November 24, 2015

Did the New York AG Wait Too Long to Attack DFS Sites?

For those following the recent legal upheaval in the daily fantasy sports (DFS) industry, tomorrow will mark an important turning point in the battle over the future of DFS. A New York state court judge will hear arguments related to the New York Attorney General's request for an injunction prohibiting continued operations of several DFS sites. A flavor of the main arguments can be found on Legal Sports Report, or by following attorney Daniel Wallach on Twitter. As might be expected, the parties primarily spar over our old friend, the "skill game" argument (see HERE and HERE for my now well-aged discussions of the "skill game" argument in the context of poker).

There is one side argument that is worth additional discussion. In a recent op-ed piece in the New York Daily News, David Boies, the highly regarded attorney retained by DraftKings, argued:
"One major problem with the attorney general’s argument is that he has been attorney general for six years, and for each of those years, FanDuel has operated openly in New York without a single suggestion from him or anyone else that its operations were at all legally suspect. DraftKings entered about four years ago and has likewise operated openly and continuously without question or complaint ever since.

During those years, major companies like NBC Sports, Fox Sports, Comcast and private equity firm KKR have invested hundreds of millions of dollars in building platforms to offer daily fantasy-sports contests; none of them had any doubts about the legality of those contests either."
DFS supporters have echoed these comments on social media, wondering why the New York Attorney General waited so long to act against the DFS industry if DFS were so clearly illegal. Some commentators have gone so far as to suggest it is too late for the Attorney General to act, that the industry cannot be attacked now after so many companies have invested so much money building up what they were led to believe was a legal enterprise condoned by the state (attorney Daniel Wallach declares this to be one of the best arguments for the DFS sites). But will this argument ultimately matter in court?

A.  Laches and the Limits of Equity

At least on the surface, it seems unfair for the state of New York to sit back for several years and let the DFS industry grow, only to swoop in and declare that the entire business operations of several multi-million (or even billion) dollar companies are in violation of state gaming laws. Shouldn't the Attorney General have filed for an injunction years ago? Isn't it too late for the Attorney General to do anything now?

Some attorneys following the New York DFS case have suggested that the principle of laches might bar the Attorney General's lawsuit. [FN1]. Laches (pronounced "latches") is an equitable doctrine which prohibits a party from sitting on his rights to bring a legal claim until after others have acted to their detriment in reliance on the party's silence. Laches generally requires not just that there was a delay in asserting a legal right, but that the delay was both unreasonable and prejudicial. A classic example would be where a landowner knows his neighbor is constructing a building partially across a boundary line, but waits to assert a legal claim related to the property line until after the construction is completed.

Interestingly, laches can in some cases operate to bar a claim even where the claim is timely pursuant to a statute of limitations. For example, in the 2012 presidential primaries, a suit by several Republican candidates to be included on the Virginia primary ballot was rejected because the candidates had waited to file the suit until too close to the election date. The Fourth Circuit Court of Appeals cited the "disruption" to the electoral process and resulting "turmoil" to the nominating process caused by the "tardy" filing of the lawsuit at the "eleventh hour" as the basis for its decision to dismiss the suit on the basis of laches.

Although laches might appear to be an appealing argument in the New York DFS litigation, the reality is that laches would be a losing argument for the DFS sites. This is because principles of state sovereign immunity require courts to apply a different set of rules when the state is a litigant. In New York (as in most states), many equitable principles, including laches, simply do not apply against the state.

The principle that laches cannot be asserted against the state is well-established. For example, in State v. Tiraco, the New York Attorney General sought to enforce state securities registration laws against a company selling shares in a theatrical company; the appellate court needed only three sentences to summarily reject the defendants claim of laches: "Laches is not available as a defense as the prosecution is in the public interest." Similarly, in a more recent decision, a New York appellate court confirmed that "the equitable doctrine of laches may not be interposed as a defense against the State where, as here, it is acting in a governmental capacity to enforce a public right or protect a public interest." In re LaPine, 18 A.D.3d 552, 795 N.Y.S.2d 294 (N.Y. Sup. Ct. 2d Div. May 9, 2005). [FN2].

In sum, the doctrine of laches will be a non-starter in the pending DFS litigation.

B.  The Florida Faircloth Decision—A Slender Reed

Legal commentators have also pointed to a Florida appellate case as authority for the position that a state's failure to enforce gambling laws against certain games over a period of years prevents the state from later taking a different position on the issue. Faircloth v. Central Florida Fair, Inc., 202 So. 2d 608 (Fla. Ct. App. 1967). The Faircloth court was presented with the question of whether certain carnival midway games were illegal under state gaming laws. The relevant passage from the court comes at the tail end of the opinion, after extensive statutory analysis (emphasis added):
"There is a further basis for our decision, suggested ironically by the defendant himself. As suggested, we discard the mantle of naivete and recognize that, if these midway games do come within the gambling laws, they have nevertheless been played throughout the state for years with the knowledge and consent of public officials, law enforcement officers and state legislators. We will not adopt an unnecessarily strict and artificial construction of our statutes which will result in further hypocritical noncompliance with our gambling law."
The Faircloth opinion will be of only limited value to the DFS sites in the pending litigation for several reasons. First, the decision was from a Florida court interpreting Florida gaming statutes; New York courts will give little weight to a decision involving significantly different state gaming laws.

Second, the court's language in Faircloth is supported only by a general citation to a law review article and a Mississippi appellate decision (State v. Wood) which really does not support the Faircloth court's argument. It is hardly surprising, then, that only one appellate court from another state (the Arizona supreme court) has ever cited Faircloth, and then only for the unrelated proposition that "wagers" or "bets" are legally distinguishable from "entry fees" for contests. State v. American Holiday Ass'n, 727 P.2d 807 (1986). [FN3]. No other appellate court has ever cited let alone adopted the Faircloth rationale that lax enforcement of gaming laws is relevant to an analysis of whether a particular game constitutes illegal gambling.

Third, and most important, the Faircloth decision ultimately turned on the language of the relevant Florida statutes. In Faircloth, a statute had authorized by name twenty-three specific carnival midway games which could be played at public fairs, and were subject to licensing requirements. The court concluded that this statute thereby implied a distinction between the specifically identified "games of skill" and those "games of chance" which were otherwise prohibited by law. In New York, by contrast, no statute exists which implicitly or explicitly suggests DFS is a game of skill or otherwise exempt from the state's general gambling prohibition statutes.

C.  Legal Irrelevance

Ultimately, the issue of why the state of New York and its Attorney General have waited several years to pursue legal action against the DFS sites is nothing more than a legal red herring. If the DFS sites establish that DFS is legal under New York law, then whether the Attorney General improperly delayed in bringing the enforcement action becomes a moot issue.

On the other hand, however, if the court determines that DFS in fact is illegal gambling, there is no legal basis for the court to give the DFS sites a "get out of jail free card" and hold that the sites can continue to operate an active illegal gambling business merely because the state took its time to bring an enforcement action. [FN4]. Courts recognize that the state has limited resources and must make judgment calls as to how best use those resources. Just because the state does not arrest every driver who speeds or bust every home poker game does not mean that the state cannot enforce traffic or gaming laws in specific instances (absent an illegal discriminatory intent). [FN5]. Here, the state can plausibly argue that DFS was, until recently, sufficiently small-scale so as not to warrant the Attorney General's attention. The recent dramatic uptick in advertising and the claim of potential for "insider trading" and other unfair anti-consumer practices easily justify the Attorney General's decision to take a closer look at the DFS industry in recent weeks. Essentially, DFS sites got too big and too brazen to be ignored, much like the difference between small-stakes home poker games and multi-million dollar online poker businesses.

D.  Rhetorical Value

David Boies is an exceptional attorney, and has to realize that the DFS sites' argument about the state's delay in bringing an enforcement action is ultimately beside the point as a legal argument. What, then, is the point of making this argument a cornerstone of the DFS defense?

Let's look at more of Boies' op-ed piece:
"Nothing has changed about the nature of the contests FanDuel and DraftKings offer.

What changed is that the attorney general’s office suddenly decided without notice or discussion that daily fantasy sports contests represented a violation of the law and a threat to public morals that had to be stamped out.

There are many things wrong with that decision, but right or wrong, no one can pretend that the illegality of these contests is clear or obvious—it certainly was not clear or obvious to Schneiderman or his predecessor, who, for eight years, did not think there was a problem.

If the attorney general (or anyone else) doesn’t like the law, the proper course of action is to get the law changed. Changing the law is up to the Legislature, not any single public official, no matter how well-intentioned. The attorney general is entitled to change his mind. He is not entitled to unilaterally change the law."
Boies' purpose for this argument is threefold. First, he wants to establish a sense of unfairness—his clients have been operating in New York for years, and now the Attorney General wants to change the rules without notice (though in fairness to the Attorney General, there was no actual "change" in opinion; the Attorney General went from having no opinion on the legality of DFS to determining DFS was illegal gambling under state law). This "innocent victim" rhetoric may not matter legally, but it can help generate both public support and political support; DFS's legal status will be a legislative rather than a judicial decision in the long run.

Second, and perhaps most important for the pending court cases, Boies wants to suggest to the judge that the legal status of DFS is, at best, murky under New York law. If DFS were clearly illegal, the state would have acted long ago. Boies' rhetoric thus is attempting to create judicial skepticism regarding the Attorney General's claims that DFS is unquestionably illegal gambling under New York law. This skepticism creates space for the DFS industry to not only advance their "skill game" arguments, but to otherwise highlight differences between DFS and traditional forms of gambling (notably sports gambling and poker).

Finally, Boies' rhetoric highlights the relative roles of the legislature and the courts. Although old laws are regularly applied to new technologies and industries, here Boies suggests that the state's delay in bringing an enforcement action demonstrates the ambiguity surrounding the status of DFS under New York's established gaming laws. Boies then argues the Attorney General was wrong to turn to the courts to resolve that ambiguity; instead, the issue of how to deal with the new DFS industry is best resolved by the legislature.

In an interview today with Fortune, Boies reiterated his rhetorical points about the perceived sudden "change" in the law, and declared:  "We feel good about the position we’re in. I think we look very strong. I’d rather have our hand than the Attorney General’s hand." Boies is a brilliant lawyer, and he has some good arguments to make on the "skill game" issue. But the smart money, as always, is to bet on the state.

* * * * *

[FN1].  In law, principles of fairness are generally governed by the rules of equity. Years ago, there were separate courts of law and courts of equity. Courts of law were concerned with bright line rules; if you signed a contract, the law wouldn't care that you agreed to terrible terms, but would hold you to your obligations. Courts of equity, however, were concerned with issues of fairness, and operated to provide relief from overly harsh or technical applications of the law; if you could prove you signed a contract because of fraudulent misrepresentations by the other side, you could ask the court to rescind the contract.

Today, courts of law and equity have generally been combined, but the distinction between law and equity remains important, particularly in the realm of remedies. If a claim is brought at law, a court will generally be limited to awarding damages (money). If a claim is brought in equity, a court will award other forms of relief, such as restitution, rescission, injunctive relief, or declaratory relief.

[FN2].  Laches may be available against the state where the state is not acting in its governmental capacity, but instead is operating in a "private or proprietary capacity" (e.g., in a manner akin to a private company). Carney v. Newburgh Park Motors, 84 A.D.2d 599, 444 N.Y.S.2d 220 (N.Y. Sup. Ct. 3d Dep't 1981). Also, the legislature can limit the state's sovereign immunity by explicitly making the state subject to statutes of limitations or other time requirements. State v. Seventh Regiment Fund, Inc., 98 N.Y.2d 249, 774 N.E.2d 702 (N.Y. Ct. App. 2002). However, neither of these limited exceptions are applicable to the present DFS litigation.

[FN3].  Ironically, the Arizona opinion in American Holiday Ass'n also cites an old New York court of appeals decision, People v. Fallon, 152 N.Y. 12, 46 N.E. 296 (1897), for the proposition that there is a distinction between a wager and a contest entry fee:
"There is a plain and obvious distinction between a race for a prize or premium contributed [by the association] and a race where the stake is contributed by the participants alone, and the successful contestant is to have the fund thus created. The latter is a race for a mere bet or wager, while the former is for a prize offered by one not a party to the contest."
Considering the DFS model relies on participant entry fees going into a common prize pool with prizes being paid out of that pool (less house rake/fees), the Fallon decision is decidedly a negative for DFS operators in New York.

[FN4]. "[T]he doctrine of laches has no application when plaintiffs allege a continuing wrong." Capruso v. Village of Kings Point, 23 N.Y.3d 631, 16 N.E.3d 527, 992 N.Y.S.2d 469 (N.Y. Ct. App. 2014).

[FN5]. New York courts follow the rule that a selective enforcement claim will fail without evidence of improper discriminatory intent (In re Matter of 303 West 42nd v. Klein, 46 N.Y.2d 686 (N.Y. 1979)):
"The burden of proving a claim of discriminatory enforcement is a weighty one. Common sense and public policy dictate that it be so. The presumption is that the enforcement of laws is undertaken in good faith and without discrimination (see, e.g., United States v Falk, 479 F.2d 616, 620). Moreover, latitude must be accorded authorities charged with making decisions related to legitimate law enforcement interests, at times permitting them to proceed with an unequal hand. For example, it has been held that, in order to bring an appropriate case to test a new regulation or statute, or because of limited manpower or other resource inadequacies, or for the purpose of deterring other potential transgressors, certain violators may be selected for prosecution out of the class of all known violators (see People v Utica Daw's Drug Co., 16 A.D.2d 12, 21, supra; Comment, 61 Col L Rev 1103, 1119-1133). Such an enforcement strategy may also permissibly be directed at only serious violations (see English v Town of Huntington, supra, p 323 [enforcement of building and zoning codes only against buildings where fire and sanitary hazards had gone far beyond tolerable limits]) or those occurring in a geographic area where the probability or rate of violations is high (see, generally, Tieger, Police Discretion and Discriminatory Enforcement, 1971 Duke LJ 717). The reasoning goes that these instances of legitimate law enforcement should not be hampered by requiring that a hearing be held every time one subject to a regulatory or criminal penalty feels he has been unfairly singled out."

October 02, 2015

PokerStars in New Jersey—Back to the Silver Age of Poker?

"Here I come to save the day!"

~ Mighty Mouse

American comic books have followed an interesting historical arc. The "Golden Age" spanned the era from the Great Depression through the post-World War II days, and saw the debuts of classic clean-cut All-American heroes like Superman and Captain America. After a period of decline for traditional comics, the "Silver Age" and "Bronze Age" of comics marked a resurgence of classic comic heroes and story lines. A turn in the mid-1980s toward darker and more dystopian themes and the rise of more conflicted heroes and anti-heroes marked the beginning of the "Modern Age" of comics.

Online poker has followed a strikingly similar course. The Golden Age of online poker ran from the rise of sites like Paradise Poker and Party Poker in the late 1990s and early 2000s through the passage of UIGEA in 2006. The Silver Age of online poker saw the rise of PokerStars and Full Tilt as the new heroes for poker players, and came to an end when Black Friday destroyed online poker in the U.S. in 2011. After enduring a Dark Age with no online poker, the Modern Age of online poker began with the rise of regulated online poker in a handful of states, set against a bleak landscape of poker prohibition, populated by a gallery of newly reinvented and rebooted heroes—Party Poker and 888 are back from exile, Caesars has been transformed from super-villain to crusading hero, Full Tilt is an ally of its former archenemy PokerStars, and everyone is threatened by a new cyborg super-villain named "SH3LD0N".

Online poker's historical arc came to mind this week when, after months of speculation and anticipation, the online poker world finally received some transformative news—as first reported by Dustin Gouker at Online Poker Report, PokerStars has been approved by New Jersey gaming regulators to operate an online poker site. But does this key development mark a return to the Silver Age of online poker, or is it another step forward into the Modern Age?

Market Expansion or Cannibalization?

The literally million dollar question is less whether PokerStars will be a major player in the New Jersey online poker market and more where PokerStars' market share will come from. PokerStars will inevitably draw players away from its established competitors. And many in the poker community seem to hold as an article of faith that PokerStars' entry into the market will create a new poker boom, greatly expanding the player base. Respected poker industry insider Nolan Dalla expresses what seems to be the prevalent view that PokerStars will cannibalize little of its player base from established competitors, and that PokerStars will significantly expand the market. But are these presumptions reasonable? Color me skeptical.

When regulated online poker launched in New Jersey, there was an initial surge of play, fueled by a combination of pent-up consumer demand from former online players and a wave of marketing recruiting new players to the pool. That surge, however, quickly subsided. During the heady post-launch days, online poker in New Jersey generated revenues exceeding $2.5 million per month over the first five months, with three months exceeding $3 million in revenue. Yet by six months post-launch, revenues settled into a rate of roughly $2 million per month, plus or minus 10% depending on seasonal variance. As we approach the two-year mark, those revenues are at best stable, and possibly in a slow decline when viewed on a year-over-year basis.

The bullish case for robust market expansion—summarized nicely by Steve Ruddock at Online Poker Report—forecasts PokerStars will expand the market and increase revenues to $3-$4 million per month. That would be an increase of 50% to 100% over current revenues. This optimistic vision is predicated on a combination of PokerStars' established branding and reputation within the poker community combined with an aggressive marketing campaign drawing in new players.

This rose-colored scenario seems implausible. Although the PokerStars brand remains strong among established poker players, those players are almost certainly already playing online on one of the existing poker sites. Even if PokerStars wins over many of these established players, they will be cannibalizing the market, not expanding it. Certainly a PokerStars marketing campaign could attract new players. But nearly two years post-legalization, it is questionable how large a pool there is of people in New Jersey who want to play online poker and who, for whatever reason, have not started playing on one of the existing sites. And, there is the problem of retaining new players once the initial marketing surge is past, a problem reflected in the sharp decline in online poker revenues mere months following legalization.

Ruddock and Dalla both assert that large numbers of New Jersey residents are unaware they can legally gamble online. According to Dalla:
"A recent poll in New Jersey revealed some staggering statistics that about 60 percent of the residents of the Garden State still are not aware that online poker/gambling is legal. Despite numerous marketing campaigns and a flood of advertising, a majority of citizens have no idea they can play poker legally on their computer. One expects that given PokerStars immense success cultivating and growing immature markets in numerous foreign countries over the past decade, with such vast resources they should have little trouble jump starting New Jersey’s online poker market into overdrive."
First off, Dalla doesn't specify or link to the survey he is citing. The only survey with results tracking Dalla's claims I could find dates back to November 2013, when online gaming was just beginning to launch. If this is the survey Dalla relies on, the results are understandable and irrelevant to the current state of the New Jersey market. But even if a more recent survey shows a high percentage of consumer confusion regarding online gaming, it is a mistake to conflate poker and casino gaming in this context. Online poker in New Jersey is most certainly not an "immature market". Online poker was available and heavily advertised for the better part of a decade prior to Black Friday, and has been available again and advertised again over the past two years. Online casino gaming, however, is in its infancy. So, while public knowledge of and comfort with online casino gaming may be low, there is no reason to assume that the same holds true for online poker.

Measuring PokerStars' success may well be a matter of managing expectations. There is nothing wrong with being bullish on PokerStars' impact on the New Jersey market; PokerStars has been the long-term industry leader for a reason. But, nobody should be shocked if the bulk of PokerStars' customers are cannibalized from the existing sites. This is not inherently a bad result, as healthy competition among the poker sites should benefit players. Further, in light of the currently stagnant-to-declining market, success for PokerStars might realistically mean expanding the New Jersey online poker market by 10% in the first year (average monthly revenues of $2.2 million/month), and 25% over three years ($2.5 million/month). Increasing the market by 50%—up to the $3 million in monthly revenues experienced immediately after legalized poker launched—should be considered a home run. Expecting PokerStars to double the market is setting everyone up for disappointment.

Will Regulation Change PokerStars?

Poker players expecting the same online experience at the new PokerStars as they had with the Silver Age PokerStars are likely to be disappointed (Chris Grove, editor of Online Poker Report, highlights many of the key issues facing PokerStars). Between being purchased by a publicly traded company (Amaya Inc.) and being licensed by New Jersey to offer online gaming, PokerStars is now subject to a host of regulations which will inevitably change how it operates. Some of the more obvious changes:
  • Ring-fencing and liquidity:  The most obvious change from the Silver Age is that players will not have access to PokerStars' global network of players. For that matter, players won't even have access to the broader U.S. market. Being limited to an in-state pool means PokerStars will likely not offer the same broad array of cash games and tournaments as in the Silver Age.
  • Age verification:  In the Silver Age, PokerStars nominally had a minimum age for players of 18, though the age requirement seemed more a guideline than a rule. The current regulatory environment means strict enforcement of the minimum age of 21 for players, which will require PokerStars to shift from those parts of its prior marketing models directed at younger players. Frankly, the age 21 requirement will make it more difficult for PokerStars to attract new players on a long-term basis, as potential players are exposed to competing games such as e-sports and daily fantasy sports which do not have the same minimum age requirements.
  • Payment processing:  Operating in a regulated environment will make moving money onto and off of PokerStars easier and more secure than in the Silver Age. But, PokerStars will have to comply with anti-money laundering and tax reporting regulations which may affect players used to the previous shadow economy of the unregulated Silver Age poker world.
  • Speed to market:  Deployment of new software and innovative games (e.g., Rush Poker, and Spin 'N Go Tournaments) may be delayed by the regulatory approval process.
  • Financial market pressures:  PokerStars' new owner, Amaya, will face pressure from its shareholders to meet certain financial benchmarks for revenues and earnings. This will impose limits on the amounts PokerStars will be able to invest in marketing campaigns, tournament guarantees, and player rewards. This is true even if PokerStars views New Jersey as worth running short-term losses to establish a strong market presence, and even if spillover effects such as improving its standing in other states are factored into the equation. At some point, even PokerStars has to worry about return on equity from its New Jersey operation.
Of course, in the regulated New Jersey market, every poker site will have to contend with the same set of regulatory issues. There is no reason to think PokerStars will have trouble adjusting to the new market conditions. But players expecting a return to the Silver Age may be unhappy about some aspects of the regulated version of PokerStars.

End of the Line for "Bad Actor" Laws?

One important effect of the New Jersey decision to approve PokerStars is that the "bad actor" debate may finally be put to rest. Immediately after Black Friday, there were strong policy reasons for legislators to cite in support of keeping PokerStars out of the U.S. market. After all, PokerStars had arguably (unquestionably, outside the poker community echo chamber) offered unlicensed gaming in violation of many state and federal laws, and had allegedly engaged in legally questionable practices in processing player fund deposits, all of which gave it an unfair advantage over companies which had followed the law strictly and stayed out of the U.S. market.

Nearly five years post-Black Friday, those arguments are obsolete, having been overtaken by events. PokerStars' competitors have enjoyed a two-year advantage in establishing a presence in the New Jersey market. More importantly, the sale of PokerStars to Amaya marked the exodus of indicted PokerStars founder Isai Scheinberg and other top executives. Consistent with how Nevada and New Jersey regulators have treated other gaming licensees with connections to individuals with sketchy legal issues, Amaya's clean record should make PokerStars a suitable operator in every state ... but for the impact of politics.

The bad actor (and related "tainted assets" provisions) have been incorporated into Nevada law and have most recently played a pivotal role in blocking passage of an online poker legalization bill in California. Such provisions have rightly been criticized as being economic protectionism for brick-and-mortar and tribal gaming interests dressed up in consumer protection and suitability clothing. But such arguments carried the veneer of legitimacy so long as the company founder remained under federal indictment. Now, with a respected state gaming board having investigated and given its stamp of approval to the new Amaya version of PokerStars, the bad actor bluff has effectively been called. The bad actor issue has always been more a political than a legal issue, but those seeking bad actor provisions will find it difficult to continue to argue that PokerStars is unsuitable in the face of the New Jersey DGE licensing decision.


The return of PokerStars to the United States market is unquestionably good for poker. Yet, PokerStars is burdened with the unrealistic expectation of returning online poker to the Silver Age, when million dollar tournament guarantees fell like manna from heaven, and rakeback flowed like milk and honey. It's simply unfair to saddle PokerStars with such a fevered vision. Far better to appreciate the return of PokerStars for what it is—an important step forward as online poker moves into the Modern Age as a regulated, legitimate, and accepted part of the American gaming experience.

August 06, 2015

Will the Supreme Court Finally Play a Hand of Poker?

For more than a decade, many online poker advocates have chased a quixotic dream of having poker declared legal in various states or even throughout the United States by judicial fiat. The ultimate dream was a favorable ruling from the Supreme Court of the United States (SCOTUS) which would sweep away legal prohibitions against poker. Yet the path to SCOTUS has proved tough to navigate for poker advocates. Prior to Black Friday, the Poker Players Alliance (PPA) brought an ill-considered court challenge to Washington state's ban on online gambling (the Rousso case), a challenge swiftly and predictably rejected by the Washington supreme court. Despite asserting a federal constitutional argument for the legalization of poker, the PPA chose not to pursue an appeal to SCOTUS, recognizing—belatedly—the futility of their case. More recently, poker advocates' hopes were dashed when SCOTUS rejected an appeal of the Second Circuit's DiCristina decision which held the federal Illegal Gambling Business Act applied to poker.

Poker may soon get its day in court, and in front of SCOTUS, to boot. Two recent decisions by the Seventh and Ninth Circuit Courts of Appeal have created a scenario where SCOTUS could reasonably feel compelled to confront the legality of poker head on. There is one catch, however. The cases do not involve online poker or even poker in general. Rather, the issue raised in these cases is whether states which prohibit poker must nonetheless permit poker at Indian tribal casinos within their borders.

I.  Cabazon and the IGRA

The law governing the regulation of Indian gaming ranges from complex (being charitable) to messy (being blunt). This complexity arises from the concept of sovereignty, by which Indian tribes retain significant control and authority to govern their people and lands. Indian tribal sovereignty, generally speaking, is co-equal to the sovereignty of the states, and can only be limited by Congress. So, a state cannot enforce its laws on tribal lands without an explicit grant of authority from Congress to do so.

Tribal sovereignty became a key issue in the realm of gaming in 1987, when SCOTUS decided California v. Cabazon Band of Mission Indians. In Cabazon, the Court was confronted with the issue of whether California could enforce its state gaming laws to prohibit bingo and poker games conducted in casinos and card rooms on tribal lands. The Court held that, because California permitted a lottery, parimutuel horse betting, and poker rooms, the state's gaming laws were regulatory (civil) rather than prohibitory (criminal) in nature. Thus, there was no basis for California to intrude on tribal sovereignty and enforce its gaming regulations on tribal lands.

In response to Cabazon, Congress promptly passed the Indian Gaming Regulatory Act (IGRA). Pursuant to IGRA, gaming is divided into three classifications. Class I gaming is limited to certain ceremonial games with modest prizes; Indian tribes retain full authority to regulate such games. Class II gaming includes bingo and pull-tabs, and also includes non-banked card games which are authorized by the state where the tribal lands are located. Indian tribes retain authority to regulate Class II gaming, subject to oversight by the National Indian Gaming Commission (NIGC). Class III gaming includes all other forms of gaming, including all slot machines and house-banked table games associated with traditional casino gaming. Class III gaming can only be conducted on tribal lands pursuant to a compact between the tribe and the state.

Under the IGRA scheme, poker is an obvious fit for Class II gaming in states which authorize poker to be played in card rooms or casinos. In those states, tribes may offer poker at tribal card rooms and casinos within the same general limits on hour of operations and wagering (e.g., limits on bet or pot sizes) as imposed by the state for non-tribal poker rooms. In states which do not authorize poker, however, poker is considered Class III gaming, and tribes wishing to offer poker must do so, if at all, pursuant to a compact with the state.

As it turns out, drawing the line between regulating poker as Class II or Class III gaming is more difficult in practice than the IGRA contemplated. In keeping with American tradition, the issue has found its way to court.

II.  The Seventh Circuit—Wisconsin v. Ho-Chunk Nation (April 29, 2015)

Wisconsin has compacts with several Indian tribes, permitting them to offer Class III gaming so long as gaming is approved by referendum in the county where the tribe intends to offer gaming. Dane County (Madison) voters rejected a referendum on Class III gaming in 2004. The Ho-Chunk Nation subsequently began offering electronic poker (traditional poker played in-person at electronic tables without a live dealer or physical chips) at its Madison casino, asserting poker was a Class II game. Wisconsin sued in federal court, requesting an injunction prohibiting poker at the casino, asserting it was a Class III game. The district court agreed with the State, and the Nation appealed.

In analyzing the issue, the Seventh Circuit first looked at the definition of Class II gaming in IGRA:
(A) The term “class II gaming” means—
(ii) card games that—
(I) are explicitly authorized by the laws of the State, or
(II) are not explicitly prohibited by the laws of the State and are played at any location in the State,

but only if such card games are played in conformity with those laws and regulations (if any) of the State regarding hours or periods of operation of such card games or limitations on wagers or pot sizes in such card games.

25 U.S.C. § 2703(7)(A)(ii)
The interesting thing about Wisconsin is that poker is not only banned by the state's broad gambling statute, it is also banned by the state constitution. In fact, the Wisconsin state constitution specifically authorizes a lottery, bingo, and parimutuel on-track betting, but explicitly prohibits casino gaming and identifies numerous prohibited games—including poker—by name (see Wisconsin State Const. Art. IV, § 24(6)(c)). Pretty compelling case that Wisconsin does not authorize and in fact explicitly prohibits poker, right? Not so fast, said the Seventh Circuit.

The court noted that the "Indian law canons"—rules for interpreting statutes touching on Indian sovereignty—require that any statutory ambiguities be resolved in favor of the Nation, and that the IGRA be interpreted broadly as protecting the Nation's sovereignty unless Congress had clearly limited that sovereignty. Consequently, the court determined it was compelled to read the definition of Class II gaming in IGRA § 2703 in conjunction with the regulatory provisions of IGRA § 2710 which provides:
(1) An Indian tribe may engage in, or license and regulate, class II gaming on Indian lands within such tribe's jurisdiction, if--
(A) such Indian gaming is located within a State that permits such gaming for any purpose by any person, organization or entity (and such gaming is not otherwise specifically prohibited on Indian lands by Federal law) ....

25 U.S.C. § 2710(b)(1)(A)
Well, again, if Wisconsin's constitution and statutes ban poker, the state can hardly be "permitting" poker to be played, right? The court, however, felt the issue was not so clear cut. Instead, the court felt compelled to apply the Cabazon regulatory/prohibitory analysis to Wisconsin's ban on poker, even though the IGRA was enacted after Cabazon was decided. In the court's view, Congress wrote the IGRA with Cabazon in mind, and did nothing to reject Cabazon's regulatory/prohibitory approach. In fact, the court noted that some legislative history suggested Congress intended for the Cabazon analysis to be used in implementing the IGRA.

Once the court applied the Cabazon regulatory/prohibitory analysis, the jig was up. The court noted that Wisconsin had moved away from a complete prohibition on gambling in favor of a system where certain types of gambling—notably the lottery and parimutuel betting on horse and dog races—were permitted. Thus, the court determined that the state's endorsement of certain forms of gaming indicated a public policy which favored regulated gaming over a prohibition on gaming. As the court concluded, "Wisconsin has not been willing to sacrifice its lucrative lottery and to criminalize all gambling in order to obtain authority under Cabazon and § 2710(d)(1)(b) to prohibit gambling on Indian lands." Rather, "The establishment of a state lottery signals Wisconsin's broader public policy of tolerating gambling on Indian lands."

The court also questioned the state's contention that it had fully banned poker. The court noted that, if the state truly had a ban on poker, then a mere municipal referendum could not override the constitution to permit poker on tribal lands. The fact that the state had negotiated with other tribes to permit poker on their tribal lands further undermined the state's position that poker was prohibited as a matter of public policy. Finally, the court noted that in 1999, the state had decriminalized video poker machines in taverns. The state essentially made possession of five or fewer video poker machines subject only to a civil penalty of $500 per machine, and further provided that possession of video poker machines could not be used as a basis for revocation of a liquor license. As the court reasoned:  "Wisconsin cannot have it both ways. The state must entirely prohibit poker within its borders if it wants to prevent the Nation or any other Indian tribe from offering poker on the tribe's sovereign lands." Thus, the court ultimately concluded:
"[T]he states lack statutory authority to deny an Indian tribe the ability to offer gaming that is roughly equivalent to what the state allows for its residents. A state must criminalize a gambling activity in order to prohibit the tribe from engaging in it. Wisconsin does not criminalize nonbanked poker; it decriminalized that type of gaming in 1999. IGRA thus does not permit it to interfere with Class II poker on tribal land. This means that the Ho-Chunk Nation has the right to continue to offer nonbanked poker at its Madison facility."
The Seventh Circuit's conclusion that Wisconsin's explicit constitutional and statutory ban on poker is less than a prohibition of poker might be viewed by non-lawyers as something of a head-scratcher. But in the realm of statutory interpretation, words and phrases often take on odd meanings and peculiar usages. Still, the court's reasoning is questionable in places; we will look at some criticisms of the decision in Section IV.

III.  The Ninth Circuit—Idaho v. Coeur d'Alene Tribe (July 22, 2015)

Moving westward, a similar dispute arose between the state of Idaho and the Coeur d'Alene Tribe over whether poker was Class II or Class III gaming. Like Wisconsin, Idaho's constitution and gaming statutes specifically permit only charitable bingo and raffles, a state lottery, and parimutuel race betting (see Idaho State Const. Art. III, § 20). Also, several traditional casino games, including poker, are explicitly named as prohibited games in both the state constitution and its enabling statute:
GAMBLING DEFINED. "Gambling" means risking any money, credit, deposit or other thing of value for gain contingent in whole or in part upon lot, chance, the operation of a gambling device or the happening or outcome of an event, including a sporting event, the operation of casino gambling including, but not limited to, blackjack, craps, roulette, poker, bacarrat [baccarat] or keno, but does not include:

(1) Bona fide contests of skill, speed, strength or endurance in which awards are made only to entrants or the owners of entrants; ....

Idaho Code § 18-3801
In the early 1990s, the state and the Tribe litigated a disagreement as to whether the state's adoption of a lottery and parimutuel betting had opened the door for broad Class III gaming on tribal lands pursuant to their gaming compact. The Idaho federal district court determined that the state constitution authorized only charitable bingo and raffles, a state lottery, and parimutuel betting, and that the state's public policy clearly prohibited all other forms of gaming, including Class III gaming. Thus, the Tribe was barred from offering Class III gaming.

In 2014, the Tribe announced plans to offer live poker—specifically, Texas Hold 'Em tournaments—at a casino located on its tribal lands. The state promptly brought suit in federal court and obtained an injunction prohibiting the Tribe from offering poker. The Tribe appealed to the Ninth Circuit.

Now, although the Coeur d'Alene case centered on a state constitutional prohibition on poker as had the Ho-Chunk case, the Ninth Circuit's analysis took an entirely different path than that laid out by the Seventh Circuit. For example, while the Seventh Circuit focused on the history of the IGRA and relied on the Indian law canons to interpret the IGRA, the Ninth Circuit rejected use of the Indian law canons, finding that the critical analysis was interpretation of Idaho's constitution and gaming statute rather than the IGRA. In fact, IGRA § 2710, which was critical to the Seventh Circuit's analysis, is essentially ignored by the Ninth Circuit in its analysis. Similarly, the Seventh Circuit relied heavily on the Cabazon regulatory/prohibitory analytical framework, while the Ninth Circuit ignored Cabazon in its analysis.

Given the widely divergent analytical path it took, it is hardly a surprise the Ninth Circuit found itself reaching a conclusion diametrically opposed to that of the Seventh Circuit. The Tribe offered three main contentions for why poker was not illegal under Idaho law:
  • Poker is a skill game, not gambling.  Yes, our old friend, the skill game argument, returns for an encore performance with predictable results. Here, the Tribe argued that the Idaho gambling statute contained a carveout for "bona fide contests of skill, speed, strength or endurance in which awards are made only to entrants or the owners of entrants". Because poker is a skill game (at least in the form of Texas Hold 'Em), the Tribe argued that it should fit into this exemption from the gaming statute. The court rejected this argument, noting that the statute specifically identifies poker as a prohibited form of "casino gambling", and thus, the more general "skill game" exemption could not plausibly be read to permit poker. Further, the court noted that interpreting the statute to permit poker would contravene the state constitutional ban on poker; courts will generally interpret a statute so as to prevent a constitutional conflict.
  • Poker is permitted under a "promotional contests" exclusion to the state gaming statute.  Here, the Tribe tried to make use of case law which had held in other states that the authorization of "casino night" charitable events constituted authorization of gaming sufficient to permit tribes to offer Class II gaming. The court, however, noted that the Idaho statute prohibited promotional contests from giving any consideration for such events, which is inconsistent with the offering of real-money poker.
  • The state does not evenly enforce its prohibition on poker.  This argument is essentially that because the state admitted it does not always enforce its ban on private poker games (i.e., the state does not prosecute all private poker games known to law enforcement), the state is de facto authorizing or permitting poker to be played within the state. The court rejected the argument, noting that to fit within the IRGA § 2703 definition of Class II gaming, the Tribe must show both that poker "[is] not explicitly prohibited by the laws of the State and [is] played at any location in the State." Although poker might be played within Idaho, it is explicitly prohibited by law, so the Tribe could not establish one of the required statutory elements. The court also found that use of prosecutorial discretion in some cases did not rise to the level of desuetude—the abandonment of a law to the point where it becomes unenforceable—particularly where the state had not disavowed the ban on poker and in fact prosecuted cases under the statute. [FN 1].
The Ninth Circuit also considered and rejected two procedural arguments raised by the Tribe. First, the court found that the dispute over poker could be resolved in court without being submitted to arbitration. Second, the court found that the State-Tribe compact encompassed all Class III gaming, rather than a limited subset of games, such that poker was a game properly covered by the compact and the court had jurisdiction over the current dispute.

Based on its analysis of Idaho's prohibition of poker, the Ninth Circuit ultimately concluded that poker was Class III gaming under Idaho law and the IGRA, and thus the Tribe had no right to offer poker at its casino.

IV.  Wisconsin's Petition for Writ of Certiorari (July 28, 2015)

Wisconsin has filed a petition for writ of certiorari, asking SCOTUS to review the case. Appeals to SCOTUS are discretionary, so the state must persuade the Court to accept the case ("grant cert" in legal lingo). The state has identified three main arguments for the Court to review.

For its first assigned error, the state asserts the Seventh Circuit erred in applying the Cabazon regulatory/prohibitory test in analyzing the IGRA's definitions of Class II and Class III gaming. As the state points out, Cabazon interpreted an older federal Indian regulatory law (Public Law 280) which is not at issue in the current litigation. In fact, Cabazon predated the IGRA (and the IGRA was a Congressional response to Cabazon). So, the proper focus for interpreting the IGRA is the language of the IGRA itself, and Cabazon has no role to play in that analysis.

The state then criticizes the Seventh Circuit's analysis of the IGRA. The state notes that IGRA § 2703 defines Class II gaming as gaming which is either expressly authorized by the state, or not explicitly prohibited. Because poker is explictly prohibited by the state constitution and gaming statute, the state contends the IGRA analysis should end at that point with poker not qualifying as Class II gaming. In the state's view, the language of the IGRA is clear and resolves the issue in its favor.

The state also took issue with other parts of the Seventh Circuit's analysis of the IGRA. The state notes that whether the state permitted poker via tribal gaming compacts was irrelevant. The IGRA only looks to whether poker is authorized by state law, and a gaming compact is a contract, not a state law. Similarly, the state's limited decriminalization of video poker machines was irrelevant to the IGRA analysis because video poker is house-banked and thus is substantially different than regular poker, which remains illegal under Wisconsin law. Finally, the state asserts the Seventh Circuit's analysis was faulty because the court relied on IGRA § 2710(b)(1)(A) in defining poker as Class II gaming. In the state's view, Class II gaming is defined by IGRA § 2703, while IGRA § 2710 imposes an additional condition on tribes seeking to offer Class II gaming. As the state puts it, by looking to IGRA § 2710 to define Class II gaming, "the Seventh Circuit's analysis placed the cart before the horse."

For its second assigned error, the state takes issue with the Seventh Circuit's use of the "Indian law canons" in interpreting the IGRA. Recall that the Indian law canons require a court to interpret ambiguous statutes in the light most favorable to preserving Indian tribal sovereignty. The state asserts that use of the canons was improper where the text of the IGRA is unambiguous. Instead, the proper analysis is to give full effect to the terms of the statute, which, as previously discussed, means that poker in Wisconsin does not fit within the definition of Class II gaming because the state prohibits poker entirely.

For its third assigned error, the state notes that the Seventh Circuit's decision conflicts with the Ninth Circuit's decision in Coeur d'Alene. Now the Seventh Circuit has no obligation to follow a Ninth Circuit decision. And, obviously, the Coeur d'Alene decision was entered three months after the Ho-Chunk decision, so the Seventh Circuit had no opportunity to review and analyze the Ninth Circuit's decision. In fact, one could argue that the Ninth Circuit should have considered and explicitly applied or distinguished the Seventh Circuit's Ho-Chunk analysis. In any event, Wisconsin argues that the Ninth Circuit got it right in Coeur d'Alene by analyzing the IGRA so that the definition of Class II gaming is limited to the express terms of § 2703, without reference to § 2710, and without use of the Indian law canons or application of the Cabazon regulatory/prohibitory test.

V.  Will SCOTUS Intervene?

As noted earlier, SCOTUS has complete discretion whether to accept cases on appeal. When it comes to granting cert, SCOTUS is the ultimate nit, the cranky old guy who sits at the poker table all day to rack up hours for a comped buffet and a shot at the bad beat jackpot. But when it comes to actually playing poker, he just folds everything except Aces and Kings. As I pointed out in the context of the DiCristina petition for cert:
[SCOTUS] receives in excess of 7,000 petitions for writs of certiorari every year, yet takes fewer than 100 cases. Even after adjusting for the in forma pauperis petitions filed by indigent criminal defendants and prisoners which are much less likely to be granted cert, the Supreme Court still grants cert in less than 4% of cases. The Supreme Court is not interested in merely correcting legal errors—that is the role of the Circuit Courts of Appeal and state appellate courts. Instead, the Supreme Court's task is to select cases which either pose important questions of federal law or which resolve significant conflicts between lower appellate courts.
As I correctly predicted, SCOTUS did not find DiCristina worthy of cert, most likely because there was no split among the Circuits as to the proper interpretation of the Illegal Gambling Business Act and because determining whether poker was covered by the IGBA did not present an important question of federal law.

The state of Wisconsin, however, has a much better shot of getting SCOTUS to grant cert in Ho-Chunk. First, SCOTUS has historically considered Indian tribal sovereignty issues to be important questions of federal law, and Indian law issues regularly appear on the SCOTUS docket. In fact, in the Court's most recent Term, the Court issued an important tribal sovereign immunity decision arising out of the IGRA, holding that the federal courts had no jurisdiction over tribal gaming conducted off of tribal lands. Considering how central the Class II / Class III gaming issue is to the operation of the IGRA, SCOTUS might well grant cert in Ho-Chunk solely to resolve yet another significant sovereignty issue created by the IGRA.

The odds of SCOTUS granting cert in Ho-Chunk are augmented by what is at least arguably a Circuit split on the proper method for analyzing whether a game explicitly barred by a state constitution and statute is Class II or Class III gaming. Certainly the Seventh and Ninth Circuits took widely divergent analytical paths to reach opposite conclusions. But, those differences are due in large part to how the cases were briefed and argued. In Coeur d'Alene, the Tribe did not argue that the Cabazon regulatory/prohibitory test should be applied. In fact, the Tribe only referenced Cabazon briefly, and then only with respect to the issue of interpreting the scope of the underlying State-Tribe gaming compact. Also, although the Tribe in Coeur d'Alene did argue in passing that the Indian law canons and IGRA § 2710 supported its position, the centerpiece of its argument was the "skill game" exemption in the Idaho gaming statute, an argument missing from the Ho-Chunk decision. Frankly, in terms of arguments and analysis, the Ho-Chunk and Coeur d'Alene decisions are the proverbial ships passing in the night. Still, given the factual similarities in the cases, SCOTUS may view the divergent results as a sufficient sign of a Circuit split in analyzing the Class II / Class III gaming question to merit granting cert to provide uniform resolution of that issue.

An additional factor that might weigh in favor of SCOTUS granting cert in Ho-Chunk is if a petition for cert is also filed in Coeur d'Alene. Multiple petitions for cert on the same issue out of different Circuits would highlight for the Court the importance of the issue raised, and would demonstrate the frequency at which the issue is confronted by the lower courts. A petition for cert in Coeur d'Alene would improve the chances of SCOTUS granting cert in both cases (in such situations, the Court could either consolidate the cases for joint consideration, or could stay one case pending its decision in the other case).

Should SCOTUS grant cert in Ho-Chunk, its ultimate decision on the merits will likely not have a significant impact on the poker industry as a whole. At most, the decision would potentially permit poker to be offered by tribal casinos and card rooms in those relatively few states which currently prohibit poker. The language of any such decision might also shed indirect light on the issue of whether tribes can offer online poker hosted on tribal lands but involving players outside tribal lands, an issue where the Class II / Class III gaming analysis and tribal sovereignty are in full play. The tribal-based online poker issue, however, will almost certainly be the subject of its own round of intense litigation, should a state and tribe come into conflict on that issue (e.g., the recent and ongoing dispute between California and the Santa Ysabel tribe).

In any event, the smart money, as always, is on SCOTUS denying cert. Yet, the odds of SCOTUS granting cert in Ho-Chunk are not nearly as long as for most cases. Ho-Chunk is a potentially attractive case for SCOTUS to take up, and it will certainly be given serious consideration by the Court. Don't be surprised if Justice Scalia gets all "jiggery pokery" with the IGRA in the Court's upcoming Term.

* * * * *

[FN 1]  The Tribe's prosecutorial discretion argument was founded primarily on a pair of related misdemeanor cases pending since 2013 in Ada County, Idaho (State v. Michael Kasper & Jared Levsinger, Case Nos. CR-MD-2013-0009859, CR-MD-2013-0009864) (See Ninth Circuit Brief of State of Idaho, pp. 35-36). The PPA supported the defendants by trotting out their usual "skill game" dog and pony show, complete with expert witnesses. During arguments on the defendants' motion to dismiss, the deputy city attorney serving as prosecutor suggested that poker games between "friends and family" would not be prosecuted. The magistrate found this degree of prosecutorial discretion was in violation of Idaho's constitutional and statutory gaming policy provisions and made the statute void for vagueness as applied to the defendants. This analytical approach is consistent with current American law, where the theory of desuetude has been abandoned by nearly every state (the notable exception being West Virginia), but where excessive prosecutorial discretion can be a factor in finding a statute void for vagueness when applied in specific situations.

According to the Idaho state court online docket, the Kasper-Levsinger cases are still open, with a hearing having been held on July 21, 2015. The cases are mildly interesting, though of little practical impact beyond the disposition of those individual charges. Still, they will be the subject of a separate blog post in the near future.

April 06, 2015

Who Will Give the PPA a Hand?

In an interesting and unintentional homage to the "throwback Thursday" (#TBT) social media meme, the Poker Players Alliance (PPA) last week launched an online petition asking the White House to "pledge to veto RAWA [the Restoration of America's Wire Act bill]." As reported by Steve Ruddock at Online Poker Report: "If the petition can collect 100,000 signatures in 30 days it would compel the White House to address Jason Chaffetz's 2015 Restoration of America’s Wire Act bill that seeks to ban several forms of online gambling including online poker."

The PPA petition created a sense of déjà vu because the PPA had previously filed another petition to the White House in the fall of 2011, asking the Obama Administration to endorse the legalization and regulation of online poker. When the Administration issued a response in 2012, my view was:
"[T]he statement is pretty much a standard political puff piece, a souped up version of a polite blow-off letter from a legislator to a constituent on an issue the legislator doesn't care about. The statement basically restates the current status of the law—federal law bans sports betting, states can authorize iPoker and other forms of iGaming, and violations of state iGaming laws may also be a violation of federal law. The statement then placates any social conservatives or law and order types by ticking off the usual laundry list of concerns—addictions, minors, fraud, and money laundering.


In short, I think this statement is utterly inconsequential, and was intended to be so. Of course, the poker world will seize on it to support their collective delusion that iPoker legalization is a major political issue."
To be blunt, the 2011 PPA petition was politically pointless and an utter waste of time. The 2015 PPA petition is equally irrelevant.

Why the PPA's 2011 Petition Was a Failure

Not surprisingly, the PPA views its 2011 petition as a "success". And, some in the poker community take the view that the 2011 petition was a political win for online poker advocates. This view, as summarized by Steve Ruddock, is essentially that the White House response in 2012 signaled a supportive view of legalized online poker / online gaming (emphasis added):
"President Obama hasn’t made it clear where he stands on gambling (particularly online gaming) issues, but a careful reading of the 2012 response shows the White House strongly leaning towards online gambling regulation being up to the individual states."
Yet nothing in the 2012 White House response supports this conclusion. The White House response merely restated, in lay terms, the substance of the Office of Legal Counsel's (OLC) opinion that the Wire Act applied only to sports gambling, and that state law otherwise generally regulated gambling. In other words, the White House response merely regurgitated the OLC's view as to the current status of the law; it was a statement of legal analysis.

Notably absent from the 2012 White House response was any statement of what the White House believed the law should be with respect to online gaming. In other words, there was no indication of the White House's policy position with respect to online gaming.

So if the 2012 White House response does not provide the Obama Administration's official online gaming policy position. where do poker advocates get the curious view that the current Administration is in favor of online gaming? Certainly not from the Administration's OLC Wire Act opinion, which carried this title:
Though it appears to be forgotten in poker circles, the entirety of the OLC Wire Act opinion was directed to the legality of online lottery sales. Also noteworthy is that the two states mentioned in the OLC opinion—New York and Illinois—are Democratic strongholds, with President Obama and several of his key Administration officials hailing from or otherwise strongly connected to Illinois (including notably former Obama Chief of Staff and current Chicago Mayor Rahm Emanuel). To the extent politics entered the equation, the OLC opinion was a sop to the lottery industry.

So, the idea that the OLC Wire Act opinion is a statement of the Obama Administration's policy position on online poker is unsupported by the language of the OLC opinion, because it is utterly silent on the poker question. Now the OLC's analysis clearly supports a legal conclusion that online poker does not violate the Wire Act for the same reasons that online lotteries do not violate the Wire Act. Nonetheless, the OLC opinion remains merely a statement of what the law is (analysis), not what the law should be (policy).

As I noted back in 2012, the Obama Administration "does not give a flying pig about internet poker or gambling." Nothing that has happened in the subsequent three years changes my view. In fact, the lack of any Administration policy statement regarding online gaming at any point in the past six-plus years only grows more ominous when one considers that the federal online gaming debate has shifted against the pro-legalization movement. At the time of the 2011 PPA petition and the 2012 White House response, Congress was considering an online gaming legalization bill championed by Representatives Barney Frank and Joe Barton in the House, and later that year considered a similar bill sponsored by Senators Harry Reid and John Kyl in the Senate. Now, three years later, Representative Frank and Senator Kyl have retired, the House just held a sub-committee hearing on a bill (RAWA) to ban all online gaming (with notable carveouts for lotteries and horse racing), and Senator Reid has gone on record supporting an online gaming ban. The federal online gaming environment has gone from temperate to downright frigid.

It would not be fair to blame the PPA's 2011 petition for the disintegration of the federal online gaming legalization effort; RAWA is the noxious by-product of a broader set of toxic political forces. Yet, in evaluating the PPA's 2011 petition against its modest goal of advancing the position of online gaming by obtaining a supportive policy statement from the Obama Administration, the 2011 petition was, charitably speaking, somewhere between "inneffective" and "irrelevant". In any event, given the lack of any policy statement, it is foolish to pretend to know how the Administration views online gaming, and it is foolhardy to speculate that the Administration either supports online gaming legalization or is opposed to RAWA.

Why the New PPA Petition Is Pointless

So, if the Obama Administration's policy views on online gaming are unknown, won't the new PPA petition force the Administration to take sides in the debate once and for all? Hardly.

Here's the thing. The Administration clearly has no skin in the game either way. Online gaming is simply not a priority for the Administration, either pro or con. So, even if forced to respond to the PPA petition (which appears a dubious longshot), the Administration is almost certain to put out yet another non-responsive response, taking neither side of the debate. In other words, at best we will get a rehash of the Administration's non-committal response to the 2011 PPA petition.

From the Administration's perspective, there is no political advantage to taking sides in the debate at present. Taking sides now when RAWA or other online gaming legislation appear unlikely to advance simply creates unnecessary enemies, while distracting from the Administration's priority legislative goals. If and when RAWA or other online gaming legislation passes out of one of the Congressional chambers, the Administration will have plenty of time to weigh the most politically advantageous response. The Administration might support a RAWA-style online gaming ban as a reward to Democratic Senate leader Harry Reid, who has done yeoman's work in advancing the Administration's agenda the past six years. Or, the Administration could threaten to veto a RAWA-style online gaming ban as a bargaining chip to extract concessions on issues where the Administration has a stronger interest. The Administration could even agree to sign RAWA into law in exchange for something—say, passage of a bill or approval of a judicial nominee—the Administration truly values, or as part of a compromise package of "must-pass" legislation.

The 2015 PPA petition also is unlikely to gain a supportive reply from the Obama Administration because of a key ideological issue—"states' rights". The PPA petition declares: "Regardless of personal opinions on wagering, the Tenth Amendment directs that states decide such matters, not Congress." The trouble with this language is that it is ideologically charged. In constitutional jurisprudence, "state sovereignty" and the Tenth Amendment have historically been invoked by conservatives seeking to invalidate liberal/progressive economic and social policies. From the Great Depression to present, Democrats' major policy initiatives—e.g., Social Security and other New Deal legislation; the Civil Rights Act; various anti-discrimination laws; wage/hour, and other employee protection legislation; the Affordable Care Act—have been achieved via federal action, generally pursuant to a broad reading of the Commerce Clause. Republicans, by contrast, have tended to resist these laws by asserting those issues were reserved to the determination of individual states. Asking a Democratic President—particularly one whose signature policy initiative (the Affordable Care Act) was nearly invalidated on a Tenth Amendment challenge—to endorse a "state's rights" argument limiting the role of Congress in regulating economic activity such as online gaming is like asking a North Carolina fan to root for Duke in the national title game just because they belong to the same conference. It might happen, but don't hold your breath. [FN1].

The 2011 PPA online poker petition did nothing to clarify the Obama Administration's policy views related to online gaming. There is no reason to expect the 2015 PPA petition to succeed where its 2011 petition failed.

Why the New PPA Petition Is (Probably) Harmless

Now, for the same reasons why the PPA's current petition is destined to fail in its quest to gain support for online gaming from the Obama Administration, the PPA's petition is also unlikely to harm the online gaming cause, either. Essentially, the Administration has an equal incentive to avoid committing to an anti-online gaming position as it does a pro-online gaming position. Again, the most likely—probably inevitable—Administration policy position is a mealy-mouthed non-committal response which allows it to take any position it finds convenient in the unlikely event online gaming legislation (pro or con) ever makes its way out of Congress.

Still, the PPA's petition could backfire in terms of public-relations. Remember, the PPA needs to gin up 100,000 signatures in one month in order to force a response from the Administration. Right now, the petition has just over 3,000 signatures. Yet, in 2011, months after Black Friday destroyed the online poker economy in the United States, when the poker community was presumably most united and most motivated, it took the PPA nearly six months to gather a mere 10,000 signatures for its first petition.

If the PPA falls short of its goal in its current petition campaign, it will walk away with a lot of egg on its face. The PPA likes to brag about its "more than one million members", a membership level it has touted since at least 2008 (and during its 2011 White House petition campaign). The potential problem with the current PPA petition is that failure to generate 100,000 signatures in a month undermines the PPA's narrative of broad public support for its position. Worse, failure to garner the requisite signatures would tarnish the PPA's credibility as an advocacy group. If the PPA fails to deliver signatures for what it considers an important initiative, outsiders will be left to wonder about the cause of the failure: Are there substantially fewer active PPA members than advertised? Are PPA members unmotivated? Is there a disconnect between the PPA's leadership and its members?

Why Poker Players Should Sign the PPA's Petition

There are many political issues which are beyond the influence of individuals or even organized advocacy groups. Many political activities—circulating and signing petitions, attending board meetings, sitting through legislative hearings, contributing to political action committees, volunteering for political campaigns, even the act of voting—are irrational to dispassionate observers who can see that these activities will have no discernible effect on the outcome of the political debate in question. Yet, for some individuals, the mere act of participating in the political process, even if that participation is pointless, provides the salutory effect of making these individuals feel a part of the civic process. For these folks, meaningless action is superior to measured inaction. Raging impotently against the machine is more existential war cry than rational argument.

So it goes for the PPA's latest petition, despite its certain destiny with the trash heap of historical irrelevancy. Signing the PPA petition provides an opportunity for online poker players worked up over RAWA to release some frustration and feel good about themselves, quickly and free from risk, without any long-term commitment. In other words, it's political masturbation.

If signing the PPA's petition makes you feel good, by all means shoot off a signature.

* * * * *

[FN1].  The appeal to a states' rights argument in the fight against RAWA is a smart decision on a tactical level. Because Republicans tend to favor state regulation over federal regulation (particularly with respect to economic issues), invoking the states' rights rhetoric divides the Republicans into the socially conservative anti-gambling (pro-RAWA) faction and the anti-federal regulation (anti-RAWA) faction (though many Republican legislators fit comfortably into both camps). Of course, the states' rights rhetoric may become detrimental in the long-term if federal legislation authorizing online gaming once again becomes more politically palatable. But in the short term, a significant division in the Republican ranks over the proper forum for legislating about online gaming is a major stumbling block for the pro-RAWA forces, and online gaming advocates are wise to fan the flames of that division ("the enemy of my enemy is my ally").

March 25, 2015

Drawing the Line Between Gambling and Finance:
Part V—Hedgers and the Law

Note:  This is the fifth article in a series looking at the legal connections between gambling and finance. The first article introduced the legal concept of aleatory contracts. Links to other articles in the series can be found at the conclusion of this article.

* * * * *

Having looked at some of the more common aleatory contractsinsurance, reinsurance, and derivatives—and found strong parallels between those legally accepted contracts and various forms of gambling, it is time to return to the original question: Why are contracts like insurance and derivatives legal if they are fundamentally identical to gambling?

The short answer is that the law regarding aleatory contracts has long reflected a struggle to resolve the tension between the economic benefits of risk hedging on the one hand, and the moral and economic dangers of unbridled speculation on the other hand. This legal tension has spanned several centuries and been addressed across many cultures. The American legal system has traditionally taken a conservative approach to aleatory contracts, permitting those which show clear economic utility while being slow to permit or enforce contracts which resembled traditional wagers. But, as the American economy has evolved into a leader in the modern sophisticated global financial markets, the American legal system has likewise evolved to accommodate a broader array aleatory contracts.

The Historical Utility of Insurance
"This [New York City] has only been made possible by the insurers. They are the ones who really built this city. With no insurance there would be no skyscrapers. No investor would finance a building that one cigarette butt could burn to the ground."

~ Henry Ford
Insurance is the oldest form of legal aleatory contract, with some forms of economic risk pooling dating back to at least the ancient Babylonian empire; the Code of Hammurabi recognized a form of insurance protecting merchants' goods transported by ship or caravan against loss by storm or theft.

With the rise of the British Empire, insurance became an important and increasingly sophisticated part of international commerce as reflected in the founding of the famed Lloyd's of London underwriting syndicate. Interestingly, the close relationship between insurance and gambling was never far from the surface. As maritime insurance revenues fell, the Lloyd's underwriters turned to other lines of insurance, some of which—death by gin drinking, say—might raise a modern regulatory eyebrow. And the Lloyd's underwriters also turned to other, more traditional forms of aleatory contracts:
"Lloyd’s coffee house soon became notorious as a gambling den. An extract from the London Chronicle of the time [1768] stated: ‘The amazing progress of illicit gambling at Lloyd’s coffee-house is a powerful and very melancholy proof of the degeneracy of the times.’"
American insurance law, as might be expected, derives heavily from English common law. The American insurance industry was slow to develop in colonial times, mostly because the high risks of loss in the New World were deemed uninsurable by established British insurers. But, following the Revolutionary War, numerous American insurance companies were founded. Despite some moral opposition from conservative churches, the American insurance industry was doing robust business by the early 1800s; ironically, one of the first insurance corporations was organized by the Presbyterian Synod of Philadelphia to protect its ministers and their dependents.

The Economic Utility of Risk Hedging

The legal acceptance of insurance contracts is based on their economic utility; insurance is legal because it is economically important. The economic benefits of insuring against catastrophic loss are readily apparent. But insurance offers other, less obvious, economic benefits. For example, two of the largest expenses most people will routinely encounter are purchases of a house or vehicle. Generally, these purchases are made on credit, via a home mortgage or an auto loan or lease. Without insurance to protect their collateral, banks would be reluctant to offer credit on as favorable of terms. Instead, banks would require larger down payments (to limit the extent of possible losses) and would charge higher interest rates (to compensate for their higher risk of loss). In other words, insurance not only protects against large scale losses to homes and vehicles, but in many cases, insurance makes the purchase itself possible.

Similar principles apply in the commercial context. Without insurance, businesses would be reluctant to make large-scale capital investments in, say, buildings or machinery, if those investments were subject to loss because of fire or storm. To the extent businesses face uninsured risks of any kind—whether from fire, storm, theft, cyber-attack, lawsuit, or other cause—prudent financial planning will result in the maintenance of substantial capital reserves to cover those uninsured risks. Insurance, then, is not just a risk mitigation tool, but a method by which businesses can free up capital for investment into business operations.

Insurable Interests and Moral Hazards

Insurance, then, derives its legal status from its obvious economic utility. The ability of individuals and businesses to hedge against catastrophic risks not only protects those purchasing insurance, but also serves to lubricate the general economic machinery. But the law is careful to limit insurance to a hedging function through a concept known as insurable interest.

The insurable interest doctrine requires a party purchasing insurance to possess some legal interest in the object of the insurance policy. For example, an individual can insure his own life, but cannot insure his unrelated neighbor's life. Similarly, a business can insure its warehouse against fire, but cannot insure the warehouse of a competitor. Although the underlying insurance contracts in each case might look the same, the purpose of the contracts is fundamentally different. When insuring a life or property in which a person or business has a direct legal interest, the purpose of the insurance is hedging against risk of loss. When insuring life or property in which a person or business has no direct legal interest, the purpose of the insurance shifts to one of pure speculation. As the U.S. Supreme Court stated:
A contract of insurance upon a life in which the insured has no interest is a pure wager that gives the insured a sinister counter-interest in having the life come to an end. And although that counter-interest always exists, as early was emphasized for England in the famous case of Wainewright (Janus Weathercock), the chance that in some cases it may prove a sufficient motive for crime is greatly enhanced if the whole world of the unscrupulous are free to bet on what life they choose. The very meaning of an insurable interest is an interest in having the life continue, and so one that is opposed to crime. And, what perhaps is more important, the existence of such an interest makes a roughly selected class of persons who, by their general relations with the person whose life is insured, are less likely than criminals at large to attempt to compass his death.

Grigsby v. Russell, 222 U.S. 149, 154-55 (1911) (emphasis added).
In other words, absent an insurable interest, an insurance policy is nothing more than rank gambling, a wager on misfortune befalling a third party. Worse, the lack of an insurable interest creates an acute risk of moral hazard—specifically, the risk that an insured will destroy property or kill a person insured in order to profit from the contract. Regardless of whether a moral hazard actually arises, this type of speculation on the misfortunes of others is generally regarded as morally repugnant. The law, therefore, has long refused to permit speculative insurance contracts, and regards as void any insurance contract in which an insurable interest is lacking.

Gambling With Insurance

Interestingly, the U.S. Supreme Court ultimately ruled in Grigsby that life insurance is a form of property that can be assigned (transferred) to another person, even a person lacking an insurable interest in the underlying policy. In other words, the insurable interest requirement is satisfied by the initial purchaser of the policy, who is then free to sell the policy and its benefits to anyone. This ruling eventually led to the explosion of viatical settlements in the 1980s and 1990s, as individuals with AIDS sought to extract enhanced cash value from their life insurance policies by selling them to speculators who would pay below the policy's death benefit but above the actual cash value of the policy (which might be zero in a term life policy, or relatively small compared to the death benefit in a whole life or universal life policy). The speculator would pay the policy premiums, and would profit if the insured died early enough such that the policy death benefit exceeded the purchase price plus additional premiums. Viatical settlements are also common with other acute diseases with limited treatment options and short life expectancies, such as certain types of neurological diseases and cancers.

Similar to viatical settlements are life settlements, where an individual may sell to a third-party a life insurance policy the individual no longer needs. As with viatical settlements, the purchaser is speculating that the policy will "pay off" with the insured dying early enough that the death benefit exceeds the purchase price plus subsequent premium payments. Life insurance policies purchased via viatical or life settlements are sometimes bundled and securitized as so-called death bonds (essentially turned into an asset-backed security, as discussed in Part IV of this series). Because of the potential for abuse and fraud, most states tightly regulate viatical and life settlements. Nonetheless, viatical and life settlements are the one area where the law permits insurance to be used for speculation—specifically, "gambling" on the life of a stranger.

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Next up, discussion of the law's view of speculation.

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Additional articles in this series (links will be added as each section is posted):

Part I—Meet the Aleatory Contracts

Part II—Insurance: Gambling on Catastrophe

Part III—The Reinsurer, the Bookmaker, the Poker Pro Staker

Part IV—Derivatives and Daily Fantasy Sports

Part V—Hedgers and the Law

Part VI—Speculators and the Law

Part VII—Risk Creation v. Risk Management