Costing a Pretty Penny: Online Penny Auctions Revive the Pestilence of Unregulated Lotteries
| Publication year | 2013 |
I. INTRODUCTION
Penny auctions, an online phenomenon imported from Europe, operate by the hundreds in the United States without meaningful oversight from consumer protection agencies.(fn1) In a penny auction, consumers compete for items one penny at a time.(fn2) Consumer complaints about penny auctions-"a combination of bingo night, the Home Shopping Network and a slot machine addiction"(fn3)-may inspire a comprehensive regulatory response. But, potential regulation will respond too slowly and unevenly to address the consumer's present concerns. A current solution is needed to address the business model that the Better Business Bureau identified as the top "Sales Scam" of 2011.(fn4) As of November 2012, just three state Attorneys General(fn5) and the Federal Trade Commission(fn6) investigated the operation of an online penny auction.(fn7) This handful of investigations into penny auctions did not challenge the legitimacy of the business model.(fn8) Instead, these investigations focused on misleading advertising or discrete instances of deceptive practices.(fn9) More recently, the Securities and Exchange Commission filed a complaint against Rex Venture Group, LLC for an alleged Ponzi and pyramid scheme through its website ZeekRewards.com, an "affiliated advertising division" of Zeekler.com, a penny auction.(fn10) To date, no significant inquiry, either academic or practical, into the legitimacy of the penny auction has oc-curred.(fn11)
Although marketed as auctions, online penny auctions may actually qualify as lotteries. Unlike the multifarious and confusing definitions of gambling,(fn12) the long-accepted definition(fn13) of a lottery consists of three elements: prize, consideration, and chance.(fn14) If a penny auction satisfies this definition then, under well-established case law in Washington, it is prohibited under the mandatory and self-executing lottery clause,(fn15) as well as a probable violation of the Washington Consumer Protection Act.(fn16)
This Comment will explore whether an online penny auction constitutes a lottery under article II, §24 of the Washington constitution. Ultimately, this Comment concludes that penny auctions are lotteries and should be regulated as such to protect consumers while improving Washington's own bottom line. Part II explains the typical operation of an online penny auction with the help of two hypothetical auctions. Part III reviews lottery law in Washington and discusses the constitutional basis of the lottery prohibition, as well as its intersection with consumer protection. Part IV explores the elements of the definition of a lottery, focusing on the most difficult element-chance. Part V discusses Washington's potential judicial, statutory, and regulatory responses to the growing penny auction industry. This Comment contends that instead of banning penny auctions outright, the state could adopt the penny auction model as an expansion of the traditional state-run lottery games into the online environment. Part VI briefly concludes.
II. WHAT IS A PENNY AUCTION?
The typical penny auction website(fn17) has several pages of auction items, including electronics, computers, jewelry, and other merchan-dise.(fn18) The website lists the items with extremely low prices and banners with flash savings of up to 90% or more.(fn19) The items on the homepage "appear to be selling extremely fast and mind-bogglingly cheaply: a $100 gift card for 160; a $150 knife set for $1.82; a $1,700 HD TV for $32.19."(fn20) Not surprisingly, most bidders, even those that win an auction, do not experience the dramatic advertised savings.(fn21) In the current economy, when the need to budget is greater than ever, penny auctions provide an incredible temptation precisely because of their unbelievable selling prices.(fn22)
Each auction starts at a very low price varying from $0.00 to $0.50, with no expressly established reserve price.(fn23) Each bid during a penny auction increases the price by $0.01.(fn24) In addition to a picture of the merchandise and the current bid amount, every auction has a countdown tim-er.(fn25) The "winner" is the person who placed the last, and therefore highest, bid when the timer runs out.(fn26) But with every bid the timer increases a set amount, anywhere from ten seconds to two minutes.(fn27)
Unlike other auction websites, penny auction websites charge bidders a small fee, usually between $0.50 and $1.00, for each bid.(fn28) Bidders buy bids in variously sized "bid packages" up front.(fn29) Packages range from as few as 10 bids to 500 or more.(fn30) For all bidders, the bid fees are paid to the penny auction website whether or not the bid is used in an auction.(fn31)
To better understand the progression of a penny auction, consider this hypothetical in which you are a new bidder on a penny auction website. You came to the website after clicking on a flashy banner ad that accompanied your search results. On the homepage, you find a smartphone "listed" at a start price of $0.50.(fn32) The low starting price entices you, a new visitor to the world of penny auctions, to give it a shot.(fn33) "After all it's 50 cents plus a penny-what a deal!"(fn34) You buy a "special offer" package of 250 bids and enter a promo code for 10 free bids you remembered from the radio this morning.(fn35) You start bidding early because of the excitement of the timer, the hunt for a bargain, and the fact that only a few bidders appear interested. For the sake of simplicity,(fn36) we will limit the auction to you and one other person.(fn37)
The price slowly increases from $0.50 to $1.00, still a bargain, as you and your opponent trade $0.01 bids. Transfixed by the excitement of your battle with an anonymous opponent, you keep clicking the "Bid" button. Finally, after what seems like hours of back and forth, your opponent fails to bid and the timer mercifully reaches zero. You win! And the final bid price for your new smartphone-just $5.00.
But to get from the start price, there were 450 bids.(fn38) And half of those bids were yours at $0.60 per bid.(fn39) Your one-time steal of a deal dissolved into $135 in bid fees, plus the $5.00 final bid price (to say nothing of taxes and shipping and handling).(fn40) Meanwhile, your competitor walks away without a smartphone and without his $135.(fn41)
Unlike a traditional in-person auction, a penny auction website generates most of its revenues from the bid fees you and your competitor expended, not from the winning bid price.(fn42) Another hypothetical illuminates how penny auction websites make a profit. In this hypothetical auction for another smartphone, bidders place a total of 999 bids, for a $10 winning bid price. At $0.50 per bid, the penny auction website collected $499.50 plus the winning bid price, for a total revenue of $509.50. Losing bidders do not get their bid fees back. As a result, the penny auction website easily covered the retail price of the smartphone, while the winning bidder received a drastic discount. The bids placed by the losing bidders funded the winning bidder's discount and the penny auction website's profits.(fn43) The openly redistributive nature of a penny auction mirrors the effect of a lottery.(fn44)
Penny auctions also differ substantially from other online auctions. A comparison to eBay, the most well-known online auction website, illustrates these differences. First, actual individuals, not eBay, list the auction items, whereas penny auction sites are responsible for listing items for auction.(fn45) As a result, eBay has a significantly reduced incentive to prolong auctions or encourage additional bidders through questionable tactics like "bidbots."(fn46) Second, an individual can choose a maximum bid amount, which eBay applies incrementally to the next highest bid; eBay users do not have to enter penny bids over and over again.(fn47) Third, eBay's revenue stream is not predicated on bid fees because eBay does not charge an individual for placing a bid in an auction.(fn48) Finally and most significantly, only the winning bidder in an eBay auction pays any money.(fn49) The losing bidders spend nothing.
The secondary effects of the penny auction boom have materialized only recently. The penny auction industry has inspired a cottage industry of strategists claiming to possess knowledge for beating the system. Various sources-mostly online-provide "strategies" for winning penny auctions.(fn50) One popular tip recommends developing a reputation as a "power bidder" by immediately outbidding any competition.(fn51) This power bidder strategy bills itself as a psychological ploy to frustrate and intimidate the competition into capitulation.(fn52) Another strategy recommends refraining from bidding until the end of an auction to score a last minute victory when other bidders appear exhausted.(fn53) By using one of these strategies, the bidder theoretically increases the likelihood of winning in the short-term as other bidders may become discouraged by being quickly outbid, have used a large number of bids early, or failed to obtain a sufficient number of bids. In the long-term, according to most strategy guides, a history of victories can establish one's reputation, which is available to other bidders on some websites, to dampen...
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