Why Penny Auction Sites Could Be Dangerous and Possibly Illegal

The Internet offers multiple websites luring consumers with promises of free iPads, TVs, and high-tech cameras. Many of these sites are auction sites, selling brand-name merchandise at deep discounts. Consumers bid on the merchandise, just as they do in an auction, but they frequently have to pay for the opportunity to bid. The sites are often referred to as “penny auction” sites, and variations on the model are proliferating rapidly on the Internet.

I was recently quoted in LAPTOP magazine’s online site  on the legal dangers of penny auction sites. The article contains one man’s journey through the penny auction sites from the layperson’s perspective. It shows readers how the penny auction sites work and where the risks are for the consumer. Here is a more in-depth look at the legal issues surrounding these sites.

The main problem with penny auctions sites is that it is difficult to verify the sites’ legitimacy. Because these online auctions move so fast, consumers can lose a lot of money very quickly, even with legitimate sites.

Some penny auction observers speculate that even non-fraudulent penny auctions are illegal gambling or possibly constitute lotteries under state law. Unlike a site like eBay, in a penny auction, bidders must pay for the right to bid. So they have spent money for the opportunity to bid on an item, with no guarantee they will actually end up with the item at the end.

The open legal question is whether the outcome of the penny auction is determined by chance or by skill. If chance, then penny auctions likely would be illegal gambling and/or illegal lotteries. If skill, then the penny auctions are likely legal, but still dangerous. At the end of the auction, the”winner” has not won the item, but rather has won the right to buy the item. Without full, clear and conspicuous disclosures, a penny auction site may deceive a consumer who does not understand the process.

Another hidden danger is the difficulty of vetting the operator of the penny auction. Of course, this problem is not unique to penny auctions. The Internet does not offer transparency in the way a bricks and mortar retailer does, but penny auctions have been plagued by fraud issues in the past, using illegal shill bids placed by software programs or manually by people. Fake bids can inflate prices or even mean nobody truly ends up a winner. Consumers seeking a bargain on a brand name products may end up bilked out of money because of these fraudulent practices.

In at least one recent instance, the FTC filed an enforcement action against a company offering “free trial” offers of its health care products. The FTC alleged that the defendant’s penny auctions were deceptive because they falsely indicated that consumers would receive free “bonus” bids in the auctions if they provided credit or debit card information. In fact, the defendants charged consumers money for the bids.

That’s not to say all penny auctions are illegitimate. The FTC has issued some best practices for consumers to help them differentiate fraudulent sites from legitimate ones and to help them safeguard their monies. Some consumers report that they develop more skill in bidding with practice, and while they may find the penny auction sites as addictive as buying lottery tickets, they have more success than they do in the lottery. For the vast majority of consumers, however, it is more likely that they will lose money in penny auction sites.

Operators who are developing penny auction sites or sites with similar qualities should be aware that the FTC, state attorneys general, and the Better Business Bureau are watching. To minimize risk associated with sites like this, best practices would include:

• eliminate the payment requirement for entry;
•  ensure that there are no fraudulent mechanisms at work driving up the quote “price” of an item;
•  offer items that the consumer has won to the consumer without any purchase requirement;
• consult with specialized legal counsel in developing your site’s terms and conditions and especially if you are requiring a purchase for entry.