Internet advertising fraud places google, yahoo on defensive.

Kevin Steele used to routinely pay Yahoo! Inc. a few bucks each time someone clicked his company's online ad, which popped up when Internet users typed the word, "karaoke."

Then, his advertising bills began to double--and his sales didn't.

That's when Steele, co-owner of Karaoke Star, an online karaoke equipment retailer in Phoenix, discovered that one of his competitors had been repeatedly clicking his ads.

Earlier this year, he sent a letter to the company threatening to sue for "click fraud," which he claims cost his company $500,000.

"Before (this), we were growing 35 to 40 percent increases year after year," said Steele, who plans to file suit. "We were looking at doing $3 million this year. This guy, through his fraudulent activity, has cut our business off at the knees."

But Steele isn't only angry at his competitor. His lawyer may add another defendant to the suit: Yahoo.

Click fraud has been a problem nearly as long as pay-per-click advertising emerged as a preferred model for Internet advertising. But now more companies are turning their ire to the search engines themselves.

At least two class action suits have been filed so far against Yahoo, Google Inc. and other search engines by advertisers, claiming they have been overcharged because of widespread click fraud activity.

"There is significant pending litigation that could hurt these companies if they don't solve the problem," said Jessie Stricchiola, president and owner of Los Angeles-based Alchemist Media Inc., which helps companies identify click fraud, referring to the search engines.

Click Suits

As paid search advertising has grown, click fraud has become a more costly problem for the companies that pay for those ads. Estimates range, but some experts believe click fraud accounts for up to 30 percent of all paid search advertising costs. Yahoo and Google, the largest search engines, claim they stop some of the fraud and regularly issue refunds to victimized advertisers.

But in the recent suits, the advertisers say that those refunds, if they receive them, pale in comparison to their advertising losses.

In February, an Arkansas company called Lane's Gifts and Collectibles filed a proposed nationwide class action lawsuit against Google, Yahoo, Ask Jeeves Inc. and America Online Inc., claiming that the search engines inflate their advertising fees because they fail to weed out fraudulent clicks.

Last month, a Colorado-based company that sells software designed to keep track of click fraud filed a $5 million lawsuit against Google. Scott Boyenger, president of Click Defense Inc., said his company sued to recover its own advertising losses, as well as those of its clients, the companies that purchase its software.

"There are a lot of companies out there that have lost business or a significant amount of money and have no course or process to get some sort of remuneration for click fraud," he said.

Advertisers claim the search engines regularly conceal some of the fraud because they have no incentive to solve a problem that ultimately boosts their own revenues. "It's like putting the rat in charge of the cheese," said Jonas Saunders, a partner at McNeil Karafa Baty & Saunders, who represents Karaoke Star. "We feel the search engines have a responsibility to do a better job of policing the click fraud."

Google and Yahoo deny they lack the incentive to stop the fraud. "If an advertiser doesn't trust us, they'll spend less money on us," said Gaude Paez, senior manager of communications at Yahoo. "It's not in our interest to do anything but try to block or remove the clicks from the system."

To that point, Google recently received a $75,000 judgment in a suit it filed last year against Houston-based Auction Experts International, which allegedly received fraudulent ad revenue from the search engine by repeatedly clicking on the ads displayed on its own Web site.

Business losses

Still, Shuman Ghosemajumder, business product manager at Google, downplayed the financial impact of click fraud. "Overall, what we see is the losses are small," he said.

But in filings with the Securities and Exchange Commission, Google has warned its shareholders that the click fraud problem may increase its refund costs, decrease its number of advertisers and lead to litigation. "If we find new evidence of past fraudulent clicks, we may issue refunds retroactively of amounts previously paid to our Google Network members," the company said in its most recent quarterly report. "This would negatively affect our profitability."

Yahoo has made similar statements in its filings.

Click fraud has become more sophisticated as the methods by which search engines sell online advertisements have evolved. About five years ago, it was limited to actions taken among competitors, who repeatedly clicked on the other's online ads to drive up advertising costs. Few advertisers filed suit over the issue.

But now many more dollars are being spent on the advertising. "In 1999, if there was a little fraudulent activity, that was no big deal," said Tom McGovern, chief executive of Snap.com, a Pasadena-based search engine launched this year. "But when you're spending 50 percent of your online marketing dollars in paid search, you say, 'Wow. That's a big issue.'"

Then there's the emerging click fraud involving "affiliate" programs offered by search engines. Those allow companies that want to expand their online advertising exposure to have their ads appear on individual Web sites with related subjects or products. Advertisers pay Google each time someone clicks on the ad from a Web site, whose publisher receives a cut of the revenue from Google.

More sophisticated

The fraud occurs when the Web site publisher, in an attempt to boost its own ad rev-. enues, repeatedly clicks on the advertisements that appear on its own site.

But as the frauds have become more sophisticated, so have the tools for fighting it. An advertiser may buy software from Click Defense or hire Stricchiola's Alchemist Media.

"Advertisers, in general, are getting more technologically savvy, as far as analyzing their data and traffic statistics," Stricchiola said. "As this industry matures, it's just normal for advertisers to get more granular and look closely at how they best spend."

James Butler, information technology director of the Chase Law Group in Studio City, said he looks for patterns to detect click fraud.

"I look at log files and find an IP address showing up 100 times. I can see they're clicking on a whole bunch of ads. That's not normal user behavior," he said.

The search engines also say they have automated software systems that filter out click fraud and teams of statisticians and analysts determining how much, if anything, should be refunded.

Executives at Yahoo and Google, citing a need to keep their "proprietary technologies" confidential, refused to say how many people they employ to combat click fraud or how they calculate the refunds. They also refused to discuss the lawsuits.