There's two issues here -- and this is a good time to mention that not only am I not a lawyer, I don't even play one on TV -- the alleged copyright infraction and the methods used by the plaintiffs to gain their evidence. Because the plaintiffs found their evidence by entering his SL home uninvited, he feels U.S. search and seizure laws should apply. However, at the time of this writing, I am not aware if Simon has filed a counter-suit.
Second Life allows content creators to place restrictions on objects they create: you can set them to be unmodifiable, non-transferrable, and non-copyable. Allegedly, Simon used an exploit to break the permissions and re-sell the items. VintFalken offers some technical insight on the matter (potential NSFW links).
In theory, the copyright infringement should be easy to prove or disprove. However, I'm curious to see how the judge and jury handle this. Virtual objects, or as a jury could see it, "not real," might be harder for a jury to grasp than if someone stole a real item and was reselling it. Depending on how many plaintiffs are cashing out, real-world monetary loss might get a jury on their side. If the jury sees it as virtual cash, like World of WarCraft's gold, it might be a harder sell. Seeing the rewards offered in McDonalds coffee suit (yes, I know the case was a legitimate lawsuit), juries have proven to be sympathetic. As a writer and thus sensitive to copyright violations, if the allegations are true I hope they win the case.
The second issue is actually the one that interests me more -- the issue of privacy in virtual worlds. How much privacy is one entitled to in a virtual world? For instance, some states provide laws on how conversations can be recorded without consent. There's nothing stopping you from copying a chat log and pasting it on a blog. It's fairly easy to adjust camera angles to view people doing acts in places they'd consider "in their own home."
This is a two part discussion: Do you feel the copyright violations are legitimate, and what do you feel about privacy in virtual worlds?