Only a Game

Michael Froomkin of the University of Miami School of Law, has a sharp eye for interesting cyberlaw issues. (Check out his blog here.) If you go trolling through his Spring 2003 syllabus for The Internet & The Market, you'll find that section 4 is very on topic for TN readers. In Section 5, you'll also find a fascinating case about games and virtual currencies, SEC v. SG, 265 F.3d 42 (1st Cir. 2001).

SEC v. SG is essentially a case about the scope of laws prohibiting Ponzi schemes and other forms of fraud on investors, but is also worth a read for those interested in the intersection between law and games. The facts involved SEC allegations that a "virtual stock market" was, for all intents and purposes, the equivalent of a real stock market that had defrauded investors. The defendants raised the defense that "this was only a game." The district court agreed with the defendants. As the Honorable Judge Bruce M. Selya summarized:

[T]he district court drew a distinction between what it termed "commercial dealings" and what it termed "games." SEC v. SG Ltd., 142 F. Supp. 2d at 131. Characterizing purchases of the privileged company's shares as a "clearly marked and defined game," the court concluded that since that activity was not part of the commercial world, it fell beyond the jurisdictional reach of the federal securities laws.

The First Circuit, however, did not think saying this was "only a game" resolved the issue:

We do not gainsay the obvious correctness of the district court's observation that investment contracts lie within the commercial world. Contrary to the district court's view, however, this locution does not translate into a dichotomy between business dealings, on the one hand, and games, on the other hand, as a failsafe way for determining whether a particular financial arrangement should (or should not) be characterized as an investment contract... As long as the [the appropriate legal tests are] satisfied, the instrument must be classified as an investment contract... Once that has occurred, "it is immaterial whether the enterprise is speculative or non-speculative or whether there is a sale of property with or without intrinsic value." It is equally immaterial whether the promoter depicts the enterprise as a serious commercial venture or dubs it a game.

The defendant contested the SEC's factual allegation that the "player" stock purchases (over $7 million) were made as investments:

It argues that the individuals who purchased shares in the privileged company were not so much investing money in return for rights in the virtual shares as paying for an entertainment commodity (the opportunity to play the StockGeneration game). This argument suggests that an interesting factual issue may await resolution -- whether participants were motivated primarily by a perceived investment opportunity or by the visceral excitement of playing a game.

If you're interested in more detail, Todd M. Tippet, class of 2004 at Southern Methodist University's Dedman School of Law, wrote a student Note about the case for the Computer Law Review and Technology Journal. Mr. Tippet's ultimate conclusion is that the "investors" in this game should have seen what was coming:

Any rational and reasonable investor should realize that promised returns of this nature are simply too good to be true, and should know that taking such a risk would simply prove to be a large gamble, not a prudent investment, and thus could only be considered a game.

Mr. Tippet's Note is available here (pdf).

Comments

[Edward Castronova]

1.

First Circuit> "As long as the [the appropriate legal tests are] satisfied, the instrument must be classified as an investment contract."

To paraphrase:

"If it looks like a duck..."

[F. Randall Farmer]

2.

So, someone runs a pyramid/ponzi scheme on the net, goes bankrupt. They defend themselves saying "it was just a game", which works for them in local court, but gets (properly) overturned in appellate court (Huzzah!) What's the big deal here?

Read the descision, it's pretty short and easy to understand. It's a pretty solid case and it doesn't resemble any virtual world/MMORG that I know of. If someone ever implements a real-$ pyrimid/Ponzi scheme in an MMORG, I hope the SEC hands their proverbial ass to them on a platter.

What does this have to do with virtual currencies or the value of virtual objects again?

Randy

[greglas]

3.

Randy> What does this have to do with virtual currencies or the value of virtual objects again?

Well, in addition to the stuff above, the first two sentences of the opinion say:

These appeals... require us to determine whether virtual shares in an enterprise existing only in cyberspace fall within the purview of the federal securities laws. [Defendants] asseverate that the virtual shares were part of a fantasy investment game created for the personal entertainment of Internet users, and therefore, that those shares do not implicate the federal securities laws.

I wholeheartedly agree with you, fwiw, that it doesn't resemble any virtual world/MMORG that I know of. My post only said it was a case about "games and virtual currencies." (Which strikes me as a true statement.)

[Bruce Boston]

4.

Hey Greg,

Thanks for this. It's a great data point. Clearly if virtual currencies can satisfy the Howey Test, we have to wonder how many other legal tests these currencies might also pass.

Randy> It's a pretty solid case and it doesn't resemble any virtual world/MMORG that I know of.

Actually, I wouldn't be so quick to dismiss this issue. As 'real economy' becomes the buzz term in the industry you can pretty much expect this type of design to become more prevalent in the industry. Also, I don't think we can say that this hasn't happened already.

See: Project Entropia Business Model
http://www.stratics.com/content/portals/entropia/content/gameplay/guides/pebizmodel.php

"Real money spent in the virtual world will generate cash flow, handled by the operators. Such sums may be assumed to be large. Just as an example, if one million simultaneous users, each connected for 1 hour, spend 1 $ (per hour), this generates a cash flow corresponding to 106 * 24 * 365 * 1 = 8,760,000,000 $ per annum. This is a huge amount of money: one percent of this amount corresponds to 87 million $ per annum."

Ponzi would have been proud.
(http://home.nycap.rr.com/useless/ponzi/ :reference from above)

-bruce

[Tengri]

5.

I remember these guys, I tryed to get the free $50 and withdrew it and waited to get paid. Then it bombed out. I remember basically cornering them and forcing them into defensive positions about some issues involiving SG on the chatroom. I was not banned but the smug attitude warranted a serious reality check. Looks like they got it. Any and all the money that went into SG was frozen, plus fines were levyed. These hacks probably had no other real jobs and only a meager investment capital which was used to start SG. So while funds were frozen they spend whatever they could on lawyers which I bet they thought were great at first, then a higher court said "no mas". I'd like to see the looks on their faces now. Famous last words: "...There is something called Personal Jurisdiction..." Yeah and you had/have it. They thought they were beyond the law and that the money was untouchable. Even if people do get away with ripping people off, the dirty money doesnt last. Not even 10 million. They would probably be victims to government run crooks, extortionists, kidnappers, organized crime, you name it "over there". They'd get homesick and want to come back and get caught coming back in or busted later on as they live in the usa, probably to be tax liened into the inability to function or travel abroad anymore. Then subsequently imprisoned with a $3 an hour job pressing license plates. Sorry folks, ordinary people will never make it with hairbrained schemes. You will never be successful with your business school reject looks--good-on-paper widget marketing. Get a real job.

[Tengri]

6.

The irony is if they werent going into this thing with deception and fraud in their hearts. They may have actually gotten somewhere. Greed, they wanted more than "a penny a day for the life of the company". Thats too bad for them.