Playing Your Cards Right in the Changing U.S. Online Gaming and Gambling Market

Worldwide online gaming and gambling is an enormous and growing business.  Over the past five years, global online gaming and gambling revenues have gone from just over $20 billion in 2007¹ to over $35 billion in 2011.²  Online poker alone generated revenue in excess of $4.8 billion in 2009³ and is expected to rise to $6.7 billion in 2012.⁴  And much of the revenue has come from millions of people in the United States playing poker or placing other bets on their personal computers.⁵  All this is remarkable, especially since online gaming and gambling, including online poker, have always been prosecuted as if they were illegal in the United States.  Notwithstanding state and federal legal prohibitions, and despite active and high profile prosecutions by the U.S. Department of Justice (“DOJ”) of several of the biggest and most successful international online gaming businesses, online gaming and gambling in the United States has continued to flourish.

And now the legal tide appears to be shifting, and with it the opportunities for entrepreneurs and investors to lawfully tap the multi-billion dollar online gaming and gambling market – a market poised to grow exponentially.  Indeed, experts have projected that legalization of online gambling in the United States would generate more than $14 billion in gross gaming revenue within a year, rising to $27 billion within five years, and if sports betting were included, these estimates would rise to $22 billion in year one and $42 billion by year five.⁶

In this article we discuss the December 2011 DOJ legal opinion that is driving the changing legal landscape, and the steps numerous states have already taken in direct response to the DOJ opinion to legalize online lotteries and gaming.  We also discuss legal impediments to online gaming and gambling, and we outline 10 steps to increase the odds of success in the online gaming and gambling business. 

The December 2011 DOJ Opinion

On December 23, 2011, DOJ’s Office of Legal Counsel released a “Memorandum Opinion” (the “Opinion”) addressing the question of “whether proposals by Illinois and New York to use the internet and out-of-state transaction processors to sell lottery tickets to in-state adults violate the Wire Act,” which is the principal federal statute concerning Internet gambling.⁷  The Opinion reversed a long-standing DOJ position that the Wire Act prohibits all forms of Internet gambling, and all interstate wire transmissions of gambling-related communications no matter what the nature of the gambling.  The Opinion found that DOJ’s prior view was “incorrect and the Wire Act prohibits only the transmission of communications related to bets or wagers on sporting events or contests.”⁸ 

Prior to the issuance of the Opinion, DOJ had “uniformly taken the position that the Wire Act is not limited to sports wagering and can be applied to other forms of interstate gambling.”⁹  And DOJ criminal prosecutors had “consistently argued under the Wire Act that, even if the wire communication originates and terminates in the same state, the law’s interstate commerce requirement is nevertheless satisfied if the wire crossed state lines at any point in the process.”¹⁰  Under this old interpretation, which was accepted by several courts,¹¹ the Wire Act was seen as prohibiting states and private parties from using the Internet for all betting and wagering, including betting and wagering originating and terminating exclusively intrastate.  The Opinion changed all this, announcing that the Wire Act only applies to sports betting, and Internet communications related to sports betting.

Specifically, the Opinion answered a question that had been posed by Illinois and New York “regarding their plans to use the Internet and out-of-state transaction processors to sell lottery tickets to adults within their states.”¹²  In finding that the proposed Illinois and New York lotteries would not involve sporting events or contests, the Opinion determined that the “lotteries are not within the prohibitions of the Wire Act.”¹³  The proposals of both states concerned intrastate lotteries and the sale of lottery tickets over the Internet to in-state customers only, with the interstate use of the Internet for processing of transactions in out-of-state data centers and through out-of-state networks.  In response to Illinois’ and New York’s question, DOJ’s Office of Legal Counsel conducted an exhaustive analysis of the Wire Act, including its legislative history, and concluded that “the Act’s prohibitions relate solely to sports-related gambling activities in interstate and foreign commerce.”¹⁴

State Reaction to the Opinion

The Opinion is just that, an opinion.  It is not binding legal precedent.  Neither the courts nor DOJ itself is bound by it.  And, even as an opinion of DOJ counsel, it is narrow in scope, limited to the Wire Act and to the specific question posed by Illinois and New York concerning their proposed online lotteries.  The Opinion does not once mention the word “poker,” and it does not concern casino-type gaming or gambling.  Nevertheless, many gaming experts and bloggers perceived the Opinion as a Christmas present for those interested in entering the business of online gaming and gambling.  And more importantly, many states agreed, viewing the Opinion as opening the door not just to online state sponsored lotteries but to state authorization of intrastate non-sports Internet gambling, including online intrastate poker, operated by private businesses.

In the immediate wake of the Opinion, New York and Illinois moved forward with their proposed online lotteries, with the Illinois lottery now up and running as of March 25, 2012.  The Nevada Gaming Commission, which just prior to December 23, 2011 unanimously approved regulations authorizing private companies to apply for in-state Internet poker licenses, pushed forward with its plans.  Nevada’s “Interactive Gaming Minimum Internal Control Standards” became effective on March 20, 2012, and its “Interactive Gaming Technical Standards” will become effective on April 8, 2012.  So far, more than 25 Las Vegas businesses, including MGM, Caesars (in partnership with 888), Boyd Gaming (with bwin.party) and Bally Technologies, have applied for licenses.
In addition to Illinois, New York and Nevada, at least 18 other states and the District of Columbia promptly responded to the Opinion with initiatives that would legalize or at least explore various forms of real-money Internet gambling within their borders.¹⁵  These states include: 

• California – Senate Bill 1463 was introduced in February to allow Internet poker to be offered in California by authorized cardrooms, Indian tribe casinos, horse racing tracks and online horse wagering sites that have been in operation for at least three years prior to licensing.  The bill may be acted upon on or after March 26, 2012.  Additional key components of the bill include the possibility of interstate agreements to provide Internet gambling if the DOJ indicates that it is permissible under federal law and the choice for the state to opt in or out of any federal framework for Internet gambling.

• Connecticut – The Connecticut House Safety and Security Committee held an informational forum on online gaming in February, including representatives from Mohegan Sun and Foxwoods Casinos.

• Delaware – Governor Jack Markell’s administration is purportedly preparing to introduce a bill by the end of April titled “Gaming Competitiveness Act,” which would allow Internet sales of Delaware lottery games as well as online casino-style games.

• Hawaii – A bill was introduced in January to establish the Hawaii Internet lottery and gaming corporation for purposes of conducting games of chance and games of skill over the Internet.  The bill would also authorize the commission to “enter into agreements with other state gaming entities for the offering of multistate games.”  Rumors have surfaced that the bill will not go forward this session.

• Illinois – A bill to allow for online sales of Powerball tickets was recently approved by the Illinois Senate Executive Committee, and a bill to permit Internet gambling operated by private businesses is under discussion, but has not yet been introduced.

• Iowa – The Iowa Senate State Government Committee voted in February to allow companies to partner with state-licensed casinos and racetracks to offer Internet gambling, and the Iowa Senate approved Senate File 2275 to legalize online poker and bring it under state regulation.  Iowa House Speaker Kraig Paulsen recently indicated, however, that the State House does not plan to take up the bill this session.

• Maine – Last month, a bill was introduced that would allow Maine to engage in online lottery sales.

• Maryland – The Governor’s proposed budget for FY2013 includes revenue from the sale of lottery tickets over the internet, indicating that the Maryland Lottery is moving forward with its plan to sell tickets and offer traditional lottery games online. 

• Massachusetts – State Treasurer Steven Grossman created an Online Products Task Force in February to explore all Internet gaming options for Massachusetts.

• Mississippi – A bill was introduced in February that would authorize licensed businesses to offer Internet gambling within the state’s borders.  The bill recently died in committee and will not be voted on this legislative session.

• New Jersey – At the beginning of March, a New Jersey senate committee approved a bill to allow Atlantic City casinos to establish Internet portals through which the state’s residents could play casino games, and a separate senate committee approved a bill to allow gambling using mobile devices within Atlantic City casinos.  Another pending bill would permit the State Lottery to sell tickets and conduct games online.

In addition to legislation designed to authorize intrastate Internet gambling, we anticipate that states will soon consider forming compacts with other states to allow for interstate gambling akin to interstate lotteries, such as Powerball and Mega Millions, both of which are legally authorized by the compact known as the Multi-State Lottery Association.  The California legislation expressly contemplates such interstate agreements to provide Internet gambling.¹⁶   

Trip Wires That Continue to Exist

While the Opinion has unleashed a torrent of activity aimed at legalizing online gambling, entrepreneurs and investors who are interested in entering the nascent market, should still be on their guard.  Obviously, under the Wire Act, Internet sports betting was and remains illegal.  Indeed, DOJ punctuated this point in February 2012, just two months after the release of the Opinion, when it indicted Bodog Entertainment Group S.A., and its billionaire founder Calvin Ayre, and seized and shut down Bodog’s popular sports betting website Bodog.com.¹⁷  In addition, DOJ has continued its highly publicized criminal prosecution of the principals and founders of the world’s three leading Internet poker companies doing business in the United States – PokerStars, Full Tilt Poker and Absolute Poker.¹⁸ 

After the Opinion issued in late December 2011, the federal judge presiding over the online poker prosecution appeared to note a tension, if not an outright inconsistency, between the Opinion and the ongoing prosecution, when he asked both sides to explain the impact, if any, that the Opinion would have on the prosecution.¹⁹  Predictably (and correctly), the government noted that the Opinion, which concerned the Wire Act, was irrelevant to its nine-count poker prosecution in which no charge implicated the Wire Act.²⁰  According to the government, “the Opinion was needed to clarify the legality of . . . proposed state-run lotteries, which in practice would involve incidental interstate Internet transmissions.”²¹  And it “does not analyze or draw any conclusions about the UIGEA, the Illegal Gambling Business Act of 1970 (‘IGBA’), 18 U.S.C. § 1955,”²² or any of the other statues under which the poker defendants had been indicted, most of which are predicated on violations of state gambling law.  As the government explained:

[T]he policy changes that flow from the Opinion are of no benefit to those offering internet poker in a manner that violates state gambling law. . . .  The effect of the Opinion is that an internet gambling company that offers lotteries (and . . . other non-sports gambling) solely to residents of a particular state, and in compliance with the state’s own gambling statutes, will not be prosecuted under the Wire Act merely because incidental wire transmissions stray across state lines.  In other words, at least outside of the context of sports betting, the determination of what forms of internet gambling to outlaw and what forms of gambling to legalize and regulate within the borders of a state will primarily be one for the states, as it has been with respect to brick and mortar gambling.

Implicitly acknowledging the force of the government’s position on Internet gambling, several of the individual defendants in the poker case, including Absolute Poker co-founder Brent Buckley and payment processor Ira Rubin, have pled guilty to conspiracy to commit bank and wire fraud.²⁴  Defendant payment processors Bradley Franzen and Ryan Lang pled guilty to violating the UIGEA, among other laws.²⁵  The single remaining defendant who is not a fugitive, John Campos, is also expected to plead guilty.²⁶
Although change is indisputably afoot, most forms of Internet gambling remain illegal under state law, and under derivative federal laws that authorized federal prosecutions of state anti-gaming prohibitions.²⁷  Those interested in taking advantage of the promise held open by the Opinion must be mindful of the passel of state anti-gambling statutes that remain in place.  Entrepreneurs and investors must proceed with caution.  The Opinion and the laws promulgated in the states in its immediate aftermath have created the groundwork for lucrative future businesses, but substantial risks remain.

Next Steps – Our Top 10 Recommendations

For those who want to take advantage of the new opportunities in the online gaming and gambling market, we recommend the following 10 steps:

1. Relationships – Establish (or reestablish and further develop) appropriate relationships in those states that have already legalized or are actively considering legalizing online gaming.  Nevada and states following Nevada’s model will require site operators to partner with licensed land-based casinos to be eligible for a license.  Other states, like California, may only issue gaming licenses to establishments licensed under existing law, in which case partnering with licensed cardrooms and casinos will be vital.
2. Start-Up Money and Reserves – Consider all options to finance your operation and the payment of initial non-refundable licensing fees (which are likely to be very steep), including through debt or equity securities, small business loans, state economic incentives, tax breaks and other non-monetary incentives.  In addition, online gaming companies must plan to maintain a cash, credit, or bond reserve equal to the sum of all of the funds in players’ accounts.
3. Patent Protection – Protect your proprietary technology by (i) having a professional conduct investigations to ensure your product is new and would not infringe anyone else’s patents and (ii) filing patent applications with the U.S. Patent and Trademark Office to cover your technology prior to disclosure outside the company.  Any patent application should cover preferred implementations of the game rules, user interfaces and back-end processing, as well as intersections with other fields such as computing, mobile communications, social media and advertising.
4. Branding – Distinguish your product and services by (i) working with your marketing team to identify strong and distinctive trademarks, (ii) having a professional conduct a search to ensure that no one else is already using the same or a confusingly similar mark and (iii) filing “intent to use” trademark applications with the U.S. Patent and Trademark Office before you go to market.
5. Know When to Hold ‘Em – When discussing your proposed project with potential partners and investors, you will be asked to share information about your intellectual property and technology, which is likely to include confidential information, trade secrets and even attorney-client privileged information.  Make sure that you enter into appropriate non-disclosure agreements in advance.  Limit the information you share to that which is necessary, and consult with your legal advisers before sharing trade secrets or privileged information.
6. $$$ – Develop an organized and secure system to process players’ money, as player-to-player transfers and credit accounts will likely be out of bounds.  In Nevada, for instance, player deposits can include cash at brick and mortar locations, checks, wire transfers, casino transfers and debit or credit cards.  Other states may broaden or narrow these restrictions, so it will be necessary to develop sophisticated, secure methods to process funds.  These processes will likely need to pass stringent suitability tests.
7. Know Your Players – Control player registration by developing secure and confidential player registration and accounts.  Site operators must prove that they have an effective way to verify that their users are of age and located in the applicable state while playing.  Operators will also be required to verify each player’s identity, ensure they are not blacklisted and determine that they are actual individuals (and not “bots”).
8. Policies and Disclosures – Be prepared to provide easily accessible information to players.  For instance, Nevada requires that online gambling sites provide links to the State Gaming Control Board’s site, information on problem gambling and a self-exclusion option.  Legislation being considered elsewhere requires online gaming sites to develop and post clear policies on items such as dispute resolution, house gaming rules, privacy and data security, and terms of use for registered users of online games.
9. Security – Guarantee that you have a secure platform and be prepared to prove it.  Player information must be kept confidential and funds must be segregated and secure.  Policies and procedures must be developed to avoid money laundering, collusion and other cheating.  Policies should also be in place to alleviate concerns that the company might deduct money from player deposits before it is earned.
10. In-State Support Services – Consider hiring employees who will help support a 24-hour gaming site.  Legislation, such as the bill proposed in California, will likely require that operators be on hand all day, every day, to address site errors or player concerns.  These operators will need to be located in the state in which the operating site has received a license, or in which it has partnered with a licensed entity.  Licensees should determine who they will hire to provide these services, develop the requisite contracts and ensure that their support service arrangements abide by all applicable legal requirements.

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Those interested in learning more about Goodwin Procter’s gaming and gambling expertise and practice, and those interested in pursuing any of the recommendations outlined above, should contact either of the authors, David Apfel or Bob Crawford, co-chairs of Goodwin Procter’s Gaming, Gambling & Sweepstakes Practice.