Read if you are Canadian or US Citizen
All bets are off: A U.S. government crackdown earlier this month has left the online gambling industry in legal limbo. Canadian players must suddenly recalculate their odds
Alex Hutchinson
The Ottawa Citizen
Thursday, October 19, 2006
The online gaming industry had been on a very long win streak, growing from nothing to a $12-billion-a-year moneymaker in a single decade. Maybe the businesses got a little cocky, with their high margins, low overhead and the still-growing poker craze. But they forgot one rule: never bet against the House of Representatives.
Last Friday, U.S. President George W. Bush signed into law the Unlawful Internet Gambling Enforcement Act, making it illegal for banks and credit cards to settle payments to Internet gaming sites -- and ending years of legal vagueness and ambiguity. That same day, two major British gaming companies, Sportingbet PLC and Leisure & Gaming PLC, sold their lucrative U.S. operations for $1 each (all figures in U.S. dollars), ridding themselves of a combined $20 million in liabilities they would have incurred in firing some 800 employees.
Earlier in the summer, two executives from British online companies, Peter Dicks of Sportingbet and David Carruthers of BetOnSports PLC, had been arrested while changing planes in the United States. As hints of a crackdown loomed, the shares of publicly traded online gaming companies hemorrhaged $7 billion in value.
Who could have predicted this cataclysmic reversal?
Just about anyone, actually. That's why Toronto-based CryptoLogic Inc., the industry-leading software provider for online gaming companies, announced last month that it was moving its headquarters to Ireland. "The cloud of uncertainty of the U.S. marketplace has been hanging over CryptoLogic for all of its 10-year history," explains Stephen Taylor, the company's chief financial officer.
That uncertainty is finally gone, but the speed of the change has left the industry in turmoil -- and forced several Canadian players to rapidly recalculate their odds. "Wherever there's change, there's opportunity," Taylor says. "And we think we're as well-positioned as anyone to take advantage of it."
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It's not easy to sort out the rules applying to online gaming. If a Canadian using a Canadian computer places a bet with money from a bank account in Antigua, and the bet is processed by a server on the Pacific island of Vanuatu, who has jurisdiction over what elements of the transaction?
"You're into a grey area," says Michael Lipton, a lawyer from the Toronto firm Elkind & Lipton LLP who specializes in gaming law. "Clearly, strong arguments can be made that the software is being used where the server is located, because that's where the bet is accepted. That's the position the United Kingdom takes. But the Department of Justice of the United States says exactly the opposite."
The U.K. and the U.S. represent the two emerging approaches to online gaming: regulation and prohibition, respectively. But in the mid-1990s, when online gambling first began to appear, lawmakers still weren't quite sure what to make of the Internet. It was into that free-for-all that CryptoLogic plunged in 1996, offering software for online versions of popular casino games like roulette and slots, along with the ability to manage the associated e-cash transactions.
"In terms of online gaming, we are the grand-daddy," says Taylor. "We've been around the longest. InterCasino, one of our licensees, was the first online play-for-money casino on the Internet. And we've been a public company, with that record of transparency, for the longest of anybody."
The results have been gratifying: revenue of $86.3 million last year, with earnings up 50 per cent over the previous year. In CryptoLogic's third-floor offices on Toronto's St. Clair Avenue West, where the company's 200 software developers work, the glass surfaces are frosted with stylized dice and playing cards. But it has been good business decisions and continued innovation - they now offer 160 different casino table and slot games -- rather than luck that has fuelled the continued growth.
One decision that now looks particularly prescient is the move to focus on non-American markets, despite the fact that half the $12 billion spent on online gaming last year came from the United States. "Four years ago, 70 per cent of our business was focused towards the United States," Taylor says. "We started a deliberate process to migrate our business to Europe and other parts of the world where this cloud of uncertainty did not exist."
By last year, only 35 per cent of CryptoLogic's business came from U.S. end users. "The move to Ireland was just the next step," he says. "Lewis (Rose, the chief executive officer) and I spend a significant part of our lives flying back and forth between here and Europe. We miss out on business by not being where the action is taking place."
The gradual shift to a European focus was a smart move, and one that was echoed by Calgary-based rival Chartwell Technology Inc., which now has only about five per cent exposure to the U.S. market, says Wojtek Nowak, an analyst who covers the online gaming sector for Blackmont Capital in Toronto. In the near-term, moving the headquarters to Ireland and getting a new CEO (Rose is staying in Canada for family reasons) will cause some disruption, Nowak cautions. "The benefits will come over the long term."
The U.K. interpretation of the law -- that online gaming is legal as long as the servers are located in a jurisdiction that permits it -- means that the biggest companies are concentrated there, many of them publicly traded on the London Stock Exchange. But the servers themselves aren't yet legal in Britain, though a new law allowing regulated online gaming is expected to come into force next year. Instead, servers are scattered in 80 or so mostly small jurisdictions around the world -- places whose names are familiar to offshore bankers: the Isle of Man, a Channel Island named Alderney, Vanuatu in the Pacific, Antigua in the Caribbean, Gibraltar, Costa Rica.
Some jurisdictions have more credibility than others. "There's one in Africa where you just pay $10,000 a year and that's it, (but) what you get for that is anyone's guess," says Judi Kelly, an Australian consultant who advises her clients on gambling licenses and runs the KellyCom news service for the gaming industry. "The good ones have strict oversight and regular testing."
Among the very best, says Kelly, is a jurisdiction about 10 minutes south of Montreal: the Kahnawake Mohawk reserve. "Their probity is unbelievable," Kelly says. "They've been the hub of Internet gaming for the last eight years." All gaming companies licensed in Kahnawake must run their sites on servers provided by an organization called Mohawk Internet Technologies, which allows the reserve's gaming commission to maintain the strict oversight. The application fee is a non-refundable $15,000, which covers the cost of extensive background checks into the applicants, the annual fee is a flat rate $10,000.
The Kahnawake set-up's legality is not unchallenged. Under Canadian law, all forms of gambling are prohibited except specified activities such as horse-racing at approved sites and provincial lottery schemes. Provincial governments are also allowed to manage casinos, or can license charities to manage casinos -- and they can run such schemes "on or through a computer," says Lipton, the gaming lawyer. Governments in British Columbia and Atlantic Canada have recently introduced limited provincially sanctioned online games.
Kahnawake does not qualify for any of those exceptions, but the Mohawk argument is that gambling -- and, less convincingly, the regulation of gambling -- are among the ancient rites and traditions of their people, dating back hundreds of years before European contact. "They talk about a modified craps game, lacrosse, horseback racing, javelin throwing," says Lipton. From there to hosting Internet blackjack is clearly a leap. Federal and provincial attorneys-general have said that the situation is illegal. "But they haven't gone onto the land to stop it," Lipton says. "That may have something to do with the Oka crisis in 1990."
This uncertain legal status has caused concern for some companies -- CrytpoLogic, for instance, does not license any companies whose servers are based there, according to Taylor. While there have reportedly been talks aimed at regularizing Kahawake's status, the reserve's convenient location compared to, say, Vanuatu, along with its connection to a major fibre-optic corridor, has overcome the doubts of many: according to a recent company prospectus, the top five online poker sites in the world were hosted in Kahnawake.
And Mohawk Internet Technologies isn't holding its breath waiting for government approval, according to company representative Chuck Barnett.
"If the Mohawks of Kahnawake, or any Indigenous Nation within the boundaries of Quebec or Canada, were to wait for the blessing of the provincial or federal governments before undertaking any economic development initiative, I believe we would all die of starvation first," he wrote in an e-mail from Spain, where he was meeting with clients.
"If Quebec or Canada should someday choose to recognize our right to self-determination, we will be happy to consider recognizing theirs as well."
The new U.S. legislation, which is focused on payment mechanisms, doesn't affect Kahnawake's status as a hosting site. But some of the reserve's licencees will likely suffer, which could affect business. "(Our) strategy to expand into data centres in both Europe and Asia earlier in the year is perhaps even more important than we had thought," Barnett acknowledged.
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Thanks to the patchwork of provincial gambling regulations, it's difficult to get reliable statistics about gambling in Canada. A report last month from the Responsible Gambling Council indicated that 63.3 per cent of Ontario adults gambled at least once in 2005, with lottery tickets by far the most common form. Another report, based on Statistics Canada data, estimated that there were 468,000 at-risk or problem gamblers in Ontario in 2002.
Over the past 15 years, the anti-gambling lobby has been steadily losing ground as provincial governments become addicted to gambling revenue. By 2002, gaming and lottery revenues were comparable to fuel taxes and liquor and tobacco taxes in provincial budgets, according to a study by the Canada West Foundation. This creates an interesting tug-of-war for provincial regulators, who benefit financially from the growth of gaming, while also being responsible for the sometimes devastating effects on problem gamblers.
In March, Peterborough MPP Jeff Leal introduced a private member's bill in the Ontario Legislature to ban advertising for online gaming. "I'd read reports about college students in the United States racking up tremendous amounts of debt through online gaming," Leal says. "And here in Ontario we have bona fide gaming, whether it's horse-racing or slot machines, operated by the Ontario Lottery and Gaming Corporation, and a number of people in that sector have seen dollars siphoned away to online gaming."
Despite the strict prohibition on unlicensed betting operations, there's no law against Canadians placing bets or playing games on offshore websites. But advertising to attract these customers faces several prohibitions under the Criminal Code of Canada: it is explicitly forbidden to advertise for games of chance and sports betting. Games of mixed skill and chance, on the other hand, are not addressed, says Lipton -- which is why ads for online poker sites are common.
Another approach is to advertise for a "play-money" site, with a suffix such as .net or .tv. As long as no link is provided to the .com "real-money" site, that approach is legal, Lipton says. Even bolder approaches, such as sports bookmaker Bowmans' high-profile endorsement deal with the Canadian Football League, have gone unpunished so far. The Bowmans.com logo was prominently displayed at last year's Grey Cup, despite complaints from the British Columbia Lottery Corporation -- which offers a rival online sports book.
So which is it? Is the government cracking down to protect consumers, or to protect its own revenue stream? Leal has watched the U.S. clampdown and followed the debate in Britain, where regulation of online gaming is seen as way of protecting consumers -- and bringing in tax dollars that would otherwise go offshore. He understands both approaches, but the key is consumer protection, he says. "If people are involved in gaming activities, they have to have some reassurance that it's legal and that they're going to get a fair return with set rules."
In Lipton's view, the benefits of regulation far outweigh the risks. "There are about 80 countries worldwide that tolerate online gaming, and I don't see any of them going down the crapper," he says. Even higher taxes and a strict regulatory burden wouldn't deter companies, he says. "The industry cries out for regulation. They would embrace it."
Taylor, of CrytoLogic, agrees. He points to the Channel Island of Alderney as a jurisdiction with strict regulation that should be emulated. To operate there, "all of our senior officers, myself included, had to have full probity checks, and our software was audited right down to the source code," he says. "We invested a significant amount of money to make sure we were compliant."
The payoff is trust. "If someone is putting money into a computer, they have to know they're being treated fairly," he says. That extends to having rigorous customer identification, so that underage gamblers are unable to register, and software that can recognize patterns of play characteristic of a problem gambler and cut the account off.
For now, the dream of a stable, regulated market remains elusive. Instead, the new U.S. legislation will usher in a period of great uncertainty. Some analysts predict the exodus of large, publicly-traded, mostly British-based gaming companies will leave the field open for less reputable private companies based in the Caribbean.
Since the new legislation is only targeted at payment mechanisms, Lipton predicts that plenty of sites will continue to serve the ravenous U.S. online gaming market. Stopping payment of credit and debit cards, which are coded 7995 for gambling payments, is relatively straightforward. Preventing payment by cheque is a much tougher challenge, he says, and other payment routes will no doubt be developed.
For CryptoLogic, aspiring to full respectability, the U.S. market is closed. Although it had already been shifting its focus to Europe, it won't escape the dramatic repercussions that are shaking the industry -- tougher competition in Europe from companies that have been ejected from the United States, for one thing, Nowak, the Blackmont analyst, says.
In the long term, Taylor hopes that more countries follow Britain's lead towards regulation -- and if Canada goes first, it could attract significant business. "Canada originally started out, from a technology point of view, as one of the original countries where the whole concept of online gaming started. (Now) nobody in online gaming has much of a presence in Canada because of the regulatory environment," he says.
"The genie has been out of the bottle for a number of years now. Trying to go the route of prohibition is very difficult to enforce, and we just believe that regulation is the right way to go."
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