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Nate McKelvey says he has hold of a smoking gun—and no one in authority is interested.

Specifically, the founder CEO of executive air service CharterAuction says he’s got clear evidence of click fraud against his company by a rival. But he can’t get the major search engines to investigate his complaint properly, or to take action against the alleged perpetrator. And that has led him to reduce his search engine marketing budget to about 5% of what it was two years ago.

McKelvey’s story is unique, both in its level of detail and in the amount of publicity it has received: He was the lead in a Wall Street Journal article on click fraud last month. But both its shape and its bitter tone are similar to many other anecdotal stories of click fraud from other small and mid-sized advertisers who are involved in search engine marketing.

Click fraud—bogus click-throughs on an advertiser’s ad by someone other than a legitimate visitor—depends on the pay-per-click business model that Google in particular has worked to build. When a visitor clicks on the ad, the advertiser pays a small fee to Google, or whatever company placed the ad. If the ad appears on a search results page, the search engine keeps the fee. If it was placed on another party’s Web page, the placement company shares the fee with that third party operator.

The problem comes when hoaxers try to game this system by clicking on ads they’re not interested in, forcing advertisers to pay for useless clicks. Web site operators might intend these bogus clicks to boost their fees from the company distributing the ads; or they might be in competition with the advertisers and hoping to drain their online ad budgets by forcing them to pay for pointless clicks.

The click-fraud problem received some attention in November 2004 when Google sued a Texas-based Wed site for clicking the ads placed on its own pages. The suit was hailed as a first step by the big search engines to combat the click fraud problem-- something even Google CFO George Reyes called a major threat to his company’s business model.

But there have not been any high-profile suits by the search engines against the other form of click fraud, the one in which one company purposely defrauds another. That’s the form that McKelvey says his company has fallen victim to. He says he has proof of the act, but adds that Google and Yahoo have been unwilling to give his case a satisfactory hearing.

McKelvey runs CharterAuction, a Quincy, MA-based company that offers private chartered jet service using an innovative online auction model. He founded the company in 1999 after several years spent running another charter jet service and with a clear notion that the Internet held some unique business possibilities that weren’t available offline.

One of these was the auction model, which links the price of a flight to real-time demand among Charter’s executive users. But another, McKelvey says, was the opportunity to linking the cost of marketing his company’s services to performance through pay-per-click ads.

“I was one of the first in my industry to spend time and money on search engine marketing,” he says. “I monopolized [search ads] for 18 months, maybe even a couple of years. It was so effective at that time, because most of it was real traffic. I was getting several hundred click-throughs per day, and registering as many as 50 prospects per day directly from my ads.”

McKelvey started by advertising on early networks such as Go2.com, then signed on with Google and Overture as they came up. At one time, he says he was advertising on as many as a dozen engines, including some obscure ones. Originally, he was paying as little as 5 cents a keyword; but as the medium became more popular, those bids elevated until eventually he was spending $20,000 a month and placing $20 bids on about 20 keywords such as “executive jet”.

“When it started getting up into that $20,000 range, I said, ‘This is ridiculous,’ and I started increasing my keywords to about 200 to minimize my exposure,” McKelvey says. That helped keep costs and ROI in line for a short while. But eventually ad spending began creeping up to the $20,000-a-month figure again. The value proposition was eroding—something McKelvey didn’t notice until 2003, when an investor questioned the amount he was spending on search marketing. “It had been kind of running on autopilot,” he says of the CharterAuction SEM effort. “But when you dug into the statistics, it wasn’t paying like it used to.”

The concept of click fraud had been on McKelvey’s mind since his first days as a search advertiser. But he dismissed the notion; with an economics degree and several graduate computer science courses under his belt, he felt that such fraud would be easily traced and not worth committing. Still, the realization that his SEM efforts were not paying the way they once did sensitized him to the performance of his keywords.

Then in January 2004 came notices from both Google and Overture of “unusual click activity” on his account: about $70 in the case of Google, and $16.91 for Yahoo. “Google didn’t even offer me a refund—they credited my account, which I thought was peculiar,” he says.

McKelvey asked around within the air charter industry to see if anyone else had a similar experience. “It’s a very small industry, and everyone knows everyone else,” he says. Eventually he came upon a charter company that had gotten the same notice from a search engine. An executive at that company had tracked down the IP addresses for the clicks and found one that hit his ad several hundred times in a single day.

“I asked for that IP address, searched my own logs and sure enough, I found it had hit my ad a lot,” McKelvey says. In fact, this IP address sent about a hundred clicks through his Google and Overture ads within a few seconds, a telltale sign of fraud. All told, the same address hit McKelvey’s ads more than 3,000 times at different places around the Web—while more fraudulent clicks hit the other charter company’s ads.

In October 2004, McKelvey got his Web hosting provider to trace the IP address to an Internet service provider, and then found out from that provider that the address was registered to a New York-based rival. “I called around to ten or 20 other air charter companies that were using search engine marketing and warned them to look out for this IP address,” he says. “Turns out everyone was finding it among their clicks. Everyone was getting hit.”

With a suspect IP address in one hand and credits for “suspicious click activity” from the search engines in the other, McKelvey got in touch with Google and Yahoo to find out if the two fit together. But he says he got no practical help and virtually no answer from either one.

“I called and said, ‘Look I need to know the IP address that this click activity is coming from, because I have a suspicion it’s one of my competitors,” he said. “But they refused to give me that information. It’s like they’re willing to charge for the clicks, and yet they’re not giving you any real accounting on the clicks.”

The search engines have traditionally been reluctant to get specific about either the scope of the click fraud problem or their counter-measures to detect and deflect it, arguing that the more they reveal about their processes, the more the bogus clickers know about defrauding their systems. But advertisers with click fraud gripes such as McKelvey’s have complained that the pay-per-click model has become too established and too expensive for marketers to be satisfied with less-than-specific remedies and compensations.

In fact, McKelvey tried to contact both search companies again after his story appeared in the Wall Street Journal on April 6, figuring that increased publicity for the case would make them more anxious to cooperate. This time, Google would neither confirm nor deny that an investigation into the incident was occurring—although the spokesperson was “very nice, very sympathetic,” McKelvey says. At Yahoo, he could only leave a voicemail message, to which the company has not yet responded.

The people who are calling, he says, are lawyers looking to persuade him to join in a class-action suit against the search engines. Rumblings about the possibility of such a suit have been abroad in the search industry for a while. They have picked up some strength recently since two small businesses—a gift shop and a private investigation firm-- filed suit this past February against Google, Yahoo, and a number of other search engines in an Arkansas court. The pair alleges that by charging for advertising services while knowing that a certain portion of those services are bogus, the search engine plaintiffs are taking money fraudulently.

But McKelvey says he’s not interested in becoming a party to a class action. “I don’t want to go down that road,” he says. “I just want them to fix the problem. But when I call them up and try to get them to fix it, they seem to be unresponsive.”

Right now, Charter Auction spends the minimum amount to keep its SEM account open with Google and Yahoo, while exploring other marketing avenues such as print ads. McKelvey feels it’s necessary to keep a presence in search, despite his click-fraud experiences. “Obviously, it’s death for a company not to be listed on the search engines,” he says. “But I only put in the minimum amount per click, five or ten cents.” He doesn’t foresee raising that level unless he gets some satisfactory assurances from Google and Yahoo that his click fraud case is being pursued with vigor.

To make matters worse, the competitor McKelvey says was behind the fraudulent clicks continues to come up in first position for search ads on both Google and Yahoo. “The thing that continues to eat at me most is that I’ve demonstrated that this IP address, coming from a competitor, has hit everyone in the space, and yet [the search engines] continue to allow them to advertise,” he says. “Why would any reputable search companies want to have dealings with a company like this?”