Legal Aspects of Penny Auctions

Penny auction websites are popping up by the dozen. Is it safe to get in on the action, or are these “entertainment shopping” sites too risky for owners and bidders alike? Here is an overview of penny auction sites and their standing under various state and federal laws.

Mixed Messages: Credit Card Processors and the BBB

The penny auction (PA) business is raising eyebrows. Some people regard penny auction sites as gambling havens that will inevitably be shut down. In fact, PayPal is denying service to certain penny auction sites, perhaps overzealously protecting themselves from charges of violating the 2006 Unlawful Internet Gambling Enforcement Act. Other merchant card processors, such as, may also be getting cold feet as the penny auction action heats up.

At the same time, it’s not unheard of for a penny auction site to earn the Better Business Bureau’s seal of approval, and merchant processors such as FirstData and Amazon Check Out have provided solid service for a number of penny auction business owners. Processors that consider a PA site to be high-risk can protect themselves from excessive chargebacks by requiring a security deposit or having the site owner keep a rolling reserve of about 10%.

Most of the online penny auction establishments seem to operate by the letter of the law and will find ways to stay in service. Securing written permission from a credit card processor, even before the website is launched, can be a proactive way of ensuring that service is not denied.

Are Penny Auctions Legal? States Weigh In

Do penny auction websites really constitute online gambling? While state laws are murky, the penny auction sites seem to be in the clear. PAs are operating out of California, Georgia, Illinois, New Jersey, and a number of other states.

As of 2010, online gambling has been expressly legalized in New Jersey. In other U.S. states, gambling has not necessarily been legalized, but that probably doesn’t even matter when penny auctions are concerned. That’s because they don’t count as gambling; they just don’t involve enough chance.

In California and most other states, a game is considered a game of chance if it’s “dominated by chance.” Being dominated by chance is different from being determined entirely by chance, and that helps to bolster the argument that the websites are legal under state law. After all, people do not bid randomly on auction items; they bid strategically. The process isn’t comparable to blindly pulling a slot machine lever or participating in a random jackpot drawing.

Another type of relevant state law concerns the penny auction bids. Since these go to the website and not to the other bidders, they are not technically part of a bet. This protects users from being charged with illegal gambling. Of course, if a website were operated unethically, it could draw more bids out of participants. This could be achieved by populating the site with bots or having an employee use phony accounts.

Penny Auctions and Federal Law

Penny auctions are relatively new to the United States, and they haven’t been outlawed under federal law. Gambling is not expressly prohibited online either, although a 2006 law, the Unlawful Internet Gambling Enforcement Act, prohibits banks from transferring funds to gambling websites. Thus, if penny auctions do become declared a form of gambling, the websites may have trouble routing funds from users’ financial institutions.

The Federal Trade Commission and other branches of the federal government are presently concerned only with fraudulent penny auction websites. They have responded to several reports of unethical websites that deceive customers with shill bids.

The Jury Is Out

Although the auction sites remain legal for now, their opponents remain in an uproar. What can opponents say? They argue that users pay a fee but receive nothing of value. That’s why penny auction sites are now touting themselves as a form of “entertainment shopping”: with each bidding right purchased, they would say, the user also gets a bit of a thrill.

As more disgruntled users file complaints, the new auction business model is likely to catch the eyes of legislators. Still, PA site owners who follow the law, keep a tidy paper trail, and treat their bidders properly should have clear skies ahead. Meanwhile, potential consumers should carefully research a penny auction site’s reputation and its terms before deciding to get in on the action.

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