Cap'n John has an interesting post how his gnome in WoW was forced to change his name, because "Knuttjob" was found to be offensive. Coincidentally yesterday I did something I really rarely do, and reported another player for a naming violation. But hey, we're on a LotRO role-playing server and the guy has to call his elf Darklegolas? I wouldn't have minded that name in WoW, but on a role-playing server and in this Middle-Earth setting the name just hurts. I am in favor of having a naming policy, and that the rules are stricter on a role-playing server. But personally I wouldn't have minded "Knuttjob", and some people really overdo it playing the naming police.
The conflict about what names are acceptable goes back a long way. I remember many years ago a player called his character in Everquest "Cupid Stunt". While that is certainly sexually offensive, it wasn't in-your-face obvious, and it took the GMs over a year to notice it. If I remember correctly the character was then even banned, although nowadays people are just forced to change their names. Having your name changed after having played for a long time, and suddenly all your friends don't recognize you any more, is harsh enough as a punishment. But sometimes it is necessary.
There are several different reasons why a name could be not allowed. One is copyright. For example City of Heroes already had enough legal trouble when people were able to create superheroes that looked like copyrighted characters. If you could have named your character Wolverine or Superman, they would have been in even worse trouble. Even if you have the license, players shouldn't be allowed to use names from that source. There should be no Gandalfs, Gandalphs, Gandralfs etc. running around in Lord of the Rings Online. It messes with the background story, and breaks the immersion of the other players. They also shouldn't be allowed to name their character after characters from other sources, like Harry Potter, and they shouldn't be allowed to name them after real people, like Arnold Schwarzenegger. This rule has the one advantage that it is relatively easy to police, and it is obvious when somebody is breaking it. A part of the policing can even be done automatically. I couldn't even name my LotRO character Tobold, because LotRO has an exception table with all names from the book, and Tobold Hornblower was on that list. That still leaves variations like Legolaz or Darklegolas, but these are so obvious that they get noticed by a GM or reported before they get very far.
Far more difficult is the rule that names aren't allowed to be offensive to other players. Because what is offensive? WoW has these violations sorted into three categories, "highly inappropriate", "moderately inappropriate", and "restricted", with each case forcing you to change your name, but the higher levels of offence also giving you a warning or suspension. Highly inappropriate would be sexual or racial/ethnic/national slurs. Moderately inappropriate includes using the names of Blizzard employees, like Tigole, or using names for advertising, so don't call your character wwwgoldfarmerscom or something like that. The restricted category has everything else, including using titles (Lordsomething), real world references, leetspeak, or even pure gibberish like "Hjklmwxcv". In practice this is a huge grey area, I'm not even sure what category "Knuttjob" fell into. Offensive to mentally handicapped people? You can run around for years with a name in this grey zone, until some day somebody, who didn't like something you did, reports you for naming violation, and some GM on a bad day agrees. Basically, if your name is "funny", it probably is in violation of the strictest interpretation of the naming policy.
Lord of the Rings Online has very helpful hints on the character creation screen, for each race and origin, on how names are usually formed. It isn't so hard to come up with a name that conforms with those naming suggestions, and isn't offensive to anyone. Some games even have random name generators, which you just hit repeatedly until they come up with something you like. I really don't mind if you prefer a "funny" name, as long as it isn't just plain stolen from somewhere, and not too offensive. But you have to be aware that there is a certain risk involved in that, somebody reporting you and you being forced to change your name.