Suits Focus on Small Bank’s Dial-a-Porn Ties : Communications: Processing of credit card charges was a major source of Charter Pacific’s profits. But its high risks backfired on the company.

Charter Pacific Bank, a small bank based in Agoura Hills, is embroiled in a legal dispute that would make most bankers cringe.

It is involved in two lawsuits and claims totaling more than $16 million. But more disturbing to Charter Pacific, the suits focus on a major source of its profits: credit card processing of the so-called dial-a-porn industry.

The dispute began last year when Charter Pacific filed suit in Los Angeles Superior Court against a former customer involved in the telephone information or audiotext industry. The company, Simple Research of Los Angeles, provided Charter Pacific with credit card checks and other technology used by dial-a-porn and other telephone information providers.

Charter Pacific alleges that it suffered a high rate of credit card chargebacks (refunds to credit card holders because of complaints that they may not have received services) because of Simple Research, which is no longer in business. Charter contends that Simple Research’s executives owe the bank about $1 million.

But last month, Simple Research’s former owners countered with their own suit against Charter under the federal Racketeer Influenced and Corrupt Organizations Act, alleging that the bank skimmed funds from audiotext merchant accounts. Simple Research blames Charter for driving it out of business; it seeks $15 million in damages.

The suits come at a time when the bank is increasingly struggling with bad real estate loans. Indeed, at a hearing earlier this month, Charter met with representatives of the Federal Deposit Insurance Corp., the federal banking regulator, to talk about the bank’s troubles. Charter’s problems related to credit card processing is “one of a myriad of problems they have,” said George Doerr, FDIC’s assistant regional director.

Charter’s attorney vigorously denies the merits of Simple Research’s suit, calling it a smoke screen intended to divert attention from the money that Simple Research owes Charter. And he said Charter has recently shifted its credit card processing business away from dial-a-porn and other audiotext customers.

But company reports and interviews with Charter’s former and current customers show how credit card processing of the dial-a-porn industry helped the small bank remain profitable during tough times--but later backfired because of the high risks involved in the business.

Indeed, the dial-a-porn business is one that most other bankers shun.

“I don’t want to have anything to do with that type of business,” said Frank Ures, chief executive of American Pacific State Bank, which is based in Sherman Oaks. Ures said that over the years, he has been approached by dial-a-porn providers. But he said he has always refused. “It reflects on the bank.”

Charter Pacific was founded in 1981 as an independent bank, and its primary market is the west San Fernando Valley.

In 1988, under the leadership of current Chief Executive Allen R. Blum, Charter began developing a niche in processing credit card transactions for the audiotext industry. In that business, customers dial 800 numbers and pay for the information or entertainment by punching in their credit card numbers. Analysts say adult entertainment, much of it X-rated, dominates the 800-line credit card business.

The 800-line credit card business has grown in recent years because various restrictions in the 900-line industry--in which calls are charged directly to a telephone bill--forced sex-talk providers to shift their operations to 800 numbers.

Charter, with assets of about $87 million and branches in Beverly Hills and Calabasas, profited handsomely from that business shift. Indeed, while many other regional financial institutions were struggling, Charter posted a profit of $1.3 million in 1991, in large part because of its high-margin audiotext credit-card business, according to the company’s annual report.

That year, Charter received $7.6 million in merchant-card processing fees, mostly from its audiotext customers, and that accounted for 46% of the bank’s overall income. In its 1991 annual report, Charter described itself as “one of the premier firms for audiotext services--providers of information and entertainment via 800 series telephone numbers.”

But with problems from audiotext customers such as Simple Research coupled with growing real estate losses, Charter reported a loss of $74,000 for the quarter that ended Sept. 30.

Charter’s top executives declined to be interviewed for this story. But in a five-page letter to The Times, Executive Vice President James Vrataric said its audiotext customers include merchants who provide sports, psychic phenomena, financial consulting, traffic information and astrology, as well as adult entertainment. And he stressed that credit card processing for the audiotext industry now accounts for just one-fourth of the $12-million monthly volume in the bank’s overall credit card processing.

Nonetheless, the tiny bank remains a relatively big player in processing dial-a-porn credit card charges, according to Simple Research and other current Charter customers.

“It’s not something we like talking about, but the majority of the 800-line credit card business is X-rated,” said a spokesman for Independent Entertainment Group, a Sherman Oaks firm that provides technology for the audiotext industry and that has a merchant account with Charter Pacific.

Like the now-defunct Simple Research and other so-called service bureaus, Independent Entertainment provides, for a fee, the technology that links customers with audiotext providers.

Service bureaus screen calls and then verify the credit card number to make sure it’s valid, and then sends the calls to businesses that provide live or recorded messages and conversation. The calls are billed to credit card accounts, and the payments flow through banks such as Charter, which then distribute the payments to audiotext providers and service providers after the bank deducts its own fees for processing the transactions.

“We get 90,000 calls a day,” the spokesman for Independent Entertainment said. A typical call lasts about 5 minutes and costs $17, he said.

It is not illegal for a bank to provide credit card processing for the adult entertainment industry, and the 800-number sex talk business has few restrictions from either government or telephone companies. Indeed, that’s why most sex talk providers are using the 800-number credit card system, said Robert Spangler, deputy chief for enforcement at the Federal Communications Commission.

Precise figures for the 800-number sex talk business are hard to come by because it is a shadowy industry. But it is a huge business in Southern California, where there are many technology providers such as Simple Research as well as “information providers,” or those who supply the entertainment to customers. Much of the sex-line business is marketed through adult publications.

Charter got into the audiotext credit-card business because of the high profit potential. SEC documents show that in 1991, Charter charged a fee of between 4% and 8% for processing audiotext credit-card charges, compared with 1% to 3% for other credit card transactions.

Allen Woskow, a Thousand Oaks insurance executive who is a director at Charter Pacific, said, “I don’t feel we’ve done anything dishonorable or dishonest.” He added, “If there is a store that is cheating the public and if we process their (credit card) drafts, does that make us guilty?”

But few bankers handle credit card processing for the audiotext industry, because of the risks involved. Telephone calls placed through the 800 line and billed to credit cards have traditionally been fraught with unusually high chargebacks.

Because of Charter Pacific’s big business in the audiotext industry, its chargeback rate was more than 6% for its MasterCard and Visa customers in 1991. (Visa now limits chargebacks as a percentage of gross sales to 1%, and MasterCard limits it to 2.5%.) As a result of the high chargebacks, Charter Pacific set aside $585,000 in provisions for chargeback losses in 1991.

“We are concerned about the level of chargebacks they had,” said FDIC’s Doerr.

In his letter, Charter’s Vrataric said that its chargeback from audiotext credit-card processing had decreased to under 1% after Simple Research’s departure. Woskow, the Charter Pacific director, said: “We’ve controlled it, we’ve reduced it and we’re within everybody’s parameter of what’s acceptable.”