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Adapting Virtual Finance to

Simulate Financial Information


Security Risk Analysis:
A Risk Management Strategy
by
John W. Bagby
Prof. of IST
Penn State
Abstract
Virtual environments such as Second Life have
progressed to include claimed resident
populations in the missions. Using simulated
versions of persons (avatars) and institutions
(e.g., virtual banks, virtual financial regulators),
these environments fuse gamesmanship with
some real-world behaviors that raise many
interesting social and economic questions.
Research into virtual environments holds
promise to provide a test bed for simulating
economic activities that can provide insights into
the real world of financial information control.
This project uses doctrinal legal research and
public policy analysis to evaluate the application
of traditional real-world law and financial
services regulation to financial activities in
virtual environments. After major areas of public
policy, regulation and law are overviewed with a
view to establishing the breadth and depth of
traditional law topics as the major constraints
and opportunities impacting virtual finance, the
potential for money laundering in virtual
environments is explored.

Key Words:
banking regulation, counterfeiting,
counter terrorism, EULA, financial
information assurance, gamblinggaming, ISP duties, investigations,
metadata, money laundering, online
contracting, online markets, risk
management, IP, law enforcement,
political economy, pre-trial discovery,
prediction markets, racketeering, virtual
environments

Introduction
Virtual environments are considered
by many as no more than fantasy 1 games
with little real-world impact. However,
this is short sighted. These massively
multiplayer online role-playing games
(MMORPG or Morpeg) and the other
massively multiplayer online games
(MMOG) have proliferated in recent
years. The distinction between their
hypothetical impact and real-world
impact is blurring. 2 While Second Life
from Linden Labs claims to be
distinguishable from other MMORPGs,
the success of Second Life is a useful
exemplar that will be invoked in this
paper to illustrate the potential impact of
all MMORPGs and MMOGs. Second
Life claims nearly 13 million
residents. 3 When estimates of regular
participation in other MMOG is also

This project has included prior research was


presented at the conference, Playing to Win: The
Business and Social Frontier of Videogames,
Penn State Outreach program of the College of
Communications, April 4, 2008, see Bagby ,
John W., Public Policy in the Virtual World:
Imagining How It Could Curb Your w00t. The
term wt is apparently recently coined idiom
referring to the joy experienced by hackers when
penetrating system defenses, but also
increasingly serves as an expression of triumph
for online gamers, see Szep, Jason, w00t
crowned word of year by U.S. dictionary,
Reuters, Dec. 11, 2007 accessible at:
http://www.reuters.com/article/internetNews/idU
SN1155159520071212
2
Castranova, Edward, SYNTHETIC WORLDS: THE
BUSINESS AND CULTURE OF ONLINE GAMES
(University of Chicago Press, 2005).
3
As of 3.18.08, Linden Labs claims 12,882,479
residents, defined as a uniquely named avatar
with the right to log into the Second Life world,
trade Linden dollars and visit the Community
pages. Casual users without official registration
may amount to many more potential resident
candidates.
http://secondlife.com/whatis/economy_stats.php

Adapting Virtual Finance to Simulate Financial Information Security


Risk Analysis: A Risk Management Strategy
considered, 4 and even after adjustments
are made for overlap among single
players participating in multiple
environments, it is clear that MMOGs
are significant activities worthy of
analysis using public policy. This paper
will analyze virtual environmental policy
issues by discussing end-user license
agreements (EULA), user property rights
and the accompanying financial services
that enable exchange in the new markets
created.

(e.g., scrip, Linden Dollars) and the


effectiveness of virtual finance
regulatory institutions. For example,
such markets suggest that banking and
contest restrictions may impede some
business models that facilitate user
conversion of virtual currencies to real
world currencies.
The matters introduced above, as
well as others likely to arise in virtual
environments, have led to real world
litigation and regulatory enforcement
analyzed in this paper. The end user
licensing agreements (EULAs) adopted
by virtual environments, most notably
the Linden Lab Terms of Service (ToS),
are analyzed. A select group of key
EULA provisions are assessed within the
policy framework of virtual
environments described above as they
impact the stability of managing virtual
environments and as they provide for
fair and balanced approaches to the
resolution of future policy problems
likely to arise as virtual environments
flourish. This analysis is used to inspire
prediction of how public policy in the
real world can benefit from simulated
activities in virtual environments. It is
anticipated that experience with virtual
finance can aid in setting standards in
the real world.

This paper first explores the range of


law, regulation and public policy
concerns likely to constrain and enable
online and virtual financial transactions
and institutions. Next, recent case law
from the real world directly concerning
virtual environments is integrated into
this framework to identify the pressing
policy issues that may impact virtual
finance. For example, the courts are
grappling with the recognition that
disputes arising in virtual environments
are susceptible to resolution by courts or
arbitration. Another interesting problem
accompanies user development and
modification of characters and virtual
environmental elements protectable
under copyright, trademark or other
intellectual property (IP) scheme.
Markets for goods, services and financial
transactions have developed in virtual
environments raising the question of
enforceability of agreements among
users, the development of virtual
property rights, the difficulties of
developing new mediums of exchange
by the virtual environment or by users

Virtual environments encourage


creativity clearly within traditional
intellectual property rights (IP) regimes.
For example, users develop and modify
characters and virtual environmental
elements or virtual objects protectable
under copyright, trademark or other IP
schemes. In the medieval genre of some
pioneering virtual environment games, a
user might develop an avatar, assets
(sword, bomb, land, clothing, currency)

Bruce Sterling Woodcock (b.1970, Missouri) is


a video games industry analyst who tracks
participation of users in massively multiplayer
online games on this website:
http://www.mmogchart.com/

Adapting Virtual Finance to Simulate Financial Information Security


Risk Analysis: A Risk Management Strategy
Penetrating vWorlds with
Policy: Jurisdiction - the
Threshold Challenge

and develop a reputation possibly


expressed as experience points but
somewhat equivalent to traditional
goodwill. It seems clear that at least
some Second Life users intend to
straddle between this virtual
environment and the real world given the
incentives to build profitable business
models around innovative activities. 5

Alternative dispute resolution (ADR)


is generally favored under U.S. federal
law 8 even to the exclusion of contrary
state law. 9 To the extent that virtual
environments have valid provisions
concerning the choice of law and choice
of forum, including ADR largely
deploying arbitration, such provisions
should generally be enforceable absent
violation of a compelling public policy.
Indeed, online dispute resolution (ODR)
is a growing phenomenon, 10 as
exemplified by the cost-effective, online
arbitration-like trademark infringement
process: the Uniform Domain-Name
Dispute Resolution Policy (UDRP)
sponsored by the International
Corporation for Assigned Names and
Numbers (ICANN). 11 There appears no

A tension is noted on how well the


objectives of some virtual environment
participants can be accommodated, that
is, the insistence that virtual
environments should and can remain
isolated or secede from traditional public
policy influences. The interaction among
various potentially applicable domains in
law strongly suggests that piecemeal and
focused inquiry on particular issues is
unlikely to develop a coherent profile of
virtual environment public policy.
Further cyber-libertarian 6 inspired
insistence on the separation of virtual
environments from the real world will
only serve to complicate the
transparency and fairness of the likely
interactions among such policy
concerns. 7

Federal Arbitration Act, 9 U.S.C. 1-16,


201-208, and 301-307, 43 Stat. 883,
amended Pub. L. 101369, Aug. 15, 1990, 104
Stat. 450, and Pub. L. 91368, July 31, 1970, 84
Stat. 693,.
9
Arbitration agreements are generally
enforceable and state laws hindering
enforcement of arbitration agreements are
preempted, but state laws defining arbitration
processes are not covered by pre-emption
provisions of the Federal Arbitration Act, see
Southland Corp. v. Keating, 465 U.S. 1 (1984);
Mitsubishi Motors Corp. v. Soler ChryslerPlymouth, Inc.473 U.S. 614 (1985); Perry v.
Thomas, 482 U.S. 483 (1987); Volt Info. Scis. v.
Bd. of Trs., 489 U.S. 468 (1989); Allied-Bruce
Terminix Cos. v. Dobson, 513 U.S. 265 (1995);
Doctor's Assoc., Inc. v. Casarotto, 517 U.S. 681
(1996).
10
Katsh, E. E., Katsh, M. E., and Rifkin, J.
ONLINE DISPUTE RESOLUTION: RESOLVING
CONFLICTS IN CYBERSPACE, John Wiley & Sons,
Inc. (New York, 2001).

Sinrod, Eric J., When virtual legal chickens


come home to roost, Nov. 8, 2007, c|net,
news.com accessible at:
http://www.news.com/When-virtual-legalchickens-come-home-to-roost/2010-1043_36217255.html
6
Winner, Langdon, Cyberlibertarian Myths And
The Prospects For Community, ACM SIGCAS
Computers and Society, Vol.27, No.3
(September 1997). See also Epilogue at the end
of this paper.
7
See generally Duranske, Benjamin Tyson,
VIRTUAL LAW: NAVIGATING THE LEGAL
LANDSCAPE OF VIRTUAL WORLDS (forthcoming:
April 2008; ISBN: 1-60442-009-X, Am.Bar
Assn.).

11

Uniform Domain Name Dispute Resolution Policy,


ICANN (August 26, 1999, published October 24,
1999); see generally Bagby, John W. & John C.

Adapting Virtual Finance to Simulate Financial Information Security


Risk Analysis: A Risk Management Strategy
compelling reason to bar well-conceived
ADR or ODR techniques from virtual
environments. However, as discussed
below, ADR provisions and ADR
practices must meet minimum standards
of fairness.

developer and service provider of adultthemed avatars 15 used in Second Life.


Eros claims to advertise and promote its
virtual sex toys under the mark SexGen
and further claims to be among the most
successful merchants selling virtual
objects in Second Life selling thousands
of items in interstate commerce. 16 Eros
claimed copyright and trademark
infringement by various in world
personas.

Litigation Among Users


Despite the clear preference by
participants in virtual environments to
avoid disputes altogether or to settle
disputes using ADR/ODR, such disputes
are nevertheless migrating to the courts
as exemplified by the Eros SexGen cases
filed or disposed in various federal
courts, including New York 12 and
Florida, 13 as well as interpretations of
the ToS for Linden Research (Linden
ToS) in the Bragg case in the Eastern
District of Pennsylvania. 14 Consistent
with many pioneering cyberlaw matters
(e.g., jurisdiction, electronic payments,
intellectual property,
obscenity/indecency), the Eros cases
may become the seminal virtual
environment precedents by conferring
jurisdiction on the courts in the
inevitable issues raised. Eros is the

In the New York litigation,


identifying and serving defendant
15

The term avatar is derived from ancient Hindu


philosophy referring to the incarnation or bodily
manifestation of a divine being. In modern
usage, avatar refers to virtual objects, personas or
directed animation that represent the appearance,
personality and powers of users as they have
adorned themselves in the virtual environment.
Therefore, a users avatar is unlikely to exactly
mirror the users real-life persona because virtual
worlds appear to encourage users to live out
their fantasies adopting aggrandized
personifications as manifest in avatars with
special characteristics. For example, normal
users may adopt avatars with greater beauty,
strength, intelligence and wealth than the user
possesses in the real world. This fantasy
improvement may be precisely the allure of
virtual environments enabling the users human
shortcomings to be largely overcome through the
unique design and development of avatars as
intellectual property as well as the purchase of
superior avatars in virtual transactions using
legal consideration inherent in virtual
transactions. See e.g., Damer, B., J. Judson, J.
Dove, AVATARS!; EXPLORING AND BUILDING
VIRTUAL WORLDS ON THE INTERNET, (1997
Peachpit Press, Berkeley) and Barfield,
Woodrow, Intellectual Property Rights in Virtual
Environments: Considering the Rights of
Owners, Programmers and Virtual Avatars, 39
Akron L. Rev. 649, 649 (2006).
16
Eros LLC v. Thomas Simon, 1:07-cv-04447SLT-JMA (E.D.N.Y. Oct. 24, 2007) Complaint
at 4.
http://www.virtuallyblind.com/files/07_10_24_er
os_et_al_v_simon_complaint.pdf

Ruhnka, Turmoil in dns Governance and its


Merger into Trademark Law, electronic
proceedings of the 32nd Telecommunications
Policy Research Conference, Oct.1 3, 2004,
accessible at
http://web.si.umich.edu/tprc/papers/2004/378/TP
RC-04-tmDomNaMergerFinal.htm
12
Eros LLC v. Thomas Simon, 1:07-cv-04447SLT-JMA (E.D.N.Y. Oct. 24, 2007) accessible
at
http://www.virtuallyblind.com/files/07_10_24_er
os_et_al_v_simon_complaint.pdf
13
Eros LLC v. Leatherwood, No. 8:07-CV01158 (M.D. Fla. filed July 3, 2007) accessible
at: http://docs.justia.com/cases/federal/districtcourts/florida/flmdce/8:2007cv01158/202603/1/0
.pdf
14
Bragg v. Linden Research, Inc., 487 F. Supp.
2d 593 (E.D.Pa. May 30, 2007).

Adapting Virtual Finance to Simulate Financial Information Security


Risk Analysis: A Risk Management Strategy
Thomas Simon was simple, particularly
when compared with Eros challenges in
the Florida case discussed next. 17 In
New York, Eros and other named
plaintiffs claim that Simon, who goes by
the pseudonym Rase Kenzo in world,
participated in a conspiracy with others
to infringe trademarks and copyrights of
Eros and the other plaintiffs. 18 The
parties in the New York case consented
to the entry of judgment and order
compelling Simon to pay $525 in
damages, certifying Simons destruction
of infringing copies of virtual properties,
imposing a permanent injunction against
Simons future infringement, imposing
confidentiality about the settlement and
its terms, and permitting access to
Simons PayPal financial records and
Linden Labs transaction records to
verify compliance.

environment (i.e., in world). Initially


brought against unnamed John Does,
Eros was forced repeatedly to amend its
complaint as well as seek subpoena
power against ISPs, TelCos, online
payment services and VEOSPs before
the defendants true identity was
eventually discovered. Indeed, victims of
wrongful acts in the virtual world
continually confront layered obstacles in
identifying wrongdoers identities,
residences and asset locations and these
difficulties can be more formidable than
is typically encountered by litigants in
the real world. 19 Defendant Leatherwood
allegedly failed to appear or plead,
operated under misleading
pseudonyms 20 (e.g., Volkov Catteneo,
19

At least two components of transaction costs


are at work here: 1st the out of pocket expenses
for private investigatory work both expended
pre-filing and during pre-trial discovery can be
extensive but usually are needed to gain some
foothold in the litigation traditionally filed
against John or Jane Does; 2nd the extensive pretrial discovery motion practice, subpoena
justification and enforcement is a wellrecognized component of litigation costs often
cited as the primary justification for tort reform.
Such costs are nearly infeasible when the parties
reside in different countries, particularly if
defendants reside in nations hostile to private
civil litigation or are hostile to the economic
interests of opponents from some particular
nations.
20
Many Morpeg participants use pseudonyms
different from their own names. While it is
unclear whether anonymity is the primary
motivation, such pseudonyms may also serve a
suggestive function hinting at some feature of
their avatar or of the in world reputation they
seek to build, maintain and enhance. For
example, Eros CEO Alderman admittedly
operates in world under the pseudonym of
Stroker Serpentine, arguably a patently obvious
sexual reference. Eros LLC v. Leatherwood, No.
8:07-CV-01158 (M.D. Fla. Filed July 3, 2007)
(complaint at 3) accessible at:
http://docs.justia.com/cases/federal/district-

The Florida litigation more clearly


illustrates the real world costs of
pursuing the users assuming disguises
while operating inside the virtual
17

Thomas Simon is identified as an individual


residing at a revealed address on 120th St. in
Flushing New York, Eros LLC v. Thomas
Simon, 1:07-cv-04447-SLT-JMA (E.D.N.Y. Oct.
24, 2007) Complaint at 2.
http://www.virtuallyblind.com/files/07_10_24_er
os_et_al_v_simon_complaint.pdf
18
The DE Designs claims against Thomas Simon
concern trademark infringement of virtual items
such as clothing, Complaint at 6. The RH
Designs claims involve copyright infringement
of virtual home furnishing accent pieces,
Complaint at 7. The Le Cadre Network claims
copyright infringement of stylish virtual shoes
and boots, Complaint at 9. The Nomine claims
involve copyright infringement for avatar
skins, Complaint at 11. The Pixel Dolls claims
allege copyright infringement of clothing
Complaint at 12. Most of these claims allege
notoriety and news media coverage reinforcing
their products favorability.

Adapting Virtual Finance to Simulate Financial Information Security


Risk Analysis: A Risk Management Strategy
beyond reach of real world justice. 23
Eros preempted any threat that Linden
Labs might assert the privacy right to
undertake anonymous speech by briefing
the exception in motions for subpoenas
and Eros OSP subpoenas were
immediately granted. The right to make
anonymous speech under the First
Amendment is qualified, particularly in
pre-trial litigation when anonymity
would create injustice. 24 In granting
Eros various discovery motions, the
Florida court impliedly holds that hiding
behind pseudonyms to shield wrongful
acts is not protected anonymous speech
when there is (i) a prima facie claim of
actionable harm, (ii) discovery request is
specific, (iii) no reasonable alternative
means exists to obtain the subpoenaed
information, (iv) the party advancing the
claim needs the subpoenaed information
and these four factors are balanced
against the other partys reasonable
expectation of privacy. 25 Eros IP
infringement claims were sufficient
prima facie, Eros sought narrow and
specific information essential to
identifying Leatherwoods identity and
Eros had undertaken considerable
alternative investigatory expense
already. Leatherwoods claim of privacy
would be trumped by his OSPs policy
of respect to court orders or other legal
process thereby defeating any reasonable
expectation of privacy. 26

Aaron Long) yet admitted infringement


to a Reuters reporter inside Second
Life. Eros encountered resistance from
both VEOSP-Linden Labs and online
payment service - Pay Pal in Eros
attempt to discover Leatherwoods real
world identity. Further difficulties were
encountered from AT&T and Charter
Communications 21 under these Internet
Service Providers (ISP) privacy policies
resisting the revelation of Leatherwoods
true identity absent a subpoena. 22
In one virtual news report,
Leatherwood made defiant claims that
in world he had no financial exposure,
held an unidentifiable real world
identity, had misrepresented his identity
to Linden Labs and thus boasted he was

courts/florida/flmdce/8:2007cv01158/202603/1/0
.pdf
21
Eros investigation initially obtained Internet
protocol (IP) addresses from which Leatherwood
allegedly conducted infringement of Eros IP.
AT&T and Charter initially declined to provide
Leatherwoods real-world contact information
Eros sought (name, address, telephone number,
email address, payment information) including
additional unique identifiers such as Media
Access Control (MAC) and Ethernet Hardware
Addresses (EHA) directly associated with
Leatherwoods IP addresses. MAC and EHA
numbers allow identification of the actual
computer or other computer hardware associated
with the use of a particular IF address. Eros
LLC v. Leatherwood, No. 8:07-CV-01158 (M.D.
Fla. filed Oct. 24, 2007) (ex parte emergency
motion for discovery filed Sept. 4, 2007)
accessible at:
http://docs.justia.com/cases/federal/districtcourts/florida/flmdce/8:2007cv01158/202603/9/0
.pdf
22
Eros LLC v. Leatherwood, No. 8:07-CV01158 (M.D. Fla. filed Oct. 24, 2007) (order
granting subpoenas Sept. 5, 2007) accessible at:
http://docs.justia.com/cases/federal/districtcourts/florida/flmdce/8:2007cv01158/202603/10/
0.pdf

23

See Reuters, Eric, SL business sues for


copyright infringement, Reuters/Second Life
News Center, July 3, 2007 accessible at
http://secondlife.reuters.com/stories/2007/07/03/
sl-business-sues-for-copyright-infringement
24
See e.g., Sony Music Ent. Inc. v. Does 1-40,
326 F.Supp. 2d 556 (S.D.N.Y. 2004).
25
Id. at 564-5.
26
Sony Music, 326 F. Supp. 2d at 566-67; In Re
Verizon Internet Servs., Inc., 257 F. Supp. 2d
244,260-61 (D.D.C. 2003), rev'd on other

Adapting Virtual Finance to Simulate Financial Information Security


Risk Analysis: A Risk Management Strategy
Litigation with vEnvironment
Sponsor

The default judgment in Eros


validates both jurisdiction and
justiciability claims in virtual
environment disputes. A default
judgment 27 and later reported
settlement 28 in the Leatherwood case
signals at least two important procedural
points. 29 First, property interests and
transactions seemingly limited to virtual
environments nevertheless spill over into
the real world and become enforceable
in real world tribunals. Second, the
demographic profiles of at least some
virtual world users is such that full
participation in real world tribunals may
be incomprehensible or discouraged as
too costly and may be misperceived as
insignificant. 30

A significant dispute resolution case


brought directly against Linden Research
also illuminates the difficulties of ADR
and ODR choice of forum and choice of
law terms in Morpeg EULAs. Indeed,
the Bragg v. Linden Research case was
particularly troublesome for the Linden
ToS. 31 Pennsylvania attorney Marc
Bragg, was a registered Second Life user
for nearly two years, having purchased
various virtual properties, including a
parcel of virtual land named Taessot
and also became engaged in virtual
fireworks sales. In May 2006, Braggs
account was frozen following a Linden
email allegation of Braggs fraudulent
virtual land transaction improperly
purchased through an exploit. Second
Life seized his property and suspended
his membership effectively confiscating
his Second Life participation, virtual
property and virtual currency. 32 The
Linden ToS required arbitration of such
claims but the trial court invalidated the
EULAs arbitration provisions holding
them both procedurally and
substantively unconscionable. 33

grounds Recording Indus. Ass'n ofAmerica, Inc.


v. Verizon Internet Servs., Inc., 351 F.2d 1229
(D.C. Cir. 2003).
27
Eros LLC v. Leatherwood, No. 8:07-CV01158 (M.D. Fla. filed Oct. 24, 2007) (default
judgment entered Nov. 16, 2007) accessible at:
http://docs.justia.com/cases/federal/districtcourts/florida/flmdce/8:2007cv01158/202603/15/
0.pdf.
28
Settlement of default judgment likely brings
something more to the table. Among the possible
new factors might be a heightened probability of
Eros loss on appeal regarding the discovery of
Leatherwoods identity, some weakness in the IP
claims or an unknown collateral claim.
29
Eros LLC v. Leatherwood, No. 8:07-CV01158 (M.D. Fla. filed Oct. 24, 2007) (default
judgment entered Nov. 16, 2007) accessible at:
http://docs.justia.com/cases/federal/districtcourts/florida/flmdce/8:2007cv01158/202603/15/
0.pdf.
30
News reports from in world illustrate that
Leatherwood was a nineteen year old with little
respect for legal process or its impact. See
Reuters, Eric, Volkov Catteneo: Yes, I am Robert
Leatherwood, Reuters/Second Life News Center,
Mar. 3, 2008 accessible at
http://secondlife.reuters.com/stories/2008/03/06/
volkov-catteneo-yes-i-am-robert-leatherwood/

Like other Second Life users, Bragg


manifest mutual assent to Linden ToS
through a clickwrap. 34 The general
31

Bragg v. Linden Research, Inc., 487 F. Supp.


2d 593 (E.D.Pa. May 30, 2007).
32
Id. at 597.
33
Id. at 611. Judge Robreno openly expressed
that concerns with procedural unconscionability
are somewhat mitigated by Bragg's being an
experienced attorney.
34
Specht v. Netscape, 150 F.Supp.2d 585
(.D.N.Y.2001) (This principle of knowing
consent applies
with particular force to provisions for
arbitration.).

Adapting Virtual Finance to Simulate Financial Information Security


Risk Analysis: A Risk Management Strategy
enforceability of clickwrap as assent
offers huge transaction cost savings 35 to
those deploying the electronic agents36
underlying the clickwrap, such as many
Morpegs. However, clickwrap scriveners
run similar risks as does any opportunist
taking personal, first mover advantage to
set terms. Foremost among these is the
other partys ignorance of the
significance of issues involved in any
particular term and the more general
trivialization of all terms when
standardized forms are repeatedly
deployed. Scrivener issues have plagued
many forms of boiler plate as evident
in this comparison between clickwrap
and shrink-wrap licenses:

the seller during online registration


through the users modem or Internet
connection. Websites requiring
clickwrap assent may cause an
immediate transmission of the
agreement back to the website
operator. The clickwrap is similar to
the shrink-wrap because both impose
standardized licensing terms to
which users agree by conduct.
Clickwraps are likely to be
enforceable under the same standards
applicable to shrink-wraps.
However, both may be vulnerable to
invalidation as unconscionable or an
adhesion contract. 37
Bragg agreed to an arbitration clause that
was buried, at that time, in the Linden
ToS under a catch-all heading General
Provisions. 38 When Bragg sought to

Purchasers of packaged software and


web sites frequently prevent use of
the software or access to a website
unless the user clicks affirmatively I
Agree during software installation
or before accessing website content.
Packaged software using a clickwrap
license can record the assent on the
users computer, although it is more
reliable to transmit the assent back to

37

Bagby, John W. & F. William McCarty, THE


LEGAL AND REGUALTORY ENVIRONMENT OF EBUSINESS: LAW FOR THE CONVERGING
ECONOMY, (West, 2003) at 306.
38
Linden has since made separate and more
conspicuous their choice of law, choice of forum
and arbitration provisions, and, in addition,
arbitration is no longer mandatory.

35

See e.g., Kuttner, Robert, The Net: A Market


Too Perfect for Profits, Bus. Wk., May 11, 1998,
at 20 (arguing ubiquitous Internet information
weakens seller profit opportunities that are based
on persistent asymmetric information due to
expected search costs).
36
Electronic Agents are defined in at least
three U.S. laws of general application as a
computer program or an electronic or other
automated means used independently to initiate
an action or respond to electronic records or
performances in whole or in part without review
or action by an individual at the time of the
action or response. 15 USCS 7006(3) (2006)
(Federal E-SIGN) see also similar treatment of
electronic agents in UNIFORM ELECTRONIC
TRANSACTIONS ACT (UETA) and UNIFORM
COMPUTER INFORMATION TRANSACTIONS ACT
(UCITA).

DISPUTE RESOLUTION
If a dispute arises between you and Linden
Lab, our goal is to provide you with a
neutral and cost-effective means of
resolving the dispute quickly. Accordingly,
you and Linden Lab agree to resolve any
claim or controversy at law or in equity that
arises from or relates to this Agreement or
our Service (a "Claim") in accordance with
one of the subsections below.
7.1 Governing Law. This Agreement and
the relationship between you and Linden
Lab shall be governed in all respects by the
laws of the State of California without
regard to conflict of law principles or the
United Nations Convention on the
International Sale of Goods.

Adapting Virtual Finance to Simulate Financial Information Security


Risk Analysis: A Risk Management Strategy
challenge the seizure of his property
more conveniently in Pennsylvania state
court, Linden sought removal to federal

court and then sought enforcement of the


arbitration agreement.
The then extant dispute resolution
provisions of the Linden ToS were both
procedurally and substantively
unconscionable. Procedural
unconscionability addresses the
cognition, consideration and negotiation
of the suspect clause(s) and is shown by
(1) oppression through the existence of
unequal bargaining positions or (2)
surprise through hidden terms common
in the context of adhesion contracts. 39
Lindens ToS were arguably tainted
under both forms of procedural
unconscionability, first, the unequal
bargaining, non-negotiable, take-it-orleave-it terms, were exacerbated by a
lack of alternative Morpegs and second,
the arbitration clause was a hidden
component, tantamount to an adhesion
contract, given that Lindens placed it in
a miscellaneous or catch-all category.
Substantively unconscionable provisions
are overly harsh or one-sided results
that shock the conscience such as in
the weaker bargaining position of
Second Life users in relation to Linden
(mutuality). As scrivener, Linden
retained self-help remedies which were
manifest in freezing Braggs account and
confiscating Braggs property. By
contrast, Bragg was only entitled to
arbitration. When this one-sided
remedies situation is combined with the
costs of arbitration, the remoteness of
the California venue and the scriveners
strategic advantage in dispute resolution
from confidential arbitration, these

7.2 Forum for Disputes. You and Linden


Lab agree to submit to the exclusive
jurisdiction and venue of the courts located
in the City and County of San Francisco,
California, except as provided in Subsection
7.3 below regarding optional arbitration.
Notwithstanding this, you agree that Linden
Lab shall still be allowed to apply for
injunctive or other equitable relief in any
court of competent jurisdiction.
7.3 Optional Arbitration. For any Claim,
excluding Claims for injunctive or other
equitable relief, where the total amount of
the award sought is less than ten thousand
U.S. Dollars ($10,000.00 USD), the party
requesting relief may elect to resolve the
Claim in a cost-effective manner through
binding non-appearance-based arbitration. A
party electing arbitration shall initiate it
through an established alternative dispute
resolution ("ADR") provider mutually
agreed upon by the parties. The ADR
provider and the parties must comply with
the following rules: (a) the arbitration shall
be conducted, at the option of the party
seeking relief, by telephone, online, or based
solely on written submissions; (b) the
arbitration shall not involve any personal
appearance by the parties or witnesses
unless otherwise mutually agreed by the
parties; and (c) any judgment on the award
rendered by the arbitrator may be entered in
any court of competent jurisdiction.
7.4 Improperly Filed Claims. All Claims
you bring against Linden Lab must be
resolved in accordance with this Dispute
Resolution Section. All Claims filed or
brought contrary to this Dispute Resolution
Section shall be considered improperly filed.
Should you file a Claim contrary to this
Dispute Resolution Section, Linden Lab
may recover attorneys' fees and costs up to
one thousand U.S. Dollars ($1,000.00 USD),
provided that Linden Lab has notified you in
writing of the improperly filed Claim, and
you have failed to promptly withdraw the
Claim.
See the Linden ToS, accessible at
http://secondlife.com/corporate/tos.php

39

Comb v. Paypal, Inc., 218 F. Supp. 2d 1165,


1172 (N.D. Cal. 2002) (applying California law
of unconscionability to PayPal arbitration
clause).

Adapting Virtual Finance to Simulate Financial Information Security


Risk Analysis: A Risk Management Strategy
factors combine to a substantive
unconscionability. 40

component(s): (1) private property rights


and (2) enforceability of contracts.

Raising the vStakes: Real IP,


Real Money & Real Markets

The first component is the existence


of private property rights because they
attract investment by individuals and
other rights holders (e.g., corporations).
Individuals, when entitled to capture the
fruits of their labor and ingenuity, have
stronger incentives to divert time and
energy from other pursuits to
concentrate on projects with promise for
success. A key component to this benefit
capture is the exclusion of others from
enjoying the benefits. The clear corollary
in virtual environments is that
intellectual property (IP), as one of the
two primary forms of private property in
virtual environments, is optimized when
adequately incentivized. Indeed, the
enforceability of IP and trade in IP lies at
the heart of the Linden litigation
discussed in this paper.

A common mantra for the success of


democratic capitalism holds that the
enforceability of private property rights
is essential to the creation of markets
and thus the inherent incentives towards
innovation and excellence that
characterize the success of the American
experience. 41 Assuming these conditions
are also necessary for the growth and
vitality of virtual environments, 42 then
the legal issues discussed above
underscore at least two major
components to this precondition,
including some additional sub40

Judge Robreno openly expressed that


concerns with procedural unconscionability are
somewhat mitigated by Bragg's being an
experienced attorney.
41
See e.g., Younkins, Edward, The Conceptual
Foundations of Democratic Capitalism, The
Social Critic (Winter 1998) and sources cited
therein.
42
Contrary arguments to enforceability of
private property rights as pre-condition to virtual
world order might be asserted. Virtual
environments flourished before any development
of the caselaw discussed herein. Therefore, there
must be alternative sufficient conditions that
incentivized participation. For example, the
incentive to engage in gaming is often tied to
innate needs for socialization or that virtual
environment activities offer other intrinsic
rewards, such as amusement and pleasure.
Perhaps these are sufficient motivators without
reference to classic economic incentives.
However, it may no longer be necessary to
construct conceptual justification for virtual
environment participation. The interposition of
real world stakes now likely explains at least
some in world activity. As more participants
personally bear the wealth effects of their in
world activities, traditional economic concepts
become plausible, a mix of incentives seems
likely just as exist in the real world.

The second component is the


enforceability of contracts. The
enjoyment and incentives from property
rights are limited unless such private
property rights are alienable. The
attractiveness of creating and holding
property is enhanced as markets develop
to trade property rights and reliable
media of exchange can be deployed to
facilitate the clearance of transactions in
these markets. A clear corollary is that
markets are viewed as reliable and
efficient when they meet various
conditions of transparency, open access
and reliability. Law has traditionally
supplied various methods to reinforce
these market factors, such as through
enforceable duties of non-deception,
fairly universal access reducing the
barrier to entry into markets by most
buyers and sellers and the enforceability
10

Adapting Virtual Finance to Simulate Financial Information Security


Risk Analysis: A Risk Management Strategy
step enables Eros follow-on claim to
ownership and legal protection of at least
two of its virtual objects 44 that it
registered under U.S. copyright law: 45
Item I the SexGen Platinum Base Unit
v4.01 and Item II the SexGen
Platinum+Diamond Base v5.01. Eros
further alleged willful conduct entitling
Eros to injunctive relief, impound of
infringing items, actual damages, interest
and attorneys fees for alleged copying,
displaying, distributing and selling
copies of the Items without Eros's
authorization. 46 Similar allegations
were made in Simon, the New York Eros
case, including infringing sales,
misrepresentation of origin, palming off
and goodwill damage and several claims
under conspiracy theories. 47

of contracts underlying all such market


transactions.
The following discussion will use the
democratic capitalism framework for the
analysis of public policy applicability to
virtual environments. However, rather
than argue that virtual environments
necessarily depend on enforceable
private property, the following presumes
some portfolio of incentives including
enforceable private property. A stronger
link between democratic capitalism and
public policies of virtual environments
can be drawn given two factors. First,
the evolving Linden ToS clearly
subsume and apply enforceable private
property rights. Arguably, the success of
Second Life depends on a social
ordering derived from familiar public
policy. Second, the expectations of
Morpeg users are likely evolving to
include free market transactions in the
virtual IP using barter, media of
exchange (e.g., L$) and the
convertibility of virtual currency into
real-world currency. The next sections
discuss the property rights aspects of
these market facilitating conditions as
adapted from the real world of
democratic capitalism under copyright
and trademark law.

create in Second Life, to the extent that you


have such rights under applicable law.
However, you must make certain
representations and warranties, and provide
certain license rights, forbearances and
indemnification, to Linden Lab and to other
users of Second Life.
In detailed commentary, the Linden ToS retains
to Second Life a royalty-free, worldwide, fully
paid-up, perpetual, irrevocable, non-exclusive
right and license to use, reproduce and distribute
your Content within the Service as permitted by
you through your interactions.
44
Eros LLC v. Leatherwood, No. 8:07-CV01158 (M.D. Fla. filed July 3, 2007) amended
complaint at 4 accessible at
http://docs.justia.com/cases/federal/districtcourts/florida/flmdce/8:2007cv01158/202603/11/
0.pdf
45
17 U.S.C.101 (2006).
46
Eros LLC v. Leatherwood, No. 8:07-CV01158 (M.D. Fla. filed July 3, 2007) amended
complaint at 9 accessible at
http://docs.justia.com/cases/federal/districtcourts/florida/flmdce/8:2007cv01158/202603/11/
0.pdf
47
Eros LLC v. Thomas Simon, 1:07-cv-04447SLT-JMA (E.D.N.Y. Oct. 24, 2007) accessible
at
http://www.virtuallyblind.com/files/07_10_24_er

IP in vWorld Expression
In Leatherwood, the Florida Eros
case, Eros admits that the Linden ToS
govern user participation in Second Life.
For Eros this admission bootstraps IP
rights because users retain IP rights in
digital content created, inserted into or
otherwise owned in world. 43 This first
43

Linden ToS 3.2 general rule:


You retain copyright and other intellectual
property rights with respect to Content you

11

Adapting Virtual Finance to Simulate Financial Information Security


Risk Analysis: A Risk Management Strategy
ISP Duties of vEnvironment
Sponsors

down provisions that enable I/OSPs to


take advantage of the safe harbor.

The U.S. has implemented at least


two international copyright treaties with
legislation following negotiations at the
World Intellectual Property Organization
(WIPO). In 1997, Digital Millennium
Copyright Act (DMCA) represented the
implementation to these two treaties: the
WIPO Copyright Treaty and the WIPO
Performances and Phonograms Treaty. 48
The DMCA creates civil and criminal
prohibitions against tampering with copy
protection schemes or billing data
accompanying digital works. Although
no new exclusive right in the copyright
bundle were added and the DMCA is not
well-integrated into existing copyright
law, the DMCA nevertheless has a
substantial preemptory and in terrorem
impact, particularly on I/OSPs. The
DMCA provides penalties for interfering
with the lock down 49 of works
reinforcing technical access controls to
protected works. The traditional focus of
infringement was on unlicensed or unfair
use of a work. Out of the DMCAs
major provisions, (1) anti-circumvention
rules, (2) anti-circumvention exceptions,
(3) copyright management information
and (4) the safe harbor for I/OSPs, the
latter is well-documented in some
Morpeg ToS. This section briefly
discusses the Linden ToS focus on its
implementation of the DMCAs take

Several early Internet era laws


recognized the extraordinary and unfair
potential for I/OSPs in republishing
defamatory, fraudulent, infringing or
obscene materials by offering safe
harbors. Like the Communications
Decency Act, 50 the DMCAs safe harbor
applies protects innocent I/OSPs when
acting as a mere conduits for users
misconduct. To fall within the DMCA
safe harbor and not be liable for
(contributory) infringement, the I/OSP
must devise and enforce a program to
terminate subscribers who repeatedly
infringe and receive notice and take
down of infringing content. Second Life
would appear to have takedown policies
and procedures directed to achieve this
immunity. However, the I/OSP safe
harbor is again involved in high stakes
litigation, Viacom v. YouTube, so
uncertainties and liability risks are likely
to remain. 51
Second Life confirms a commitment
to stay well within the DMCA safe
harbor. The Linden ToS prominently
display a heading for the DMCA. 52
Indeed, in an italic paragraph after the
beginning paragraph, users are reminded
that the DMCA is not an in world
consequence:
Please note that these [DMCA]
notifications and counternotifications are real-world legal

os_et_al_v_simon_complaint.pdf see also


pleadings collected at:
http://dockets.justia.com/docket/courtnyedce/case_no-1:2007cv04447/case_id-274521
48
Pub. L. No. 105-304, 112 Stat. 2860 (Oct. 28,
1998).
49
See e.g., Julie E. Cohen, Lochner in
Cyberspace: The New Economic Orthodoxy of
Rights Management, 97 Mich.L.Rev. 462 (1998).

50

47 U.S.C. 230(c) (2006).


Viacom v. YouTube, 07 civ. 2103 (SDNY
Mar.7, 2008) (denying punitive damages under
copyright).
52
Linden ToS on the DMCA are accessible at:
http://secondlife.com/corporate/dmca.php
51

12

Adapting Virtual Finance to Simulate Financial Information Security


Risk Analysis: A Risk Management Strategy
Eros recited jurisdictional requirements
under the Lanham Act of its use of the
SexGen marks in interstate commerce
since at least January 1, 2005, the
promotion of its products under these
marks, knowledge among market
participants in world and press
reporting in the real world of its
marketing of products under these marks
and that this exposure contributes to
making this a famous and distinctive
mark among the relevant consuming
public. 58 Eros alleges Leatherwoods
trademark infringement through willful
false designation of origin, confusion,
mistake and deception as to the origin,
sponsorship or approval by Eros of
Leatherwood's goods resulting in Eros
damages from lost sales, the diversion
of consumer interest, and injury to its
business reputation and to the
goodwill. 59

notices provided outside of the


Second Life environment. Linden
Lab may provide copies of such
notices to the participants in the
dispute or third parties, at our
discretion and as required by law the privacy policy for Second Life
does not protect information
provided in these notices. 53
(emphasis added)
Such a reminder of the of real-world
laws is made no where else in the Linden
ToS with the same force with the
possible exception of European users
obligation to remit the very-real world
Value Added Tax (VAT). 54 Thereafter,
detailed procedures are provided for
filing notifications (takedown demands)
and counter-notifications (complaints
challenging takedown notification
demands) including FAQs.

vBusiness Goodwill under


Trademark

EULAs Constrain User IP


The EULAs in various virtual
environments vary considerably and

As with Eros copyright claims in


Leatherwood, Eros admission of the
Linden ToS enforceability bootstraps
Eros trademark claims 55 of ownership
and legal protection of its SexGen
mark 56 for which it has applied for
registration under U.S. trademark law. 57

a virtual world accessed through a 3-dimensional


virtual platform, USPTO file is accessible at
http://tmportal.uspto.gov/external/portal/!ut/p/kc
xml/04_Sj9SPykssy0xPLMnMz0vM0Y_QjzKL
N4r3CQXJgFieAfqRqCLGpqgiBvGOcAFfj_zc
VP0goESkOVDE0MhHPyonNT0xuVI_WN9bP
0C_IDc0NKLc2xEAkgNVFQ!!/delta/base64xml
/L0lJSk03dWlDU1lKSi9vQXd3QUFNWWdBQ
0VJUWhDRUVJaEZLQSEvNEZHZ2RZbktKM
EZSb1hmckNIZGgvN18yXzEyTC8xNy9zYS5n
b3YudXNwdG8udG93LmFjdGlvbnMuRGV0Y
WlsVmlld0FjdGlvbg!!#7_2_12L
58
Eros LLC v. Leatherwood, No. 8:07-CV01158 (M.D. Fla. filed July 3, 2007) amended
complaint at 3 accessible at
http://docs.justia.com/cases/federal/districtcourts/florida/flmdce/8:2007cv01158/202603/11/
0.pdf
59
Id. at 7. Eros sought injunctive relief,
destruction of embodiments, treble damages,
interest and reasonable attorneys fees.

53

Id.
Linden ToS concerning VAT for European
Residents, accessible at
http://secondlife.com/corporate/vat.php
55
Supra note 44.
56
Eros LLC v. Leatherwood, No. 8:07-CV01158 (M.D. Fla. filed July 3, 2007) amended
complaint at 4 accessible at
http://docs.justia.com/cases/federal/districtcourts/florida/flmdce/8:2007cv01158/202603/11/
0.pdf
57
U.S. Trademark Application No. 77202601,
described as: Scripted animation system
utilizing a defined menu to actuate avatars within
54

13

Adapting Virtual Finance to Simulate Financial Information Security


Risk Analysis: A Risk Management Strategy
few, with the notable exception of the
Linden ToS, directly address how
property rights are created, registered or
transferred or how disputes among users
are resolved. The EULAs of virtual
environments tend to protect the service
provider with provisions governing
disputes between the I/OSP and users.
With the clear exception of the
mandatory arbitration provisions that
Second Life was forced to revise in the
Bragg case, the Linden ToS are
particularly prescient in that many
aspects of markets were foreseen and
default mechanisms included to facilitate
the creation of property rights. Although
most have not yet, it can be expected
that other Morpeg institutions will
mimic at least some of the Linden ToS
or are developing additional useful
mechanisms to facilitate trade in
property rights and services and to
resolve user to user (U2U) disputes. 60
Some evidence is beginning to emerge
that Linden will be aggressively
protecting its trademarks including
renewed vigor in infringement
management of users who misuse
Lindens registered marks and trade
dress in various ways. 61

bullion, precious metal holdings or as


inflation hedges (e.g., Kruggerand,
Maple Leaf). Few coins today have
intrinsic value from their precious metal
content. Furthermore, few major
governments back their paper currency
with gold or other form of intrinsic
value. Therefore, modern money seldom
serves as a storehouse of value but
succeeds as a medium of exchange if
users retain confidence. A sufficient
supply of money is needed to enhance
this confidence and the relevant users
must accept money willingly to create
network effects. Any new form of
money faces three significant challenges
in achieving status as a medium of
exchange: switching costs, critical mass,
and government control.
First, new forms of money, whether
traditional paper currency and coin or
electronic money, must overcome the
competition. Two conditions make user
acceptance more likely: (1) difficulties
with legacy money and (2) attraction for
the new money. For example, while the
EUs Euro is clearly a strong currency
today, the won user acceptance only
after the legacy European currencies
(e.g.,) were banished, thus eliminating
competition and lowering the costs of
switching from legacy currencies, e.g.,
francs, marks, to Euros. Similar
problems plagued the U.S. during
colonial times when paper notes were
issued by various governments (e.g.,
England, all 13 colonies, eventually all
the states, and the U.S.), by private
banks and various private parties. This
proliferation of monies caused
confusion, inflation and were not
reliably convertible, thus diminishing
their attraction. New currencies must
compete favorably with legacy monies

Law and Economics of vMoney


The payment system depends on
money. Since B.C. successful monies
have had two major functions, first as a
storehouse of value and second as a
medium of exchange. Today, few gold
or silver coins persist beyond
collectables, convenient, reliable sub60

Linden Research, Inc. Terms of Service


(Agreement or EULA), accessible at
http://secondlife.com/corporate/tos.php.
61
Linden ToS on Trademarks is accessible at
http://secondlife.com/corporate/brand/index.php

14

Adapting Virtual Finance to Simulate Financial Information Security


Risk Analysis: A Risk Management Strategy
or the switching costs will prevent
critical mass.

writing and are a promising subject for


research.

Second, money requires critical


mass, a sufficient supply to achieve
widespread acceptance among the target
user group. This was historically a
daunting task for governments because
intrinsic value generally requires either
coining using scarce precious metals or
strong government to back the currency.
However, electronic money is relatively
cheap to create. Like paper currencies,
eMoney is easy to create but this can
cause inflation: too much (new) money
chasing too few goods. Critical mass
enables network effects for money
caused by standardization and universal
acceptance. Trust is also a key
component of user acceptance, mistrust
in monies has myriad causes that
electronic money must likely also
overcome to be successful, such as
inflation, government confiscation, long
successful experience using the money
and general confidence in the political
economy issuing the money.

Is vMoney a Unique Electronic


Payment Success?
Electronic payments began in the
mid-19th century with wire transfer of
funds. Most payments today include at
least one or more components that are
electronic. Contemporary users most
frequent electronic payment experiences
are: withdrawals from bank credit card
accounts for cash using automated teller
machines (ATMs), face-to-face retail
sales using point of sale (POS)
transaction processing for debit and
credit cards, online sales using credit or
debit cards and various P2P
technologies. Less visible are
transportation-related payment systems
such as toll tags like EZPass and RFID
tags for charging gasoline with
electronic token-readers at the pump.
Nearly all inter-bank transactions
between bank payors, drawers and
payees process their wholesale transfers
electronically, including checks, direct
deposits, and clearance of credit or debit
card transactions. Retail cash payments
are typically deposited so this reconnects
even F2F paper currency transactions to
the electronic payment system.

Third, governments control money


for many reasons, notably to set
monetary policy, control the money
supply, prevent international trade
warfare, control inflation, discourage
counterfeiting, protect the financial
system, regulate banking, discourage
bank failures and engage in AML
enforcement. New forms of money must
survive this gauntlet of government
scrutiny. There is little evidence yet that
the U.S. banking authorities are either
interested in fostering new forms of
electronic money or are seriously
attempting regulation of vMoney.
Regulatory tools and regulatory
authorities are uncertain as of this

Most experimental consumer


electronic payment systems have
eventually failed due to various
unsolvable critical mass, and
reliability/trust and government control
problems. None has yet achieved
widespread success, except, perhaps for
PayPal-like transfer services. New
electronic payment systems and the
vMoney architectures that are a variation
of electronic payment systems, must
respect the key aspects derived from 850
15

Adapting Virtual Finance to Simulate Financial Information Security


Risk Analysis: A Risk Management Strategy
years of remote payment and
correspondent banking experience. The
basic design of our contemporary
banking system was developed by the
Knights Templar during the Crusades.
Innovators in electronic payment
architecture apparently cannot ignore
two lessons from this experience. First,
user acceptance depends on proven
system security and reliability. Second,
electronic payment systems depend on
trusted third parties intermediaries.
Originally the Knights Templar and their
correspondent monasteries throughout
Europe provided the trust element.
Todays trust is derived from solvent and
reliable commercial banks, financial
service provider intermediaries to which
banks outsource certain functions, and
the key protections provided by various
government control and regulation
programs (e.g., deposit insurance,
monetary policy, central bank oversight
of transaction clearance, bank chartering,
bank solvency examinations). These
institutions of trust and critical mass are
seldom well-duplicated in either
electronic payment innovations or in
vMoneies. Unfortunately, this erects
prodigious barriers to electronic payment
innovation. According to former Federal
Reserve Chairman Alan Greenspan,
Electronic money is likely to spread
only gradually and play a much
smaller role in our economy than
private currency did historically. 62

Nevertheless, vMoney appears to be


gaining success for four reasons. First, it
can compete well with conventional
money in some instances. Second, it has
experienced some reliability
engendering trust. Third, the anonymity
features attract users away from
conventional money and traditional
payment system architectures in some
instances. Fourth, the regulatory costs of
government oversight are largely
avoided. vMoney users apparently do
not yet demand trust equal to or superior
to conventional payment systems. Users
may be more willing to experimental
with novel electronic payment systems
because vMoney still carries the stigma
of merely being play money such that
many users are not as fully invested in
the stakes of vMoney as are users of
conventional money. If vMoney
eventually migrates to require traditional
trust and government regulation, all the
aforementioned challenges confronting
any new type of money will likely attach
to vMoney as well. 63

http://www.cato.org/pubs/policy_report/cpr19n2-1.html
63
The challenges of new monies, electronic
payment schemes, scrip and vMoney include the
following:
Confidence in money is gained when its
value is linked or it can be converted into
something of value, such as an acceptable
denomination of a respected currency ($, ,
, ) or another liquid asset with reliable
value (gold).
Electronic payment forms should be as
convenient as cash, that is, readily
transferable, capable of convenient
exchange in scalable denominations, easily
stored and transmitted or received to and
from various locations.
There must be security and accuracy in
transactions.

62

Greenspan, Alan, Regulating Electronic


Money, in The Future of Money in the
Information Age (Cato Institute, 1997), also
published as Cato Policy Report, March/April
1997 and originally presented at the U.S.
Treasury Conference on Electronic Money &
Banking: The Role of Government, Washington,
D.C., September 19, 1996, accessible at:

16

Adapting Virtual Finance to Simulate Financial Information Security


Risk Analysis: A Risk Management Strategy
Money Laundering

transaction practices intended to create


the illusion of legitimate dealings to
disguise the origin and movement of
proceeds from unlawful activities.
Laundering techniques are most
successful when there are plausible
explanations for cash flows and cash
reserves. In the law enforcement
vernacular, the phrase follow the
money suggests that tracking the trail of
money movements helps to discover
terrorists, criminal masterminds and
their accomplices. The classic method is
to examine the finances of suspects for
suspicious receipts or spending beyond
the suspects regular earnings or means.
This enables tracking back to all payers
and recipients of suspicious, repetitive or
large transactions for further
investigation. Money laundering is a
classic component crime in racketeering
because both the underlying crimes for
which money is laundered and the
money laundering itself are repetitive
and similar. Racketeering is a compound
crime illegal under state and federal
law. 64

Counter-terrorism and law


enforcement increasingly focuses on
tracing payments to discover money
laundering schemes - a wide variety of

There must be reliable means to authenticate


electronic money as genuine, not counterfeit
or forgery.
Anonymity for the purchaser is a
contentious issue. Some users may seek an
audit trail of all prior transactions, including
the identity of payors, payees and
intermediaries. This capability is now
possible with checks, wire transfers, POS or
credit card transactions. Law enforcement
prefers traceable payments for evidence of
criminal activity such as the money
laundering discussed in chapter 7. Paper
currency has serial numbers and can be
marked while contemporary coins are low
value making them impractical for large
transactions. By contrast, many other users
prefer to maintain transaction anonymity.
Some privacy advocates suspect that
comprehensive transaction records weaken
personal freedoms and become a tool for a
repressive government.
Few payment schemes are practical without
the participation of trusted and reliable third
party intermediaries. Third parties, like
banks, provide useful services such as
experience, transmission of orders, account
information or documents, useful relations
with correspondents, provide security and
safekeeping and they can connect the
payment scheme to reliable sources of value.
New forms of money created outside the
traditional framework of regulatory
oversight may weaken control over the
economy. Alternative forms of money and
payment schemes processed outside the
banking system threaten the power of the
Federal Reserve and other financial
regulators to control the money supply, to
maintain the solvency of financial
institutions and maintain the integrity of
deposit insurance (FDIC).
Bagby, John W. & F. William McCarty, THE
LEGAL AND REGUALTORY ENVIRONMENT OF EBUSINESS: LAW FOR THE CONVERGING
ECONOMY, (West, 2003) at 354-55.

64

Key but controversial components of the


Organized Crime Control Act of 1970 are known
as the Racketeer Influenced and Corrupt
Organizations (RICO) provisions, 901(a) of the
Organized Crime Control Act of 1970 (Pub.L.
91-452, 84 Stat. 922) codified as 18 U.S.C.
19611968. RICO imposes criminal liability,
fines up to $25,000 and/or imprisonment up to
20 years per violation. The civil provisions
authorize private plaintiffs to sue for civil treble
(triple) damages against persons convicted of
racketeering.
RICO outlaws a pattern of illegal activities,
that include thirty-five crimes (27 under federal
law, 8 under various state laws), called predicate
offenses, including, e.g., securities fraud,
murder, arson, extortion, drug dealing, mail and
wire fraud, bribery, loan sharking, and money
laundering. RICO requires proof that the accused
committed at least two prohibited acts, that the

17

Adapting Virtual Finance to Simulate Financial Information Security


Risk Analysis: A Risk Management Strategy
official records so their payments are not
easily accessible by law enforcement.
Cash is king, so transfer of currency to
launder money is preferable to payment
by checks, wire transfers or credit cards
because cash transfer can be
accomplished without official
recordkeeping, thereby providing cover
for transactions. Furthermore, cash
movements in small bills can impose
staggering practical impediments to
tracing marked currency or verifying
serial numbers.

Money laundering is both a literal


and metaphoric reference to cleansing
the appearance of money sullied by
criminal activities. In the 1920s and
1930s gangster era, a large, recurring
and potentially incriminating cash flow
of coins accompanied the numbers
racket, illegal, small stakes gambling.
Mobsters owned coin-operated laundries
that provided plausible excuses for
handling coins and some currency.
Laundering the wagering proceeds
through the laundries helped to cover up
the criminal payments making them
practically untraceable. Indeed,
unregulated gambling today remains a
substantial money laundering front for
organized crime. Money laundering may
have existed for over 4000 years having
originated to hide both legitimate and
illegitimate earnings from oppressive
government taxation or unfair
confiscation.

Under one general model developed


by federal financial regulators, money
laundering has three basic stages:
placement, layering, and integration. 65
Placement describes when laundered
funds are initially made less suspicious,
more convenient and first fall under the
financial systems control after initial
acquisition. This is the initial step to hide
funds following their receipt in an illegal
activity. Second is layering, a process of
movement that separates the proceeds
from their illegal source by using
multiple complex financial transactions
(e.g., wire transfers, monetary
instruments, asset purchases/sales) that
further obscures the links between
placement and integration. Layering
activities may alter the size of the lump
sum to obfuscate an audit trail. Third is
integration, when the funds reenter the
legitimate economy through expenditure

Money laundering methods are


varied, many are well-known but
detection often remains difficult and
enforcement is too often costly.
Launderers prefer methods with few
criminal acts constitute a pattern of racketeering
activity, and that this pattern results in the
investment in, maintenance of an interest in, or
participation in a (criminal) enterprise affecting
interstate or foreign commerce.
Criticism of RICO argues it expanded well
beyond the anti-mob, organized crime context
that first inspired the legislation. Aggressive use
against Wall Street and accounting firms
eventually led to some reforms, such as: stiffer
proof requirements for financial crimes, the
accused must have clearly participated in the
crimes and the pattern of wrongdoing must
clearly pose a threat of continuity. Nearly half of
the states also have RICO-like laws.

65

Report To Congress, In Accordance with


356(C) Of The USA Patriot Act, Secretary of
the Treasury, Board of Governors of the Federal
Reserve System, Securities and Exchange
Commission (Commodity Futures Trading
Commission staff), Dec. 31, 2002 at 7,
accessible at
http://www.fincen.gov/news_room/rp/files/356re
port.pdf

18

Adapting Virtual Finance to Simulate Financial Information Security


Risk Analysis: A Risk Management Strategy
federally insured credit unions, and
investment advisors that are not
required to register with the SEC. 66

or investment. This is only a basic


model, so it can be modified or made
even more complex when launderers
successfully avoid detection or add costs
that might eventually exhaust
investigator resolve or resources.

Additional private sector financial


institutions that have direct
responsibility over recordkeeping for
transactions they handle are also held
responsible to assist in money
laundering enforcement, these financial
institutions include:

Fronts are useful to money


launderers; these are apparently
respectable businesses that cover up
illegal activities. Increasingly, sham
transactions and inter-corporate transfers
among complex or nested shell
corporations are used. In addition, phony
charities or trusts, and investment
accounts are chosen as intermediaries to
handle payment flows. Bank or trading
accounts located offshore or in tax
havens provide additional cover because
cooperation from local authorities in
some foreign nations is restricted.
Indeed, Swiss bank secrecy has been a
traditional and recurring impediment to
law enforcement. Increasingly, other
financial services can be deployed to
transfer wealth such as fictitious trading
in securities or commodities, use of
money transmitters, remittances to
developing countries handled through
wire transferors and currency exchange
firms. The Federal Reserve Board is
continually expanding the list of
financial service firms including the
following as potential financial
institutions:

depository institutions (e.g., banks,


credit unions and thrifts); brokers or
dealers in securities; money services
businesses (e.g., money transmitters;
issuers, redeemers and sellers of
money orders and travelers' checks;
check cashers and currency
exchangers); casinos and card clubs;
and dealers in precious metals,
stones, or jewels. 67
As the two lists of financial institutions
above suggests, money laundering does
not rely solely on the physical movement
of currency or the traditional paperbased or electronic transfer of funds
through commercial banking networks.
Increasingly, goods or even services may
constitute the flow of value to or from
the criminal perpetrator or terrorist back
to the illegal organization sponsoring or
assisting in the illegal activity. Indeed,
diamonds, gold or other precious and
valuable assets might be used. Countertrade is particularly insidious method

mortgage lenders, pay day lenders,


finance companies, mortgage
brokers, non-bank lenders, account
servicers, check cashers, wire
transferors, travel agencies operated
in connection with financial services,
collection agencies, credit
counselors, and other financial
advisors, tax preparation firms, non-

66

See 65 Fed. Reg. 33646, 33647 (May 24,


2000) interpreting 4(k) of the Bank Holding
Company Act.
67
See discussion of financial institution duties
regulated by FinCEN accessible at:
http://www.fincen.gov/about_fincen/wwd/

19

Adapting Virtual Finance to Simulate Financial Information Security


Risk Analysis: A Risk Management Strategy
because of the appearance of
humanitarian motives. 68

additional criminal activity by reducing


the incentive to spend criminal proceeds.

Money Laundering
Enforcement

Money laundering enforcement


relies heavily on assistance from the
private sector, particularly the financial
services industry and the Financial
Crimes Enforcement Network
(FinCEN). 69 Clearly, commercial banks
are the most important because their
primary business is to handle money
transfers and money accumulations as
deposits. Large cash payments over
$10,000 must be reported in currency
transaction reports (CTR) by
businesses and banks to create an audit
or paper trail. 70 However, because
successful money launderers
continuously adjust their transactions to
avoid suspicion, businesses and most
financial services firms must also make
suspicious activity reports (SAR) at the
$5,000 threshold. 71 For example, a
money launderer might divide up a large

Law enforcement and counterterrorism forces now focus increased


attention on money laundering because
payment flows are indispensable to so
many unlawful activities such as
underground economic activities: drug
trade, terrorism, organized crime,
weapons trade and smuggling. Antimoney laundering (AML) laws help
identify criminals, reveal accomplices,
accessories and co-conspirators who
might testify against others in the money
laundering supply chain, recover money,
assets or freeze accounts, and help deter

68

Countertrade is a complex reciprocal barterlike exchange in which international brokers


match buyers and sellers who trade goods and
services without transferring cash. Many
developing countries and former Soviet bloc
nations have negative trade balances, their
currencies do not convert well into hard
currency, they have large debt burdens or their
government restricts currency outflows. These
problems restrict the very foreign trade so badly
needed to invigorate their economies. There are
several types of countertrade. Barter is the direct
exchange of different types of goods or services
between the two parties. In a swap, two sellers of
the same goods exchange delivery obligations,
reducing transportation costs. The most common
form of countertrade is counterpurchase: a seller
from an industrial nation exchanges goods or
services for other goods from the buyer, often
through an intermediary such as the government
or a firm in the developing nation. In a buyback,
industrial machinery acquired from the seller is
paid for with goods eventually produced with
those machines. Bagby, John W. & F. William
McCarty, THE LEGAL AND REGUALTORY
ENVIRONMENT OF E-BUSINESS: LAW FOR THE
CONVERGING ECONOMY, (West, 2003) at 34647.

69

FinCEN is a bureau within the Department of


Treasury. FinCEN was established in 1990 to
prevent corruption of the U.S. financial system.
Since 1994, FinCEN is delegated authority to
oversee money laundering enforcement. In 2004
FinCEN became a part of Treasury's new Office
of Terrorism and Financial Intelligence.
Hundreds of thousands of financial institutions
must comply with Bank Secrecy Act reporting
and recordkeeping requirements. FinCENs
revised mission includes fighting the financial
war on terror, combating financial crime, and
enforcing economic sanctions against rogue
nations.
70
Bank Secrecy Act of 1970 (BSA a/k/a
Currency and Foreign Transactions Reporting
Act,), 31 U.S.C. 5311-5330, 12 U.S.C.
1818(s), 1829(b), and 1951-1959 requires
the report of cash payments over $10,000
received in a trade or business from one buyer as
a result of a single transaction or two or more
related transactions.
71
See e.g., 31 CFR 103.18 and 12 CFR 21.11
(February 1996).

20

Adapting Virtual Finance to Simulate Financial Information Security


Risk Analysis: A Risk Management Strategy
cash transaction into several smaller
ones each under the $10,000 CTR
threshold. Financial institutions must
report customer activities deemed
suspicious if the activities have no
business or apparent lawful purpose or is
not the sort in which the particular
customer would normally be expected to
engage, and the bank knows of no
reasonable explanation for the
transaction after examining the available
facts, including the background and
possible purpose of the transaction or
constitutes activity inconsistent with the
customers business. 72

authorities, AML regulators or banking


authorities. The ease of converting
vMoney into real money using debit
cards, credit cards, PayPal and the
Linden Labs own servicing Second Life
users (LindeX) and the difficulty of
tracking online services purporting to
provide exchange services will likely
continue to provide virtual asset creation
inconsistent with banking law while
permitting the seclusion of assets and
transactions.
Interpol has recognized the risks of
vMoney laundering by taking the
initiative in defining virtual money as:

Adapting Virtual Finance as a


Money Laundering Tactic

money value as represented by a


claim on the issuer which is stored
on an electronic device and accepted
as a means of payment by persons
other than the issuer. 74

Money launderers may already be


ecstatic that virtual money could become
a most effective form of value. Law
enforcement and AML regulators do not
publicly nor clearly recognize that
virtual environments may become ideal
money laundering settings unless several
institutional challenges are overcome. 73
As of this writing, there is no direct and
unequivocal authority for vWorld
monitoring or enforcement by taxation

Technically, virtual money is a form of


electronic payment, usually secured
through encryption and other metadata
and embodied in distinctive (computer)
graphics. Interpols emergent taxonomy
defines two types of virtual money:
Identified virtual money contains information revealing the
identity of the person who originally
withdrew the money from the bank.
This can be traced through the
economy, by the bank or law
enforcement personnel, in much the
same way as credit cards.

72

Bank Secrecy Act/Anti-Money Laundering:


Comptrollers Handbook, Comptroller of the
Currency, Administrator of National Banks,
(September 2000) at 11-12, accessible at
http://www.occ.gov/handbook/bsa.pdf
73
See Kane, Sean F., Asset Creation, Seclusion
and Money Laundering in the Virtual World, 4
Internet L. & Strat. 1 (July 2006), accessible at:
http://www.drakefordkane.com/articles/Virtual%
20Money%20Laundering%20Article.pdf
(arguing Interpol understands these challenges,
but U.S. law is not keeping pace with virtual
finance prospects and developments and that
AML regulators (e.g., FinCEN, Department of
Treasury, Department of Justice) have
inadequate enforcement tools and
understanding).

74

See generally Virtual Money, Information


Technology Crime, Financial and high-tech
crimes, Interpol, accessible at:
http://www.interpol.int/Public/TechnologyCrime
/CrimePrev/VirtualMoney.asp

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Adapting Virtual Finance to Simulate Financial Information Security


Risk Analysis: A Risk Management Strategy
Anonymous virtual money (also
known as digital cash) - once it is
withdrawn from an account, it can be
spent or given away without leaving
a transaction trail. Using blind
signatures rather than non-blind
signatures creates anonymous emoney. 75

users, (2) the lack of location to an


inherently global medium, (3) the crossborder rights vindication, regulatory and
law enforcement challenges similar to
that of cyberspace generally and (4)
challenges in evidence gathering and
proffer in an evanescent, virtual world.
The larger and more successful virtual
environment communities, like Second
Life, may close these practical gaps with
well-designed EULAs anticipating
property rights, reinforcing transaction
reliability and providing reasonable
access to effective dispute resolution
mechanisms. The emerging caselaw
already takes great strides in clarifying
the closing of this gap.

Identified vMoney has metadata and/or


other identifiers enabling traceability
using similar methods as traditional
electronic payments. However,
anonymous vMoney leaves a much less
standardized and evident transaction
trail, such as by using blind signatures.
Without full and real time network
forensics, the evanescent network
communications log data of anonymous
vMoney makes it an ideal form of high
tech value for vMoney launderers.

Cyberlibertarian utopian ideals


nevertheless maintain that the occupants
of new worlds deserve a freshly
constructed environment to be nearly
devoid of legacy baggage from the
human experience-inspired rule of law.
This mindset may be a more potent
barrier to rights vindication under
accepted principles using traditional
institutions than has been the uncertainty
before clear cases like Eros or Bragg.
However, if the virtual environment
stakes continue to rise and the efficiency
and fairness of dispute resolution
alternatives becomes better known,
traditional legal principles and dispute
resolution methods are likely to resume
their importance, even if this
development might curb the wt of
virtual inhabitants. The clear evolution
from the warmth of cyberlibertarial
idealism to the cold reality of traditional
real world rights and obligations need
not curb the wt of all. Indeed, as users
are increasingly attracted by fair
treatment for participation in virtual
markets, the application of traditional

vMoney resembles scrip in that it is


not legal tender, because it is created
outside the government sanctioned
monetary system, and is used as a
substitute currency. Traditionally, scrip
has had very limited utility outside the
closed social networks in which they
arise (e.g., tokens, tickets and points).
However, as vMoney gains easier
convertability from inside the closed
social network of a vWorld, and flows
beyond into legal tender, it assumes
status as a near money equivalent.

A CyberLibertarian Epilog
Cyberlibertarian dogma is likely to
become pervasive among many
participants in MMORPGs and MMOGs
for various reasons, not the least of
which are practical: (1) likely the
difficulties of gaining jurisdiction over
75

Id.

22

Adapting Virtual Finance to Simulate Financial Information Security


Risk Analysis: A Risk Management Strategy
public policy, as driven by the ideals of
democratic capitalism, may supplant an
adequate level of comfort.
The insertion of illegal activities into
vWorlds is already clear. Expansion of
unlawful activity to new environments
with more limited law enforcement has
characterized many of historys cultural
migrations. As trade increases between
these new vWorlds and real world, two
conditions appear inevitable: (1)
unlawful activity will flourish and (2)
public policy will intervene to impose
civilization. Theft, pornography, IP
infringement and money laundering are
just the tip of these new icebergs.

23

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