Internet Gambling - The Legal Issues

This kind of activity is clearly illegal, and we're not going to put up with it in our state.

—Attorney General Jay Nixon of Missouri

Regulating any activity on the Internet has turned out to be a political and legal headache for authorities. Every country wants jurisdiction (the authority to enforce its own laws) over content that its citizens can access over the Internet. However, this has proved to be very difficult, because the Internet has no boundaries. A business based on a host computer might be legal in the country in which it is physically located but illegal in another country where it can be accessed over the Internet. This is the case for American online gamblers. Most countries are much less restrictive of gambling activity than is the United States.

In America, regulation of gambling falls under state jurisdiction. Although there are federal antigambling laws, they defer to the Tenth Amendment of the Constitution, which guarantees the rights of the states to govern their own affairs. Utah and Hawaii, for example, prohibit all types of gambling. Commercial casino gambling is legal in eleven states. Pari-mutuel wagering on horse and dog races is legal in more than forty states. Gambling on sporting events through a bookmaker is legal only in Nevada. Every state allows or disallows different forms of gambling, but the Internet has no borders. A user in any state can access online gambling sites operated from countries around the world where gambling is legal.

Determining jurisdiction is a major problem for authorities. Does online gambling occur at the location where the Web site is hosted or at the location where the gambler is located? The U.S. Department of Justice has said that gambling occurs in both places. The problem grows even more complicated when one or the other is not on U.S. soil. Although an international treaty with extradition rights could settle such matters, it is extremely unlikely to happen.

Various forms of gambling are legal in many parts of Europe, Central and South America, and the Caribbean, as well as Australia and New Zealand. In March 2001 Britain announced that it would legalize Internet sports gambling. In June 2001 the Australian Senate passed the Interactive Gambling Act, which prohibits online casinos in the country from taking bets from Australians. The law has provisions allowing interactive sports gambling and wagering services. Foreign residents can gamble at the Australia-based online casinos unless their governments sign up to be excluded from the program.

In September 2001 MGM Mirage started its own online casino, the first U.S. casino company to do so. The company set up its operations on the Isle of Man, a tiny island located in the center of the British Isles. Although it is a dependency of the British Crown, it is not part of the United Kingdom but institutes its own legislation and handles its own tax matters. The online casino did not accept bets from U.S. residents. The company closed down operations in 2003 citing concerns about legal and political issues affecting online gambling in the United States.

Federal Laws

Three federal laws on the books are directly applicable to online gambling: the Interstate Wire Act (18 U.S.C. § 1084 [a]), the Illegal Gambling Business Act (18 U.S.C. § 1955), and the Foreign Travel or Transportation in Aid of Racketeering Enterprising Act (18 U.S.C. § 1952). Only the Interstate Wire Act has been used in federal prosecutions of online gambling sites.

THE INTERSTATE WIRE ACT. In 1961 President John F. Kennedy signed the Federal Interstate Wire Act, which is widely known as the Wire Act. The Wire Act, § 1084(a) of Title 18 of the U.S. Code, makes it a crime to use telephone lines ("wire communication") in interstate or foreign commerce for the placement of sports bets or even to transmit information assisting in the placement of bets on sporting events. The act applies only to the gambling business, not to gamblers themselves.

In February 2001 the Harvard Medical School's Weekly Addiction Gambling Education Report examined the legal issues involved in Internet gambling, particularly criticisms of the Wire Act. Many legal experts say that it does not directly apply or is too ambiguous to apply to offshore online gambling sites for the following reasons:

• The Internet did not exist when the act was made law.
• Gambling Web sites maintained on offshore computers are not under U.S. jurisdiction.
• Internet service providers do not fall under the definition of wire communications facilities (particularly those associated with satellite and mobile phone transmissions).
• The law only specifically mentions sports betting, not casino games.
• Prosecutors cannot prove that online gambling sites "knowingly" transmit bets from U.S. citizens, because there is no way to know for sure the physical location of online gamblers.

The states have interpreted the Wire Act to mean that online wagering is illegal if it occurs to or from any state in which gambling is illegal. In 1999 the issue was addressed by the New York Supreme Court in People v. World Interaction Gaming Corp. (WL 591955 NY Sup. Ct. July 22, 1999).

The state of New York brought suit against World Interactive Gaming Corporation (WIGC) and Golden Chips Casino, Inc., for offering online gambling to residents of New York. Golden Chips Casino operated a legal land-based casino in Antigua. The company was wholly owned by WIGC, a Delaware-based corporation with corporate offices in New York. The suit alleged that the casino had installed interactive software on its computer servers in Antigua that allowed Internet users around the world to gamble. The online casino was advertised on various Internet sites and in U.S. gambling magazines, both of which were accessible to New York residents.

The New York attorney general's office actually downloaded the software and gambled at the Web site. Users had to wire money to a bank account in Antigua and type in their permanent address prior to play. Only users who entered addresses within states that permitted land-based gambling, such as Nevada, were allowed to play. A user who entered a New York address was not granted permission. However, the suit alleged that the barrier was easily overcome by typing in an out-of-state address, because the software had no way of checking the physical location of the user. The state did not consider this a "good faith effort" to keep New Yorkers from gambling as required by law.

WIGC argued that the federal and state laws in question did not apply to an offshore casino operated in full compliance with the law in the country in which it was located. The court ruled in favor of the state, saying that the act of entering the bet and transmitting the betting information originated in New York and constituted illegal gambling activity. The legality of gambling in Antigua was not an issue.

Furthermore, the court ruled that the gambling activity violated three federal laws: the Wire Act, the Foreign Travel or Transportation in Aid of Racketeering Enterprising Act (18 U.S.C. § 1952), and the Interstate Transportation of Wagering Paraphernalia Act (18 U.S.C. § 1953). The so-called Travel Act prohibits the use of "any facility in interstate or foreign commerce" with intent to promote any unlawful activity. The "Paraphernalia Act" is specific to gambling activity, prohibiting the interstate or foreign transmission of any item for use "in (a) bookmaking; or (b) wagering pools with respect to a sporting event or (c) in a numbers, policy, bolita, or similar game." WIGC violated this law because it had used the U.S. mail to send literature to potential investors and to send computers to the Antigua operations.

During the late 1990s federal prosecutors went after the operators of offshore sports books that had taken bets from Americans via the Internet and telephone. In March 1998 they charged twenty-two defendants with conspiring to violate the Wire Act. Ten defendants pled guilty to that charge, and three pled guilty to related misdemeanor charges. Seven of the defendants could not be apprehended and are considered fugitives. The last defendant, a U.S. citizen named Jay Cohen, decided to stand trial. Cohen and three of the fugitives operated a sports book called World Sports Exchange on Antigua.

The trial was held in Manhattan federal court for two weeks during February 2000. Prosecutors presented evidence that Cohen, as president of the company, solicited American customers through U.S. newspaper and magazine advertisements, encouraging them to contact World Sports Exchange via a toll-free telephone number and Internet site to place sports bets.

On February 28, 2000, Cohen was convicted of conspiracy to violate the Wire Act and seven substantive violations of the Wire Act. He was sentenced to twenty-one months in prison and assessed a fine of $5,000, the lightest sentence that the judge could assess under federal sentencing guidelines. Although Cohen's lawyers appealed the decision, a federal appeals court upheld his conviction in July 2001. His lawyers petitioned the U.S. Supreme Court to review the case, but the Court refused in June 2002.

Legal experts say that in this instance, the government's case under the Wire Act was strong because Cohen is an American and his company clearly accepted bets over the telephone on sporting events. The ramifications of the case to online gambling companies operated by non-Americans and those that offer only casino games are not clear.

THE INTERNET GAMBLING PROHIBITION ACT. Politicians have long recognized the shortcomings of the Wire Act to address modern gambling technologies. The NGISC recommended in 1999 that Congress enact federal legislation that would prohibit wire transfers from U.S. banks to online gambling sites or their banks.

Some form of the Internet Gambling Prohibition Act has been circulating around Congress since 1997. It was originally introduced by Senator Jon Kyl, a Republican from Arizona, to amend the Wire Act to specifically prohibit online gambling via the Internet and satellite technologies.

Senator Kyl has publicly called online gaming "the crack cocaine of gambling." The Kyl bill would have allowed individual states to permit online forms of gambling already allowed in their states (such as lotteries and casino games), while prohibiting forms that are not allowed (chiefly sports gambling). The Kyl bill never received popular support and was considered virtually impossible to enforce. It failed to pass in 1997 and 1999.

Between 2000 and 2002, other bills to combat online gambling were proposed by Republican representatives Jim Leach (Iowa), Bob Goodlatte (Virginia), and Michael Oxley (Ohio) and Democratic representative John LaFalce (New York). On October 1, 2002, the Unlawful Internet Gambling Funding Prohibition Act was passed by the House of Representatives. The so-called Leach bill would update the Wire Act to specifically outlaw the use of credit cards or electronic payment services for online gambling. However, the bill was not passed by the Senate.

In January 2003 Leach and Oxley introduced a new version of the bill as H.R. 21. It was modified and reintroduced in May 2003 as H.R. 2143. The new version gave enforcement power to the Federal Trade Commission. The bill was ultimately passed by the House of Representatives and was referred to the Senate. Meanwhile, in March 2003 Kyl and fellow-Senators Richard Shelby (R-Alabama) and Dianne Feinstein (D-California) introduced a somewhat different bill (S. 627) with the same title. As of fall 2004 neither bill had been considered by the full senate.

Federal legislation against online gambling has been difficult to pass for a variety of reasons. There are special-interest groups and lobbyists on all sides of the issue. The horse- and dog-racing industries want to be exempted from any ban on online gambling, as do Native American tribes running casinos. Internet service providers and financial institutions do not want to be burdened with enforcement duties or threatened with penalties for their involvement.

All of the major casino companies that originally fought for legislation against online gambling are now changing their stance. Many operate free-game Web sites that they hope to convert to money-based gambling sites once the legal issues are settled. They feel their name recognition and existing client base might allow them a substantial profit from such enterprises.

State Laws

The attorneys general of many states have publicly stated their belief that Internet gambling is illegal based on their interpretation of existing gambling laws. According to the U.S. General Accounting Office (GAO), the investigative arm of the U.S. Congress, five states have enacted laws specifically prohibiting aspects of Internet gambling:

• In Illinois, Public Act 91-0257 became effective January 1, 2000. It amended the state's criminal code to prohibit anyone from establishing, maintaining, or operating an Internet gambling site and prohibits making a wager by means of the Internet.
• Louisiana's R.S. 14:90.3 was enacted July 15, 1997. It prohibits operating an Internet gambling business and providing computer services to Web sites primarily engaged in gambling businesses.
• Oregon's Senate Bill 755 was passed in 2001. It prohibits the collection of Internet gambling debts through credit-card payments, checks, or electronic fund transfers. Credit-card providers are not held liable for debts incurred by Internet gamblers.
• South Dakota's House Bill 1110 was passed in 2000. It prohibits anyone engaged in a gambling business from using the Internet to take bets and prohibits anyone from establishing an Internet gambling business in the state. The law does not apply to the state's licensed casinos.
• Nevada's Senate Bill 318 was passed in November 1997, making it illegal to make or take an Internet bet within the state.

NEVADA. Nevada was one of the first states to make online gambling illegal (in 1997). However, the statute excluded bets transmitted to licensed gambling establishments within the state as long as the wagering was conducted in compliance with all applicable laws and regulations. In June 2001 legislation was enacted that allows the Nevada Gaming Commission to adopt regulations for the licensing and operation of online gambling. The following conditions apply to any online gambling systems developed:

• They must be reliable and secure.
• They must provide reasonable assurances that minors cannot play.
• They must ensure that wagering occurs only in jurisdictions where it is lawful.

In August 2002 the U.S. Department of Justice sent the Nevada Gaming Commission an advisory letter outlining the federal government's stance on online gambling in Nevada. The letter said that "federal law prohibits gambling over the Internet, including casino-style gambling." The letter also clarified that the federal government considers online gambling to occur both at the location of the bettor and the location of the gambling business. Nevada still plans to continue investigating online gambling opportunities.

NEW JERSEY. New Jersey, another state heavily dependent on traditional gambling markets, has taken a different approach to online gambling. The state's Division of Gaming Enforcement filed civil lawsuits against eleven online gambling sites during 2001 and 2002 for taking bets from New Jersey residents. The companies had gotten very bold, even advertising on billboards along major highways. Most of the companies have refused to acknowledge U.S. jurisdiction and ignored papers that the state has tried to serve to them.

Credit-Card Issuers and Other Financial Institutions

In 1997 and 1998 a California woman named Cynthia Haines charged more than $70,000 in online gambling losses to her credit cards. Providian National Bank, which issued the cards, sued her for nonpayment. In June 1998 Haines countersued the bank, claiming that it had engaged in unfair business practices by making profits from illegal gambling activities. At that time, all casino gambling was illegal in California. Haines's lawyers argued that her debt was void because it arose from an illegal contract. Providian ultimately settled out of court, forgave her debt, and paid $225,000 of her attorney's fees. The company decided to no longer accept online gambling transactions.

The settlement caught the attention of other major credit-card issuers. Nonpayment of outstanding credit-card charges results in serious losses, called "charge-offs" in the industry. Faced with the potential for massive charge-offs and legal uncertainties, many card issuers decided to stop accepting financial transactions from online gambling sites. This includes such major companies as Bank of America, Chase Manhattan, Citibank, Direct Merchants, Fleet, and MBNA. Issuers that do accept online gambling transactions generally delay payment of part or all of the money to the online sites for several months in case the user decides to dispute the charges.

In December 2002 the GAO issued Internet Gambling: An Overview of the Issues. The report discusses the payment systems, chiefly credit cards, used in Internet gambling. The four major credit cards issued in the United States are VISA, MasterCard, Discover, and American Express. The first two cards are issued by a large network of financial institutions that have credit-card associations. These associations set policies for the member institutions and provide the computer systems used to process financial transactions between the institutions and merchants. The Discover and American Express cards are issued and processed by their respective companies. Just over 500 million credit cards were in use in the United States at the end of 2001.

Experts estimate that 90–95% of all online gambling transactions are performed with credit cards. All of the major credit-card companies have enacted measures to restrict the use of their cards for Internet gambling. Discover and American Express primarily do so by preventing Internet gambling sites from becoming merchants in the first place. All potential merchants are screened, and existing merchants are spot-checked to make sure that they are not engaged in online gambling.

The credit-card associations allow their member institutions to decide whether or not to accept transactions from online gambling sites. The associations have a coding system that merchants must use to distinguish transaction types when the card is checked for authorization. This system was refined in 1998 so that Internet gambling transactions can be easily identified. Online gambling sites must enter a special two-part code that tells the issuer the nature of their business and gives the issuer a chance to deny authorization. Figure 9.2 shows how an online gambling transaction can be blocked at various points in the process. The GAO estimates that member institutions controlling more than 80% of the VISA and MasterCard credit cards issued in the United States deny payment authorization for online gambling transactions.

The coding system, however, has several problems. It does not distinguish between legal and illegal transactions. For example, Americans visiting countries in which online gambling is legal may find their credit cards rejected when they try to gamble over the Internet. The coding system can also be tricked by unscrupulous merchants who enter the wrong code for their businesses. The credit-card associations reported various instances in which Internet gambling merchants had been caught doing this.

The GAO states that four out of five credit-card transactions are now blocked at online gambling sites. Increasingly,

FIGURE 9.2

merchants and gamblers are turning to alternative payment systems, called online payment providers. These services allow customers to transfer money from their credit cards into accounts that can then be debited to pay for a variety of online goods and services, including gambling. Money going to and from these intermediary accounts is not easily traced. Online payment providers include PayPal, NETeller, FirePay, and ECash. Some creditcard associations are refusing to do business with online payment providers unless they receive assurances that money will not be transferred to Internet gambling sites.

In 2002 and 2003 the online payment network PayPal, Inc., paid millions of dollars in fines to settle allegations that the company violated the Patriot Act during 2001 and early 2002 by processing online gambling transactions from American citizens. The Patriot Act (officially titled Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001) forbids the electronic transmission of funds known to be associated with criminal acts. PayPal stopped handling online gambling transactions in November 2002.

Federal Crackdown on Advertising

Web languages include a navigational tool called hypertext that allows immediate jumping from one Web site to another. An Internet user who clicks on a hypertext link will immediately access the Web site associated with that link. Many online businesses pay other Web sites to offer such links. Every so-called click-through earns a commission for the webmaster offering the link. Webmasters can also earn money by renting out advertising space on their Web pages.

According to the Newsbytes News Network, a technology news Web site operated by the Washington Post Company, online casinos were the fifth-largest Internet advertisers at the end of 2001, following companies offering books, investments, consumer credit, and travel. Jupiter Media Metrix reported that there were 170% more advertisements for online casinos during 2001 than the year before. Increasingly, these advertisements are on mainstream Web sites rather than just in niche markets. However, some Web sites have run into trouble with other advertisers for including Internet gambling advertisements. In 2000 Web portal Yahoo pulled Internet gambling advertisements from its football pages after the National Football League complained.

In April 2004 major Internet search engines, including Yahoo and Google, announced that they would no longer display ads for online gambling sites that targeted American citizens. The companies reportedly acted to head off plans by the U.S. Department of Justice to pursue legal action against them.