Presentation on Internet Gambling

Michael D. Shagan
16A WEST 88th STREET
NEW YORK, NEW YORK 10024
(212) 873-0244 FAX (212) 873-1708
email: shagan@worldnet.att.net

PRESENTATION ON "INTERNET GAMBLING"
before the
PUBLIC SECTOR GAMING STUDY COMMISSION
CHARLOTTE, NORTH CAROLINA
JUNE 18, 1999

Thank you for giving me the opportunity to present to you my views concerning Internet gambling. For your information, my background includes some 28 years as a participant in, and then consultant to, the wagering and racing industries principally, plus involvement with other forms of gambling. During that time, I have participated in the implementation of most product and technological innovations that have affected racing and pari-mutuel wagering. I was a founder of, and first General Counsel for, the New York City Off-Track Betting Corporation, and consider myself a "student" of remote gambling activities such as OTB, Intertrack wagering, the Simulcasting of live races, and more recently, Internet and other interactive wagering models. I have been deeply involved in the debate over Internet gambling for the last two years, including participation in many American conferences on the subject, plus a learning and speaking trip to Australia in 1998. While I serve as a consultant to the American Horse Council and the National Thoroughbred Racing Association with regard to the Kyl bill and other related matters, the views expressed in this Presentation are entirely my own, and do not necessarily reflect the views of anyone else.

Before I begin, let me say that I think the Australians have been doing interesting things with regard to gambling policy, and the Internet. I think we can learn a lot by observing their efforts -- and the problems they have encountered along the way. In the course of my remarks as well as in the material I am providing to your staff, I am taking the liberty of including some examples of what is happening "down under."

I want to begin my Presentation by making clear to you all where I am coming from -- the tentative conclusions that I have reached in reviewing these issues.

I believe that the appropriate American policy with regard to gambling is that

" - the States should have the primary responsibility for determining what forms of gambling may legally take place within their borders;" and that

" - the Federal Government should prevent interference by one State with the gambling policies of another, and should act to protect identifiable national interests…"

Commissioners, I did not make up this language. As you can see from the material I have provided you, this language states the position of the United States Congress --- as set forth in the Congressional Findings contained in the Interstate Horse Racing Act of 1978. It is a very appropriate policy and I see no reason why our Federal government should change it.

How should this apply to "Internet Gambling"? Over the last few years, offshore Internet gambling has presented a new and disturbing challenge to policy makers, regulators, and law enforcement officials. In this past decade, widespread deployment of new technologies has changed the landscape concerning gambling, and decisions about legalization. Government officials no longer have the assurance that if they ban a form of gambling, their citizens can't get access to it. Technology in gambling is spreading quicker than government's current ability to make policy decisions about it, or to regulate it.

It appears, however, that -- at least in the United States -- understandable concerns about this use of new technology - the potential abuses and consumer frauds that may result, and the difficulty of applying traditional forms of regulation and oversight - these concerns have all been lumped together into a "need" to attempt to prohibit such activities altogether.

In my view, a policy seeking outright federal prohibition is the wrong policy.

Notice that the Congressional Findings I quoted to you do not say that it is Federal policy to prohibit forms of gambling, or to prohibit mechanisms by which gambling is conducted. What it says is that the federal level of government needs to focus on 3 things, simultaneously.

It needs to identify what legitimate national interests could be impeded by gambling, and if necessary act to protect those national interests, At the same time, it needs to --

Maintain at the State level the primary responsibility for establishing what gambling should be legal or illegal within that State's borders. And also at the same time, it needs to --
Help prevent interference from outside of that State with those favored gambling policies

In my judgement, the problem with outright Federal prohibition, for instance of Internet gambling, is that it deprives a State of the right - in the future - to permit some form or other of technology-enhanced gambling - when and if that State determines that the proper technology and controls do exist that will allow such an affirmative policy decision.

If there are conditions that are in the national interest that must be satisfied in the course of permitting such policy decision on the State level - for instance prohibiting minors from betting, or insisting on some mandatory level of minimum regulatory controls -- then it behooves the Congress to act, but only to this limited extent.

But to completely ban Internet gambling for the future, because there may or may not be evidence at present that the proper safeguards are or will someday be available, is a dangerous example of "throwing out the baby with the bathwater." And with serious policy consequences for the whole country.

First, such an approach would make the United States a "non-player" in the evolution of this new and dynamic business and cultural enterprise. We would, in effect, be ignored, while other jurisdictions such as Australia are setting policy in this area. [This is, in fact, a significant factor in the decision of some Australian states to legalize, license and regulate Internet gambling: In doing so, and doing so early, Australian regulators are fulfilling their conscious intention of placing their imprint on the future direction of this new industry and the standards under which it will be permitted.]

Second, outright prohibition would force American businesses to go offshore in order to legally participate in this business; and it would force those Americans who were interested in playing, to find ways to circumvent the law.

Third, it would make all Internet gambling service providers ("IGSPs") equally "illegitimate" in the eyes of both the American government and casual citizens who chose to play, thus lumping together the extremes of

Those IGSPs that agreed to licensing, rigorous probity investigations and strict regulations (by jurisdictions such as some of the Australian states whose regulatory systems approach or equal those in Nevada and New Jersey), and, alternatively, at the other extreme,
Those IGSPs that maintain an anonymous presence on the Internet and that pose the greatest danger to committing fraud against consumers.

Fourth, federal prohibition also interferes with the decision by a state government to legalize one or more forms of gambling within its borders, and to derive from these sanctioned activities revenues both for government, and for local industries in support of the legalized gambling.

Fifth, there is the enormous effect such a prohibition can have on an existing industry, such as the horse racing industry. Here is a brief background about this industry:

Since 1971, customers in one state have had the state-sanctioned right to make pari-mutuel wagers on races in another state, with approval of regulators in that other state.
Since 1979, such interstate wagering has been available with closed circuit "Simulcasts" of the live races.
Since 1990, state regulators have approved the merging of wagering pools between two or more states to produce a common payout price to customers holding winning tickets in any of the participating states.
And in 1998, racing fans in France and two other European countries were able to wager in more than 1000 European betting outlets, into the pari-mutuel pools at Churchill Downs in Louisville, Kentucky, for the championship Breeders' Cup races. This wagering amounted to $1.4 million dollars, and represents a significant milestone in the merging of wagering pools on an international scale.
I should also point out that legal telephone account wagering has been operated in New York State, without scandal, since 1971.
Account wagering is legal in 8 American states, and actually operating in 6 states - in some of those states supported by a sophisticated cable television presentation of simulcast races from around the World.
In 1998, account wagering on horse races in the United States was about five hundred million dollars!

This multi-dimensional marriage between racing and modern technology has produced a very significant change in the industry, especially in the choice of locations where racing's customers do their wagering. In 1998 more than 80% of all wagering on American thoroughbred horse racing took place away from the "Host Track" facility where the live horse race was going on.

The dilemma is this --- If a "Host Track's" races are used as a vehicle for betting without reasonable compensation back to the industry, then the economic model on which the racing industry is built, is undermined, and the industry (as we know it) may not survive.

Alternatively, if racing handle falls as a result of offshore competition, the industry also may not survive.

This competition could take two forms:

(a) foreign internet (or other interactive platform) gambling service providers taking unauthorized bets on American races, or

(b) foreign IGSPs taking race bets from customers in America, who in turn lessen their patronage of the American racing scene.

Therefore, any wagering on races, via the Internet or the equivalent, is both an Opportunity and a Threat. It is an Opportunity in which we very much want to participate. But it is a Threat that could bring down our industry, and therefore also bring down our Sport.

There is one final reason why outright Prohibition of Internet gambling is the wrong policy approach: As was stated by the cabinet minister responsible for Gaming in the Australian State of Victoria, government should not "attempt to enforce an unrealistic and unworkable form of blanket prohibition."

……

The Questions you have posed to us are in the context of "Internet Gaming". I want to take a few minutes to look at both of these words, "Internet" and "Gaming".

First, the "Internet." What do we mean when we (or the Congress) talk of the "Internet"? I think that "Internet" is a word that we all use generically but that many of us only pretend to truly understand. I think what we really need to focus on is the broader concept of "advanced technological platforms" (of which the Internet is one) or "gambling with the use of advanced technology."

In Australia as in the United States, the primary determiners of policy towards gambling are the individual Australian states, and not the federal government. Nevertheless, for many of the same reasons that you and the Congress are reviewing these issues, there are two groups in Australia at their National level exploring the policy implications of technology-and-gambling: One is a Parliamentary committee: the Senate Select Committee on Information Technology. The other is the Australian Productivity Commission, a group described as "an independent commonwealth agency that serves as the Australian Government's principal review and advisory body on microeconomic policy and regulation." It is currently reviewing gambling policy within Australia, including Internet gambling, and its results are expected shortly.

Here is a statement in a consultant's Report issued to the Productivity Commission this past February, by a company called ACIL Consulting:

The term "Internet gambling" is something of a misnomer as the Internet is only one, albeit a very important, aspect of rapidly growing and developing communications technologies which are used to convey gambling information. To focus exclusively on Internet gambling would be to exclude newer forms of technology (such as the potentially widespread home access to interactive television) and forms of technology yet to emerge. Perhaps a more appropriate term is "interactive gambling" which encompasses a wider net of telecommunications and computer technologies than just accessing Web pages via the Internet. That said, at the present time interactive gambling in many countries is dominated by the Internet.

In 1996, the Ministers with responsibility for gambling policy in each of the Australian States and Territories, jointly established a Task Force to review the issues involved with Internet gambling. [I have written extensively on the results of the Task Force, and resulting legislation in the State of Queensland, and have provided my articles to your staff.] The Report of the Task Force set forth a "Model" for legalization and regulation of Internet gambling, to be implemented by legislation and rulemaking by each separate state when and if they decided to do so. Two states and the Australian Capital Territory have enacted such legislation. It is not an accident that the title of the legislation in each of these jurisdictions includes the phrase "Interactive Gambling" or "Interactive Gaming", rather that just a reference to the Internet.

As epitomized by the Model, and the legislation based upon that Model, Australia's response to the difficult issue of Internet gambling is to legalize, regulate, and license, and provide pro-active advantages to those Internet Gambling Service Providers who accept strict regulation. For instance, licensees would be free to advertise and promote their lawful gambling products as does any other legal activity. But those not licensed would be committing a criminal act if they engaged in the exact same advertising of their unauthorized gambling product.

As argued by the author of the Australian Model, the Internet is here to stay, and is not subject to traditional forms of regulation that are primarily based upon intervention at a physical place. The Internet will contain many sites at which persons in any country will be able to wager, with untested probity of the operators and without technical testing of the "games."

By legalizing Internet gambling, and applying a carefully prepared, rigorous scheme of regulations, Australian policy makers hope to protect the interests of their citizens by "ensuring that the games are conducted fair and honestly and by people who are of good repute." The Model assumes that the public will distinguish between licensed sites and "overseas or illegal sources", and will prefer the ones that are subject to strong and credible regulation, especially if only the legal sites will be "visible" through advertising and promotion. In the process, according to the Australian theory, the potential diminution of gambling tax revenues caused by unauthorized interactive gambling would be combated, and government revenues from gambling could even go up.

There is far more in the Model, and resulting legislation, than time permits me to cover here. But I would mention two foundation requirements within the Australian approach: First, that no person may participate in interactive gambling as a Player unless the Gambling Service Provider has established a virtually foolproof method of verifying the identify of the person wanting to play, and that person has registered with the licensed gambling operator. [This requirement insures, at least as effectively as for land-based gambling, that minors will not have access to participate and that problem gamblers can be assisted.] And second, that unless regulators are convinced that a gambling game is as susceptible to rigorous scrutiny and regulatory oversight as is any permitted land-based gambling game, then that gambling game will not be approved for playing on the Internet.

Under the Model, each Australian state would decide for itself whether to license Internet gambling operators, whether to permit its citizens to participate in Internet gambling, and what gambling activities its licensees could offer, or what gambling activities would be lawful for its citizens.

And that brings me to my next point. Having commented on "Internet Gaming" [the technological medium to be utilized for gambling], I now want to comment on "Internet Gaming", or the type of gambling that might be offered over the Internet.]

In Australia, not one but two separate Task Forces were established to review interactive gambling issues. The Report that was issued dealt with matters related to "Gaming", which encompassed casino style gambling. The other Task Force, which has never issued a public report, considered the separate field of "wagering" or "betting", which includes betting on horse and greyhound races, plus legal sports betting, and includes both pari-mutuel wagering operations and the operations of legal sports bookmakers. The Gaming Task Force, in making its recommendations, specifically stated that it was not intending to recommend policy with regard to the wagering industry and their already existing interactive wagering activities. The States that have enacted statutes based upon the Task Force concepts, have excluded "wagering" from the new legislative scheme and recognized that there can be valid public policy reasons why rules governing interactive wagering may well be different from rules governing interactive gaming. And even the Task Force on Interactive Gaming suggested that the states may reach different conclusions as to what interactive gaming activities they would choose to legalize, or prohibit their licensees from operating.

(By the way, the other Australian states that have not adopted the Task Force approach are split in what they think they should do. One state has indicated they will not go along with the Task Force. Another has indicated they may legalize Internet gaming, but only as an export product that is not permissible to its own residents. And a number of states are struggling with the question of the scope and timing of legalization, since they currently have exclusive arrangements with local casinos or local pari-mutuel operators.)

The point I would like to emphasize here, is that there can be valid public policy reasons against looking at all gambling the same way. In developing policy for the Internet, as with developing policy for "terrestrial" or land-based gambling, there can be valid reasons for policy makers to differentiate between different types of gambling activities, both as to whether they should be permitted, and as to the timing of legalization. As, for instance, Congress differentiated -- when prohibiting sports betting on the one hand, but passing the Interstate Horseracing Act on the other hand: In the words of Congress within the Horseracing Act, its purpose was ---

"to further the horseracing and legal off-track betting industries in the United States."

In concluding my remarks, I want to again make reference to the Interstate Horseracing Act, which was designed to deal with an analogous problem to what we are discussing today. In enacting the IHA, Congress established a sensible alternative to outright federal prohibition.

In that situation in the mid 1970s, participants and regulators of the horse racing industry were concerned that "modern" technologies [as of that time] would permit entities in one state to conduct legal gambling operations on races taking place in another state, without the approval of the racing licensee conducting that race, or the regulators of that race track licensee.

The response of the federal government was to enact new law to the effect that - while upholding the principal that States should have the primary responsibility for determining their own gambling policy, this was an instance that without some form of federal action, States might not be able to do so: that State regulators could lose control of the process. However, the federal action taken to assist the states was not an absolute prohibition, but what I would call a "limited prohibition": States were "prohibited, unless."

In the Interstate Horseracing Act, "unless" constituted a series of consents (including the consent of regulatory bodies in both states) without which the offending conduct is in violation of the Federal statute. Over the past twenty years, a sophisticated and effective system of regulation and oversight has developed at state level in response to this Federal statute.

It seems to me the IHA "model" can serve as the basis for an American model for Internet gambling. Congress could pass a statute that includes many of the well-intentioned provisions concerning the Wire Communications Act contained in the "Kyl bill." ["Internet Gambling Prohibition Act of 1999"] But instead of outright prohibition, the criminal penalties would apply only unless and until a State acted to legalize and regulate Internet gambling, with regard to its citizens as players and/or its business entities as licensed providers.

This is a different approach from prohibition. It is also a far different approach from decriminalization, or from industry self-regulation. It assumes that the same sophistication and expertise that states such as Nevada and New Jersey, and Australian states such as New South Wales and Victoria, have applied to regulating casinos, testing technology, and investigating the probity of gaming license applicants, will be applied to entities and individuals seeking or holding licenses as Internet Gambling Service Providers. I suggest it is totally consistent with the concerns expressed by the National Association of Attorneys General that were the impetus behind the Kyl bill.

In the course of this Presentation, I believe I have addressed your core questions about Internet Gambling. Should it be legalized and how can it be regulated and controlled? Only those interactive gambling activities that regulators are convinced can be properly regulated and controlled, should be a candidate for legalization. But that threshold isn't even met, if there is broadstroke, outright prohibition at the federal level.

As to whether it should be legalized once this threshold test is met, that depends on a whole series of policy decisions, both as to the gambling activities themselves, and the timing of when and if a particular activity is to be authorized.

Finally, if a gambling provider, or a specific activity is not to be legalized, how can it be prohibited? My answer must be twofold: First, it can be addressed in the same way land-based illegal sports betting is addressed -- not well, but the public can be made aware of what is legal and what is illegal. And second, the Internet and other technology-based innovations are at a very early stage; regulators must have access to knowledgeable experts, who can help develop reasonable (not foolproof) methods of controlling, if not eliminating, the worst abuses. But the Australians may, in the end, be right: Unless you offer the public a valid, legal and "visible" alternative to the illegal activities or unapproved operators, you may have limited success at best in maintaining the policy of prohibition.

Thank you