Hidden Truth about Penny Auctions

As posted on June 27, 2013 on consumerfederationse.com

 

Most consumers are familiar with online auctions – consumers bid up the price of an item until a timer expires. The high bidder at the end of the auction wins the item at the winning bid price. However, another form on online auctions, Internet penny auctions, have expanded at a drastic pace in recent years. While some of these sites are technically legitimate and legal, many of their business practices are questionable, and NCL is warning consumers to avoid them altogether.

How penny auctions work

In some ways, online penny auctions are essentially bidding Web sites not unlike auction sites like eBay. The key difference, however, is that all consumers who bid on penny auctions must make some sort of financial concession, regardless of whether they win or lose the auction. Here’s how penny auctions work:

  1. Generally, consumers must pay a registration fee before gaining access to bidding. This fee, while not required by all penny auction Web sites, is often expensive and undisclosed. An NBC News article discussing online penny auctions reports that one user on Grabswag.com was charged $99 as part of the registration process. While this consumer did provide his credit card information, he did not authorize any payment.
  2. A prospective bidder then pays for bid credits. Users must purchase non-refundable bid packs, or bundles of credits, before they can begin bidding. Each credit entitles the user to one bid. The price of each bid pack varies by Web site, but a Business Insider article reports that one popular site, Quibids.com, sells different size bid packs­­ for anywhere between $24 and $480. Each bid costs approximately $0.60 and is non-refundable.
  3. The bidding begins at $0 and then increases by one cent each time someone bids automatically (hence the “penny auction” name). There is a countdown clock that restarts every time someone places a new bid. Some Web sites even allow users to set up automatic rebids if they are out-bid. A penny doesn’t seem like much, right? Wrong! The total price of the item “won” is determined by the number of bids so you could end up paying well over the value of the item you’re bidding on. Generally, if you lose the bid, you have also lost the money spent on the used bids.

Some sites allow users to apply a portion of the money spent on bidding towards buying the product at retail price. However, penny auction sites often misreport the retail price of items, so buyers could be overpaying regardless.

Penny auctions are a bit complicated. Becky Worley, a writer at Yahoo! News, illustrates the process quite simply in her recent piece, “Hidden Dangers of Penny Auctions:”

“I bought $60 in bids and got in on an iPad auction. I bid occasionally, trying to time it when the counter neared zero, but I quickly blew 40 bucks in bids. Someone always jumped in at the last second, usually someone using the automated bid setting. So I signed up for automated bids myself, and I was amazed. My $20-worth of remaining bids flew out in 24 seconds. And I didn’t win. My 60 bucks was goners! In fact, I watched the most aggressive bidder make 30 bids a minute for 2 more hours until the auction ended. 3600 bids, at a minimum 55 cents a bid. That’s $1980 for a device that costs retail $499, and that guy didn’t even win!”

What’s wrong with penny auctions?

Some critics of online penny auctions claim that they should be considered illegal online gambling sites. Others argue that most of the auctions are illegitimate or use illegal sales tactics.

There is some debate over whether penny auctions are actually just a form of an online casino. Generally, something is considered to be illegal gambling if it includes a prize, chance, and some sort of personal consideration (a potential loss). Critics such as Brian Kongszik of the Florida Council on Compulsive Gambling claim that the sites meet the definition of gambling. The prize is the potential low cost of the product, the chance is that the consumer will be outbid and will be unable to continue the bidding process, and the consideration is the money lost on registration and bid packs. Critics also claim it can be addictive like gambling.

Those in the industry, such as Quibids.com spokeswoman Jill Farrand, counter that while the auctions have prizes and consideration, there is no chance involved because people can decide whether or not they want to continue to bid. Farrand also claims that the consideration is not a factor because consumers can apply a portion of the money spent on used credits to buy the product at retail price.

It is very difficult for users to determine which penny auction sites are legitimate. For example, several state attorneys general have found that some penny auction Web site use software “bots” that automatically outbid people as the clock reaches zero, making it virtually impossible to win items at a reasonable price. Some of these “bots” even show a fake username in order to persuade consumers that they are bidding against a real person. This tactic was used by ArrowOutlet.com, a site that the Washington State Attorney General sued for using “bots” against consumers. The site had voluntarily shut down before the legal action, but it was still required to pay restitution to affected consumers as a part of a settlement.

In a case in Georgia, the Governor’s Office of Consumer Protection entered a settlement with Wavee.com because the company failed to “send a number of purchased products to consumers in a timely manner and failed to clearly and conspicuously disclose that consumers were purchasing bid credits when they registered.”

Other penny auction fraudsters use “shilling,” a process in which site owners have their friends bid in order to drive up prices and prevent consumers from winning. These sites are often used by scammers to steal the money paid in auctions without shipping the merchandise, sell financial information about users, or to simply place additional charges on credit cards without permission.

There are also reports of fraudsters running Ponzi schemes that convince consumers to invest in online penny auction Web sites. These criminals claim that the investors will receive payouts based on profits earned by the sites. Unfortunately, like all pyramid schemes, the payouts generally stop when the scheme becomes unsustainable. In one such example, people of Lexington, North Carolina were duped by Paul Burks and his $600 million scheme. Burks convinced potential investors that ZeekRewards.com was immensely popular and was growing quickly. Unsuspecting investors (many of whom were families that took out second mortgages to invest) lost thousands of dollars when Burks could not get enough people to invest in the scheme. The Securities and Exchange Committee shut the scam down and is working to recover millions of dollars for the victims.

Avoid penny auctions

While online penny auctions may sound like an attractive deal at first, consumers should be very wary before handing over any money or credit card information. It is very unlikely that consumers will save any money by using the service to purchase goods, and it is difficult to know if you are using a legitimate site. The National Consumers League advises consumers to avoid these sites.