Should Penny Auctions Be Regulated under Gaming Law? Experimental Evidence Indicates the Auctions Are Gimmicks, Not Gambles

By Caldara, Michael | Regulation, Summer 2014 | Go to article overview

Should Penny Auctions Be Regulated under Gaming Law? Experimental Evidence Indicates the Auctions Are Gimmicks, Not Gambles


Caldara, Michael, Regulation


Shop here and you could win your favorite brand-name item for up to 95 percent off retail prices!" boasts a standard advertisement for the penny auction industry. This attractive proposition sounds too good to be true, and for most customers it is. To offer that ostensibly great deal, penny auction websites like Beezid and Quibids charge every bidder-win or lose--a multiplicity of small transaction fees that can be sizeable in total. The fee structure resembles a lottery, which has raised concerns with regulators that penny auctions may be a form of gambling. Average revenues for the website far in excess of the value of the item have only increased scrutiny, given the seemingly raw deal offered to the average penny auction participant.

A typical penny auction works as follows: A valuable item is put up for auction at an attractive starting price. A countdown timer demarcates the tentative end point of the auction. A participant may press a button at any time to increase the auction price by a penny and become the high bidder. If he does so, the participant is then charged a nonrefundable bid fee, typically between 50c and $1. The fee is charged every time a bid is placed, and time is added to the clock if a bid is placed in the last few seconds of the auction. When time runs out, the high bidder wins the item and pays the end auction price (plus accrued transaction fees), which often is a fraction of the item's value. Losing bidders likewise pay their transaction fees.

REGULATION

To date, the penny auction industry is not subject to any special regulations, but it is subject to substantial regulatory uncertainty. The industry has recently drawn the attention of regulators such as the Federal Trade Commission, Securities and Exchange Commission, the United Kingdom's Office of Fair Trading, Connecticut's Department of Consumer Protection, and Washington State's Office of the Attorney General. Major penny auction websites have also been the subject of numerous private lawsuits, the outcome of which could potentially shape how the auctions are classified under existing law.

Criticisms of penny auctions can generally be grouped into three categories: accusations that the auctions are a form of illegal gambling, complaints about deceptive advertising practices, and allegations that certain websites utilize computerized shill bidders (i.e., fake auction participants that artificially increase prices). Concerning the latter two categories, deceptive advertising and known cases of shill bidding by some websites have given the industry a black eye, but those problems are not unique to the penny auction industry and can be dealt with largely through existing channels. For example, the Better Business Bureau tracks and rates the major industry players, several of which have earned high marks. The auction websites also submit to periodic third-party audits, in part to alleviate concerns about shill bidding. Consumers can file complaints with the Better Business Bureau or the Federal Trade Commission if they encounter unfair or illegal business practices. Both entities have issued warnings to consumers about penny auction scam websites. Furthermore, in the United States and the UK, shill bidders have been successfully sued for unlawful business practices and fraud.

Putting aside the concerns about deceptive practices and shill bidders, this article examines the question of whether penny auctions are a form of gambling and should be regulated as such. As part of that examination, I present the results of an economic experiment that tested whether the behavior of auction participants, rather than their proclivity to gamble, can explain high penny auction revenues. If behavior alone can explain the high revenues, then that suggests the auctions should not be regulated like gambling.

ILLEGAL GAMBLING? THE CASE FOR AND AGAINST

The legal definition of gambling requires the game in question to have a prize, chance, and consideration. …

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