Problems and Opportunities for Interactive Pari-Mutuel Wagering

Presented by Michael Shagan at the "Gaming Online" Conference in New Orleans on October 29, 1998.

My presentation today integrates two themes - my views on Internet gambling, and my views about the American racing industry [comprised of the breeding, training and racing of horses and greyhounds] with relation to interactive wagering and the Internet. While I will try to convey the consensus attitude of participants in the racing industry, the views expressed are entirely my own.

Allow me to start with an overview of the American Racing Industry, primarily horse racing. First, the Racing Industry is technology-driven. Whether it was always this way, it is certainly this way today, and the future of this industry is dependent on its ability to apply state-of-the-art technology to its racing and wagering products.

If I were making a presentation like this some ten years ago, I would be telling you that about three-quarters of all pari-mutuel wagers on horse racing were made at the racetrack where the race was actually taking place. But in a short period of time, the numbers have reversed. According to 1996 figures, less than 30% of the betting takes place this way. The remaining wagers are bet through some form of off-course wagering: at remote wagering sites or through account wagering. Thus, a "host" racetrack has, effectively, three betting products - its live races at its own track; simulcasts of other races at its own track; and simulcasts of its races wagered upon at remote locations.

For a graphic depiction of the "live on-track versus simulcasting" phenomenon, I happened to choose Retama Park in San Antonio, Texas because the data for its most recent racing season was published in the last couple of weeks. This troubled racetrack reopened two years ago and has just concluded its most successful meeting. Average daily "handle" at the track was only about $320,000, but about three-fifths was bet on its races at other racetracks. An average of only $135,000 was wagered at Retama, on Retama's live races. But an average of one and a quarter million dollars was bet daily on Retama's races, with nearly ninety per cent (90%), or over $1.1 million, bet away from Retama Park, at simulcast facilities.

Continuing with this overview, my second point is that the racing industry has suffered dramatically from a loss of market share because -- for many reasons -- it has not expanded its base during the time that other gambling (and leisure time activity) has skyrocketed in the United States.

Third, the pari-mutuel industries' best hope for the future lies in the fact that their sporting events are the only sporting events on which people in the United States (outside of Nevada) may legally make a bet. This exclusivity provides some hope for the future, especially if it can be tied into racing as an interactive, home, sport and wagering entertainment product.

Fourth, the racing industry is dependent upon the revenues generated from rights to its audio/visual presentations, called "Simulcasts", and the share of wagering revenues that remains after paying expenses plus government taxes.

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 even further as a result of offshore competition, the industry may not survive. This competition could take two forms:

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

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

Therefore, any wagering on races, via the Internet, 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.

The views just expressed are not mine alone or only those of a consensus of the American racing industry. Here is how a racing regulator for the Australian State of New South Wales addressed the same concern earlier this year:

"[I]t is generally agreed that the taking of the Australian racing wagering product into cyberspace must clearly be handled in a controlled and planned manner. It is crucial that any release of the product via the Internet must be accomplished by assurances that revenue flows back to the racing industry will occur now and into the foreseeable future....

Plainly, if a vehicle for wagering, such as the Internet were to lead to net cannibalisation of ...wagering in one State at the hands of bookmakers in other jurisdictions, it is clearly the case that the revenue flows of the racing industry in the aggrieved jurisdiction would suffer and the vicious circle of reduced prizemoney would be activated."

That concludes my grossly oversimplified background. It is within this context that the racing industry confronted Congressional efforts to change the federal Wire Act [18 U.S.C. 1084.] Our biggest fear was that we would end up in the worst of all possible worlds:

A situation where we were PROHIBITED from using emerging technologies, including Internet wagering, to pursue our business and strengthen ourselves;
But where, at the same time, we would be defenseless to defend ourselves from offshore activities that provided no compensation to our industry.

In our view, early versions of the Kyl bill in the Senate, plus other bills in the House of Representatives, could well have produced this "doomsday scenario." It was for this reason that we embarked on an educational campaign to explain all this to members of Congress and their staff. To make a long and difficult story short, we were somewhat successful in convincing those in Congress who were reviewing these issues that - whatever else they chose to do in their Internet gambling bills, they needed to make sure they did not undermine the racing industry. The two different bills, one as passed in the Senate and the other as approved by a House subcommittee, both went a long way in this direction.

Now, there are still aspects of both the Senate and House bills that should be rethought, and not just for their effect on racing. As I proceed with my remarks, I think you will see where I come out on these issues. In the written material I provided for this Conference, I summarized my views as follows:

I agree with those who note that since the Internet does not easily recognize jurisdictional boundaries, traditional methods of regulation and control may not suffice. I also believe, however, that for the same reasons, traditional methods of "prohibition" may not suffice.

In previous articles that I wrote in this publication about attitudes towards Internet gambling in Australia and the U.S., I spent quite some time describing the so-called "Model" for interactive gambling and regulation that was adopted as a working model by the Ministers responsible for gaming in Australia. I also analyzed the recent legislation on Internet gambling adopted in Queensland that is based upon that Model. An understanding of what is happening in Australia is significant both because that country is taking the leadership of considering a non-prohibitory, strict regulation and licensing approach to Internet gambling and because Australia's decision-making about commercial gambling has been - as in the United States - based upon policy decisions at the State level.

Briefly, the Queensland statute provides an infrastructure for legalizing gambling via the Internet, and for licensing participating ISPs, investigating the probity of the ISP principals and their technological equipment and computer software and maintaining a strict regulatory scheme. Under this legislation, a taxation and license fee structure will be in place, and those gambling providers that agree to abide by the terms of the Act, the regulations promulgated under it, and the policy decisions of the Queensland Minister responsible for Internet gambling, will have the ability to market and advertise their services. Similar advertising by non-licensees will be a criminal violation of State laws.

But here is what the Queensland statute does not do. It does not encompass existing wagering activities, in addition to gaming activities. That is, the Act makes a distinction between different forms of gambling. By doing so, it protects the existing operators of interactive race wagering and sports betting, maintains their current monopoly and does not open up licensing to competitive entities.

It provides the Minister with the right to decide (as a matter of "public interest") what forms of gambling should or should not be available to be operated by its licensees, or what forms of gambling should or should not be permitted to its citizens. It provides for reciprocal agreements with other jurisdictions (so that licensees need not be licensed in each separate jurisdiction that is a party to the agreements) but maintains the ability to enforce its own policy decisions even if in opposition to practices or gambling opportunities that are available in the other participating jurisdictions.

All of this is healthy and sensible. Nevertheless, since the generation of revenue for government was a primary mission expressed in the Australian Model, drafters of the Model state explicitly that such conduct which is illegal in a foreign jurisdiction will not bar the Australian licensee from soliciting citizens of that foreign jurisdiction and offering them the prohibited gambling opportunities. While (under the new statute) the Queensland Minister has the ability to decide otherwise, and make a precondition of being licensed in Queensland that foreign laws and rules will not be violated, there has been no indication that Queensland will adopt rules to this end.

So there are at least two clear differences between the Australia/Queensland approach and that in the United States. In Queensland, the government will provide a proactive framework for those who agree to be licensed; and it appears that such licensees will have the right to solicit (or "poach") the citizens of a foreign country where the gambling conduct has not been sanctioned.

As we all know, Internet legislation being considered by the Congress is prohibitive in nature. And even if the principal were maintained that decisions as to prohibition versus legalization-plus-licensing were left to the American states -- as has been the logical position followed in this country up to now -- there is no indication that any American state would follow a proactive approach.

I want to take a moment to review the interesting - and often overlooked - concept that even in Australia, where there is an enlightened attitude towards legalized gambling, not all forms of gambling are treated the same. I have already mentioned that there is a legislated distinction between "wagering" on racing or other sports, and "gambling" (which includes casino table games, gaming machines, and so forth.) I believe these distinctions are appropriate, and can serve as the basis for differentiation in the legalization of Internet gambling - both as to timing, and as to particular laws and rules.

The wagering component of racing in the United States (except to a limited extent in Nevada) is carried out under the pari-mutuel system, where the players are betting against each other and the operator of the pari-mutuel pools is just a stake holder. Here's a quick look at what this means:

Volume counts in our gambling game. The provider has no economic interest in whether players win or lose their individual bets.
In racing as in other sports betting, the outcome of the wager is determined by an independent "event-certain" (the results of a race or sporting contest) rather than by a computer-generated algorithm.
Race wagering is not based upon pure chance, but includes an element of skill.
Wagering in this manner is legal in some 40 American states. It is fully regulated by Racing Commissions in each state in which such betting is legal (in some cases, for more than 50 years.) Under state laws and regulations, various safeguards against consumer fraud are already in place, and vigorously enforced.
The states derive both direct and indirect economic benefit from their racing, breeding, and pari-mutuel wagering industries.
With the blessing of statutes and regulators, legal account betting already exists in 8 states, and is being actively explored in several others.
The "commingling" or merging of pari-mutuel wagering pools across state lines is a current practice that is essential to this industry. (Such practice was specifically protected in the Congressional legislation on the table at the end of this past legislative session.) Regulators from different states are already well versed in coordinating this form of interstate activity.
Racing is a statistically-intensive game. Use of the Internet for information pertaining to racing and race betting is already carried out extensively and is also essential to this industry. Currently, one hundred different racetracks in North America have their own web sites, for display of data, information about their program, and in many cases actual audio or visual presentations of their live races, plus information as to the current odds for betting.

As we approach the Millennium, the racing industry and its strategic commercial partners are expending a great deal of energy developing interactive wagering opportunities. Here are some examples:

In the State of Kentucky over the last few years, a company called "ODS" ["On Demand Services"], in cooperation with Churchill Downs, has conducted interactive account wagering, plus local cable telecasts of live races, with the wagering conducted through the television set by means of a remote control device and a modem connecting the TV set to a telephone line.

Another company, "You Bet", is using Intranet technology to display changing odds from multiple racetracks, provide audio or visual coverage of the live races, and provide wagering opportunities through an account wagering system operated by a licensed racetrack in Pennsylvania. The wagering system is currently telephone-based, but wagers could be placed via the Intranet system if American laws are interpreted or clarified to permit such wagering.

And Starnet utilizes an Internet-based system based in an offshore jurisdiction and has determined that it will not accept wagers from persons in North America (the United States and Canada.)

What is common about these systems is that the economic model under which they will operate:

Provides no races or betting opportunities without the permission of the host track, and
Provides negotiated compensation to the host track.

Further, the ODS system, since it relies on permission of a licensee where the bettor is located in order to conduct its operations in that state, also provides compensation to the industry participants in the bettor's jurisdiction. (I am not familiar with how the other interactive systems will address this issue, but such revenue sharing with the bettor's jurisdiction is a principle element of the licensing scheme in the Australian Model, where different jurisdictions are expected to enter into intergovernmental participating agreements to receive compensation when their citizens gamble via ISPs licensed in the other jurisdiction.)

There is a parallel effort going on, to create one or more vehicles whereby racing simulcasts, and interactive wagering on the races, will be available into the home virtually around the clock, including races from other countries to fill the time gaps when there is no racing on this side of the "pond". Currently, simulcasts of English racing are available some mornings, and racing from Hong Kong and Australia is available late at night. Racing from other countries is sure to follow. Already, the Australian racing is available on a cable channel in New York, with accompanying account wagering.

In the other direction, the Breeders' Cup day of high-purse championship races will take place at Churchill Downs, and included in the wagering pool, in real time, will be wagers from over 1000 locations in Europe. Last year, French bettors wagered more than $1 million that was merged into the Breeders' Cup pools at the American host track, Hollywood Park.

One new element in racing is the creation of a new organization called the NTRA - the National Thoroughbred Racing Association. The NTRA is intended to serve the interests of racing in the same way that a "league office" serves the interests of other professional sports. In its first year, the NTRA has commitments for annual funding at the level of $25 million or more. For present purposes, it is significant to note that the NTRA is committed to supporting an interactive, home-betting presence for racing and will devote time, effort and financial resources towards facilitating such activity. This includes helping to coordinate legislative efforts at both the federal and state levels.

I want to refer to the model for interactive wagering that I have developed. It is not revolutionary, but it might help satisfy the needs of regulators, players and many commercial providers. I suppose that, in great part, this model is an outgrowth of my industry's experience with an existing piece of federal legislation, the Interstate Horse Racing Act of 1978. The IHA deals with the issue of inter-jurisdictional wagering and permits consenting jurisdictions to move forward with regulated interstate activities while protecting the interests of non-consenting jurisdictions. It could serve as a model for both U.S. and global Internet wagering.

In accordance with this statute, pari-mutuel wagering (including home wagering) has for years taken place on races run in other jurisdictions, with the prior approval of regulators and industry participants in both jurisdictions (and in some instances, in multiple jurisdictions.)

I refer to the theory of this statute as one of "Limited Prohibition" - that states are "Prohibited, unless...". Instead of outright prohibition, federal 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.

I do believe this approach is more realistic than "Prohibition" and would be more effective in counteracting the potential consumer frauds that we all deplore and the unauthorized activities from which there is no economic gain to the state or to its licensed businesses. It should also shift the onus of enforcement away from a new layer of federal involvement. And it would honor the principle of "States' Rights," and continue the role of the federal government in support of state policy.

Inherent in this model is the right of a jurisdiction to "opt out" of one or more forms of interactive gambling, and the responsibility of other jurisdictions - if they accept this model - to require their licensees to honor this "opting out."

In conclusion, let me end where I began. The future of American racing is technology-driven. The well-being of this industry can be greatly enhanced by an orderly expansion of regulated interactive wagering. Or it can be damaged from "poaching" by non-U.S.-based Internet gambling service providers, if the racing industry (the track operators; and horsemen and breeders via purse money) is denied appropriate compensation for the race betting. The industry can also be damaged if not permitted to extend its reach beyond American borders, to the degree that new technologies [and international agreements] will permit.

The Australian Model for Internet and other interactive gambling is based on an assumption of inter-jurisdictional cooperation in implementing interactive gambling, but mainly where the jurisdictions are already compatible and committed (or resigned) to interactive gambling by their residents. My suggestion builds on that model but adds the requirement that there be inter-jurisdictional cooperation in letting countries decide for themselves whether interactive gambling should be implemented, on a jurisdiction by jurisdiction basis.

In this disparate world, the alternative is a limited bunch of jurisdictions cooperating, and the rest cursing them for interfering with their sovereignty. The resulting resentment and chaos is not in the "public interest" of anyone and will not lead to the internationally-coordinated system of legalization, regulation and licensing that is needed, if Internet gambling is to develop as a mature, politically acceptable industry in its own right.

Other speakers have referred to Internet gambling as an Evolutionary Highway, that will take five to ten years to travel. The proposals I've suggested in this presentation are, in effect, part of a "road map" making it possible to avoid the "mine fields" that are an inevitable hazard on this informational superhighway.

Michael D. Shagan is a New York based attorney/business consultant, primarily to the racing and wagering industries. In his 28 years in this field, he helped launch U.S. off-track betting in the 1970s, spent five years as VP/Business Development for Ladbroke Racing Corporation, and has been consulting full-time since 1991. He specializes in strategic planning within a competitive environment for the entertainment dollar; the application of emerging technologies to racing, simulcasting, and wagering; plus legal analysis and legislative drafting/review.

Mr. Shagan serves as an advisor to the American Horse Council and the National Thoroughbred Racing Association with regard to interactive wagering and pending congressional legislation that addresses American participation in Internet gambling.