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Why not just "out" them and provide a link to the original domain?

"To play Sqword, please visit <domain> directly. You are currently visiting a site that has put ads around the original game without the game creator's consent."

By replacing it with goatse, a number of people will think, "I wanted to play Sqword but now it's pornographic" and never play again.

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Not only this, but I imagine some of the less tech savvy end users (kids, grandparents) would be the ones who found the game from one of these parasitic sites inundated with ads. The goatse image doesn’t help those users. They probably won’t realize what that’s about and then just stop playing altogether.

If an iframe displays that content, could the creators webhost be contacted and would they cancel his account?

Possibly, yes.

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