Another story from Pay Per Click Universe talks about click fraud and how it only applies to Google Adword accounts because Adwords is the only PPC to use a complex algorithm to determine how high your overall ranking is.
This is where a lot of people get confused about Google adwords. Its not as simple as Overture, where whoever bids the highest, gets the top spot. At Google adwords, its different because your CTR / click through rate determines how high your position is. The article goes into more detail with a good example.
"For example, if you get a 5% CTR (50 clicks out of 1000 impressions), but your maximum bid is only 50 cents, and your competitor bids 80 cents but has 1% CTR, you WILL appear higher than him. With AdWords, though, if your CTR is less than 0.5%, your ad is disabled and disappears until you make some changes to bring your CTR back up."
The story goes on to talk about how certain click fraudsters will artificially inflate the number of impressions for certain keywords and what happens is your CTR will go down and if its under .5%, your ads will be disabled and then when your sites out, someone else moves into your position.
Now I don’t know how illegal that is since they are not clicking on ads. I would be more concerned about your competitors who might click on your keywords.
Its key to have someone pay attention to the pay per click traffic and monitor the stats and make sure the same IP address isn’t visiting your site multiple times. This is usually only an issue when you are bidding on high valued keywords like "vioxx" or "mesothelioma lawyers".