Internet Poker: Indictments, Ponzi Schemes and Legislation

As an ongoing drama for gaming-industry lawyers, the prolonged contest over the legality of Internet gambling has had no rival.  The stakes could not be higher.  If it is legalized, those who can exploit the online gambling market in the United States will profit handsomely; that market is the most promising opportunity in the industry.  If the legal environment stays the same, however, those people attempting to operate in the U.S. market could be looking at both financial ruin and an extended stay in a federal penitentiary. 

The pivotal event on this question came on April 15, with the announcement that a New York grand jury had indicted the founders of the three largest Internet poker operators that were accepting bets from U.S. residents — PokerStars, Full Tilt Poker, and Absolute Poker/Ultimate Bet. The charges focus on the processing of payments to and from their customers, alleging that those transactions involved bank fraud, money laundering, and the maintenance of illegal gambling businesses (18 U.S.C. § 1955).   The U.S. Justice Department (DOJ) filed a parallel civil complaint demanding forfeiture of the Internet domains used by those operators.  United States v. Scheinberg, et al., S3-10CR336 (LAK) (SDNY).  Several of the defendants remain outside the United States and have not answered the charges, which are often referred to as the “Black Friday” indictments.

Although dozens of offshore websites continued to accept bets from U.S. residents, many online gamblers reduced their online gambling activity because of uncertainty over its legality, and also because they had trouble recovering funds deposited with operators who were leaving the U.S. market. Before the indictment, PokerStars and Full Tilt held 60 percent of the global Internet poker market.  Within a day of the indictments, both firms stopped taking new bets from U.S. residents; Absolute Poker and Ultimate Bet, continued to allow Americans to play but froze those customers’ ability to deposit or withdraw funds.

The Black Friday indictment may end years of inventive theorizing by industry lawyers who have strained to demonstrate the legality of Internet poker.  These theories included the proposition that poker is predominantly a game of skill, not a game of chance.  Another popular contention, based on a 2002 ruling of the U.S. Court of Appeals for the Fifth Circuit, was that the 1961 federal Wire Act (18 U.S.C. § 1084) applies only to sports betting, not any other form of betting; that ruling, however, has been rejected in two later federal court decisions.¹

The Black Friday indictment unmistakably rejects these arguments.  In a recent pleading filed in those cases, the prosecutors insisted that poker has “historically” been considered gambling, “is regularly treated as gambling under state law, is a game where people are betting on indeterminate outcomes, [and] is a game where people can lose large sums on a bet.”²  The prosecutors also rejected any principled distinction between poker and sports betting, stressing that a skilled bettor can improve his prospects of success in both activities, but that both remain gambling.

The Black Friday indictment makes the Wire Act arguments largely irrelevant by focusing on the financial transactions that are central to any betting business.  The indictment states no charges under the Wire Act, but instead proceeds under the Illegal Gambling Businesses Act of 1970, which incorporates state-law bans on commercial poker games.  The charges also rely on statutes targeting illegal financial activity, including the Unlawful Internet Gambling Enforcement Act of 2006 (UIGEA).

This strategic move climaxed a multi-year effort by the DOJ to choke off the financial transactions that supported offshore Internet gambling sites.  In more than a half-dozen actions since 2008, DOJ had seized over $100 million of bank funds that were deposited with or by payment processors who were working for offshore gambling websites. These enforcement actions demonstrated the vulnerability of the payment processing system and laid the groundwork for the Black Friday indictment.³

The Justice Department’s hostility to Internet gambling was underscored in September when it filed a civil action against Full Tilt Poker alleging that after the Black Friday indictment, the company operated as a “global Ponzi scheme” by failing to repay funds deposited by customers, and instead funneled that money to prominent directors like Howard Lederer, Chris Ferguson, and Rafael Furst.⁴  In that action, the government is demanding forfeitures of tens of millions of dollars.

The federal government’s relentless opposition to Internet gambling has directed considerable attention to legislative activity that might legalize at least Internet poker.  Several states have explored the possibility of authorizing intrastate Internet poker, using authority apparently created by UIGEA. 

In early 2011, the New Jersey Legislature approved intrastate online gambling under this authority, but the governor vetoed the measure on state constitutional grounds.  Similar proposals have been considered in Iowa, Nevada, Florida, California, and the District of Columbia.  Most single-state markets would be too small to provide the liquidity required for a successful online poker industry, while separate intrastate markets with different rules and regulatory structures would create considerable market confusion.

Consequently, attention increasingly has turned to possible congressional action.  Rep. Barney Frank (D-Mass.), while chair of the House Financial Services Committee in 2010, introduced and held hearings on a bill to create a licensed Internet gambling industry, subject to federal regulation. The legislation has been reintroduced in the current Congress by Rep. Frank and Rep. John Campbell (R-Calif.) (H.R. 1174), as has a bill submitted by Rep. Joe Barton (R-Texas) (H.R. 2366), that would legalize only Internet poker.  At the end of 2010, when the outgoing Congress met in a “lame duck” session, Senate Majority Leader Harry Reid of Nevada circulated draft legislation to permit only Internet poker, though he never moved forward on that plan.⁵

In recent weeks, the House Energy and Commerce Committee and the Senate Indian Affairs Committee have both held hearings on the authorization of Internet poker, while the now-failed “supercommittee” on deficit reduction considered legalization as a possible revenue-raising device.