Digital Transactions, June 2011
June 1, 2011
The odds may be growing that Internet poker and possibly other forms of online gambling will become legal. That would mean new transaction and revenue opportunities for payment processors.
Just say the words “online gambling” to payments-industry executives, and most run for cover. Next to processing for porn sites, Web gambling is a topic they just don’t like to discuss, at least in public.
Yet Internet gambling is a big merchant market, with poker alone potentially generating $4 billion to $6 billion a year by some estimates. But it is a market that currently is off limits to U.S. merchant acquirers because of a controversial 5-year-old federal law called the Unlawful Internet Gambling Enforcement Act, or UIGEA.
The law bans payment processors and banks from facilitating online-gambling transactions for U.S. players. In effect, the UIGEA deputizes banks and processors as enforcers of an inexplicit federal ban on using the Internet for wagering (“The High-Stakes Bid to Stop Online Gambling,” May, 2008).
Opponents have been trying to get UIGEA watered down or repealed ever since Congress passed it, and they appeared to be making some headway until April 15. That’s when the U.S. attorney in Manhattan announced sweeping indictments against executives with three big online-poker companies and several individuals, including a Utah banker, who allegedly aided the sites in processing payments from American players.
To make its point, the government even seized the U.S. domains of the companies—Poker Stars, Full Tilt Poker, and Absolute Poker—and froze more than 75 bank accounts they and their alleged processors held. Mournful online-poker partisans immediately dubbed April 15 “Black Friday.” The poker companies, all based offshore, deny wrongdoing.
The indictments took the steam out of the accelerating anti-UIGEA train. Some observers, however, say the charges will only delay the repeal effort, not derail it.
Adding fuel to the pro-gambling argument is the desperate need among cash-strapped state governments for new revenues. Some have set their sites on intrastate Web gambling, where their take could be 20% or more.
“I think Internet gaming is going to come back,” says Richard W. Noble, chief executive of North Kansas City, Mo.-based BCC Enterprises, parent company of BankCard Central, an independent sales organization that provided online-gaming processing services until they were outlawed by UIGEA. “It’s going to come back because they’re going to tax it.”
‘We’re out of It’
Almost thumbing its nose at Congress, the District of Columbia government recently approved the nation’s first plan for legalizing and promoting online poker and other forms of online gambling. Whether D.C.’s plan actually will take effect is problematic, but the D.C. Council’s brash act confirms a measure of support for Web gambling in states and cities, though certainly not everywhere.
Gambling in some form is legal in more than 45 states, according to the Washington, D.C.-based Heartland Institute, a free-market think tank. But online versions of wagering are legally chancy.
Some states prohibit Internet gambling, and on the federal level, online poker occupies a statutory gray area that, as the poker companies found out, puts them in legal jeopardy even though Congress has never explicitly outlawed the games.
“There is no federal law against playing Internet poker,” says Eli Lehrer, vice president at the Heartland Institute. “There’s no support of it.” He adds that the existence of UIGEA is “grossly hypocritical.”
But Preet Bharara, the U.S. attorney for Manhattan, doesn’t see it quite that way. Whether they like it or not, UIGEA is the law and, according to the indictments, the defendants were willing to violate that statute as well as engage in wire fraud and bank fraud to enable U.S. residents to play online poker.
The indictments claim the defendants created phony Web sites to mask their true business as they tried to secure processing services from suspicious U.S. companies. The April crackdown was accompanied by a government civil money-laundering lawsuit seeking $3 billion in penalties and forfeitures.
“As charged, these defendants concocted an elaborate criminal fraud scheme, alternately tricking some U.S. banks and effectively bribing others to assure the continued flow of billions in illegal gambling profits,” Bharara said in a news release. “Moreover, as we allege, in their zeal to circumvent the gambling laws, the defendants also engaged in massive money laundering and bank fraud. Foreign firms that choose to operate in the United States are not free to flout the laws they don’t like simply because they can’t bear to be parted from their profits.”
If anything, the indictments showed that gambling, like abortion, remains a controversial social issue despite the growth of state lotteries, riverboat gambling, Native American casinos, and other forms of legal wagering since the 1970s.
“The DoJ [U.S. Department of Justice] has taken the position that The Wire Act of 1961 ... effectively—but not explicitly—prohibits Internet gambling despite a ruling in 2002 by the U.S. Fifth Circuit Court of Appeals that says the federal Wire Act only applies to sports betting,” says an April commentary about online poker by securities rating agency Moody’s Investors Service. “However, rather than crack down on Internet gamblers, the DoJ has largely focused on gambling Web sites that accept bets from U.S. players.”
Making this legal stew even thicker is the fact that while the UIGEA bans banks and payment processors from handling U.S. players’ online bets, the law leaves states free to run intrastate online betting, according to Moody’s.
The report, which estimates the online poker market at $4 billion to $6 billion, also cites a statement from the American Gaming Association that said the UIGEA did not update the Wire Act “to specifically apply to all forms of online gambling and did not resolve the conflict” between the DoJ and the Fifth Circuit appellate court.
Until there is some resolution, legitimate processors are keeping their heads down. “One of the things I want to underscore is we’re out of it, we got out of it when it became illegal to do,” says BankCard Central’s Noble.
In an e-mail, a spokesperson for Atlanta-based First Data Corp., the largest U.S. merchant processor, says, “First Data requires that merchants agree not to use their merchant account or the services provided by First Data for illegal transactions such as those prohibited by the Unlawful Internet Gambling Enforcement Act.”
First Data has a large international processing division, and the company does process online-gambling transactions for merchants in countries where such activities are legal, the spokesperson adds. “Such merchants must comply with all applicable laws and employ mechanisms to identify and block transactions involving cards issued in the United States,” she says.
A walled-off market with $5 billion in annual revenues, more or less, has got to cause some heartache for U.S. acquirers and payment card issuers, however. There is little competition from cash or checks. Assuming each transaction generated 2% in interchange for issuers and 2% in processing fees for acquirers, the foregone revenue for each side is $100 million a year.
While gambling has a seamy image in the eyes of many Americans, it’s not the risky market for payment processors that some might think it is, according to Noble.
“Gaming transactions are not risky at all,” he says. “The [gambling] companies have a blacklist. Once you screw one of them, you’ve screwed them all and you’re not going to go anywhere.”
BankCard Central’s online-gambling business did not generate many chargebacks, which meant modest profits, not the high margins normally associated with risky merchants. The ISO mainly provided gateway services so that players could load prepaid card accounts they used to pay for wagers.
“When it was a legitimate business, it wasn’t terribly profitable ... because it wasn’t high risk,” says Noble.
Margins, however, undoubtedly would be high enough that legitimate online-poker providers would immediately find a U.S. acquirer should UIGEA be repealed. The business case for online poker is of equal or even greater interest for casino companies than it is for processors.
Despite trepidations that online poker could divert revenues from their land-based casinos, wagering companies had begun to join the online-poker phenomenon rather than fight it. For example, Wynn Resorts reportedly had signed alliances with PokerStars and Full Tilt Poker, but in the wake of the indictments could seek other European partners, according to Moody’s.
And Wynn and Caesars Entertainment Corp. are suggesting that the time might be right for the legalization of regulated online gambling, The Washington Post reported recently.
Further, Congress is giving some signals that it could revisit the Internet gambling issue and the UIGEA. U.S. Sen. Harry Reid, D-Nev., the Senate Majority leader, told the Associated Press this spring that regarding legal, regulated Internet gambling, “I hope we can get something done.”
In March, U.S. Reps. John Campbell, R-Calif., and Barney Frank, D-Mass., ranking member of the House Financial Services Committee and a long-time critic of the UIGEA, introduced H.R. 1174, the Internet Gambling Regulation, Consumer Protection, and Enforcement Act. The bill would permit licensed online gambling under U.S. Treasury Department regulations.
After the indictments, Campbell issued a press release saying they would “add urgency to my bill.” He also said that, “we have a law in this country that a large amount of otherwise law-abiding citizens are routinely disobeying. This is not good for the nation and it is a problem that needs to be addressed.”
In April, U.S. Sen. Jon Kyl of Arizona, the Republican whip and a long-time opponent of Internet gambling, discussed on his Web site some major issues on his mind as he nears the end of his term. He reiterated his objections to Internet gambling in general, but appeared to give online poker an opening because an element of skill, not merely chance, comes into play.
“I have opposed efforts to legalize Internet gambling in the past because evidence suggests that it fosters problems unlike any other forms of gambling,” he wrote. “Online players can gamble 24 hours a day from home; children can play without sufficient age verification; and betting with a credit card can undercut a player’s perception of the value of cash—leading to possible addiction and, in turn, bankruptcy, crime, and even suicide.
“Efforts to carve out an exception for games like poker, which many believe is a game of skill, may be considered later this year. Until I have the chance to review them, I cannot make a judgment about their merits; but I will consider them carefully as long as they leave in place the broader proscriptions against online betting.”
Whether the 112th Congress actually will pass legislation to explicitly legalize some forms of Internet gambling, however, is highly uncertain. Frank, the former chairman of the House Financial Services panel, has tried and failed before, as has Reid.
But new momentum is coming from lower levels of government where, in theory, online gambling would be legal under UIGEA as long as the entire operation functions within state borders. Still, nothing is certain. The Moody’s report notes that Nevada has legalized online gambling but hasn’t passed enabling legislation because of the conflict with federal laws. New Jersey’s legislature passed a legalization bill, but Gov. Chris Christie vetoed it. California, Florida, and Iowa have bills pending, the report says.
Then there is the case of Washington, D.C., a city with a local council but where Congress plays a major role in governance. The D.C. Council last December approved what would be the nation’s first plan by a city to promote online poker and other games.
But, in an April 26 editorial, The Washington Post chided the Council for approving the plan with little debate. The proposal was not a separate measure, but was included in a supplemental budget plan and bypassed public hearings.
“It would be prudent of the District to take another look at this issue to determine if it’s really a gamble worth taking,” the editorial says, noting that Illinois and New York have asked the Justice Department for clarification about the legal ambiguities.
The District’s existing DC Lottery would oversee the online operation should it clear all the hurdles. The District hasn’t yet lined up a payment processor. According to a DC Lottery spokesperson, when the time comes, selecting a processor will be the responsibility of the DC Lottery’s operator, Intralot, an Athens, Greece-based firm with worldwide operations. “At this time, Intralot and the Lottery are still reviewing this issue,” the spokesperson says by e-mail.
Indeed, online gambling, especially poker, is getting a lot of review nowadays. But despite the indictments in New York, the smart money appears willing to put some chips into a regulated market that would enable Americans to play legally.
Online Poker Looks for a Royal Flush in the U.S.
Potential Market: Approximately $5 billion annually.
Potential tax revenues for states: 20%-30%.
Legality in limbo because of Unlawful Internet Gambling Enforcement Act, which bans banks and processors from facilitating payments from U.S. players.
Three leading online poker sites are fighting federal indictments.
Casino companies are beginning to embrace online poker.
Source: Moody’s Investors Service, news reports, Digital Transactions
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