Iron Fist, Velvet Glove

17 November 2008

Once again, the Bush administration’s Department of Justice is trying to outlaw the future of gaming. The current controversy revolves around the supposed right of Illinois to lease out its state lottery. Since the rationales, pro and con, likely affect the application of Internet gambling in the States, we may as well have a look.

Also as usual, a little history is in order, if only to correctly label the confusion. The United States began as a string of English colonies, balancing the traditional English zest for gambling of all kinds (London’s Great Virginia Lottery of 1612 financed the settlement at Jamestown) with the Puritan prejudice against amusements of any sort (first "gaming equipment" law was enacted in Massachusetts in 1631).

By the time of independence, lotteries were established in America, mainly as a substitute for a central banking system or an income tax. Funding for roads, bridges -- even Harvard University -- all came from event-specific lotteries, endorsed by such luminaries as Thomas Jefferson and even George Washington. Alas, not everyone had the ethics of the Founding Fathers. By the 1830s a succession of scams and scandals had brought lotteries into general disrepute. So great was the public disgust that newly formed States of that period added clauses to their constitutions forbidding lotteries altogether.

Lotteries were revived after the Civil War by impoverished Southern states seeking alternatives to taxation. But the sharp practices and frauds returned too, culminating in the Louisiana Lottery Scandal of the 1890s. Exploiting the national postal system’s immunity to state interference, crooked operators opened ticket-sales offices nationwide, defying local laws. The Federal government was forced to step in.

Among the results were the lottery laws, 18 United States Code 1301 through 1307, which make it a crime to physically carry or mail illegal lottery tickets into United States territory (including records of purchase or ownership). Banks and post office officials are also specifically barred from functioning as lottery agents -- which shows you how deep the corruption of the 1890s actually was. It is also against federal law to print or broadcast advertisements and promotional material for illegal lotteries.

But section 1307, predictably enough, allows a safe harbor for lotteries which are authorized by state authorities -- this is why lotteries were able to return to the United States. For almost 70 years after the Louisiana Lottery swindle was finally put down, no lotteries of any kind were allowed in the United States, above the level of charity raffles. From 1964, when New Hampshire revived its state lottery, the institution has spread through America until 42 states, the District of Columbia and three Territories have their own lotteries. So long as the lottery is “conducted by a State acting under the authority of State law,” then it's legal. Since a number of states still retain laws against advertising lotteries other than their own, there is an agreement between the states not to pitch their lotteries to each other’s citizens, at least directly.

But once all these lotteries were in place, a funny thing happened. Lottery income didn’t stay steady. In fact, it tended to decline. Simply having a legal monopoly on lottery tickets turned out to be no guarantee of profit: after all, nobody had to buy. Inevitably, then, a state proprietor finds itself competing not just with the other lotteries next door, and other legal gaming formats (slots, bingo, horse racing) -- but with every other choice for an entertainment dollar (taking the kids to the movies or going fishing, for instance). And so, after the initial novelty wore off, many states found themselves with flat or even declining lottery income.

To keep customers, you have keep the lottery games fresh and attractive. There have been numerous experiments with formats and themes. One of the most successful variations has been interstate pooling, creating gigantic jackpots with nationwide programs such as Powerball and Mega Millions. And state lotteries are increasingly following the lead of European countries and the Canadian provinces, and taking ticket sales onto the Internet. (Note: be careful of the term “online” when speaking of lotteries. State lotteries predate the Internet, and in their vocabulary, “online” refers not to the Web but to the dedicated network of ticket machines in the various outlets, as opposed to the all-paper scratcher sheets.) At present, New Hampshire, New York, North Dakota and Virginia have approved Internet lottery sales. Since Virginia is the home of Congressman Bob Goodlatte, who has been sponsoring laws against Internet gambling for the past 10 years, it’s not hard to see which way the wind is blowing.

Just now, standard operating procedure for state lotteries is a system designed and installed under contract by gaming corporations like Gtech or Scientific Games, then placed under specified state lottery bureaus. But as tax revenues decline, expenses go up and the economy languishes, states are beginning to dabble in leasing out their non-governmental functions such as roads and airports in return for quick cash. Well, then, why not the state lotteries, too? Gambling is certainly not one of those core government functions which must never be delegated. Why not lease out the state lottery to a private operator, in return for a hefty up-front payment? California, Indiana, Illinois and Vermont are considering this option.

Well, just try it and watch what happens! When Illinois Governor Rod Blagojevich proposed leasing out the Illinois state lottery, The Bush administration's Justice Department, which has appointed itself the blocker of gaming expansion of any sort, issued a memo on this subject. It was a classic example of the iron fist obscured -- just barely -- by a velvet glove.

The Justice Department alleges that only a lottery directly administered by state authorities meets the requirements of “conducted by a State acting under the authority of State law.” This is a hypertechnical reading of the language, and it is significant that there is no case law to support this interpretation. And very few facts.

You see, the states do not actually run their lotteries, the way they run the highway patrol. They contract out many of the actual functions to contractors like Gtech or Scientific Games, who print the tickets, program the machines and train the merchants to operate them. Other contractors handle the advertising. This outsourcing is similar to the way states contract out construction and highway repairs. Or, for that matter, to the way states grant licenses to racing associations to run the horse tracks. So read as strictly as the Justice Department seems to require, no state in the union is in compliance with the federal lottery standard, because they are already partly run by contractors under state oversight.

Of course, there is more here than meets the eye. There is a threat underneath: a lottery which is not “conducted by a State acting under the authority of State law” is subject to prosecution. After eight years, the government in charge of the War on Terror well understands the use of fear. It’s not the open threat that chokes initiative; it’s the threat of what an open threat might do, especially when there are investors involved. It’s been said the Justice Department opinion is not binding. Rubbish! As far as the gaming industry is concerned, the Justice Department effectively exercises the power of arrest, imprisonment and confiscation without trial, as Neteller, Google and David Carruthers have already found out.

The Justice Department letter is meant to chase off private independent companies interested in leasing gaming programs, in effect forcing the states to continue the more or less directly administered (and less profitable) status quo. And there is more. For if in-house-only becomes the standard, this would tend to discourage such innovations as online sales of lottery tickets, and state licensing of Internet gaming. Technological innovation is not the function of state governments, so obviously such projects would rely on outside contractors.

Once again, the Justice Department is trying to outlaw the future of gaming. Once again, they will fail. In a few weeks there will be new hands at the Washington helm, and the petty oppression of gaming operators will cease to be one of the fixations of the executive branch. There will be other concerns for the new government. One of them might well be an investigation into previous abuses of power.

In the meantime, it would be well for gaming advocates not to become discouraged. Rather they should hold their course, and convince the state governments to look at licensed I-gaming. The greatest rewards will come to the first entrants in this renewed market.

Click here to view the Justice Department's opinion, which was issued on Oct. 16, 2008.

Mr. Owens is a lawyer in Sacramento, Calif., specializing in Internet gambling law. Released in 2005, he coauthored "Internet Gaming Law" with Professor I. Nelson Rose, America's senior authority on gambling.