overestimating the public's appetite for pornography?

Despite the stories of bounced checks and bogus charges, that's still not clear. James Trujillo, the former IEG accountant, says that in his estimation IEG was profitable, despite mismanagement and cash shortfalls. But IEG's recent run of trouble probably means that the prospect of the company going public and giving investors a chance to put their money in online porn is no more than a distant memory.

It might be just as well. Perhaps Warshavsky's porn empire has received as much publicity as it has because there is something irresistible about the prospect of profiting from other people's sin. It comes as something of a refreshing shock to find that what goes on at our neighbors' computers is not as bad as we assume it must be. Perhaps it should come as less of a surprise -- Americans, after all, have always been fonder of financial sin than of any other kind.

By Mark Gimein

Mark Gimein is a staff writer for Salon Technology.

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