The Legality of Penny Auctions

In an online penny auction, participants purchase bids for a fee, with each bid placed on a particular item increasing the price of the item by a small increment (e.g., one penny) and extending the bidding period for that item by a few seconds. The last participant to place a bid before the bidding period ends pays the website the final price for the item. Unlike traditional online auction websites like eBay, all penny auction participants must pay to play. Thus, it is common for losing bidders to spend significant amounts of money, but receive nothing of value. In this sense, critics have likened penny auctions to gambling.

Are Penny Auctions Considered Gambling?

In general, bid fees are paid to the penny auction website, rather than pooled and awarded to the winner, so a bid is not technically a “bet” or “wager.” As such, existing gambling legislation probably does not apply, so consumers are protected from illegal gambling charges. Moreover, under California law, whether online gambling is an illegal “lottery” depends in part on the degree of chance involved—specifically, whether the game is “dominated by chance.” While penny auctions involve chance, the element of strategic bidding, based on factors like remaining time to bid and expected website traffic, weighs against finding that the auctions constitute illegal lotteries.

The Unlawful Internet Gambling Enforcement Act prohibits the transfer of funds for unlawful online gambling, so the potential classification of penny auctions as a form of gambling is concerning not only for penny auction operators, but for financial institutions as well. For example, Paypal has already begun denying service to penny auction websites, likely in an attempt to avoid liability under this statute.

The Federal Trade Commission has recognized the penny auction websites’ potential for fraud, particularly with unethical operations like shill bidding, which involves automated robots or inside bidders engaged in phony bidding with consumers. Further, the websites that employ these tactics are often scammers who never ship the prize. In addition, penny auction websites have been used to facilitate Ponzi schemes that induce consumer investments by making unfounded promises of payouts.

What Legal Repercussions Do Unethical Penny Auction Websites Face?

Although, it may be difficult to discern the legitimacy of a penny auction website, exposure to civil liability may deter websites from these unethical behaviors. For example, in 2011, the Georgia Governor’s Office of Consumer Protection sued for untimely shipping and insufficient disclosure that consumers were purchasing bids upon registration, leading to a settlement requiring the website to pay over $200,000 in consumer restitution, a $35,000 civil penalty, and $15,000 in administrative expenses. In 2013, the Washington State Attorney General sued for using shilling bots, resulting in a settlement in which the website paid $50,000 in consumer restitution. In 2012, the Securities and Exchange Commission sued and CEO Paul Burks for operating a $600 million Ponzi scheme via its “penny auction” website. Though, the suit is ongoing, the SEC seeks to recover millions of dollars for consumers.

In sum, considering the questionable legal status and business practices of penny auctions, consumers, investors, and financial institutions should approach these websites with caution. At our law firm, we assist clients in legal issues related to online penny auction websites. You may contact us in order to set up a free consultation.