Consoles today play an increasing part in even local police investigations across the country. In a presentation to law enforcement, Microsoft recently made clear that "investigators may participate in Xbox live in undercover operations."
The company explained how to record suspect conversations by building a special capture rig. The task is more complicated than just capturing the audio output from the Xbox, since game chat isn't routed through the speaker outputs. Instead, investigators need to build a small splitter that can send headset audio to a mixer and from there on to any standard audio/video recording device.
Microsoft can also provide IP addresses for Xbox Live logins, registration and billing information, titles of games accessed, etc., but the actual content of user communications does not appear to be logged by the company, nor is it stored on the Xbox hard drive or memory stick—to the chagrin of investigators in many cases, who report looking for logs and chat data on seized console hard drives, but coming up empty.