An official publication of Global Gaming Expo

The official publication of the Association of
Gaming Equipment Manufacturers

DECEMBER 2002

Locked Doors Shrink U.S. Net-bet Chances

Will lawmakers prevail in efforts  to block online gambling?

By Bob Shemeligian

Only a few short months ago, cyberspace was considered the final frontier of the gaming industry, where the potential for growth was without bounds. But relentless pressure from lawmakers in recent months is downsizing growth estimates as it shifts the nucleus of online gaming farther and farther from the United States.

Because of increasing regulatory pressures—such as recent passage in the House of a bill that would outlaw the use of credit cards, checks and electronic fund transfers to pay for online betting transactions—Bear Stearns gaming analysts have cut their growth estimates for the online gaming industry in half, to 20 percent from 43 percent. Bear Stearns gaming analysts now project total industry-wide revenues of $4.2 billion in 2003, down from recent estimates of as high as $5 billion.

“The industry will face a number of challenges over the next several years, and certainly many are a direct result of the credit-card issue,” says Bear Stearns online-gaming analyst Michael Tew. “However, I will say that as we see this industry move to a more secure standard for regulation, we will see a bigger attraction for the large brick-and-mortar gaming companies to enter the online industry.”

Wait and see

But, following various recent setbacks and regulatory challenges to the online gaming industry, the big casino players—for now at least—are taking a wait and see approach.

Among them is Station Casinos in Las Vegas, which agreed in February to pay $5 million for a 50 percent stake in a new Web casino operated by Sun International Hotels, owner of the Atlantis resort on Paradise Island, and licensed on the Isle of Man. But growing concerns about U.S. regulatory issues prompted Station to spend $4.5 million in July to convert its agreement into an option.

“There’s a level of uncertainty in the Internet gaming environment that contributed to our decision,” says Leslie Pittman, spokeswoman for Station Casinos. “While we still have confidence there is a future for Internet gaming and we want to be a leader in that segment of gaming operations, we feel that for now at least, this is the wisest course of action.”

And while MGM Mirage in Las Vegas last fall received an Internet gaming license from the Isle of Man, a 220-square-mile island nation off the coast of England, MGM spokesman Alan Feldman stresses the company will take bets only from users in jurisdictions where Web gaming is a “clearly permitted activity.”

While The Venetian announced in an August Securities and Exchange Commission filing that it had applied for an Internet casino license in Alderney in the Channel Islands, an offshore European jurisdiction, executives from the Las Vegas Strip’s flagship resort have declined comment on the filing.

Other gaming officials are about as talkative on the issue of Internet gaming as the brick and mortar in the walls of their resorts. Indeed, in a recent equity research report on e-gaming, Bear Stearns notes: “Whether on a national, regional, or state-by-state basis, Internet gaming continues to be a very controversial issue within the U.S.”

Privately, gaming officials say they are extremely wary of pending U.S. regulations on Internet gaming, and until they get a clearer picture, they will remain neutral on the issue.

Storms brewing

Meanwhile, storms are brewing in the uncharted waters of cyberspace gaming. Among them:

• The U.S. House of Representatives in early October passed by voice vote a bill that would outlaw the use of credit cards, checks and electronic fund transfers to pay for online betting transactions. The bill, sponsored by Rep Jim Leach (R-Iowa) also includes elements of a previous bill by Rep. Bob Goodlatte (R-Va.) and would allow law enforcement to order Internet service providers to shut down gambling Web sites and would amend the federal Wire Act to prohibit the use of the Internet to place bets across state lines.

• The Justice Department in late August told Nevada gaming regulators that federal law already bans Internet casino gaming as well as interstate sports betting. The opinion by Assistant Attorney General Michael Chertoff carries enough weight to all but permanently derail plans by Nevada regulators to draft cybergaming regulations.

• As part of its recent merger with eBay, PayPal—an electronic payment service with 18 million members including countless Web bettors—agreed to stop enabling online gambling. PayPal also paid a $200,000 fine for having done so in the past and agreed to a demand by New York Attorney General Elliot Spitzer that the payment service must turn in customers running any Web site that “reflects or represents conduct that violates any state or federal law.”

PayPal spokesman Vince Solitto tells the Wall Street Journal, “When something is of murky legality, a company is stuck between customer desire to do what they think is legal and the law-enforcement folks who may have a different view.”

Four representatives of BetOnSports.com, an offshore Internet betting service, were arrested in mid-October in Tampa and charged with various gambling- related offenses. The arrests came during a promotional campaign for the offshore online betting service. The representatives, who were operating a luxury bus, allegedly took bets from undercover officers on a Tampa Bay Buccaneers game.

After the arrests, BetOnSports.com CEO David Carruthers said: “The bets take place in Costa Rica, where our servers are, and not in Tampa or St. Louis. We operate out of a licensed jurisdiction and we follow the letter of the law down here. This is a legitimate operation in a legitimate industry. … We aren’t criminals.”

Convinced to be unconvinced

One group that remains unconvinced Web gaming is a legitimate enterprise is the American Gaming Association, a Washington group that lobbies for the casino industry.

“We are opposed to Internet gambling because we don’t believe the technology exists to properly regulate it with law enforcement oversight,” says Frank Fahrenkopf, president of the AGA. “And I think that will be our position until such time as the regulatory bodies we deal with are convinced they can regulate it.”

What is of most concern to Fahrenkopf, among other gaming officials, is the Leach bill. While the AGA president says he’s not convinced the Senate will pass the bill into law, he adds the ramifications of the recent House voice vote of approval should not be taken lightly. [Editor’s note: No Senate version of the Leach bill had appeared before Congress recessed for November’s election, but observers were uncertain what might occur during the lame-duck session that began just after press time last month.]

Leach notes the sponsors and supporters of the Internet Gambling Bill all have strong ties to the very powerful House Committee on Financial Services.

Leach is former chairman of the Financial Services committee, and co-sponsor of the bill is Rep. Mike Oxley (R-Ohio), chairman of Financial Services. Moreover, bill supporter John LaFalce (D-N.Y.) is the committee’s ranking Democrat.

“You can imagine how much pressure financial-services companies are under these days,” Fahrenkopf says. “You’ve got the leadership of the House that day in and day out deals with banking issues putting a lot of pressure on the credit-card companies.”

Credit cards drop out

As Fahrenkopf explains, most credit-card companies aren’t waiting to see what develops from the Leach bill. Most have already begun declining approval on transactions involving Web gambling sites.

One who agrees is Eugene Christiansen, CEO of Christiansen Capital Advisors, a New York firm that studies the industry.

“You don’t need an act of Congress to change the online payment process,” Christiansen says. “The credit card is already dropping out, and people who want to continue online will have to find another payment method.”

Among alternative online payment methods:

• Firepay personal accounts, a Web-based store-value account offered by SureFire Commerce, a Quebec-based global business-to-business provider of proprietary payment processing solutions. The company processes credit-card payments for various transactions, as well as processing checks online and by phone.

• Digital wallets, software that takes the place of the traditional leather billfold and eases the online shopping experience. Most digital wallets are server based. Following an online purchase, participating merchant sites automatically ask customers to sign up for a wallet of their choice by entering a user name and password for future purchases. Once the form is completed, digital wallets pop up as a window on consumers’ computer screens during cyber shops.

• E-cash, the “electronic cash” form of computer-generated currency that can be purchased with credit cards, checks, money orders, and wire transfers. Typically, e-cash account holders are issued PIN numbers for security.

All these alternative payment sources are growing in popularity among Web casino players, as more and more credit-card companies decline direct transactions to online gaming sites. Among those who use these alternative sources are online poker players.

“Online poker is becoming very popular,” says Bonnie Rattner, director of sales for Card Player magazine. “And with all the e-cash systems, digital wallets and other services that are available today, there’s no more of these credit-card hassles.”

Rattner recently competed in the $50,000 Virtual Challenge at the Sycuan Casino and Resort in San Diego, Calif., the world’s first poker tournament that combined online players and those who regularly play in brick-and-mortar casinos. The event was co-sponsored by Sycuan and World Sports Exchange, the world’s largest online sports book, licensed and operated in Antigua. The online sports book’s card room is known as WSEX Poker.

“During the event, you could tell who were the online players by the way they fumbled with their chips,” Rattner says with a laugh.

While this unfamiliarity with handling tokens—the casino version of real money—is humorous in a poker room, the concept is not so funny when it applies to accountability in online casino transactions.

“One of the drawbacks to using e-cash is that it’s very difficult to keep records of all transactions, and this type of system is more susceptible to infiltration by a criminal element or to those who might conduct money-laundering activities,” says Tew of Bear Stearns. “Indeed, we believe the entire industry is susceptible to money laundering, given the size of the market and our view of the market as one of under-regulation.”

Offshore dangers

Online gaming experts say the region that potentially poses the most problems is the “under-regulated” Caribbean, as Bear Stearns describes the region in its recent equity research report on e-gaming.

“A number of islands in the Caribbean have established regulatory regimes that have attracted hundreds of e-gaming businesses, many of them successful,” the report states. “However, in our view the Caribbean continues to lose ground in the e-gaming marketplace as other jurisdictions around the world begin to establish tighter regulations in an effort to attract already established gaming operators.”

One who doesn’t need to be convinced of the dangers associated with Caribbean gaming Web sites is Richard Fitzpatrick, chief executive of the Interactive Gaming Institute (IGI), a Las Vegas-based nonprofit agency formed about a year ago to “advance and expedite” participation in online gaming by Nevada casinos.

“Two Internet casinos [licensed in the Caribbean] abruptly went out of business this spring, taking millions of dollars from the funds players had deposited with them. They were both located and ‘licensed’ in Curacao, Netherlands Antilles,” Fitzpatrick says. “I believe that it is most likely that a number of other similar events have taken place this year—but there is no central location to report such an incident. It’s certainly not something you can complain to U.S. law enforcement about.”

Unfortunate incidents such as these should serve as examples to U.S. lawmakers that the online gaming industry should be addressed and regulated and not prohibited, says Fitzpatrick, who adds it’s not clear whether the federal government can draft a workable carte-blanche prohibition.

“The big question that is not addressed by the Leach bill is how it affects regulations within each state,” says Fitzpatrick. “If a state allows you to take bets from customers within that state, then are you also allowed to take bets from another part of the world?”

‘None has passed’

Indeed, Fitzpatrick and other experts believe state’s rights could eventually prevail in the ongoing battle to allow Web gaming in the United States.

“We could be going back to Marbury vs. Madison,” says Internet gambling-law expert Tony Cabot, referring to an 1803 lawsuit over the presidential appointments of many Federalists as federal judges.

“One thing we have to keep in mind is that every legislature since 1995 has considered some sort of anti-gambling bill and none has passed,” Cabot says.

“The fundamentally difficult dilemma Congress faces is a conflict between federalism and state’s rights,” the Lionel Sawyer & Collins attorney says. “Should the government outlaw Internet gambling on a federal level? Or should it use federal law to assist states in enforcing state policies with regard to interactive gaming? These are some of the questions legislators are facing.”

Besides protecting the assets of online players, another good reason why the United States should regulate rather than try to prohibit the growing online gaming industry is tax revenue, proponents say.

“Before growth estimates were downsized, the market for online wagering on NFL games was $1.25 billion,” Fitzpatrick says. “Today, the market is projected at $1 billion. Well, even a modest tax of 6 percent on that would be $60 million. That’s a lot of potential tax revenue that’s leaving our shores.”

Cabot believes much of that revenue will eventually flow to online casinos in the United Kingdom. He notes the Budd Report, published recently by the Gambling Review Board chaired by Sir Alan Budd, indicates the government wants to relax regulations on online wagering.

Bear Stearns, in its recent equity research report on e-gaming, agrees the recommendations in the Budd Report “are indicative of the more liberal approach to Internet gaming the U.K. has taken when compared to regulators in the United States.”

One thing virtually all online gaming experts agree upon is that it’s going to occur somewhere.

“If you look at online gaming activities in other parts of the world, you see it’s taking off like wildfire,” says Sue Schneider, publisher of Interactive Gaming News. “In regions like Europe and Asia, the markets are more mature, and there isn’t the same sort of stigma to Internet gambling that you see in the United States.”

One who agrees is Cory Aronovitz, owner of the Casino Law Group and an adjunct professor of gaming at the John Marshall School in Chicago.

“People like to gamble, and those who operate online gaming sites stand to make a lot of money, and changes in legislation and opposition from credit card companies is not going to stop it,” Aronovitz says. “It just means we’re going to have a cat and mouse game.”

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