Could Second Life Be In Serious Trouble? The Risk of Real-Life Legal Consequences for Hosting Virtual Gambling

At the end of 2006, Congress passed the Unlawful Internet Gambling Enforcement Act (UIGEA). The statute forbids banks and other entities from processing payments for Internet gambling transactions. It also tasks the Treasury Department and Federal Reserve with issuing regulations to guide financial institutions in identifying and blocking such transactions. UIGEA can be enforced by both federal agencies and state governments, and violations trigger civil remedies and criminal penalties.

The goal of UIGEA was to stop Americans from betting online - and, indeed, some online casinos are shutting down their U.S. operations. However, Americans can now turn instead to virtual casinos to fulfill their urge to wager. Within the marketplace of the popular online virtual world Second Life, in addition to many legitimate businesses, there also reside hundreds of "virtual" casinos offering slot machines, and card games like poker and blackjack.

Does Second Life's gambling sector violate UIGEA? The creators of Second Life aren't sure. Thus, at their request, FBI agents have been roaming the virtual landscape of Second Life to visit its virtual casinos.

In this column, I'll examine whether UIGEA, in fact, applies to Second Life. Though the law's language is not entirely clear, I believe a good case can be made that Second Life may have a duty, under UIGEA, to prohibit gambling transactions in its community -- as long as its Linden dollars can be converted back into actual U.S. currency.

Second Life's "Linden Dollar" System

Second Life's 4.5 million registered users can exchange their U.S. dollars for "Linden dollars," which can be used to transact business only within Second Life itself. (The name comes from Linden Lab, the San Francisco-based company that runs Second Life.) Though the Linden dollar is often referred to as a virtual currency, no real government issues it. Thus, it is instead, technically, a stored-value or token system.

Linden's Terms of Service agreement, in section 1.4, states that Second Life "currency" is merely a "limited license right available for purchase or free distribution at Linden Lab's discretion, and is not redeemable for monetary value from Linden Lab." The terms further state that users "acknowledge that the Service presently includes a component of in-world fictional currency ("Currency" or "Linden Dollars" or "L$"), which constitutes a limited license right to use a feature of our product when, as, and if allowed by Linden Lab. Linden Lab may charge fees for the right to use Linden Dollars, or may distribute Linden Dollars without charge, in its sole discretion. In addition, section 5.3 states that players have no legal claim to their Linden dollars -- which are merely a class of "data" that can be deleted, altered, moved or transferred at any time. Linden Lab disclaims any value, cash or otherwise, to data residing on its servers. Thus, the currency is "licensed content," for which a license can be revoked as easily as it is granted.

However, one can exchange Linden dollars for U.S. dollars. Residents of Second Life may purchase Linden dollars directly through Linden Lab, or they may use Linden Lab's currency exchange to buy or sell their Linden dollars, or use other third-party currency exchanges to convert between Linden dollars and U.S. dollars. The exchange rate fluctuates daily based on usage.

While it is difficult to estimate the total size of the gambling economy in Second Life, news reports indicate that the three largest poker casinos are earning profits of a modest $1,500 each per month (in U.S., not Linden, dollars). But Second Life is growing rapidly, and its casinos may be benefiting from monies switched from the offshore gambling websites that have been closed down under UIGEA.

Does UIGEA Apply to Second Life - or Could It?

Does UIGEA apply to Second Life's casinos? It's possible - and here's why:

To begin, UIGEA prohibits gambling businesses from accepting credit cards, checks, or other bank instruments from American gamblers who illegally bet over the Internet.

Is it thus illegal, under U.S. anti-gambling statutes, for Second Life casino operators to accept bets placed with Linden dollars? The answer is probably yes. The relevant statutes cover circumstances in which not currency, but simply "something of value," is wagered. And Linden dollars have "value" because they are convertible into U.S. dollars.

But what does that mean for Linden Lab? The UGIEA bans online gambling operators from accepting most forms of funds to be used by the players to gamble on their Websites, to the extent that such transactions occur offshore or are currently illegal under existing state law.

Moreover, subsections (1) to (3) of the relevant statute, 31 U.S.C. Sec. 5363, state that these forms of funds include credit (such as through a credit card), or its proceeds; electronic fund transfers, or money-transmitting-business transfers, or their proceeds; and checks and similar instruments payable through a financial institution.

In addition, subsection (4) of the same Section allows the Board of Governors of the Federal Reserve to issue regulations that would also encompass the "proceeds of any other form of financial transaction…. which involves a financial institution as a payor or financial intermediary on behalf of or for the benefit of such other person." In other words, even if a form of funds does not fit in the first three categories, the Federal Reserve could issue a regulation to deem its system to fall within the fourth, catch-all category.

But wait a minute: Is Second Life off the hook because it is not itself an online gambling operator, but simply a host site where casinos are among a variety of business? The answer is no - as Second Life might still be liable for aiding and abetting Internet gambling.

Moreover, the definition of aiding and abetting set out in the relevant criminal statute is quite broad: It sweeps in anyone who "aids, abets, counsels, commands, [or] induces" a criminal act, or "procures its commission"; and anyone who "willfully causes" an act that, if he had done it directly, would count as a federal crime. And it states that such persons are punishable as if they were the perpetrators themselves.

In addition, the UIGEA also requires payment processors to block transactions to online gambling sites, or face possible enforcement actions by federal regulators. Linden could also potentially be civilly liable as a payment processor, if it is deemed a "financial transaction provider" - a term which encompasses a "creditor, credit card issuer, financial institution, operator of a terminal at which an electronic fund transfer may be initiated, money transmitting business, or international, national, regional, or local payment network utilized to effect a credit transaction, electronic fund transfer, stored value product transaction, or money transmitting service, or a participant in such network, or other participant in a designated payment system." (Emphasis added.)

Note that a "stored value product transaction" is specifically listed here - negating any argument that Linden dollars, since they are not funds or money, fall outside this provision of the UIGEA. Also, to the extent that Linden allows users to exchange money, it may be viewed as a payment processor.

The Catch: Can Linden Lab Effectively Block Illegal Offshore Gambling?

Even if UIGEA does apply to Linden Lab and Second Life, a key question remains: Linden Lab itself is located in California, but where do the casino operator reside? If they are offshore, to what extent can Linden can actually block payments to and from their users?

Perhaps Linden could ask users to provide the source of their funds before allowing users to exchange their currency into U.S. dollars by selling it to willing buyers. On one hand, this would block at least some virtual gambling in Linden dollars from being translated into real-life gambling in U.S. dollars (that is, if users were truthful as to the source of funds). On the other hand, users could lie, leading to the need to verify fund sources.

For the time being, the FBI is simply exploring this virtual world. But eventually, it is likely that some kind of enforcement or voluntary action by Linden Lab will have to occur, so that Second Life's currently modest gambling operations do not surge further to become a much larger problem. If Linden can indeed figure out how it might block payments to its virtual casinos, that might be the best solution.