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Auction Law and Ethics

Do You Want to Know a Secret?

by Steve Proffitt

The knowledge that many auctioneers have about legal requirements and ethical duties has largely come from other auctioneers. That's unfortunate, because a good amount of this "knowledge" is wrong. Indeed, some auctioneers have done so much wrong for so long they've come to believe it's right—but it's not. It's just repetitious wrong.

I recently received a letter from a reader who raised an issue that reveals a slice of this customary wrongdoing at some auctions. Here's the letter.

Dear Mr. Proffitt:

I've been going to auctions with reserves for over 20 years. What's bothered me all this time is how auctioneers deal with reserves when the reserve price is not met.

I have no problem with the practice of using reserves. Reserves are part of the auction business because they protect the seller against a weak market where there is little or no demand for the item. However, in my experience, the majority of auctioneers call "sold" and use a "buy-back" number when the reserve is not met. Most bidders assume the item has been sold. In my area, I know of only two auctions where the auctioneer explicitly states, "Pass" or "The reserve has not been met." In these auctions, the bidders know the item was not sold.

Webster's dictionary defines "sell" as: "To give up to another for money or other valuable consideration." An owner cannot buy something he already owns. So to use the term "sold" as a buy-back for the owner is deceptive and misleading. It causes bidders to falsely believe that the auctioneer actually sold the item for the price stated. I think this practice is as egregious as phantom bidding.

What is the legality of "buy-back" bidding? If it's legal, wouldn't it be more ethical for an auctioneer to let bidders know that an item did not meet the reserve, rather than call "sold" under a phantom buy-back number?

You've asked an excellent question. You've also opened the eyes of some readers who didn't know things like this happen in auctions. They do, and we're going to talk about it.

Deception

This reader believes the practice he described is "deceptive and misleading." He's right. The sad part is, it's intended to be. This practice flowers from an auctioneer's desire to stage an illusion that everything that crosses the block sells for strong prices. Often this is not what's happening.

Auctioneers mislead bidders to keep them excited and willing to spend, as opposed to having them slip into an unenthusiastic stupor when too many lots go unsold. The spinners think the truth would chill bidders and cause them to conclude that the lots are not so desirable, nor the sellers so eager to sell, nor the bargains so good, as to merit spirited bidding. So these auctioneers play a charade I call "Watch me say `Sold,' when I really mean `Hold.'" The problem is there's another name for this game—fraud.

The Ploy

The seller sets a reserve (minimum threshold price) on a lot to protect it in the auction against an unwanted sacrifice. The auctioneer may not sell the lot for less than the reserve. But bidders don't come to auctions to pay high prices. They come for bargains. They also want everything to sell for the highest bid—to them. While everything at an absolute auction sells to the highest bidder regardless of price, it's often not what happens in a reserve auction.

Here's where the con game is played. Auctioneers who practice this deception hide the truth by "selling" the lots that don't make their reserves to a house number. This is a fictitious bidder number that the auctioneer uses to secretly buy in lots that either don't reach their reserves or that get stuck on a phantom bid.

When a buy-in occurs, the crowd thinks the lot has sold. It hasn't. There's no sale, and it goes back into inventory. These unsold lots are placed in future auctions (almost always elsewhere) or returned to the seller. The practice of hidden buy-ins is illegal.

Who and Why?

In my experience, auctioneers who use hidden buy-ins do so for one of three reasons:

1. They were taught this trick by other auctioneers and believe it's a legitimate practice and don't understand that it's fraud.

2. They were taught this trick by other auctioneers and don't care that it's fraud.

3. They were taught this trick by other auctioneers and believe auctioneers don't have to follow the rules other sellers do and that the end justifies the means.

The first group comprises naive practitioners that we can hope to educate and change. The second group is made up of hard-core miscreants that no one is going to change. The third group is even more disgusting than the second. That's because "justifiers" hold themselves out to be law-abiding people, while they cheat bidders with dishonest tricks in the name of auctioneering.

"Justifiers" think the title of auctioneer allows them to operate outside the rules that regulate all other sellers. While this is obviously ridiculous, this mindset is not uncommon in auctioneering. What these auctioneers do is every bit as bad as the fraud practiced by purposeful crooks because the damage inflicted on the victims is the same. When someone cheats you out of money, it doesn't hurt less if that person does a crooked act while claiming to be an honest person. "Justifiers" believe the end (making the sale at a good price for the seller) justifies the means, whatever that requires.

Bidding to Reserves

There's even more to this hidden buy-in iceberg—a twin wrong that dovetails perfectly. Who do you suppose makes these bids to get the lot near or at the reserve before it's finally bought in for lack of a sufficient real-money bid? If you think it's legitimate bidders, think again. The same auctioneers who use hidden buy-ins also do phantom bidding to carry lots to their reserves.

Many auctioneers believe this practice is legitimate. After all, they learned it from other auctioneers. Again, both teacher and student are wrong. It's illegal, and there are two wrongs committed when auctioneers bid lots up to their reserves and use secret buy-ins.

Phantom Bidding

The first reason these practices are illegal is that they're done with phantom bidding. When an auctioneer calls a bid that no one has made, it's a false bid—a phantom bid. The auctioneer secretly makes these bids to trick legitimate bidders into believing there is demand for a lot when there's not. Phantom bids are used to advance the bid amount in the hopes of luring a legitimate bidder into making a real-money bid. A phantom bid is the misrepresentation of a material fact in an auction, and that's fraud.

Consider an auction lot that has a $5000 reserve. The bidding opens and an exchange of bids follow. A bidder finally claims the lot for $5500, more than satisfying the reserve. This bidder thinks he has just beaten one or more other bidders for the lot. In fact, the only bids he ever competed against were phantom bids called by the auctioneer. No one else bid. The auctioneer just carried this fellow to $5500. Do you suppose this bidder would have voluntarily paid $5500 had he known the truth? So what kind of auction is this? It's an auction that's rigged with phantom bids.

Seller Bidding

The second reason these practices are illegal is that they represent unannounced seller bidding.

Section 2-328 (4) of the Uniform Commercial Code states in relevant part: "If the auctioneer knowingly receives a bid on the seller's behalf or the seller makes or procures such a bid, and notice has not been given that liberty for such bidding is reserved, the buyer may at his option avoid the sale or take the goods at the price of the last good faith bid prior to the completion of the sale."

In addition to the two remedies it provides, the statute tells us several things.

First, section 2-328 (4) clearly forbids unannounced bidding by sellers on their goods.

Second, section 2-328 (4) doesn't require that the seller make the bid. Instead, the provision encompasses anyone who makes it, whether it's the seller or someone acting "on the seller's behalf...."

Third, there is no doubt that auctioneers who bid lots up to reserve levels (with phantom bids) are included within the ambit of section 2-328 (4). The legal relationship of an auctioneer to a seller is that of an agent to a principal. An agent exercises the apparent or implied authority granted by the principal to act in furtherance of the principal's interest (the subject of the agency). With an auctioneer, that authority is the power to offer and sell the seller's assets at auction. When the auctioneer acts, it's the same as the seller acting.

If an auctioneer bids to drive up the price in an effort to reach a lot's reserve, he's acting as an agent of the seller. Since section 2-328 (4) prohibits undisclosed bidding by a seller, or anyone acting "on the seller's behalf," this proscription clearly runs to the seller's agents, including the auctioneer.

No Exception

Section 2-328 (3) of the code reads in part: "Such a sale is with reserve unless the goods are in explicit terms put up without reserve." This statute that provides for reserves gives no authority to an auctioneer or seller to make bids on reserved lots. Such bidding would be the undisclosed seller bidding that section 2-328 (4) explicitly prohibits.

As noted, section 2-328 (4) states that neither the seller, nor anyone acting for the seller, may bid without reserving that right and announcing it to the other bidders. Again, there is no exception that would allow an auctioneer or seller to bid up to a lot's reserve without disclosure.

To further emphasize this point, section 2-328 (4) provides that an auctioneer cannot knowingly receive undisclosed bids on a seller's behalf. If an auctioneer cannot receive such bids, there is no doubt that he cannot make such bids. To argue that he could make the bids that he can't receive would be to urge an absurdity.

Where an auctioneer feels the need to make bids on behalf of a seller, that can be done legitimately. The inoculation against illegal conduct is found in disclosing that intention to the other bidders (unless in a jurisdiction where auctioneer bidding is prohibited under any circumstance).

Tips for Bidders

Auctioneers who practice buy-ins and secretly bid up to reserves carefully disguise their tricks. If bidders aren't fooled, there's no advantage. Here are several suggestions for safer bidding and buying.

First, don't go to unknown auctions and plunk down a lot of money. You know nothing about these strangers. Instead, do your homework and find honest auctioneers. Then limit your dealing to those good people.

Second, always be skeptical about everything—caveat emptor! A lot of wrong is done by others (like dishonest sellers), even in auctions run by honest auctioneers.

Third, never patronize a dishonest auctioneer. All you do is give him the chance to cheat you while helping him stay in business so he can cheat others.

That's it for now, but I'll see you again in the May issue of M.A.D. Until then, good bidding!

Steve Proffitt is a Virginia attorney-at-law, auctioneer, and an instructor at the Reppert School of Auctioneering in Auburn, Indiana, and at the Mendenhall School of Auctioneering in High Point, North Carolina. He welcomes questions from readers about all aspects of auctions and auctioneering. Mr. Proffitt will answer selected questions in this column, but he cannot provide personal answers. The answers given do not represent legal advice or the formation of an attorney-client relationship. Readers should seek the advice of their own attorneys in their respective states on all legal issues. Please submit questions to PO Box 1013, Dept. M, Staunton, VA 24401, or e-mail AuctionLaw@msn.com.