No. You don't need an SSN as long as it's less than $600 a year. This was correct.
His money hasn't been taken; they just won't disburse it until he does his free paperwork, as required by the US Government. That's entirely legitimate.
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> PayPal is the one at fault here. Don't let someone use your service without adequate ID.
They did not. When OP does the rest of what he's supposed to do, he's going to have his money unlocked.
PayPal is being as liberal, correctly, as the law permits.
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> Tell them and require it before you can use the service.
Yeah, they did. Maybe you should read the user agreement of a system before using it to collect nearly a quarter million dollars internationally. It's only three pages.
There is a point at which OP had a responsibility, too.