Mr. Chairman and members of the committee, I want to thank you for the
invitation to appear before you today and testify. The subject of Internet
gambling and in particular Internet poker is very complex. Over the last 15 years I
have worked with many of the companies and individuals that you will also hear
from today. I am a lifelong resident of California. I have practiced law in California
for 35 years. I am a tax and gaming law attorney. I have worked as in house
general counsel to Centaurus Games, LLC and other companies and I have served
as outside counsel for variety of internet entertainment companies. I am very
familiar with internet gaming. I am a member of the International Masters of
Gaming Law. I appear today as a consultant to the CTBA and as contributor to the
report prepared by Michael Genest for the CTBA1.
In the course of the last 15 years I have witnessed the growth of Internet poker
from a cottage industry to a maturing market sector with small, medium and large
companies and in a few cases state run enterprises aggressively competing for
market share. It has been estimated that there are globally in excess of 550 online
poker companies operating over 2,300 sites which run on 45 platforms. Some of
the competitors in Internet poker are now very well known, even household
names in the gaming sector. The sector participants range from traditional brick
and mortar companies, who have internet divisions, to companies that have
Internet only operations, to technology providers and software development
companies.
There is no doubt that many people use the internet for a portion of their leisure
time experiences and some choose to play poker on line, whether for fun or to
gamble or as on‐line poker professionals. There are some important issues with
respect to the role of both the federal and state governments and many of these
issues are quite complex.
The issues that I am going to testify about today are the following:
(1) Should California legalize internet poker?
a. The choices are:
i. Adopt enabling legislation under the intrastate exemption
of the Unlawful Internet Gambling Enforcement Act of
1986, (“UIGEA”).
ii. Wait for federal enabling legislation, like that being
considered in the House and Senate and then either “Optin”
or “Opt‐out”.
(2) If the state chooses to legalize internet poker which regulatory model
should it choose? The alternatives are;
a. monopoly model
b. Licensing model
(3) Assuming the state acts under the intrastate exemption of UIGEA, are
the revenue and market forecasts you have seen reliable and if not why
not?
a. What is the effect on forecasts of competition from offshore
operators who have “extraterritorial” licenses?
b. Can the state effectively limit competition from off‐shore
operators by restricting access to sites or restricting advertising?
c. What other competitive forces come into play.
(4) Would the licensing of intrastate poker violate the “exclusivity clauses”
of the Tribal‐State Compacts?2
In essence the discussion today and for the foreseeable future will hinge on: first,
whether there is a viable revenue model to move the state toward regulation on
an intrastate basis and if so, what is that model (monopoly or license), and;
second, what is the effect of the Tribal‐State Compact “exclusivity clauses”?
Summary Conclusion
The integrity of any revenue model is dependent on the discount attributable to
the effects of offshore competition. Under a monopoly model the discount will
be greater than with a licensing model. However, neither model will overcome
the loss of revenue to the state if the licensing is found to violate the “exclusivity
clauses” of the Tribal State Compacts.
Monopoly or License Models
First, a bit of background on internet gaming. Poker is but one aspect of the
internet gaming sector. Some of the written discussion has broadly referred to all
internet gambling in describing the market. We need to focus only on poker.
Internet poker players break out into three discrete groups. There are individuals
who play for fun only, those who play on subscription sites or virtual prize sites
for fun and prizes and those who play in real money games. It is the real money
group that is the focus of regulatory efforts on many scales and a source of
potential licensing and income tax revenue.
As a point of reference, according to the web site www.PokerScout.com, (a
credible industry source) there are currently 13 sites that they follow that accept
2 Article II. Section 3.2 of the 2004 Amendments to One of Five Tribal‐State Compacts
U.S. players for real money poker and all of these would appear to accept players
from California.
There are approximately 76 jurisdictions that license Internet Gambling3 (all
forms, including: sports, horseracing, skill games, including poker, bingo and
lotteries). There are, various regulatory models being used at the nation state
level. A good example of differing approaches is seen in Europe where at least
two approaches are used. One is the licensing model and one is the monopoly
model. All other models derive from these two. Both of these models have their
limitations and benefits. In the United States we have a potential third, nation
state, model. The U.S model as seen in the Frank4 and Menendez5 bills would be
a hybrid of the licensing model at the federal level but then the states which
choose to “opt out” can decide which model to use if they elect to regulate under
the intrastate exemption.
There is also a derivative of the licensing models and that is extraterritorial license
which is the form of license used by offshore operators6. Under this form of
regulation, companies obtain licenses to operate from the licensing jurisdiction,
but not within the jurisdiction. The servers and other facilities are based in the
jurisdiction but the customers are not. The compliance controls, both gaming,
and financial are done in accordance with the regulations established by the
hosting jurisdictions licensing authority. These are typically low tax or low fee
jurisdictions and generally allow the site operator great flexibility. Some of these
jurisdictions have developed sophisticated systems and are very diligent in
supervision. But it is the extraterritorial model, itself, that is the foundation for
the offshore operators.
3 Jason Gross, Internet Gambling & the Law‐Prohibition vs. Regulation, 14 Metro.Corporate Counsel, Aug. 8, 2006,
at No. 84 H.R. 2267‐H.R. 2269
5 S 1597
6 Among the licensing jurisdictions are: Antigua‐Barbuda, Alderney, Costa Rica, Dominican Republic, Gibraltar,
Ireland, Isle of Man, Kahnawake, Malta, Netherlands Antilles, and Panama. A list licensing jurisdictions compiled by
GamblingLicenses.com is available at its website.
The UIGEA is one of the responses of the United States to the extraterritorial
model and to offshore operators. UIGEA provides for the ban on unlawful
internet gambling by seeking to control the flow of funds, specifically through
credit cards transfers. Its focus is the regulation of payment processors.
MasterCard International, Visa International and other credit card companies
have stopped processing credit card payments originating from the U.S. which use
the merchant code attributable to gambling, code 7995. It is important to note
that the UIGEA regulations exempt from the processing ban, ACH systems,(debit
cards), check collection systems and wire systems7. It is through these devices,
ACH (debit cards), checks and wires, as well as eWallet companies that the
offshore companies (identified on PokerScout.com) are able to get money from
players in the U.S., including California and to pay out winnings.
It is only recently that the federal government has taken enforcement action
against some payment processors by seizing funds on deposit and the associated
records and initiated prosecutions8. However, in spite of the seizures and
prosecution, the offshore operators continue to operate and even grow. They
pose a serious competitive threat to a wholly intrastate market such as that
which California would offer.
A good point of reference to see the effect of offshore competition on a state
monopoly is to look at the Swedish model. Sweden has a state licensed monopoly
system and yet it has, according to Deutsche Bank only a 30% market share9. The
remaining 70% of market share leaks to sites unlicensed in Sweden. The
explanation is not as a result of weakness in the Swedish regulatory scheme, it is
an example of how the extraterritorial model works. The licensing jurisdiction
allows an operator to host its operations in the licensors facilities and reach
outside its borders for customers. Sweden is also a bit late in getting to the
7 12 C.F.R. 233 and 31 C.F.R. 132
8Example: United States vs. Douglas Rennick, USDC (SDNY) 09Crim752; In the Matter of the Seizure of the
Contents of One Citibank bank account. USDC ( Maryland), Case No. 09‐2891
9 Deutsche Bank Company Alert: Party Gaming PLC 11 Jan 2009
market having entered when offshore sites have built brand identity and loyalty.
Similar to what could happen in California. There are forecasts that anticipate
growth in Sweden of the market share for its monopoly, but the competitive
forces will still be there10. It should also be noted that Lotto‐Quebec announced
February 6, 2010 that as the monopoly online operator in Quebec Province it will
offer online poker in the second half of 201011, but Italy has just moved from a
monopoly model to a licensing model.
It is worth noting that there is no homogenous license fee (tax rate) through the
various licensing jurisdictions12.
An example of a current tax rate in a licensing jurisdiction is the Italian approach.
The Italian regulatory regime has a differentiated license rate. The license rate
ranges from 20% of GGY (revenue) for cash games and for casino games, to 11%
for bingo, down to 3% for poker13. Other examples of licensing jurisdictions are
Gibraltar which has an annual license fee of 2,000 (GPB) plus 1% of GGY with a
cap. The U.K. has a licensing fee which is 15% of gross profits.
What is important to note is that the economic risk in the two models is very
different. In state monopoly jurisdictions the operator typically pays a fee to the
software and technology operator, and the state owned operator bears most of
the market risk, including the risk from offshore competition. The risk of success
is shifted to or borne by the state. In the licensing model, the licensee has the
entrepreneurial risk. The Swedish experience is an example of what happens
when a monopoly market is faced with offshore competition. The Italians are
also illustrative for having moved from a monopoly to a licensing model. But
these again, are nation state jurisdictions.
10 Lotto‐Quebec announced February 6, 2010 that as the monopoly online operator in Quebec Province it will offer
online poker in the second half of 2010.
11 Pokernewsdaily.com, February 7, 2010
12 A complete comparative analysis of tax and license rates is beyond the scope of this statement
13 GamingTechLaw.com January 28, 2010
The unknown factor here is consumer behavior. How will consumers respond
when faced with a choice of a regulated activity wholly in state, which requires
proper identification, tax compliance, age and location monitoring when there
will still be access to the offshore operators.
There are several methods of attempted Internet regulation none of which truly
successfully impair the extraterritorial reach of otherwise unlicensed companies.
The methods breakdown into (1) nation‐state censorship14, (2) advertising bans
by imposing sanctions on ISP’s15 and (3) censorship of other forms of media
advertising. None of these approaches in and of themselves work on a nation
state imposed basis let alone have any been proven to work in a single state like
California.
Here are just some of the methods used to avoid censorship by the
extraterritorial operators and attract new customers. First, some operators have
“free play” sites that sponsor television programs. These sites use a domain URL
that usually ends in .NET or .TV. The consumer is counted on to recognize that
the most common domain is .COM. The consumer may instinctively direct
himself or herself to the .COM site. In addition the sites use online magazines and
information sites to host advertising for their .COM site. They also use “blogs”.
The site operators also use traditional print. The operators use these in
combination with customer sign up and retention bonuses and celebrity player
endorsements. All of which serve to build their brands and their market share. It
is worth noting, that on the most prominent offshore sites, a full 75%‐80% of all
players are playing for free. The play for free offer and learn to play is a key
recruiting tool for the real money games. Further, and most importantly, the
extraterritorial operators are not limited by geography. They create player
liquidity pools on a global basis, as opposed to having to deal with a physically
14 China as an example
15 Italy implemented ISP blocking which the AAMS determined was of limited effectiveness
restricted geography and inelastic pool of players. The global reach allows for
constant regeneration of players.
The question then is can the state licensed site operating in fixed geographic
boundaries, compete for market share with already established and well branded
offshore operators. Put differently, is censorship an answer? No.
Internet censorship is a highly controversial issue and one that should be
considered with all due caution and in light of the already existing ability to avoid
restrictions on marketing by nation state regulators, it is doubtful that California
could implement a system of internet advertising censorship that would pass legal
challenge and work. This committee should recognize that any proposal that
bases its license fee forecast to the state on a premise of Internet censorship is
deeply flawed. Further, ISP regulation while tried in Italy 16has not proved to be
truly effective when done at the nation‐state level. It is doubtful whether the
state could impose ISP blocking mechanism that did not meet with federal
challenges.
In essence, the intrastate model may very well “ring fence” California by
preventing it from reaching players outside the borders of the state, but yet be a
target for offshore operators who choose to continue or choose to enter this
market. They can add to their player liquidity pool by drawing from California,
but California could not reach outside its borders to compete.
As I stated earlier, I consulted with Michael Genest on the letter delivered to the
CTBA which you should all have. I did so with the understanding that I would
testify here today with the express purpose of helping you find a path through the
conflicting opinions, and proposals. The market and revenue data is difficult to
assess, because most of the analysis is based upon projections of will happen
using assumptions that may not accurately assess the effects of offshore site
competition. The just mentioned issues should be sufficient to cause concern
16 Italy has moved to adopt a licensing model
about any revenue forecast that does not consider the effect of offshore
competition.
Exclusivity
But there are other issues to consider as well. In seeking to reach the leaching
revenue (that is the lost tax and potential licensing fees or revenue share)
whether through a monopoly model or a licensing model the State of California
runs head long into a battle with holders of Tribal‐State Compacts. The battle will
be over the enforceability of the “exclusivity” clause in these Compacts.
In the Genest letter we discussed the financial repercussions of violating the
“exclusivity” clause. The Compact revenue runs at about $1m per day or $365m
per year. The State runs the risk of losing that revenue if it violates the provision
on “exclusivity”. The revenue estimates from licensing Internet poker, which are
set forth in the Genest report, show that the licensing fees would be a fraction
the Compact revenue. Even if you were to accept other estimates the cost benefit
does not seem to lean in favor of the violating the Compact.
What some of the forecasts fail to consider is the fact that the Compact revenue
has an estimated life of 20 years which must be balanced against the uncertain
forecast of a consumer on an internet poker site with a geographically defined
player pool. It has already been stated by some Compact members, including
those who are members of the CTBA, that the licensing of internet poker would
violate the “exclusivity” clause of the 2004 and 2006 Amendments to the
Compacts. I have not seen a 20 year Net Present Value forecast by any proponent
that forecasts internet poker revenue from a wholly intrastate operation in
California. This is an important omission from the data as the NPV of the two
income streams needs to be compared, not just short time periods in order to
determine the real cost benefit figures.
I recognize that the Legislative Counsel on April 11, 200817 came to a different
conclusion, based upon a review of the 2006 Amendment, but apparently without
consideration of the 2004 Amendment or the opinion of the National Indian
Gaming Commission of December 21, 200418. Without belaboring the point, this
is a huge issue. It should be clear, however, that there is no agreed position
among the Compact participants on allowing Internet poker.
There are some who suggest that the State wait and see if the proposals being
discussed in House and Senate produce a federal bill and then make a decision on
whether to Opt‐in, or Opt‐Out. There are others who suggest that the state move
forward on an intrastate basis. There may be some merit in deferral to gather
more data and better enable the state to make an informed decision on whether
to join a federal regime or not and which model, monopoly or licensing to choose,
should the state so decide.
You have a very difficult task. The people you will hear from today are all very
knowledgeable and of high character. They all speak from strong conviction. I am
willing to work with you and them to help guide us to a workable result.
I thank you for your time.
Sanford I. Millar
17 April 11, 2008, ONLINE POKER: State Authorization‐ # 0808054
18 Opinion of Whiting Hagg & Hagg, December 21, 2004 Re: Classification Opinion…
Tags: poker taxation, taxation of pokers