ATTACHMENTS

The EC Green Paper The Sparrow Report The Spectrum Report The AGA Testimony

EUROPEAN COMMISSION

Brussels, COM(2011) 128

GREEN PAPER On on-line gambling in the Internal Market

{SEC(2011) 321}

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TABLE OF CONTENTS
GREEN PAPER on on-line gambling in the Internal Market.................................................... 3 1. 1.1. 1.2. 2. 2.1. 2.2. 2.3. 2.3.1. 2.3.2. 2.3.3. 2.4. Regulating on-line gambling in the EU: Recent developments and current challenges from the Internal Market standpoint ............................................................................ 6 Purpose of the consultation .......................................................................................... 6 On-line gambling in the EU: current situation............................................................. 8 Key policy issues subject to the present consultation ................................................ 13 Definition and organisation of on-line gambling services ......................................... 13 Related services performed and/or used by on-line gambling services providers ..... 16 Public interest objectives............................................................................................ 19 Consumer protection .................................................................................................. 19 Public order ................................................................................................................ 26 Financing of benevolent and public interest activities as well as events on which online sports betting relies ............................................................................................. 29 Enforcement and related matters................................................................................ 33

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GREEN PAPER On on-line gambling in the Internal Market The purpose of this Green paper is to launch an extensive public consultation on all relevant public policy challenges and possible Internal Market issues resulting from the rapid development of both licit and unauthorised on-line gambling offers directed at citizens located in the EU. Broadly speaking there are currently two models of national regulatory framework applied in the field of gambling: one based on licensed operators providing services within a strictly regulated framework and the other on a strictly controlled monopoly (state owned or otherwise). These two models co-existed within the internal market given the relatively limited possibilities of selling gambling services across borders in the past. The online gambling market is the fastest growing segment of the overall gambling market, with annual revenues in excess of 6,16bn in 20081. Thus monopolies have often been authorised to develop on-line activities and certain Member States2 with monopoly regimes have gradually opted for an opening of their on-line gambling and betting market. It is important to note that sports betting as against other forms of gambling in certain national regulatory regimes are subject to relatively lighter licensing regimes. In summary, the development of internet and the increased supply of on-line gambling services have made it more difficult for the different national regulatory models to co-exist. The challenges posed by the co-existence of differing regulatory models is illustrated by the number of preliminary rulings in this area as well as by the development of significant socalled "grey"3 and illegal on-line markets across the Member States. Enforcement of national rules is facing many challenges, raising the issue of a possible need for enhanced administrative co-operation between competent national authorities, or for other types of action. Furthermore, out of 14,823 active gambling sites in Europe more than 85% operated without any licence4.

There is limited data available for on-line gambling. These figures provided by H2 Gambling Capital, are estimates primarily based on public information provided by regulators, monopolies and companies. Further guidance and data have also been supplied on a confidential basis (2008 figures). H2 Gambling Capital has also assessed the Member States serviced by operators where not primary information is available. For more detailed information on these figures:http://ec.europa.eu/internal_market/services/gambling_en.htm The Commission is aware that certain on-line gambling services are regulated for at a regional level in a number of Member States. However, for reasons of simplicity, this Green paper only refers to "Member States" or "national". The notion of "grey" market is often used to describe a factual or legal situation in the context of EU law (regarding for instance, i.a., the parallel imports of goods). For the purpose of this consultation, it is used to describe markets consisting of operators duly licensed in one or more Member States providing on-line gambling services in other Member States without having obtained an authorisation to do so under the corresponding national legislation. In contrast, illegal or black markets are used to describe markets on which unlicensed operators seek to provide on-line gambling services. Cyber-criminality in Online Gaming, White Paper by CERT-LEXSI, (Laboratoire d'Expertise en Securite Informatique), July 2006. http://www.lexsi.com/telecharger/gambling_cybercrime_2006.pdf.

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In view of the self-evident cross-border impact of this on-line gambling service growth in both its legal and unauthorised dimension, as well as of its nexus with many issues already dealt with by EU legislation, it is the Commissions intention to exhaust a number of questions related to the effects of, and to the possible public policy responses to, this growth in on-line gambling activity in order to have a full picture of the existing situation, to facilitate the exchange of best practices between Member States and to determine if the differing national regulatory models for gambling can continue to coexist and whether specific action may be needed in the EU for that purpose. This consultation also responds to a series of Presidency conclusions (2008-2010) and to the resolution of the European Parliament on integrity in on-line gambling (2009). The Commission launches this consultation with an open mind in that it does not prejudice the conclusions to be subsequently drawn as to the necessity to take action, the form of such action, as appropriate, and the level at which such action should be taken. Its fundamental purpose is to collect the facts, assess the stakes and to gather the views of all interested stakeholders on a phenomenon that has multiple dimensions. Comments are invited on all or some aspects of the document. Specific questions are listed after each section. The consultation and the questions asked in this document focus primarily on on-line gambling, and issues linked to the free movement of services (Article 56 TFEU), due to the well developed cross-border supply of such services. However, although this consultation does not focus on the freedom of establishment (Article 49 TFEU) a number of questions may also be of direct relevance for other gambling services (offered in "bricks-and-mortar" establishments). The Commission would also like to stress that, in the absence of harmonisation in the field, it is for each Member State to determine in those areas, in accordance with its own scale of values, what is required in order to ensure that the interests in question are protected, in line with the subsidiarity principle. A staff working document accompanying this Green paper is available on the Commission's website: http://ec.europa.eu/internal_market/services/gambling_en.htm This staff working document provides interested parties with additional information relating to the stakeholders involved and their interests, the size of the on-line gambling market, secondary legislation, jurisprudence and the notification of national legislation under Directive 98/34/EC laying down a procedure for the provision of information in the field of technical standards and regulations. Member States, the European Parliament, the European Economic and Social Committee and all other interested parties are invited to submit their views on the suggestions set out in this Green Paper. Contributions should be sent to one of the following addresses to reach the Commission by 31 July 2011 at the latest: markt-gambling@ec.europa.eu European Commission DG Internal Market and Services [J-59 08/061] Rue de la Loi 200 B-1049

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Contributions will be published on the internet. It is important to read the specific privacy statement attached to this Green Paper5 for information on how personal data and contributions will be dealt with. The Commission asks organisations who wish to submit comments in the context of public consultations to provide the Commission and the public at large with information about whom and what they represent. If an organisation decides not to provide this information, it is the Commission's stated policy to list the contribution as part of the individual contributions. (Consultation Standards, see COM(2002) 704, and Communication on ETI Follow-up, see COM(2007) 127 of 21.3.2007) In addition, the Commission intends to organise consultations of national authorities and targeted stakeholder meetings and expert workshops. In follow-up to this Green Paper and on the basis of the conclusions drawn from the results of this consultation, the Commission will consider the next steps to be taken.

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1. 1.1.

REGULATING

ON-LINE GAMBLING IN THE EU: RECENT DEVELOPMENTS AND CURRENT CHALLENGES FROM THE INTERNAL MARKET STANDPOINT

Purpose of the consultation

This Green paper is launching a public consultation on the regulation of on-line gambling services in the Internal Market. It seeks to canvass views from all interested parties in order to get a better understanding of the specific issues arising from the development of both legal and "unauthorised" offers of on-line gambling services directed at consumers located in the EU. The consultation aims at collecting information on the existence and extent of societal and public order risks associated with this activity. It furthermore seeks contributions on the regulatory and technical means Member States use or could use to ensure consumer protection, the preservation of public order or other public interests, and their effectiveness, in view of the need for a proportionate, systematic and coherent application of their policy vis-vis on-line gambling. Finally, the consultation should help identify if the current rules applicable to on-line gambling services at EU level are fit to ensure the overall coexistence of the national systems and determine if greater cooperation at EU level might help Member States to achieve more effectively the objectives of their gambling policy. Today on-line gambling services are widely offered and used in the EU and the economic significance of the sector is growing. The on-line offer is the fastest growing segment of the gambling market, accounting for 7.5% of the annual revenues of the overall gambling market in 2008, and it is expected to double in size by 2013. At the same time, the regulatory framework applicable to gambling differs significantly across Member States. While some Member States restrict or even ban the offer of certain games of chance, others have more open markets. Many Member States have also recently reviewed their gambling legislation or are in the process of doing so in view of the growth of on-line gambling services. The advent of the internet and the rapid growth of on-line gambling opportunities combined with the considerably differing national regulations have resulted not only in an increasing legal offer of gambling services in certain Member States but also in the development of a significant unauthorised cross-border market. This consists of both a black market (with unlicensed clandestine betting and gaming, including from third countries) and a so-called "grey" market (operators duly licensed in one or more Member States promoting and/or providing gambling services to citizens in other Member States without having obtained a specific authorisation in those countries). This unauthorised cross-border market remains accessible to consumers, due either to de facto tolerance or lack of effective enforcement, and adds to the legal national offers that are available to consumers depending on the legal situation prevailing in the Member States where they are located. Since July 2008, Member States have, within a Council Working Party on Establishment and Services, discussed matters of common interest in relation to the gambling sector. Consecutive Presidencies have asked for the European Commission's active participation and detailed consultations. The French Presidency suggested in 20086 that the Commission , in due course, should consider the possibility to make proposals to identify ways forward. The Swedish Presidency encouraged the European Commission to engage in the work on this

Presidency progress report, presented on 1 December 2008 (doc ref 16022/08).

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topic to address gambling responsibility7 and the Spanish Presidency invited the Commission to initiate consultations with the stakeholders and the Member States in view of EU actions in this field8. Most recently, under the Belgian Presidency, all Member States agreed on Council conclusions that welcome a broad consultation by the European Commission on online gambling in the internal market which will allow for an in-depth discussion on issues raised by on-line gambling services in particular. These conclusions, adopted on 10 December 20109 also addressed cooperation between regulatory authorities and noted that the Internal Market Information system could become a useful tool in order to facilitate this administrative cooperation. This Green paper also responds to the resolution of the European Parliament adopted on 10 March 2009 that called on the Commission to study, in close cooperation with national governments, the economic and non-economic effects of the provision of cross-border gambling services in relation to a wide range of issues10. Under EU law, as confirmed by the CJEU, gambling services fall under Article 56 TFEU and are thus covered by the rules on the provision of services. According to these rules, operators authorised in one Member State may provide their services to consumers in other Member States, unless those impose restrictions justified by overriding reasons in the public interest, such as consumer protection or the general need to preserve public order. The Member States' overall policy vis--vis on-line gambling must be proportionate and be applied in a consistent and systematic manner. Moreover, such restrictions must also be consistent with EU secondary legislation: although gambling services are not regulated by sector-specific regulation at EU level and excluded from horizontal acts such as the Services Directive (2006/123/EC) or the E-commerce Directive (2000/31/EC), they are subject to a number of rules in EU secondary legislation11. In view of recent trends, restrictions imposed to online gambling by each Member State can be expected to continue to vary considerably, with the effect that what is, or will become, considered a legal offer in one Member State will continue to be deemed unlawful (in that it has not been implicitly or explicitly authorised) in the territory of another Member State. It follows that, subject to the legal conditions set out above, effective enforcement will be essential to ensure the achievement of the objectives of a Member State's gambling policy. The Commissions objective is to contribute, through this consultation and building on the active involvement of the Member States, the Council and the European Parliament, to the emergence in the Member States of a legal framework for on-line gambling providing for greater legal certainty for all stakeholders. The consultation should embrace all the relevant public interest objectives that this activity touches on and allow for the identification of the best possible ways to reconcile them with the Internal Market principles. At the end of this process and in light of the responses received, the Commission will report on what appears to be the most appropriate follow-up.
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Presidency progress report, presented on 3 December 2009, (doc ref 16571/09). Presidency progress report, presented on 25 May 2010, (doc ref 9495/10). Conclusions on the framework for gambling and betting in the EU Member States, adopted at the 3057th Competitiveness Council meeting, Brussels, 10 December 2010. Council document 16884/10. The resolution followed the SCHALDEMOSE report. See European Parliament resolution of 10 March 2009 on the integrity of online gambling (2008/2215(INI)); P6-2009-0097. These issues include advertising and marketing and under age people (p 29), fraud and criminal behaviour (p. 30) and integrity, social responsibility, consumer protection and taxation (p. 31). See section 1.2: subsection "EU secondary legislation relevant to on-line gambling".

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1.2.

On-line gambling in the EU: current situation

Main features of the on-line gaming industry operating in the EU In 2008, the annual revenues generated by the gambling service sector, measured on the basis of Gross Gaming Revenues (GGR) (i.e. stakes less prizes but including bonuses), were estimated to be 75,9 bn (EU 2712), showing the economic significance of the sector. On-line gambling services accounted for annual revenues in excess of 6.16 bn, 7.5% of the overall gambling market. This on-line market is the fastest growing segment and in 2008 it was expected to double in size in five years13. The transmission channels for on-line gambling services can be divided into three main categories, namely internet, mobile applications and IPTV:
2003 Internet Mobile phones/ other IPTV14 4.8 bn 0.78 bn 0.32 bn 2008 5.9 bn na na 2012 7.32 3.51 1.33 Projected increase 152.5% 450.0 % 415.6%

Figure 1. Projected increase in three main categories of remote gambling15

National levels of demand for these on-line services vary across the Union depending on a number of factors. In that respect it is not surprising to see that the UK is the largest market at the current time given that its e-commerce market is twice as large as the average for the Member States16 It is however interesting to note that some of the largest markets in 2008 were Member States characterised by the restrictive regulatory model, i.e. France, Germany, Italy and Sweden.

Figure 2. Five largest national on-line gambling markets in the EU in 2008 (GGR in bn )17

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H2 Gambling Capital (2008 figures). EGBA and H2 Gambling Capital, 2009, http://www.egba.eu/pdf/EGBA_FS_MarketReality.pdf Internet Protocol Television. SICL study, page 1407, http://ec.europa.eu/internal_market/services/gambling_en.htm See Report on retail Market monitoring, 5 July 2010 - COM(2010) 355. H2 Gambling Capital.

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Currently internet is the most significant channel but very high rates of growth are expected through the roll out of new mobile applications. Five major categories of on-line gambling services are offered (see Figure 3).

Figure 3. Breakdown of the Gross Gambling Revenues by type of on-line gambling service (EU-27)18

A wide range of stakeholders have an interest in, or are affected by, the provision or promotion of on-line gambling services. These include citizens, operators, media, intermediaries, sport events organisers, clubs and associations, good causes and other beneficiaries19. As regards citizens, the market for gambling (online and offline) is one of the 50 markets covered in the annual Consumer Market Monitoring Survey. The market is rated 29th out of 50 included markets. The consumer ranking for "comparability" is relatively high, the rating for "trust" is average and the rating for "experienced problems" is much lower than the average. The overall rating for whether the product lived up to what the consumer expected is relatively low but this is perhaps to be expected given the nature of the product20. Questions: (1) Are you aware of any available data or studies on the EU on-line gambling market that would assist policy-making at EU and national level? If yes, do the data or study include licensed non-EU operators in the EU market? Are you aware of any available data or studies relating to the nature and size of the black market for on-line gambling services? (Unlicensed operators) What, if any, is your experience of EU-based on-line gambling operators licensed in one or more Member State and providing and promoting their services in other EU Member States? What are your views on their impact on the corresponding markets and their consumers?

(2) (3)

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H2 Gambling Capital. For a more on the stakeholders and their interests, see "Staff working document". Specific scores for market in specific countries (dashboards), the overall report (where gambling is dealt with on page 243), tables, etc. can be found at this link: http://ec.europa.eu/consumers/strategy/cons_satisfaction_en.htm

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(4)

What, if any, is your experience of licensed non-EU on-line gambling operators providing and promoting their services in EU Member States? What are your views on their impact on the EU market and on consumers?

Online gambling under the Treaty rules The regulatory situation for on-line gambling is characterised by the fact that in 2006 the Commission, following a unanimous demand of the Council and the European Parliament in first reading, excluded gambling services from the scope of its modified proposal for a Services directive21. As a consequence of the lack of political will to consider the adoption of secondary law in this sector, the focus turned to the application of primary law. A number of infringement proceedings22 against cross-border restrictions to such services were processed as a result of the many complaints lodged with the Commission for alleged violations of the Treaty. As the Court of Justice of the EU (CJEU) has now developed and set out a number of guiding principles, a significant proportion of the Member States against which the Commission opened infringement cases have since launched national regulatory gambling reforms and more than 150 draft Acts and regulations have been notified to the Commission23. A study by the Commission in 200624 examining the various laws regulating on-line and offline gambling services'25 and their impact upon the smooth functioning of the Internal Market for these and associated services presented a picture of a very fragmented Internal Market where Member States frequently imposed restrictions to cross-border gambling services. The interpretation of national rules was not always clear and the study listed almost 600 cases before national Courts demonstrating the significant legal uncertainty affecting the EU market for such services26. The Treaty on the functioning of the European Union (TFEU) Article 56 of the TFEU prohibits restrictions on the freedom to provide services to recipients in other Member States. In Schindler27 the CJEU confirmed for the first time that the provision and use of cross-border gambling offers is an economic activity that falls within the scope of the Treaty. The Court furthermore held in Gambelli28 that services offered by electronic means were covered and that national legislation which prohibits operators
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COM(2006) 160, 4.4.2006. Currently Article 2(2)(h) of the Services Directive expressly excludes gambling activities. Commission launched inquires into restrictions on sports betting services in a number of Member States on 4 April 2006 (IP/06/436). The Commission was criticised for not processing these complaints fast enough by the European ombudsman following a complaint lodged with his office by the European Parliament (Case number: 289/2005). 151 notifications relating to gambling were notified to the Commission under Directive 98/34/EC laying down a procedure for the provision of information in the field of technical standards and regulations (OJ L 204, 21.7.1998, p.37) (amended by Directive 98/48/EC (OJ L 217, 5.8.1998, p. 18)) 2005 - 2010. See also: http://ec.europa.eu/enterprise/tris/index_en.htm Study on gambling services in the EU Internal Market, by the Swiss Institute of Comparative Law. See http://ec.europa.eu/internal_market/services/gambling_en.htm (1) lotteries, (2) betting; (3) gambling offered in casinos; (4) gambling on gambling machines that are placed in locations other than licensed casinos; (5) bingo; (6) media gambling; (7) sales promotion services consisting of promotional games with a prize exceeding 100,000 or where participation is exclusively linked to purchase; (8) gambling services operated by and for the benefit of recognised charities and non-profit making organisations. 587 cases, most of these cases were dealt with by German Courts. Case C-275/92, ECR 1994 Page I-01039. Case C-243/01, ECR 2003 Page I-13031.

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established in a Member State from offering on-line gambling services to consumers in another Member State, or hampers the freedom to receive or to benefit as a recipient from the services offered by a supplier established in another Member State, constitutes a restriction on the freedom to provide services. Restrictions are only acceptable as exceptional measures expressly provided for in Articles 51 and 52 TFEU, or justified, in accordance with the case-law of the Court, for reasons of overriding general interest. A certain number of reasons of overriding general interest have been recognised by the Court, such as the objectives of consumer protection and the prevention of both fraud and incitement to squander on gaming, as well as the general need to preserve public order. The reduction of tax revenue however is not one of the grounds listed in Article 52 TFEU and does not constitute a matter of overriding general interest. The recognised societal issues can all serve to justify the need for national authorities to have a sufficient margin of discretion to determine what consumer protection and the preservation of public order require in terms of type of service provision offered in this field29. The case-law also requires that such service provision and the cross-border restrictions that may result from the regulatory approach must bring about a genuine reduction of gambling opportunities and be applied in a consistent and systematic manner to all service offers in the area30. In so far as the authorities of a Member State incite and encourage consumers to participate in lotteries, games of chance and betting to the financial benefit of the public purse, the authorities of that State cannot invoke public order concerns relating to the need to reduce opportunities for betting in order to justify restrictions31. Restrictions must be applied without discrimination and be proportionate, i.e. they must be suitable for achieving the objective which they pursue and not go beyond what is necessary in order to attain it. The procedure for the grant of a licence is bound to comply with the principles of equal treatment and non-discrimination and with the consequent obligation of transparency32. Of particular interest for this consultation is the Court's view that gambling services offered via the internet have several specific characteristics which enable the Member States to adopt measures restricting or otherwise regulating the provision of such services, in order to combat gambling addiction and protect consumers against the risks of fraud and crime. Those specificities are the following: (1) In the sector of on-line gambling, authorities of the Member State of establishment encounter specific difficulties to assess the professional qualities and integrity of operators. These difficulties justify that a Member State takes the view that the mere fact that an operator lawfully offers on-line gambling services in another Member State, in which it is established and where it is in principle already subject to statutory conditions and controls on the part of the authorities of that Member State, cannot be regarded as amounting to a sufficient assurance that its own consumers will be protected against the risks of fraud and crime33;

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C-275/92, ECR 1994 Page I-01039; Case C-124/97, ECR 1999 Page I-06067; Case C-67/98, ECR 1999 Page I-07289. Case C-67/98, ECR 1999 Page I-07289; Case C-243/01, ECR 2003 Page I-13031. Case C-243/01, ECR 2003 Page I-13031. Case C-203/08, ECR [0000] Page I-0000. Case C-42/07, ECR [2009] Page I-7633, 69, see also section 2.4 (enforcement) and question 48.

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(2)

The lack of direct contact between the consumer and the on-line gambling operator gives rise to different and more substantial risks of fraud by operators against consumers compared to the traditional gambling market34; and The particular ease and the permanent access to on-line gambling services and the potentially high volume and frequency of such an international offer, in an environment which is characterised by isolation of the player, anonymity and an absence of social control are factors likely to develop gambling addiction and lead to other negative consequences (The Court also states that the internet may prove to be a source of risks of a different kind and a greater order in the area of consumer protection, particularly in relation to young people and those with a propensity for gambling or likely to develop such a propensity, in comparison with traditional markets for such games)35.

(3)

The Court developed its case-law primarily on the basis of references for preliminary rulings from national courts. At the same time however the Commission launched a series of infringement proceedings against Member States in order to verify on the basis of the jurisprudence of the Court the proportionality of restrictions implemented in Member States. Following reforms in Member States the Commission has already closed some of these cases36. Furthermore, the European Commission has opened, under EU state aid rules (Articles 107 and 108 TFEU), a formal investigation to examine whether lower taxes for online casinos in comparison to traditional casinos in Denmark are in compliance with the Treaty rules37. EU secondary legislation relevant to on-line gambling As regards secondary European law, gambling services are not regulated by sector-specific rules at EU level but nevertheless are subject to a number of EU acts38. The following texts are noteworthy in this respect39: the Audiovisual Media Services Directive40, the Unfair Commercial Practices Directive41, the Distance Selling Directive42, the Anti-Money Laundering Directive43, the Data Protection Directive44, the Directive on privacy and electronic communication45, and the Directive on the common system of value added tax46. In

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Case C-42/07, cited above, 70. As regards face-to-face customer identification and age verification, see questions 16 and 24. Case C-46/08, ECR [0000], Page I-0000, 103. As regards factors linked to problem gambling, see questions 17 and 19. See IP/10/504 (Italy) and IP/10/1597 (France). The Commission has also closed a case against Austria (no IP) Case C35/2010 - DA - Duties for online gaming in the Danish Gaming Duties Act (OJ C 22, 22.1.2011) and IP/19/1711. See also Staff working document Section 2.3. See Section 2.1 of the Staff working paper. For a more complete listing of EU secondary legislation, see "Staff working document". OJ L 95, 15.4.2010, p. 1. OJ L 149, 11.6.2005, p. 22. OJ L 144, 4.6.1997, p. 19. OJ L 309, 25.11.2005, p. 15. OJ L 281, 23.11.1995, p. 31. OJ L 201, 31.7.2002, p. 37. OJ L 347, 11.12.2006, p. 1.

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other cases gambling services have been explicitly excluded from the scope of EU law. This is the case of the E-commerce Directive47 and of the Services Directive48. Questions: (5) If any, which are the legal and/or practical problems that arise, in your view, from the jurisprudence of national courts and the CJEU in the field of online gambling? In particular, are there problems of legal certainty on your national and/or the EU market for such services? Do you consider that existing national and EU secondary law applicable to online gambling services adequately regulates those services? In particular, do you consider that coherence / consistency is ensured between, on one hand, the public policy objectives pursued by Member States in this field and, on the other hand, the national measures in force and/or the actual behaviour of public or private operators providing on-line gambling services? KEY POLICY ISSUES SUBJECT TO THE PRESENT CONSULTATION

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2.

The following sections of this Green paper examine the key issues associated with the efficient and fair regulation of on-line gambling services. These issues, which may not be exhaustive, can be broken down into four main categories: conceptual/organisational, societal, public order and economic/good causes. All considerations and questions developed hereunder and pertaining to the organisation or regulation of the on-line gambling sector are without prejudice to the wide margin of appreciation left to Member States as to their regulatory approach to this activity, including as to the use of the revenues from gambling activities. For example, the discussion of issues such as licensing is not based on any presumption that there is a de jure obligation on Member States to allow on-line gambling or to open their markets to private operators. Member States remain free to determine their approach to this sector within the limits of the principles as set out by CJEU case law. 2.1. Definition and organisation of on-line gambling services

Definitions A large number of differing gambling services are covered by the term online gambling. These include on-line provision of sports betting services (including horse racing), casino games, spread betting, media games, promotional games, gambling services operated by and for the benefit of recognised charities and non-profit making organisations and lottery services. Internet (and other interactive technological platforms, such as m-commerce49 or IPTV) are used to (a) offer gambling services to consumers, (b) allow consumers to bet or gamble

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OJ L 178, 17.0.2000, p. 1. OJ L 376, 27.12.2006, p. 36 Mobile Commerce - completed by using mobile access to computer-mediated networks with the help of an electronic device (for example a mobile phone).

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against each other (e.g. betting exchanges or on-line poker) or (c) as a distribution technique (e.g. to purchase lottery tickets directly on-line). The long-standing definition that exists for gambling activities in general in EU secondary legislation is that relied upon to exclude such services from the e-commerce directive: "gambling activities ...involve wagering a stake with monetary value in games of chance, including lotteries and betting transactions." In later texts such as the Services directive and most recently in the Audiovisual Media Services Directive a slightly different definition is "games of chance involving a stake representing a sum of money, including lotteries, betting and other forms of gambling services"50. The term 'casino' is not defined in the Money laundering Directive. Subject to the outcome of the present consultation, it is the Commissions preliminary view that the broader definition as set down in the e-commerce directive should be maintained for gambling and that this should be combined with that for information society services as set down in Directive 98/34/EC such that the following common definition for on-line gambling services should be applied as defining the scope of the current consultation: On-line gambling services are any service which involves wagering a stake with monetary value in games of chance, including lotteries and betting transactions that are provided at a distance, by electronic means and at the individual request51 of a recipient of services. Questions: (7) (8) How does the definition of on-line gambling services above differ from definitions at national level? Are gambling services offered by the media considered as games of chance at national level? Is there a distinction drawn between promotional games and gambling? Are cross-border on-line gambling services offered in licensed premises dedicated to gambling (e.g. casinos, gambling halls or a bookmaker's shop) at national level?

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Establishment and licensing of on-line gambling services According to the Court's case law under Article 49 TFEU, the concept of establishment is a very broad one, allowing an EU national to participate, on a stable and continuous basis, in the economic life of a Member State other than his State of origin and to profit from this

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In a proposal for a regulation concerning sales promotions on the Internal Market - COM(2001)546 the Commission drew a distinction between games of chance and games of skill. This was necessary due to differing national definitions of "chance". Such differences could also be explaining differing national regulations of certain betting activities or poker. At a distance and "at the individual request" meaning a direct on-line request from the recipient to the on-line gambling operator without reliance on any intermediaries such as shop staff working at a point of sale. To the extent that the distance transaction takes place through a network of natural persons acting as intermediaries using electronic means it is not intended to be contained in the above definition.

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market, so contributing to economic and social interpenetration within the Community52. However, in order for the provisions relating to freedom of establishment to apply, it is generally necessary to have secured a permanent presence in the host Member State53. Such a permanent presence could for example be an office set up to follow sport in order to set fixed odds or a commercial office with the objective to promote cross border gambling services or to provide local customer support. According to the e-commerce directive54, a company offering information society services is established where it pursues its economic activity. It is therefore neither the place where the technology supporting its website is located nor the place where the website is accessible. In cases where it is difficult to determine from which of several places of establishment a given service is provided, the place where the company has the centre of its activities relating to the particular service should be the deciding factor. Since a company can use one or multiple servers or a "cloud-based"55 infrastructure and since it can switch and relocate them within a very short period of time, a server cannot be considered a secure link to determine the company's place of establishment relating to a particular on-line service. National laws sometimes set quantitative limits on the number of licences that may be held for on-line gambling services or may even ban them altogether within their jurisdictions. (E.g. a prohibition or a legal or de facto monopoly for one or more categories of gambling services). Other Member States do not set limits on the total number of licences that they may issue a licence is given to any on-line operator that meets a number of conditions set out in law or regulations. Licences may be limited in time or granted for an undefined period. Within the EU, the largest number of licensed on-line gambling operators is to be found in Malta (ca 500 licences in 2009). The current regulatory situation in the Member States is such that operators may be required, when offering the same type of on-line gambling service (e.g. sports betting) in different Member States, to apply for a licence in each of these Member States. Certain Member States recognise licences issued in other Member States that are notified to them (white listing) and allow such licensed providers to offer their on-line gambling services into their territories without an additional licence. Others may take account of such licences when issuing their own licences to such operators but impose double licensing regimes whereby each operator, irrespective of whether he is operating in another Member State, must be licensed within their territory before he can offer such services. Question: (10) What are the main advantages/difficulties associated with the coexistence in the EU of differing national systems of, and practices for, the licensing of on-line gambling services?

52 53 54 55

Case C-55/94, ECR 1995, Page I-4165. Case C-386/04, ECR 2006, Page I-8203. The e-commerce directive, cited in footnote 47, recital (19). A cloud is a platform or infrastructure that enables execution of code (services, applications etc.), in a managed and elastic fashion.

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2.2.

Related services performed and/or used by on-line gambling services providers

A number of services, including marketing and payment services, are used by gambling operators to encourage or facilitate on-line gambling. Some of these services are subject to secondary legislation. Promotion of on-line gambling Commercial Communications On-line service providers use commercial communications to promote their services, related products and image to final consumers and/or distributors. The Commission understands that the following commercial communications are the most frequently used: (1) (2) (3) (4) (5) (6) TV advertising; Printed press advertising; On-line commercial communications; Sales promotions; Direct marketing (which includes direct mail, primarily by e-mails and sms to registered customers, for example personal follow-up contacts); and Sponsorship agreements.

The Commission is aware that, in many Member States, there are restrictions on such commercial communications ranging from prohibitions to content requirements on media advertising of on-line gambling services. Whereas the Commission welcomes comments on such restrictions (points (1) and (2) above) it wishes to focus its consultation on certain forms of commercial communications, points (3) (6) On-line commercial communications

On-line banners and pop-ups on non-gambling sites are two forms of internet advertising intended to redirect traffic to on-line gambling services. They therefore appear on nongambling information society services. They do not fall under the scope of the E-commerce directive but fall within the scope of the Unfair Commercial Practices Directive and, in so far as the use of on-line commercial communications includes the collection and processing of personal data, the Data Protection Directive 95/46/EC and E-Privacy Directive 2002/58/EC. Sales promotions

Sales promotions cover discounts of all forms; premium offers, free gifts, promotional contests and promotional games. They are an important multi-faceted tool that can be adjusted to various circumstances: to enter into markets with innovative products; to encourage customer loyalty; to stimulate short-term competitive actions; or to rapidly respond to lost sales. One of the most common types of sales promotions are the use and communication of registration and deposit bonuses, i.e. where on opening a player's account a sum of money is paid or extra funds are added to deposits made by an already registered customer.

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Sales promotions relating to on-line gambling services are regulated by the Unfair Commercial Practices Directive as well as Data Protection Directive and E-Privacy Directive 2002/58/EC. Direct marketing

All on-line gambling operators use direct marketing strategies (via mail, telephone, Internet and direct response) as they are considered an essential tool for companies to approach, inform and retain customers, as well as providing customer after-sales services. These are regulated by the Distance Selling Directive, the Unfair Commercial Practices Directive, Data Protection Directive 95/46/EC and the E-privacy Directive 2002/58/EC. Such direct marketing may include player-to-player marketing and could be combined with sales promotions. Sponsorship

Sponsorship means any commercial agreement by which a sponsor, for the mutual benefit of the sponsor and sponsored party, contractually provides financing or other support in order to establish an association between the sponsor's image, brands, goods or services and a sponsorship property in return for rights to promote this association and/or for the granting of certain agreed direct or indirect benefits56. Sponsorship is central to on-line gambling service providers' marketing mix whether they are national lotteries or commercial operators. Question: (11) With focus on the categories mentioned above, how are commercial communications for (on-line) gambling services regulated for at national level? Are there specific problems with such cross-border commercial communications? On-line payment services, pay-outs and customer identification

Since truly effective distance micro-payment services are not yet available, on-line gambling operators typically require their customers to deposit funds on player accounts before playing. Deposits can be made by credit cards, e-Wallets, bank transfers, pre-paid cards or cash transfers.
Payment method Credit cards (including Maestro) E-wallets Bank transfers Prepaid cards Estimated percentage57 64-65% 12-14 % 11-13% 9-11%

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ICC International Code on Sponsorship (2003) http://www.iccwbo.org/policy/marketing/id926/index.html European Commission estimates based on information from operators that accept deposits from customers who are resident in another Member State (February 2010).

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Additional limits are typically set by on-line gambling operators, such as on deposit and withdrawal levels from the player's account. Limits on withdrawals range from a fixed limit to the requirement for the player to contact a bank in person to withdraw larger sums from the player's account. Certain operators require that the same payment method is used for both deposits and withdrawals of funds (a so-called closed system). Gambling services offered over mobile telephony or IPTV will also include transmission charges linked to invoices for telephony services. Questions: (12) (13) Are there specific national regulations pertaining to payment systems for online gambling services? How do you assess them? Are players' accounts a necessary requirement for enforcement and player protection reasons?

Customer identification is necessary for, in particular the protection of minors, fraud prevention, "know-your-customer" controls and prevention of money laundering. Customer identification may raise specific Internal Market problems when the service provider and customer are at different locations and also because of the current lack of mutual recognition of electronic identification and authentication across the EU58. In contrast, bricks-and-mortar establishments that offer games of chance will have the possibility to obtain an identity card and carry out a face-to-face recognition at the gambling venue. Today, on-line gambling service providers' customer identification is based on: Previous identifications carried out by payment service providers, as most of the payment options require that the customer has a bank account; Own controls in view of information and documents requested from the potential customer; and Controls by verification service providers subject to compliance with obligations laid down by EU data protection law.

Mystery shopping exercises of licensed operators suggest that there are very few weaknesses that could allow for under aged persons to gamble and withdraw winnings59. Age verification takes place before the new customer can start playing. It has been suggested that additional pay-out age verification could work as a further deterrent to minors and adolescents seeking to register.

58 59

See also A Digital Agenda for Europe - COM(2010) 245, 19.5.2010. The UK Gambling Commission conducts a rolling programme of mystery shopping on gambling websites as part of its compliance activity, see www.gamblingcommission.gov.uk/.

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Question: (14) What are the existing national rules and practices relating to customer verification, their application to on-line gambling services and their consistency with data protection rules? How do you assess them? Are there specific problems associated with customer verification in a cross-border context? Public interest objectives

2.3.

The Commission fully respects the principle of subsidiarity and recognises that Member States have a margin of discretion to protect valid public interest objectives in accordance with the Treaty. This section focuses on the following three public interest objectives which, to various degrees, may be valid for Member States in terms of their national on-line gambling policies: Consumer protection (2.3.1); Public order (2.3.2) and financing of what they define as public interest activities (2.3.3). 2.3.1. Consumer protection

The evidence available to the Commission at this stage seems to indicate that a majority of players do not suffer from problem gambling. However, those that do must be fully accounted for given the associated social costs for the player, his or her family and society as a whole. All gamblers need protection against fraudulent services. For this reason regulators seek to ensure that all games offered are controlled, fair (i.e. that random number generators are in conformity with technical standards and in line with the rules for each game) and free from crime. Transparency is key. Problem gambling The need to protect players and to prevent problem gambling is invoked when restricting the offer of on-line gambling services to consumers. Problem gambling is often described as an urge to gamble despite harmful negative consequences or a need to stop. To assess the extent of problem gambling in the population of a country, comprehensive surveys, so called 'prevalence' studies, are carried out. The two most widely used screening instruments to identify problem gamblers are DSM-IV60 and SOGS61. Depending on the responses to a list of questions, the player is defined as a problem gambler (SOGS), a potential pathological gambler (DSM-IV) or a probable pathological gambler (SOGS and DSM-IV), also referred to as a gambling addict (see below).

60

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Diagnostic and Statistical Manual of Mental Disorders, 4th ed. for pathological gambling, American Psychiatric Association, 1994. A publication of the 5th edition of Diagnostic and Statistical Manual of Mental Disorders (DSM-V) is foreseen for May 2013. The South Oaks Gambling Screen, Lesieur & Blume, 1987. Both tools (DSM and SOGS) also exist in versions adapted to adolescents: DSM-IV-J (juvenile), DSM-IV-MR-J (multiple response-juvenile) and SOGS-RA (revised for adolescents).

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The Commission is aware of nationwide prevalence studies for problem gambling in eight Member States62 and seven more63 have carried out some studies of limited scope (either regional or on specific age categories, mostly adolescents). The level of problem gambling in the eight Member States that have carried out nationwide prevalence studies varies from 0.5% of the entire population in the UK to 6.5% in Estonia64. As regards the prevalence of problem gambling in the field of on-line gambling in the EU, only four Member States65 provide nationwide statistics, three others66 provide some partial information (surveys of limited scope, carried out on a certain age group or concerning only a certain type of on-line games). These studies suggest that the main factors that influence problem gambling are the following: (1) (2) (3) (4) Event frequency. The briefer the time between the game taking place and the opportunity to place a stake the greater the risk. Payout interval. The time between placing of the stake and the result. The shorter this is the greater the risk. Accessibility and social environment. Chasing losses or being close to winning, The greater the pay-out and probability of winning, the greater the delusion that lost stakes can be won back and therefore the increased risk (this is also linked to "excitement" or "dream effect"). Perceived skills and involvement. The possibility of getting involved in the event being gambled on and of using ones own skills to assess the chances of winning provide evidence of the near-miss psychology. This strengthens the feeling that one is in control of the game, thus increasing the risk. This includes variation of the stake. Note that this effect may be enhanced when some element of skill rather than purely chance is perceived to be a characteristic of the game. Commercial communications that could trigger vulnerable groups.

(5)

(6)

In this respect different types of games or different kinds of bets might pose different risks to players. For example, fast pay out slot machines, scratch cards and casino games are often considered to be the most problematic in this respect. Lottery games that are run on a weekly basis are considered less risky (although suffering from factor (4) mentioned above) than those run on shorter intervals (because of factors (1) and (2)). Sports betting and poker are considered to suffer more from the risk identified under point (5) above. "Live" sports betting suffers additionally from the risk set out under point (1). Question: (15) Do you have evidence that the factors listed above are linked to and/or central for the development of problem gambling or excessive use of on-line gambling services? (If possible, please rank them)

62 63 64 65 66

BE, DK, EE, FI, DE, NL, SE and UK. ES, HU, IT, LT, RO and SK. M. Griffiths, Problem gambling in Europe: An overview, Appex Communications, April 2009. BE, EE, NL and UK. FI, DE and MT.

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To date across the Member States the instruments that have been used to try to limit excessive problem gambling in on-line services are those applied to all gambling, viz., (1) (2) (3) (4) (5) (6) (7) (8) Age limits, Self-limitation (financial and time) and self-exclusion, Information/warnings/self tests (more easily applied on-line than off-line), Banning the use of credit, Reality checks, Diligence obligation for the on-line operator, Restricting certain forms of games or bets that are considered to be the most risky (e.g. casino games or in sports betting restricting bets to final results only), and Other (e.g. limits on commercial communication restrictions on the use of certain media, sales promotions and sign-up bonuses or free practice games).

Question: (16) Do you have evidence that the instruments listed above are central and/or efficient to prevent or limit problem gambling relating to on-line gambling services? (If possible, please rank them)

Gambling addiction Where such information is available, rates of probable gambling addiction appear to vary from 0.3% to 3.1% of the entire population67. Pathological (addictive) gambling has been considered by some specialists as an impulse control disorder68 and therefore not referred to as addiction. However, recent studies have discovered similarities between gambling and substance addiction69. As mentioned in section 3.1, gambling problem screening tools used in surveys allow for the identificationof individualsthat have severe problems with their gambling behaviour. There are contrary views as regards the addictive potential of on-line gambling. Although remote gambling fulfils the criteria of availability and accessibility, making frequent playing easier than in case of land-based gambling venues, it is difficult to draw direct links between remote gambling and the likelihood of becoming an addicted gambler. On-line gambling provides operators with more sophisticated possibilities to track the transactions of each player compared to off-line gambling formats. In contrast to prevalence studies, on-line gambling data allow for studies of the players real behaviour. A study of on-

67

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69

Data from 7 Member States, M. Griffiths, Problem gambling in Europe: An overview, Appex Communications, April 2009. Diagnostic and Statistical Manual of Mental Disorders, 4th Ed., American Psychiatric Association, 1994. Draft of the Diagnostic and Statistical Manual of Mental Disorders, 5th Ed., American Psychiatric Association, publication planned for 2013.

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line gaming behaviour carried out by the Division on Addiction, Cambridge Health Alliance, a teaching affiliate of Harvard Medical School70, based on a long term analysis of individual gaming activity of a random sample of nearly 50,000 on-line casino players from 80 countries and an almost equal sample of on-line sports betting participants showed that 99% of the customers of on-line sports betting did not display any unusual gaming behaviour compared to 95% in the case of on-line casino players71. The report prepared for the Swedish Presidency in 200972 mentions that although some research suggests the existence of a positive link between accessibility and gambling addiction, the available empirical data do not always confirm this. Where it has been possible to compare the results of prevalence studies carried out 7-10 years ago (when on-line gambling was less popular) with the results of studies carried out more recently, the gambling addiction prevalence rate remained steady73. Also the British Gambling Prevalence Survey carried out for the Gambling Commission in 2007 found that addiction rates for on-line gambling in the UK were lower than for some types of off-line games and that the addiction seemed to be more linked to the introduction of new and thus more "attractive" types of games, whether on-line or off-line74. The Commission notes that most on-line gambling websites established and licensed in the EU have hyperlinks to help-lines or organisations working with problem gamblers. However, even if 15 Member States have carried out national or regional prevalence studies there is little information available about the relevant policy response to these studies (e.g. launch of educational campaigns or additional recourses given to prevention or treatment) or to what extent problem gamblers have access to treatment75. Questions: (17) (18) Do you have evidence (e.g. studies, statistical data) on the scale of problem gambling at national or EU level? Are there recognised studies or evidence demonstrating that on-line gambling is likely to be more or less harmful than other forms of gambling for individuals susceptible to develop a pathological gaming pattern? Is there evidence to suggest which forms of on-line gambling (types of games) are most problematic in this respect?

(19)

70

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72

73 74

75

The study was carried out in a research partnership with bwin who made its customer database available. LaBrie, LaPlante, Nelson, Schaffer, Assessing the Playing Field: A prospective Longitudinal Study of Internet Sports Gambling behaviour (with Schumann,) Journal of Gambling Studies, 2008; Inside the virtual casino: A prospective longitudinal study of Internet casino gambling (with Kaplan), European Journal of Public Health, 2008 and Population trends in Internet sports gambling" (with Schumann),Computers in Human Behaviour, 2008. Svenska Spel, The cost of gambling. An analysis of the socio-economic costs resulting from problem gambling in Sweden. Council of the EU. DS 406/09. Brussels, 2009. For example: Finland and UK. Addiction rates among past year gamblers. British Gambling Prevalence Survey 2007, National Centre for Social Research, Sept 2007. Only 4 Member States (AT, EE, FI and UK) provided the Commission with information on problem gambling in the context of the Commissions study "Study on gambling services in the EU Internal Market", Chapter 9.9, p. 1453, cited above.

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(20) (21)

What is done at national level to prevent problem gambling? (E.g. to ensure early detection)? Is treatment for gambling addiction available at national level? If so, to what extent do on-line gambling operators contribute to the funding of such preventive actions and treatment? What is the required level of due diligence in national regulation in this field? (E.g. recording on-line players' behaviour to determine a probable pathological gambler?).

(22)

Protection of minors and other vulnerable groups The regulatory frameworks in all Member States seek in different ways to protect minors, i.e. children and adolescents, against the risks of gambling in general76. Age limits for gambling may be set out in law or in licence conditions and operators (including retailers/concession holders) are obliged to carry out age verification. The age limits in an individual Member State may also vary from one gambling service to another. Questions: (23) (24) Are the age limits for having access to on-line gambling services in your or any other Member State in your view adequate to attain the objective sought? Are on-line age controls imposed and how do these compare to off-line 'face-toface' identification?

Minors access to payment systems Payment processing systems can be an effective means to prevent access to on-line gambling services by minors. Though it is possible for persons under the age of 18 to open bank accounts, there are limitations. A wide range of documents and proofs of identity must be presented and, as a rule, a parent or a legal guardian must present him/herself in the bank together with the underage account holder (parental control). Young persons are not normally legally responsible for their debts so they are unlikely to be granted an overdraft on a bank account and credit card applications from people under the age of 18 will be turned down. As a consequence, the bank or the financial service provider will provide an extra level of age verification before a young player can open a player's account with an on-line operator. However, stakes can, and will increasingly, be paid by using a mobile phone (added to the invoice), e.g. by a text message or a call to premium rate phone number and in these cases it may be easier for minors to be able to gamble. Minors and marketing of on-line games

As Member States authorities (and operators) seek to prevent minors from having access to on-line gambling services, they also seek to control marketing and promotion of such services. Examples of restrictions include rules that require promotions for such services not to:

76

The age of majority in all Member States except Austria is 18 (Austria 19).

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Be directed at those aged below the national limit for participation; Be broadcast (TV or radio) or communicated during specific programmes aimed towards young people on mainstream channels, or for certain periods of time before or after such programmes; Include or display a person that appears to be of an age below the national limit for participation; Otherwise appeal to children or young persons, e.g. by being associated with youth culture or communicated by a celebrity (e.g. replica jerseys promoting an on-line gambling operator) ; or Be displayed close to areas that children frequent (e.g. billboard advertising close to schools).

Question: (25) How are commercial communications for gambling services regulated to protect minors at national or EU level? (E.g. limits on promotional games that are designed as on-line casino games, sports sponsorship, merchandising (e.g. replica jerseys, computer games etc) and use of social on-line networks or videosharing for marketing purposes. Other vulnerable types of players

Other players may be vulnerable due to their: Financial situation; players on low incomes; Inexperience; in particular young adults (aged 18-21) and/or those that are not awareof the risks associated with problem gambling; Previous dependency or addiction relating to a chemical substance use or behaviour (use of off-line gambling services); Easy access to gambling; sales agents or employees of gambling service providers or contractors; and Other frequent exposure to gambling and/or strong links to betting objects. This could include persons employed in the horse racing sector, athletes (amateurs and professionals), coaches, referees, stock-brokers etc.

Question: (26) Which national regulatory provisions on licence conditions and commercial communications for on-line gambling services account for these risks and seek to protect vulnerable consumers? How do you assess them?

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2.3.2.

Public order

Prevention of fraud All Member States seek to prevent fraud and unfair games. National legislation aims to protect, consumers (from fraudulent and criminal operators), operators (from fraudulent players or player syndicates) and event organisers. Examples include: unauthorised use of credit cards, which may also be associated with "identity theft" and 'match-fixing' (eventfixing) where an individual, a group of persons (typically associated with organised crime) seek to influence the outcome of an event (e.g. a sports event or a card game)77. Fraud also occurs when a group of players colludes against another player (e.g. rigged poker tables). The Commission has identified the following three types of fraud on which it wishes to consult: Players not receiving their winnings. Typical examples include fraudulent "lottery scams", where an unlicensed illegal operator contacts consumers asking them to pay an amount of money (handling fee) or give personal information (bank details) before a prize can be paid. Such scams frequently make false reference to authorisations given by European gambling authorities78. Identity theft and data protection related issues. These involve the unauthorised use of another persons personal information to assume that person's identity and thus access resources or obtain credit and other benefits in that person's name. Manipulation of the outcome by tampering with the software associated with the game or through corruption of persons involved in organising the game or event.

Questions: (27) (28) Are you aware of studies and/or statistical data relating to fraud and on-line gambling? Are there rules regarding the control, standardisation and certification of gambling equipment, random generators or other software in your Member State? What, in your opinion, are the best practices to prevent various types of fraud (by operators against players, players against operators and players against players) and to assist complaint procedures? As regards sports betting and outcome fixing - what national regulations are imposed on on-line gambling operators and persons involved in sport events/games to address these issues, in particular to prevent 'conflicts of

(29)

(30)

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E.g. criminal organisations based in China or Croatia have been involved in match fixing in BE, DE and FI. This should not be considered to be associated with delayed winnings where a licensed operator withholds winnings for due diligence purposes without giving the player sufficient information why this is done. The operator should in such cases explain why the payment is withheld. The most common explanation for such delays is additional customer identification controls.

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interest'? Are you aware of any available data or studies relating to the magnitude of this problem? (31) (32) In your view what issues should be addressed as a priority? What risks are there that a (on-line) sports betting operator, which has entered into a sponsorship agreement with a sports club or an association, will seek to influence the outcome of a sports event directly or indirectly for profitable gain?

Prevention of Money laundering The two extreme types of "money laundering" activity are on the one hand, complex transnational operations designed to hide the criminal origins of large scale crimes so that people and property are made to appear legitimate, and on the other, any activity that conceals, disguises, or disposes of the proceeds of any crime, no matter what the sum (selflaundering by offenders sometimes expenditure but also crimes to feed gambling addiction). As regards money laundering techniques, there is very limited information or evidence suggesting that licensed on-line gambling operators in Europe are subject to money laundering activities. However, the problem is obviously linked to illegal operators. The Commission understands that the following practices could potentially be used for such purposes: On-line gambling firms could credit winnings or unused funds back to an account other than the one from which the original bet was made. They could allow one player to register multiple accounts with the same operator. Peer-to-peer games such as e-poker, where value transfers can occur between both electronic and human players as a result of deliberate losses, at a relatively low cost to the players. Such games could allow for on-line chip dumping. For example; a player deposits funds with a stolen credit card and then "dumps" the chips at a table to an accomplice or another account he created. These activities can be detected given that the principles are simple players will make large bets on very bad hands (expecting to lose to the accomplice)79. Use of e-cash as a payment option or similar means of payments such as Stored Value Cards80 (those of concern are characterised by high limits, no post-purchase monitoring and poor know-your-customer (KYC) controls). This could also include payment enabled mobile phones that have not been through adequate KYC controls.

Questions: (33) What cases have demonstrated how on-line gambling could be used for money laundering purposes?

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On-line poker rooms are aware of this scam and are seeking to detect perpetrators before their cash-outs are approved. A stored-value card refers to monetary value on a card not in an externally recorded account and differs from prepaid cards where money is on deposit with the issuer similar to a debit card.

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(34)

Which micro-payments systems require specific regulatory control in view of their use for on-line gambling services?

The 3rd Money laundering Directive81 is applicable to the financial sector as well as to other areas including casinos (bricks-and-mortar and on-line). A particular problem with the enforcement of the provisions of this directive to on-line gambling services is that such websites frequently offer a variety of other (non-casino) gambling services and the operator may be licensed in more than one jurisdiction. In addition to such general principles, the Commission is aware that licensed on-line gambling operators and national regulators have established a range of operational practices to fight against money laundering. These include: Customer due diligence only registered players holding an account with the licensee are allowed to play. Application forms must be completed containing information (1) that the player is over the legal age limit to gamble (2) the players identity (3) the players place of residence and (4) the players valid e-mail address. The due diligence process may include velocity analysis (deposit/trades), geographic risk analysis, player behaviour anomaly, exposing player associations and cybercrime arrest policy. In all cases the player has to opt-in to provide the relevant personal data to allow for his account to be established. Payment controls - the player should always receive any payout from winnings (balance of account) by the same means in which the money was originally received (and to the account from which it was deposited). Operators must also make sure that they have control over the credit card numbers and personal data, relating to players, which they have stored in their systems. Moreover, direct payments between customers are prohibited. Operational controls Operators use age verification lists and lists used by banks to identify terrorists and politically exposed persons (PEPs), i.e. World Check82 and the European Sports Security Association's (ESSA83) watch list. Operators also keep statistical records of transactional behaviour, which must comply with EU data protection rules, in order to be able to identify suspicious activities. They are required to apply stricter due diligence requirements where there are high limits on stakes. Operators must also submit Suspicious Activity Reports (SAR) to the national Financial Intelligence Units (FIU).

Questions: (35) (36) Do you have experience and/or evidence of best practice to detect and prevent money laundering? Is there evidence to demonstrate that the risk of money laundering through online gambling is particularly high in the context of such operations set up on social web-sites?

81 82 83

Cited in Section 1.2. http://www.world-check.com/politically-exposed-person-pep-compliance/ http://www.eu-ssa.org/Home/tabid/36/Default.aspx

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Prevention of other crimes Other crimes that may be linked to on-line gambling include: Provision of gambling services offered by illegal operators (e.g. criminal organisations or individuals). A French report on Cyber crime and Gambling estimates that a thousand gambling websites are directly operated by criminal groups84, Non-authorised on-line games offered by a licensed operator, Tax evasion (where there is an obligation for the user to pay tax on winnings, i.e. tax evasion may primarily be invoked in relation to winnings from off-shore activities).

There are also a number of criminal activities that are relevant for many gambling services but not specifically for on-line gambling, such as (i) match fixing or rigged poker tables (see above), (ii) loan sharking activities and (iii) criminal activities carried out to finance the use of gambling services (e.g. theft) and (iv) the financing of terrorism. Question: (37) Are there national on-line gambling transparency requirements? Do they apply to cross border supply of on-line gambling services and are these rules enforced effectively in your view? Financing of benevolent and public interest activities as well as events on which online sports betting relies

2.3.3.

Restrictions on gambling services at national level are at times justified by policy reasons such as the financing of benevolent or public interest activities. Notwithstanding that the systems put in place for this purpose should comply with applicable state aid rules, it is noteworthy that according to the Court of Justice the funding of such social activities may not constitute the substantive justification for the restrictive policy but only an ancillary beneficial consequence85. Such restrictions seek to assist the funding of "public interest activities" that society at large can benefit from. More specifically, the public interest activities that currently benefit directly in this manner in the Member States are the arts, culture, sport86, youth/educational programmes and charity related activities. Systems of revenue channelling The reliance on gambling revenues to fund public interest activities is organised in various ways. The organisation or company responsible for the public interest activities:

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The French Institute (CERT-LEXI) analysed 70 million websites in 2005 and found 14823 sites offering online gambling. Only 2005 websites were subject to a licence. E.g. case C-67/98 (Zenatti) 36-37 and case C-316/07 (Markus Sto) 104. See also the Judgement of the EFTA Court in case 3/06 (Ladbrokes) 63. See also the Commission's Communication "Developing the European Dimension in Sport" COM(2011) 12, which notes the need to take account of the sustainable financing of sport when addressing the provision of gambling services in the Internal Market (page 9)

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(1)

Is granted a licence87 to offer on-line gambling service in order to support the good cause recognised by the relevant licensing authority (e.g. a national Olympic committee, a national horse racing body , an association for blind persons etc.); Receives funds directly from a State gambling operator (e.g. a national lottery) according to a rate fixed by the licence or legislation regulating that operator; Receives funds from a State gambling operator indirectly via the State budget into which that State operator has contributed; Receives funds from one or more private gambling operators and the contribution of funds is: (a) (b) Determined by the licence or legislation or Based on voluntary contributions from the operators;

(2) (3) (4)

(5)

Receives economic compensation for the use of an event it organises and on which bets are placed even if the organisation or company is not involved in the organisation of the gambling activity itself; Receives funds from the State budget that has been contributed to by both State and commercial gambling operators.

(6)

Questions: (38) (39) (40) Are there other gambling revenue channeling schemes for the public interest activities at national or EU level? Is there a specific mechanism, such as a fund, for redistributing revenue from public and commercial on-line gambling services to the benefit of society? Are funds returned or re-attributed to prevention and treatment of gambling addiction?

87

Organisations or companies responsible for benevolent or public-interest activities may, to varying degrees, be allowed to enter into agreement with private operators that provide the gambling platform and promote the gambling services (who fully or partly runs the operations and receives economic compensation for this).

EN

30

EN

The Commission wishes to focus further on two issues: Possible existence of a principle of return to event organisers National and non-domestic sport events are used by on-line operators to present an attractive selection of gambling services to their potential customers. These events may benefit from such gambling activities in that they create additional public interest and possibly also increase the event's media exposure. There is a broad consensus that sport events, on which gambling relies, should receive a fair return from the associated gambling activity: Taking the specific case of horse-racing some Member States impose an exclusive licence for horse race betting to an organisation or company with the objective to ensure that the turnover from horse-race betting, except for winnings, totalisator fee and operating expenses, is given to equestrian sports, horse breeding and horse husbandry. While national structures vary, the support to the horseracing and equine sector can be significant rising to more than 8% of the total betting turnover in certain countries. A specificity of horse racing compared to other sports is that its primary attraction is for gamblers. Thus, to a greater degree than other sport events, its viability will depend on sufficient proportions of gambling revenues being reinvested into the activity. Furthermore, in certain Member States the tradition of equestrian sports, horse breeding and husbandry, all of which are supported through this channelling of gambling revenues, have and continue to play an important economic role in rural areas and may therefore be linked to regional development and territorial cohesion policy objectives. Other sports have a more mixed revenue stream either because they have wider public appeal and/or because they lend themselves less to gambling services. Nevertheless, when gambling services are offered on an organised sport competition, the issue of whether the organisers (sport organisations, teams etc.) should be able to generate an additional revenue stream through such exploitation of their images or events by gambling service providers has been addressed by Member States. Given that without the use of their events the gambling services would not be viable, a fair return for the use of their events is sought. Certain State operators offering sports betting services on professional sports are thus obliged to channel revenues back into grassroots sports and thus help assist the public interest activities of encouraging participation in sporting activities in general. The Commission has launched an EU study on the funding of grassroots sports which should show the real importance of the different funding sources, including revenue from the organisation of gambling services, for grassroots sports88.

Finally, sport events on which sports betting can be organised may, due to criminal activities, be subject to a higher risk of match fixing. One Member State (France) has established a nonexclusive sports betting right for gambling services to contribute to the investment by organisers of sport competitions that is motivated primarily on the grounds of the need to ensure integrity. Questions:

88

COM(2011)12 p. 9

EN

31

EN

(41) (42) (43)

What are the proportions of on-line gambling revenues from sports betting that are redirected back into sports at national level? Do all sports disciplines benefit from on-line gambling exploitation rights in a similar manner to horse-racing and, if so, are those rights exploited? Do on-line gambling exploitation rights that are exclusively dedicated to ensuring integrity exist?

The risk of "free-riding" through the provision of on-line gambling services Member States, given their differing national cultural and historical traditions, will rely on differing gambling revenue channelling systems and rates. For example, Member States that have no history of horse-racing or horse husbandry obviously have no need for a revenue channelling scheme for that purpose. Likewise, certain Member States will choose to finance certain public interest activities exclusively from fiscal revenue whereas others may wish to also rely on channelling gambling revenues for the same purpose. It follows that when gambling services are offered on events taking place in other Member States or when gamblers from one Member State choose to place stakes on gambling services provided from another Member State there will be direct effects on the efficiency of national gambling revenue channelling systems. This will be particularly the case when gamblers are exclusively focussed on seeking highest returns. This "free-riding" problem is strictly speaking not limited to cross-border on-line gambling services since gamblers can in principle always physically cross borders to access gambling services but nevertheless on-line gambling services in practice differs as it heightens this possible effect significantly. The effect may be tempered or even reversed by the fact that certain gamblers play on particular gambling services because those services are linked to the financing of public interest activities. This may be because the link to the public interest activities reduces the social stigma associated with gambling or may even be the primary motivation for gambling on such services. For example, given the very low odds of winning in certain types of gambling services (e.g. low value lotteries offered by charitable organisations) it can be considered that many players of such games place a stake on them rather than on other types of gambling services offering higher odds of winning primarily because they consider that that stake will go to a valid public interest activities. These types of gamblers may even be attracted to offers of such on-line gambling services emanating from other Member States that have stronger direct links to public interest activities that they wish to support compared to national on-line gambling service offers. Questions: (44) Is there evidence to suggest that the cross-border "free-riding" risk noted above for on-line gambling services is reducing revenues to national public interest activities that depend on channelling of gambling revenues? Are there transparency obligations that allow for gamblers to be made aware of whether and how much gambling service providers are channelling revenues back into public interest activities?

(45)

EN

32

EN

2.4.

Enforcement and related matters

An unauthorised cross-border market may be accessible to consumers, due either to de facto tolerance or lack of effective enforcement. Effective enforcement is essential for Member States to ensure the achievement of the public interest objectives behind their national gambling policy. Gambling authorities in the Member States Different types of organisational structures are used for the granting of licences, regulation and supervision of on-line gambling. The independence and power of these structures vary. Within a Member State differing forms of on-line gambling services may also be regulated or supervised by separate bodies (e.g. promotional games, media games and spread betting)89. Activities of gambling authorities may cover a wide range of issues, including: Issuing, suspending and revoking licences; Control and supervision functions including administrative or financial controls, onsite inspections, technical inspections (e.g. equipment or software), and on-line monitoring of activities; Enforcement - to open, institute and prosecute proceedings involving offences relating to (a) provision of illegal/unauthorised gambling services; and (b) commercial communications relating to gambling services or operators (legal as well as illegal/unauthorised gambling services); Providing advice, information or support to Government, players (the public) and/or operators.

Questions: (46) Is there a regulatory body in your Member State, what is its status, what are its competences and its scope of action across the on-line gambling services as defined in this Green Paper? Is there a national register of licensed operators of gambling services? If so, is it publicly accessible? Who is responsible for keeping it up to date?

(47)

Administrative cooperation Administrative cooperation between EEA regulators is today based on ad-hoc cooperation between a limited number of Member States. Regulators from all over Europe have a specific forum in which they meet, exchange views and discuss policy on gaming matters (GREF90). Possible areas of administrative cooperation include sharing or exchanging information relating to:
89

90

The differing authorities at national level that carry out the regulatory tasks are as follows: (i) A ministry with no specialised office; (ii) A specialised office within a ministry; (iii) A ministerial office located outside the ministry; (iv) An agency/inspectorate under ministerial control; and (v) A State recognised independent regulatory body. http://www.gref.net/index.htm

EN

33

EN

licence holders (including licence conditions, professional qualities of staff and integrity of operators); unlicensed and fraudulent operators (common blacklisting); issues of a technical nature, such as national standards, testing and certification; good practices (including public campaigns to prevent crime or problem gambling and the costs and effects of such campaigns).

Question: (48) Which forms of cross-border administrative cooperation are you aware of in this domain and which specific issues are covered?

Enhanced cooperation with other stakeholders Gambling authorities in the Member States may also be working with national/European sport stakeholders and/or public/private betting operators to develop: Educational programmes or campaigns for athletes (amateurs and professionals), coaches, referees, persons employed in the horse racing sector or by public/private on-line gambling operators etc.; and/or Early warning systems to strengthen enforcement to prevent match-fixing.

Question: (49) Are you aware of such enhanced cooperation, educational programmes or early warning systems that are aimed at strengthening integrity in sport and/or increase awareness among other stakeholders?

Payment blocking and liability regimes for ISPs Payment and communication providers (telecom operators, television channels and information society providers) enable on-line gambling services. Today, in order to restrict "unauthorised" and cross-border on-line gambling services the following types of methods are imposed on such intermediary service providers: Domain Name System (DNS) filtering; A DNS filtering mechanism seeks to ensure that potential customers are prevented to gamble on unauthorised pre-listed sites or are redirected to another address (website) on the basis of a pre-defined list of internet addresses (domain names) e.g. from a .com site to one established within the relevant national jurisdiction91. Internet Protocol (IP) blocking. Every device connected to the public internet is assigned a unique number known as an IP address, which includes the hostname. IP blocking prevents the connection between a server/website and one or more IP addresses.

91

Italian experiences suggest that millions of redirections take place every week.

EN

34

EN

Payment blocking, may be based on the operators "Merchant Category Codes" (MCC)92. However, the prohibition of processing of payments linked to a certain code may block licit commercial transactions other than payments relating to stakes and prizes.

The efficiency of a blocking system depends on a pre-defined and updated list of items to block as well as efficient software systems. Questions: (50) Are any of the methods mentioned above, or any other technical means, applied at national level to limit access to on-line gambling services or to restrict payment services? Are you aware of any cross-border initiative(s) aimed at enforcing such methods? How do you assess their effectiveness in the field of online gambling? What are your views on the relative merits of the methods mentioned above as well as any other technical means to limit access to gambling services or payment services?

(51)

92

The MCC used for gambling is 7995.

EN

35

EN

Can Internet Gambling Be Effectively Regulated? Managing the Risks

Authored by

Malcolm K. Sparrow
John F. Kennedy School of Government Harvard University

With Contributions by
Coleman Bazelon, PhD Charles Jackson, PhD

December 2, 2009

TABLE OF CONTENTS

I.

OVERVIEW OF APPROACH AND SUMMARY OF RESULTS ................................... 1 A. Our Approach.......................................................................................................... 2 1. 2. 3. 4. B. C. D. Gambling by Minors ................................................................................... 3 Criminal and Fraudulent Behavior.............................................................. 3 Network Access, Data Privacy and Security Issues.................................... 3 Problem Gambling ...................................................................................... 4

The Status Quo Offers No Effective Protection ..................................................... 4 Legalization and Regulation Would Afford Significantly Better Protection than the Status Quo ................................................................................ 6 Regulatory Methods and Technologies for Controlling Each Type of Risk Already Exist .............................................................................................. 7 1. 2. 3. 4. Gambling by Minors ................................................................................... 9 Criminal and Fraudulent Behavior.............................................................. 9 Network Access, Data Privacy and Security Issues.................................. 11 Problem Gambling .................................................................................... 12

E. II.

Conclusions ........................................................................................................... 15

REGULATORY METHODS AND TECHNOLOGIES AVAILABLE FOR CONTROLLING EACH RISK ............................................................................... 16 A. Gambling by Minors ............................................................................................. 16 1. 2. 3. 4. B. 1. 2. 3. 4. C. 1. 2. 3. 4. D. 1. The Issue of Gambling by Minors ............................................................ 16 Existing Controls in Other Jurisdictions ................................................... 17 Relevant Technologies for Risk Mitigation .............................................. 20 Conclusion ................................................................................................ 23 The Issue of Fraud by Site Operators ....................................................... 24 Existing Controls in Other Jurisdictions ................................................... 26 Relevant Technologies for Risk Mitigation .............................................. 28 Conclusion ................................................................................................ 29 The Issue of Players Being Defrauded by Other Players .......................... 29 Existing Controls in Other Jurisdictions ................................................... 31 Relevant Technologies for Risk Mitigation .............................................. 32 Conclusion ................................................................................................ 33 The Issue of Involvement of Organized Crime in Online Gambling................................................................................................... 33

Defrauding of Consumers by Site Operators ........................................................ 24

Cheating or Defrauding of Players by Other Players............................................ 29

Involvement of Organized Crime in Gambling Operations .................................. 33

2. 3. 4. E. 1. 2. 3. 4. F. 1. 2. 3. 4. G. 1. 2. 3. 4. H. 1. 2. 3. 4. I. 1. 2. 3. 4. J. III. 1. A. B.

Existing Controls in Other Jurisdictions ................................................... 34 Relevant Technologies for Risk Mitigation .............................................. 36 Conclusion ................................................................................................ 36 The Issue of Money Laundering by Players ............................................. 37 Existing Controls in Other Jurisdictions ................................................... 39 Relevant Technologies for Risk Mitigation .............................................. 40 Conclusion ................................................................................................ 42 The Issue of Money Laundering by Site Operators .................................. 43 Existing Controls in Other Jurisdictions ................................................... 44 Relevant Technologies for Risk Mitigation .............................................. 44 Conclusion ................................................................................................ 45 The Issue of Violation of Jurisdictional Restrictions ................................ 45 Regulatory Strategy .................................................................................. 46 Relevant Technologies for Risk Mitigation .............................................. 47 Conclusion ................................................................................................ 49 The Issue of Data Confidentiality ............................................................. 50 Existing Controls in Other Jurisdictions ................................................... 51 Relevant Technologies for Risk Mitigation .............................................. 52 Conclusion ................................................................................................ 53 The Issue of Communications and Computer Security Failures ...................................................................................................... 53 Existing Controls in Other Jurisdictions ................................................... 55 Relevant Technologies for Risk Mitigation .............................................. 56 Conclusion ................................................................................................ 58 Problem Gambling .................................................................................... 59

Money Laundering by Players .............................................................................. 37

Money Laundering by Site Operators ................................................................... 43

Violation of Jurisdictional Restrictions or Prohibitions........................................ 45

Breaches of Data Confidentiality .......................................................................... 50

Communications and Computer Security Failures ............................................... 53

Problem Gambling ................................................................................................ 59

SPECIAL ATTENTION TO PROBLEM GAMBLING .................................................. 60 Introduction ........................................................................................................... 60 What is Problem Gambling? ................................................................................. 60 1. 2. C. Terminology.............................................................................................. 60 Prevalence Rates and Trends .................................................................... 61

Potential Effects of Legalization of Online Gambling on Problem Gambling............................................................................................................... 62 1. Potential Adverse Effects of Legalization ................................................ 63 ii

2. D.

Potential Benefits of Legalization............................................................. 69

Concluding Remarks ............................................................................................. 72

iii

Acknowledgements The authors would like to thank Dorothy Robyn, PhD, who contributed to this project while at The Brattle Group. The authors would also like to thank Pallavi Seth, PhD, and Michael Sutcliffe of The Brattle Group for their assistance.

iv

EXECUTIVE SUMMARY
This study was commissioned by Wired Safety, an Internet Safety and Educational charity. It examines a range of harms potentially associated with online gambling, and alternative methods for mitigating or minimizing them. Recognizing that the current U.S. prohibitionist regime with respect to online gambling is largely ineffective in achieving its aims, and provides no platform or opportunity for the implementation of most of the relevant harm-reduction strategies, we find that an alternative regime of legalization and regulation of online gambling would likely improve consumer welfare and protections. The body of this report evaluates a range of strategies, both regulatory and technological, that could be used to mitigate potential harms associated with online gambling more effectively. Notwithstanding the current prohibitionist legal and regulatory approach, millions of U.S. residents gamble online through offshore gambling sites. As a result, the United States finds itself in the unfortunate position of incurring all the social costs of online gambling while having no control over the gaming sites that serve U.S. residents. The United States cannot disqualify industry participants from competing effectively for U.S.-based customers or offer its residents any consumer protections. Nearly all states permit some form of commercial gambling, and the industry is large and well-established. Clearly, policymakers have extensive precedent from which to draw strategies to mitigate the potential social harms of gambling. Although some controls used in bricks-and-mortar casinos may not translate well to online gambling, several of the risks we examined become more amenable to control online. New technologies can be effective, even for those risks that are more difficult to address online. For example, geolocation and age verification technologies can help turn potentially significant risks into manageable ones. In this study, we analyze 10 specific risks that others have suggested are potentially associated with online gambling: gambling by minors, fraud by operators, fraud by players, organized crime, money laundering by players, money laundering by operators, violation of jurisdictional prohibitions, breaches of data confidentiality, lack of site security, and problem gambling. It is important that regulators treat each of these potential risks differently. For some risks (such as players cheating other players), the public interest and the interests of the gaming industry align, making a cooperative regulatory relationship natural. For others (such as those involving potentially criminal conduct by operators), a strict enforcement regime would be more appropriate. Still other potential risks (such as underage and problem gambling) call for a more nuanced regulatory approach involving a mixture of strict enforcement, effective nonprofit support, community education, and cooperation, in keeping with the more complex motivations and incentives facing site operators. For each of the 10 risks, we examined a set of regulatory methods and technologies that would provide a reasonable degree of risk management in a regulated environment. Most of these methods have already been implemented in some form in other jurisdictions. The United Kingdom, Alderney, Gibraltar, and others have successfully implemented v

regulation, and nearly all of the well-regulated jurisdictions we studied address the 10 risks to some degree. The establishment of a well-regulated industry under U.S. jurisdiction would offer far better protection against online gamblings potential social harms than outright prohibition. Combining a thoughtful regulatory scheme with education, technology tools, and support appears to be the most effective means of handling the realities and risks of online gambling in the United States. Therefore, we recommend that plans for regulating online gambling include the design and use of different risk-management strategies tailored to the different classes of risk that are associated with Internet gambling. In the end, consumers in the United States would be better protected than they are now.

vi

I.

OVERVIEW OF APPROACH AND SUMMARY OF RESULTS

Congress is debating legislation that would remove the existing prohibition on the use of the Internet for most types of gambling.1 The proposed legalization of online gambling would be conditioned on the imposition of regulation designed to limit or prevent potential harms such as underage gambling, money laundering, and problem gambling. A key issue in the debate over legalization of online gambling is whether regulation and technology could effectively control such potential harms. Some of the opposition to legalization reflects a perception that online gamblingin contrast to gambling in bricks-andmortar casinoswould be difficult, if not impossible, to regulate effectively. This study reviews the research literature and international approaches to online gambling. WiredSafety (the Internet safety and educational charity) has commissioned this study to help inform the legalization debate and to help educate the public on the risks associated with online gambling and the best ways to address those risks. 2 We note that our expertise is in regulatory policy and its relationship to risk analysis, rather than in any extensive prior knowledge of the gaming industry and gambling behavior per se. We have critically reviewed the existing literature, evaluated relevant technologies, and interviewed a range of scholars and practitioner experts, both here and abroad. We have not, however, conducted any new epidemiological studies or field research. Our distinctive contribution is the frame for risk management and regulatory analysis, rather than any new scientific inquiry. Our analysis does not directly address whether online gambling should be legalized. In focusing on managing risks, we did not weigh moral or religious objections to gambling, nor did we examine broadly libertarian arguments in favor of allowing adults to engage in pastimes they may enjoy. We did not conduct any analysis to quantify the benefits of potential tax revenues attributable to regulated online gambling. Further, we have not focused on any issues of federalism or on exactly where regulations and laws should fit into the U.S. multijurisdictional
1

Internet Gambling Regulation, Consumer Protection, and Enforcement Act, H.R. 2267, 111th Cong. (2009), http://www.house.gov/apps/list/press/financialsvcs_dem/21frank_008_xml.pdf (last accessed on July 23, 2009), and Internet Gambling Regulation and Tax Enforcement Act of 2009, H.R. 2268, 111th Cong. (2009), http://frwebgate.access.gpo.gov/cgibin/getdoc.cgi?dbname=111_cong_bills&docid=f:h2268ih.txt.pdf (last accessed on August 28, 2009). This study was commissioned by WiredSafety.org, a 501(c) (3) charity and the largest and oldest online safety, education, and help group in the world. Originating in 1995 as a group of volunteers rating websites, it now provides one-to-one help, extensive information, and education to cyberspace users of all ages on a myriad of Internet and interactive technology safety issues. WiredSafety works in four major areas: help for online victims of cybercrime and harassment; assisting law enforcement worldwide on preventing and investigating cybercrimes; education; and providing information on all aspects of online safety, privacy and security. WiredSafety also has a longstanding interest in gambling policy and the prevention of underage gambling. The study was sponsored by Harrah's Operating Company, Inc and the Poker Player Alliance, who share many of WiredSafetys concerns. While the sponsors have provided valuable input into the framing of the research, the final decisions regarding the research approach and the final written product was solely made by the authors of the study, following consultation with WiredSafety, ensuring that the study was independent.

governance structure. Instead, we concentrated more narrowly on the obligations of government to protect citizens in general, and vulnerable groups of citizens in particular, from unnecessary exposure to harm. We sought (1) to identify the specific risks that are associated with, or perceived to be associated with, Internet gambling; (2) to determine suitable regulatory strategies for controlling or managing those risks; and (3) to assess how effective those strategies are likely to be. We identified 10 distinct risks that fall into four broad categories. Those categories are as follows: Gambling by minors Criminal and fraudulent behavior Network access, data privacy and security Problem gambling

On the basis of our review of the existing literature and interviews with academics, regulators, industry participants, and public interest advocates, we came to the following conclusions: Online gambling could be regulated effectively if it were legalized. A well-structured regulatory regime should provide much better social and consumer protections than the status quo for the risks we identified. At a minimum, even an imperfect legalization and regulatory regime for online gambling would give Americans much more protection than they have now. The current prohibitionist policy is extremely weak: large numbers of U.S. residents already gamble online, but they do so using offshore sites, many of which are poorly regulated or unregulated.

For each of the 10 risks we examined, a set of regulatory methods and technologies exist that would provide a reasonable degree of control, and most of them have been implemented effectively in other jurisdictions or in other online settings. Although some controls used in the bricks-and-mortar environment may not translate to online gambling environments, several of the risks we examined become more amenable to control online. Comprehensive electronic records and the ability to track financial transactions and betting patterns provide more opportunities for analysis and audit, and hence improve the chances of discovering fraud or criminal activity. They also allow gambling websites to provide tools to mitigate problem gambling in a timely manner. A. Our Approach

Our approach has been to identify the specific risks that are perceived to be associated with Internet gambling and then to determine how best to control or manage them. Those risks are described below.

1.

Gambling by Minors a. Gambling by minors: There is concern that minors might find it easier to access and use online gambling services in a legalized environment.

2.

Criminal and Fraudulent Behavior a. Defrauding of consumers by site operators: There is the possibility that online site operators may be more likely than their bricks-and-mortar counterparts to rig games, refuse to pay out winnings, or simply vanish, taking with them players account balances. Cheating or defrauding of players by other players: There is a concern that players could collude to defraud others, particularly in online poker. Online gambling may offer opportunities for collusion that are not available in a physical environment with visual surveillance. Involvement of organized crime in gambling operations: Organized crime has a history of involvement with the bricks-andmortar casinos and is now involved in some online commerce. There is some concern that involvement in the online gambling industry may be a natural next step. Money laundering by players: There is concern that players or groups of players acting in concert could use legitimate gambling operations for money laundering. Money laundering by site operators: The possibility has been raised that site operators could use online gambling operations, with its significant financial flows, as a cover for money laundering on a large scale.

b.

c.

d.

e.

3.

Network Access, Data Privacy and Security Issues a. Violation of jurisdictional restrictions or prohibitions: Government at the state, local, and tribal levels has traditionally exercised control over gambling within a given jurisdiction. The advent of the Internet has opened the question as to whether controls mandated by any proposed laws can be enforced within particular jurisdictions. Breaches of data confidentiality: To register for play, players surrender personal or financial data to site operators. Consumers might be harmed by deliberate or accidental breaches of the confidentiality of those data. 3

b.

c.

Communications and computer security failures: Some are concerned that site operators might not use appropriate security practices, procedures, and technologies to ensure the integrity of their sites, the gaming on those sites, and player interactions. Absent proper security measures, malicious code could be transmitted to players, game operations could be infiltrated, and intrusions into the systems could compromise the game play and security of users.

4.

Problem Gambling a. Problem gambling behaviors: Some argue that increased opportunity to gamble at any time, from anywhere, and at a faster pace might exacerbate pathological, addictive, or problem gambling behaviors.

With respect to each of these four categories of risks, we sought to answer three broad questions: (1) (2) In the existing prohibitionist legal and regulatory regime, what level of protection are U.S. consumers afforded? With legalization, could these risks be addressed more effectively than they are now, and assuming legalization, what regulatory strategy is best suited for addressing these risks? What are the potentially relevant technologies and methods available for effective risk mitigation, and how might other parties contribute toward effective control?

(3)

Our answer to the threshold question of whether online gambling can be effectively regulated came out of our analysis of these more specific questions. B. The Status Quo Offers No Effective Protection

Many U.S. residents already use online gambling services despite statutory restrictions. Recent estimates indicate that U.S. gamblers constitute roughly one-fourth to one-third of the global market for online gambling services.3 The size of the U.S. share of that global market was estimated to be $5.9 billion in 2008.4

G. Srinivasan, EU Slams US on Its Remote Gambling, Betting Laws, Business Line, June 14, 2009, http://www.thehindubusinessline.com/2009/06/14/stories/2009061450870400.htm (last accessed on September 10, 2009). Also noted in an August 4, 2009 interview with Simon Holliday, Director of H2 Gambling Capital (U.K.). Also see Simon Holliday et al., Internet Gambling Market Overview: AGA Internet Gaming Task Force, H2 Gambling Capital, December 2, 2008, p. 8. From H2 Gambling Capital, cited in American Gaming Association, Internet Gambling, AGA Fact Sheet,

(continued...) 4

The mainstay of the current prohibitionist regulatory structure is the Unlawful Internet Gambling Enforcement Act (UIGEA). Instead of criminalizing gambling itself, the UIGEA was intended to prevent U.S. residents from gambling by placing restrictions on the role of financial institutions in transmitting payments to and from gaming operators. However, because workarounds such as e-wallets (essentially a payment processor situated between banks and gambling sites), phone-based deposits, and prepaid credit cards have proliferated, very few U.S.based gamblers are presently much inconvenienced.5 Most gamblers are either unaware of or confused by the patchwork of federal and state restrictions, and many are readily guided by unregulated online gambling sites toward financial mechanisms that they can use to make deposits and withdrawals.6 The net effect is that the U.S. attempt to prohibit online gambling has instead pushed it offshore. Sites are readily available to U.S. residents through the essentially borderless medium of the Internet. Some sites are well-regulated, such as those based in the United Kingdom, Alderney, and Gibraltar, and others are less-well-regulated or unregulated, such as those in Antigua, Grenada, or the Kahnawake Mohawk territory. (Of course, it is the less-well-regulated international sites that provide easier access to U.S. consumers.) As a result of the global gaming industrys adaptations to the U.S. strategy, the United States finds itself in the unfortunate position of incurring all the social costs related to U.S. residents online gambling; exercising no jurisdiction or control over the gaming sites that serve U.S. residents; being unable to offer U.S. residents who choose to gamble on overseas sites any consumer protections or to implement any other harm-reducing strategies; and being unable to qualify industry participants or even exclude criminal groups from competing for U.S.-based customers.

In an effort to address this reality and enforce current restrictions more aggressively, federal officials recently instructed four banks to freeze accounts belonging to online payment processors. The frozen accounts apparently contained funds owed to some 27,000 people who used offshore poker websites.7 Such financially based efforts seem to have had only a temporary
http://www.americangaming.org/Industry/factsheets/issues_detail.cfv?id=17 (last accessed on August 27, 2009).
5

USAplayers.com, USA Poker Deposit Methods, http://www.usaplayers.com/poker/deposit-methods/index.html (last accessed on August 8, 2009), and USAplayers.com, Online Poker Deposits and the UIGEA, http://www.usaplayers.com/deposit-methods/articles/poker/online-poker-deposits-and-the-uigea.html (last accessed on August 8, 2009). Bo Bernhard et al., Internet Gambling in Nevada, University of Nevada, Las Vegas, April 2007, at p. 26. Also see, Gilbert M. Gaul, Players Gamble on Honesty, Security of Internet Betting, The Washington Post, November 30, 2008, p. A12. Tamara Audi, U.S. Deals Blow to Online-Poker Players, The Wall Street Journal, June 10, 2009, http://online.wsj.com/article/SB124459561862800591.html (last accessed on August 3, 2009).

chilling effect.8 Over the long run, it is probably not feasible for the federal government to prevent U.S. residents from accessing foreign sites via the Internet. Unlike China or Iran, for example, the United States has displayed no appetite for centralized control of the Internet to block citizens access to undesirable sites. Nor would criminalization of the gambling itself be an effective strategy. 9 First, it would likely generate a massive pool of lawbreakers, almost none of whom would make attractive targets for criminal prosecutionbecause it would likely be a waste of law enforcement resources to pursue individual online gamblers. Second, it would exacerbate the dangers of consumer fraud at online gambling sites by making aggrieved consumers more reluctant to report their experiences. C. Legalization and Regulation Would Afford Significantly Better Protection than the Status Quo

At a minimum, legalization and regulation of online gambling would give Americans much more protection than does the current prohibitionist regulatory framework. Although the kind of regulation that would accompany legalization would not be failsafe, it would be a significant improvement over the current regulatory and enforcement structure. We believe that safeguards could be implemented that would, on balance, substantially improve protections against the identified risks. These safeguards would also provide protection equal to or greater than that provided within the U.S.-based bricks-and-mortar gambling industry. We recognize that no set of technical or regulatory controls could ever eliminate these risks entirely. But even if the new fence had a few holes, it would be an improvement over having no fence at all. The view that online gambling, in contrast to its bricks-and-mortar casino counterpart, is impossible to regulate reflects an old-fashioned perception of cyber jurisdictional authority. Many offshore commercial entities that operate online are subject to U.S. legal jurisdiction under existing long-arm statutes and authority. When coupled with governmental licensing authority, the ability to police online activities is even more powerful. Legalization with regulation would provide U.S. authorities with the power to grant or deny licenses and to impose significant sanctions on noncompliant licensees. Those licenses would be highly valuable to site operators. Compliance with any regulatory requirements and strict licensing conditions that Congress chooses to impose in return for the privilege of the license would therefore become a cost of doing business.

Noted in an August 4, 2009 interview with Simon Holliday, Director of H2 Gambling Capital (U.K.). Ryan S. Landes, Layovers and Cargo Ships: The Prohibition of Internet Gambling and a Proposed System of Regulation, New York University Law Review, 82 (May 2007): 913943, at p. 927936. Also see Gerd Alexander, The U.S. on Tilt: Why the Unlawful Internet Gambling Enforcement Act Is a Bad Bet, Duke Law & Technology Review, No. 5 (2008), at 44. Also see Roger Clarke and Gillian Dempsey, The Feasibility of Regulating Gambling on the Internet, Managerial and Decision Economics, 22 (2001): 125132, at p. 130. Also see Testimony of John Lyons, in U.S. House of Representatives, Committee on the Judiciary, Establishing Consistent Enforcement Policies in the Context of Online Wagers, 110th Cong., 1st Session, November 14, 2007, p. 107.

Just as with bricks-and-mortar casinos, the requirement for site operators to maintain a license gives the government the ability to exclude bad actors as well as impose a broad array of conditions for, and oversight of, licensees. In contrast, the current prohibitionist policy is extremely ineffective: large numbers of U.S. residents already gamble online, but they do so using offshore sites, many of which are poorly regulated.10 With legalization, we would expect that most online gamblers would prefer licensed U.S.-based sites because of their integrity and security, rather than accept the risks posed by unregulated or poorly regulated sites. A wellstructured regulatory regime would provide better protections against all of the risks we identified. This conclusion is supported by the experience of other jurisdictions in regulating online gambling. Some of these, such as the United Kingdom and Alderney, have adopted regulatory regimes that appear to provide protection against the identified risks. That may be the most compelling evidence that online gambling can be effectively regulated. D. Regulatory Methods and Technologies for Controlling Each Type of Risk Already Exist

For each of the 10 risks we examined, a set of regulatory methods and technologies already exists that would provide a reasonable degree of risk management. Moreover, most of them have been implemented in other countries. One general insight from regulatory policy, and a review of other countrys experiences, is that no one size fits all: regulators should treat different risks differently. The incentives and motivations of different parties vary across risk categories, as does the locus for detection and control interventions. Understanding the natural incentives of the gaming industry with respect to each class of risk reveals whether a cooperative regulatory strategy would likely be more effective than a traditional enforcement-centric one. For example, for at least one of the risks we identified (protecting the integrity of poker games by preventing players from colluding or conspiring to cheat other players), the interests of the public and of the gaming industry align reasonably closely. Both groups are interested in ensuring the integrity of the games. That makes a more cooperative and less adversarial regulatory relationship quite natural. For other risks (such as defrauding of consumers by site operators, involvement of organized crime, and money laundering by site operators), a strict enforcement regime focused on identification and rapid exclusion of bad actors is more obviously appropriate. Oversight in these areas would focus heavily on up-front qualification or suitability to exclude those with criminal histories or connections and persons otherwise lacking in good character, honesty, and integrity as is the case in the bricks-and-mortar space. Enforcement activity would focus on bad actors, with the goal of exclusion and sanction. The intense and strict monitoring regime for reputable sites would include provisions designed to prevent or reveal any infiltration over time

10

G. Srinivasan, EU Slams US on Its Remote Gambling, Betting Laws, Business Line, June 14, 2009, http://www.thehindubusinessline.com/2009/06/14/stories/2009061450870400.htm (last accessed on June 30, 2009). Also see Supra at footnote 7.

by undesirable groups or influences. Such regulations would mirror those now in place for bricks-and-mortar casinos. Reputable sites, whose competitive advantage lies substantially with their reputation for integrity, would not be much troubled by the type of oversight designed to keep the good character, honesty, and integrity bar for admission high and the bad players out. In fact, they should appreciate such oversight as a positive contribution to the overall public perception of their industry, and the regulatory certainty provided by a licensing model would help with the industrys overall long-term planning.11 Some risks (gambling by minors, money laundering by players, problem gambling, breaches of data confidentiality, and lack of site and technology security) present more complex challenges in terms of regulatory design. If site operators were driven solely by their short-run economic incentives, they would more likely take bets from minors, problem gamblers, and money launderers (because the sites gain financially, at least in the short run, from all such bets), and they might limit their investments in data privacy and security. Site operators might also gain, in the short run, from abusing or selling personal and financial data provided to them by gamblers. In the longer term, of course, site operators value their brand names and reputations matter, and these five risks all figure as reputational risks from the industrys perspective just as they do in the bricks-and-mortar gambling industry. By setting the admission bar for licensees suitably high, U.S. regulators would intend to admit only reputable operators, whose behaviors would be guided by the value they place on establishing and maintaining a trusted brand. This is the approach taken by regulators in other jurisdictionslicense only reputable firms. Probity investigations are conducted into the companies and their associates before a license is issued. 12 Hence, for these five risks, close supervision would be required if an operator were regarded as a rational but short-sighted actor. At the same time, a more cooperative and symbiotic regulatory relationship ought to emerge when reputable operators take a longer-term, strategic view. To better align site operators short- and long-term interests, regulation also would provide for sanctions, from monetary fines up to and including loss of license for those site operators that choose to disregard mandated operational and consumer protections. One strategy to provide longer-term, reputation-based incentives for good behavior is to create costs to entrythrough the regulatory process, licensing fees, or other meansthat reduce
11

Noted in an August 13, 2009 correspondence with Katharina Riedl of bwin (Austria). Noted in an interview with Phill Brear, Head of Gambling Regulation at the Gibraltar Regulatory Authority and an interview with Glenn Gibson, Manager of Technical and Systems Audit at the Tasmanian Gaming Commission, and Damien Jarvis, Assistant Director of the Liquor and Gaming Branch of the Tasmania Department of Treasury and Finance (Australia). Also, as noted in an August 31, 2009 correspondence with John Sealy, Manager of Information Systems and Technology Services at the Licensing, Regulation and Alcohol Strategy Division of the Northern Territory Department of Justice (Australia), licensees often wish to be seen as responsible and as good corporate citizens. Also see Testimony of Andr Wilsenach and Testimony of Mary Williams, in U.S. House of Representatives, Committee on Financial Services, Can Internet Gambling Be Effectively Regulated to Protect Consumers and the Payments System? 110th Cong., 1st Session, June 8, 2007, p. 122 and 140.

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incentives to make a quick profit and leave the industry. For all risks created by operator shortsightedness, regulators need to establish and retain sufficient audit and monitoring systems so they can see when organizations that are otherwise reputable tilt too heavily toward short-term gain at the expense of public protection. Regulators should not accept the industrys protestations that they can be entirely trusted to take care of such risks without oversight simply because it is in their interest to do so. It is indeed in the industrys long-term interests to do so, but short-term considerations sometimes prevail, even in major corporations and multibillion dollar industries. The following sections of this study describe a variety of control technologies and regulatory tactics relevant to each risk, and identify the most promising approaches in each case. Table 1, in Appendix A, lists the 10 risks and for each outlines the level of protection afforded under the current regime (column 2); the overall structure and style of regulatory oversight most natural for each risk (column 3), and some key points regarding relevant technologies and control strategies (column 4).

Below we summarize key points in relation to each risk. 1. Gambling by Minors

There is a general concern that underage gamblers may access or attempt to access online gambling sites. Gambling by minors: A number of technologies routinely used in other industries can be used to exclude minors from online gambling, including a variety of datamatching techniques, electronic or other submission of documentary evidence of age, and possibly application of biometric identification systems. The strongest form of control would require positive matching of a player at the time of registration against existing databases of known adults, thus excluding minors, as well as identity-verification prior to initiating any session of play. U.S.-licensed operators would be expected to use filters and procedures that are as discriminating as reasonably possible. With respect to U.S. residents, we would expect available data needed for age-verification to be of high quality and reliability. Site operators could also be required to provide child-protective software to parents to help prevent minors from accessing gambling sites. Alternatively, a separate governmental or nonprofit entity could provide such software. 2. Criminal and Fraudulent Behavior

Criminal activity can stem from site operators or the players themselves. The following risks are related to criminal activity by site operators:

Defrauding of consumers by site operators, Involvement of organized crime in gambling operations, and Money laundering by site operators.

These risks would be effectively limited by a regulatory strategy designed to keep the bar for admission high and to keep criminals out. Such controls have worked well in bricks-and-mortar casinos and would operate similarly with U.S.-licensed online site operators. Relevant tactics include rigorous vetting procedures for new applicants and monitoring of licensed site operator behavior to prevent or detect regulatory noncompliance, criminal conduct, fraudulent and deceptive practices, and disregard for consumers rights. Regulatory strategy with respect to these risks would be enforcement-centric with a focus on excluding operators with criminal histories or connections. Reputable site operators with brands to protect could not afford to risk damage to their reputations, loss of their licenses, or regulatory sanctions. Thus, we would expect the industry at large to support the type of demanding admission standards, regulatory monitoring, and sanctions designed to keep bad actors out of the business. Players, best positioned to detect improper conduct or consumer fraud by site operators, would be enabled and encouraged to report site operators improper conduct directly to regulators and others in law enforcement. Players would also have access to U.S. courts for dispute resolution. Player criminal behavior falls into two major categoriescheating or defrauding of players by other players and money laundering by players. Cheating or defrauding of players by other players: Most of the cases of improper player collusion or cheating that have come to light have been detected by other players. With a regulator in place for U.S.-licensed sites, players would have stronger recourse against the sites, or against other players, by lodging complaints with the regulator or relevant law enforcement agencies. More important, licensed operators could be required to maintain comprehensive databases of all betting transactions and these databases could be examined and analyzed by regulators in the event of an inquiry or the triggering of red flags. Site operators, who themselves have a strong interest in maintaining the integrity of their games, could be expected or even required to implement pattern recognition software to scan routinely for anomalous betting patterns. Money laundering by players: Online gambling operators, like operators of bricks-and-mortar casinos, would be subject to current anti-money-laundering regulations. These regulations would require site operators to expend some level of effort in detecting money laundering. The online environment provides better opportunities for detecting money laundering by players or player groups than the bricks-and-mortar casino environment. Site operators could be required to retain comprehensive data on all deposits, withdrawals, and betting transactions and to make these data available to regulators for examination and analysis. Given complete data, most patterns related to money laundering (such as light betting or

10

matched bets placed by collaborators) would be easier to detect than they are in a physical environment (where complete transaction histories are available only in the form of video recordings). Software that detects anomalies and suspicious behaviors could be operated easily and routinely on digital databases by the site operators, by regulators, or by both. The site operators obligations with respect to their own detection of money laundering would form a part of their ordinary compliance obligations under the licensing regime. 3. Network Access, Data Privacy and Security Issues

Any U.S. legalization and regulatory regime would likely address the risk of access to online gambling sites from jurisdictions that prohibit such activity. Violation of jurisdictional restrictions or prohibitions: State, local, and tribal governments may continue to prohibit or restrict (1) the operation of gambling sites from within their jurisdictions and (2) online gambling by individuals resident or physically present within their jurisdiction. Licensed U.S. sites could be required to take all reasonable steps not to permit registration or participation by individuals in such states. A range of geolocation technologies are now available, mostly tied to identification of the user location by reference to their IP addresses. Such technologies, while not entirely foolproof, have the capability of reducing risks as much as is required by regulators. IP geolocation, together with address verification at registration and other controls, can be expected to deter the bulk of casual attempts to gamble from within restricted states. Determined users, of course, already have access to foreign sites and would probably continue to use those rather than go to the trouble of devising sophisticated technological means for defeating U.S.-based geolocation controls. Regulatory oversight methods could include audits of U.S.-based operators software controls and routine mystery shopping at U.S. sites conducted from locations within states that had chosen to exercise their rights to restrict online gambling.

Data privacy and security risks include: sites not using commercially appropriate security systems and practices; intentional or accidental breach of the gambling sites and users data security; and the introduction of spyware, adware, or malicious code into gambling websites software or transmission of such malware to users computers. Breaches of data confidentiality: Under legalization and regulation, U.S.-licensed operators would be subject to all applicable federal and state requirements regarding data confidentiality and security. Site operators would be subject to regulatory and potentially criminal sanctions and civil liability for any breaches or abuses of personal or financial data. Their data-protection controls would be subject to regulatory audit. There is no reason to believe that licensed online gambling operators would be any less able or willing to fulfill these obligations than other online merchants with similar data custody obligations. Communications and computer security failures: Under the current regime, U.S. authorities have no oversight over security for online gambling sites. With

11

legalization and regulation U.S. licensed sites would be subject to existing data protection laws. Furthermore, U.S. regulators would have an opportunity to require state-of-the-art cybersecurity controls to protect against the introduction of malicious code or the unauthorized manipulation of games. 4. Problem Gambling

It is relatively easy to demonstrate for the other risk categories that a well-structured regulatory regime coupled with relevant technologies should provide better protection than the status quo. For problem gambling, however, the potential effect of legalization is less obvious a priori. Many might assume that pathological or addictive gambling behaviors would be exacerbated by the increased opportunity to gamble at any time and from anywhere online. But research on this topic does not support this conclusion. In particular, the link between the availability of online gambling and increases in the prevalence of problem gambling has not been established. Nevertheless, some online gamblers would be problem gamblers. In a well-regulated online environment, gamblers could have opportunities and technologies made available to them to help curb addictive or problematic gambling behaviors. Such mechanisms would permit them to limit their gambling volume, deposit rates, loss rates, and the size of each wager. Users could also access online clinical and self-help resources from links provided at the gambling site. The relationship between legalization and potential effects on problem gambling rates must certainly be examined carefully. Opponents of legalization fear an increase in problem gambling rates. However, gambling experts in the United States and the United Kingdom have reported that the prevalence rates for pathological gambling have remained static and low (roughly 0.7% of the adult population, in both countries) for many years. A large-scale study of gambling prevalence in the U.K. found the 0.7% rate remaining stable from 1999 through 2007 despite substantial increases in gambling opportunities during this period.13 Because this issue is likely to receive considerable attention as the United States considers legalization, we have attempted to analyze the various arguments given as to why the act of legalization might drive the level of problem gambling up or down. We have identified five popularly discussed mechanisms through which legalization could drive problem gambling up, and describe them here along with some observations that help mitigate the anticipated effects:
13

Mechanism: Inhibitions to gamble that are based on would-be gamblers knowledge of current legal restrictions would be removed.

Noted in a June 10, 2009 interview with Howard Shaffer, Director of the Division on Addictions and Associate Professor of Psychology in the Department of Psychiatry at the Cambridge Health Alliance. Also see Jacob Sullum, Some Bets Are Off: The Strangely Selective and Self-defeating Crackdown on Internet Gambling, reasononline, June 2008, http://www.reason.com/news/show/126022.html (last accessed on September 10, 2009). Also see Heather Wardle et al., British Gambling Prevalence Survey 2007, National Centre for Social Research, Prepared for the Gambling Commission, September 2007, http://www.gamblingcommission.gov.uk/pdf/Britsh%20Gambling%20Prevalence%20Survey%2007%20%20Sept%202007.pdf (last accessed on September 10, 2009), p. 10.

12

Observation: Gamblers in the United States are generally ignorant of or completely confused about existing legal restrictions, and (until very recently) there has been no enforcement against the gamblers themselves.14 Hence, the lifting of the prohibition itself is unlikely to have any significant impact on would-be gamblers willingness to gamble online.

Mechanism: Gamblers may be more comfortable gambling online because licensed operators are reputed to be trustworthy. Observation: The gamblers most likely to be influenced by the availability of trusted brand-name sites are those who gamble already, perhaps in the casino environment, and hence know the brands. Knowledgeable gamblers may indeed shift their business, but this represents displacement, not overall growth. And the displacement would be from bricks-and-mortar to online gambling, which can offer many more options and protections for problem gamblers than can land-based casinos.

Mechanism: Gambling opportunities would be ubiquitous and available 24/7. Observation: U.S. residents already have online gambling options available to them all day, everyday, and from anywhere. So the addition of U.S.-licensed sites would not alter that particular reality.

Mechanism: Lifting the UIGEAs restrictions on financial transactions might make it easier for consumers to place bets online. Observation: Lifting the restrictions of the UIGEA would not make it significantly easier for U.S. residents to make deposits to online sites. Enough workarounds have been designed, and are energetically promoted to consumers by the offshore sites, to render the existing restrictions largely ineffective.15

Mechanism: Advertising by licensed online gambling sites might lead to increased problem gambling. Observation: Although advertising is one avenue for the expected increase in online gambling that would follow legalization, little evidence exists to show whether and to what extent advertising-induced growth in, or redistribution of, gambling volume might produce increases in problem

14

The recent seizure of online poker players funds was termed an unprecedented action by the Poker Players Alliance. See Supra at footnote 7. See Supra at footnote 5.

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gambling rates.16 Furthermore, this mechanism (allowing advertising for online gambling sites) is controllable to the extent deemed necessary or desirable, through regulatory restriction. We also looked at two mechanisms through which legalization and regulation could drive problem gambling down: Mechanism: Tax and license-fee revenue distributions may provide an opportunity to extend and enhance counseling, treatment, and support programs for problem gamblers. Observation: Significant tax revenues might be anticipated from U.S. operators, and revenue distributions from taxes and license fees could substantially boost publicly funded prevention, counseling, and treatment programs, as well as research on gambling addiction. Existing budgets for counseling and treatment services for problem gamblers have been limited, and most health insurance programs do not currently cover these services.17

Mechanism: Regulators could require licensed domestic sites to lead the world in offering a full suite of advice and protections for problem gamblers to an even greater extent than is the case in bricks-and-mortar casinos. Observation: U.S.-licensed sites could be required to display offers of help prominently on their websites, including (1) registration pages that offer self-diagnostic tests designed to help would-be gamblers understand their own attitudes and vulnerabilities; (2) web pages that display prominent links to support and counseling services; and (3) availability of speed-of-play, compulsory time-outs, or player-loss-rate caps. All players should be offered the opportunity up front and at subsequent intervals to voluntarily exclude themselves or to limit their own deposit rates, loss rates, betting rates, or periods of play.

16

Noted in an August 4, 2009 interview with Simon Holliday, Director of H2 Gambling Capital (U.K.). Franklin (2001) discusses lack of federal funding for treatment or awareness of problem gambling, lack of insurance parity for problem gamblers, and limited or lack of funding from most states in the United States. Joanna Franklin, Problem Gambling in the U.S: From the Beginning Into 2001, http://www.responsiblegambling.org/articles/Problem_and_Pathological_Gambling_A_view_from_the_States.p df (last accessed on September 10, 2009). Also, Winslow (2008) discusses the lack of state funding for problem gambling services in Colorado and other states in the United States. Kyle Winslow, A Problem for Gamblers, The American Prospect, March 10, 2008, http://www.prospect.org/cs/articles?article=a_problem_for_gamblers (last accessed on July 13, 2009). Also see the website of the Association of Problem Gambling Service Administrators (APGSA), http://www.apgsa.org/State/index.aspx (last accessed on September 10, 2009).

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We believe that the opportunities to mitigate problem gambling provide significant benefits not available under the status quo. These benefits provide a significant counterweight to any potential increases in problem gambling that result from legalization. Furthermore, the potential benefits of mitigation would become available to most existing online problem gamblers.\ E. Conclusions

We have examined 10 distinct risks in four categories that may be associated with the growth and availability of online gambling. In each case, the current legislative framework is failing to provide any effective risk control or consumer protection. The establishment of a well-regulated industry under U.S. jurisdiction would offer the opportunity for much better protection. We recommend that plans for regulating online gambling include the design and use of different riskcontrol strategies for different risks that may be associated with Internet gambling, as well as education and consumer support. If the United States decides to legalize and regulate online gambling sites, we would expect most U.S.-resident gamblers to be diverted from overseas sites toward reputable and trusted domestic operators. In the long run, reputable gambling operations under U.S. control should come to dominate online gambling opportunities chosen by U.S. consumers. All four categories of risk would be better controlled in such circumstances than they are at present. In the end, U.S. consumers would be better protected than they are now.

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II.

REGULATORY METHODS AND TECHNOLOGIES AVAILABLE FOR CONTROLLING EACH RISK

For each of the 10 risks outlined above, a set of regulatory methods and technologies already exists that would provide a reasonable degree of control. Moreover, most of them have been implemented successfully in other countries and other online settings. This section describes a variety of control technologies and regulatory tactics relevant to each risk, and identifies the most promising approaches in each case. A. Gambling by Minors

A common concern about legalizing online gambling stems from the fact that many current online gambling sites do not have adequate regulations or safeguards against gambling by minors. The primary concern is that underage access to and use of online gambling services might increase because it may be difficult to verify age and replicate controls used by bricksand-mortar casinos to exclude minors. However, effective measures to prevent online gambling by minors have been implemented in well-regulated Internet gambling environments in many European countries and in Australia. Moreover, a number of technologies routinely used in other industries can be applied to the online gambling environment. We discuss below the issue of online gambling by minors and strategies to prevent it. 1. The Issue of Gambling by Minors

Age restrictions apply to virtually all forms of legalized gambling, though the specific age restriction varies by jurisdiction. The typical rationale for age restrictions is that children and young persons are highly vulnerable and are more likely to become problem gamblers if they begin gambling at a young age. In the online environment, gambling by minors is a problem that stems from the inherent difficulty in separating underage users from adults on the Internet because of the absence of an official personally verifying a gamblers age. 18 Minors can gain access to online gambling websites either by providing false credentials during the registration process or by gaining access to their parents or others online gambling account. Anecdotal evidence suggests and surveys have shown that underage gambling is widespread. Studies conducted between 1999 and 2004 covering Canada, the United States, the United Kingdom, and Australia indicated that 47% of adolescents exhibited serious patterns of pathological gambling and 1015% were at risk of either developing or returning to a serious gambling problem.19 More recent studies have revealed an increase in the involvement of
18

Ryan S. Landes, Layovers and Cargo Ships: The Prohibition of Internet Gambling and a Proposed System of Regulation, New York University Law Review, 82 (May 2007): 913943 at p. 923. Sally Monaghan, Internet and Wireless Gambling A Current Profile, Australasian Gaming Council, 2008. http://www.austgamingcouncil.org.au/images/pdf/Discussion_Papers/agc_dis_internet.pdf (last accessed on July 11, 2009). Also the extent to which rates of problem gambling among adolescents are elevated is controversial. For example, in exploring the properties of two screening instruments in identifying problem gambling among students aged 15 to 17 , Ladouceur et al. (2005) discuss the need to clarify the construct of pathological gambling among youth and note that neither the SOGS nor the DSM-IV subscale (MAGS) was perfect in identifying problem gambling. R Ladouceur et al., Concordance between the SOGS-RA and the

19

(continued...) 16

Canadian youth in online gambling. In 2006, 9% of Canadian high school students reported having gambled online for money, an increase from 3.6% in 2005.20 According to the National Annenberg Survey of Youth, in the United States, card playing for money on the Internet by male youth aged 14 to 22 rose to 3.3% in 2008 from 2.4% in 2007.21 In a 2008 study of general gambling attitudes among Canadian youth aged eight to 20, 76% of those surveyed admitted to having gambled at least once in their lives.22 Among the group aged 18 to 20, 90% had gambled at least once and approximately 39% admitted to gambling once a week or more.23 2. Existing Controls in Other Jurisdictions

States with commercial casino gambling typically limit access to persons 21 or over, although most lotteries and some Native American casinos allow 18-year-olds to gamble. Most other countries have an age limit of 18, which applies to both online and casino gambling. There is no established minimum age for online gambling in the United States because it is done outside of U.S. legal and regulatory safeguards. Well-regulated overseas gambling jurisdictions require online operators to verify the identity, location, and age of their customers and to use various mechanisms to curb underage gambling. Some evidence suggests that age restrictions for online gambling have not been uniformly required or rigorously implemented. In an exploratory study of 30 U.K.-based sites conducted before the United Kingdoms regulation of online gambling, researchers noted that 11 of those sites had no age verification check.24, 25 Although 17 sites had age checks, they simply required a person registering to either check a box to confirm that they were 18 years of age or older or
DSM-IV Criteria for Pathological Gambling among Youth. Psychology of Addictive Behaviors, 19, No. 3 (2005): 271276 at p. 274-275.
20

J. McBride, Internet Gambling among Youth: A Preliminary Examination, International Center for Youth Gambling Problems & High-Risk Behaviors Newsletter, 6, No. 1 (2006); cited in Sally Monaghan, Internet and Wireless Gambling A Current Profile, Australasian Gaming Council, 2008. http://www.austgamingcouncil.org.au/images/pdf/Discussion_Papers/agc_dis_internet.pdf (last accessed July 11, 2009). The Annenberg Public Policy Center Internet Gambling Stays Low Among Youth Ages 14 to 22 but Access to Gambling Sites Continues; Sports Gambling Makes Resurgence, November 26, 2008, http://www.annenbergpublicpolicycenter.org/NewsDetails.aspx?myId=306 (last accessed July 25, 2009). Jeffrey L. Derevensky et al., Adolescent Attitudes toward Gambling, Brazilian Journal of Cognitive Psychology, 4, No. 1 (2008), http://pepsic.bvs-psi.org.br/scielo.php?script=sci_arttext&pid=S1808-56872008000100002&lng=en&nrm= (last accessed on September 1, 2009). See Id. U.K.-based online gambling operators first came under regulation with the introduction of the Gambling Act 2005 in September 2007. Before the Gambling Act, online gambling fell under no specific regulation. Michael Smeaton and Mark Griffiths, Internet Gambling and Social Responsibility: An Exploratory Study, CyberPsychology & Behavior, 7, No. 1 (2004): 4957.

21

22

23

24

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enter their date of birth.26 In addition to lax age checks, most websites required only a valid credit card to begin gambling. However, some minors in the United States as young as 13 have access to credit cards in their name, rendering this mechanism ineffective as an age check.27 Moreover, minors may have access to their parents credit card information. In a 2004 British study, a 16-year-old girl attempted to access 37 gambling websites using her debit card, lying about her age but being otherwise truthful. Only seven sites prevented her from registering.28 A more recent mystery shopping study performed between April 2008 and March 2009, after U.K.-based online gambling had come under regulation, revealed quite different results. The British Gambling Commission noted that more than 95% of gamblers were registered with websites that had sufficient age verification checks, and only 2.2% were registered with sites that had age verification weaknesses.29 Other jurisdictions have also had success in preventing underage gambling through effective use of restrictions and mechanisms. In his testimony to Congress, the CEO of the Alderney Gambling Commission noted that during the seven years of regulation of online gambling in Alderney, the Commission had not had any complaints about minors gaining access to an Alderney-regulated site. He further noted that the primary reason that Alderneys licensed sites are able to prevent minors from gaining access is the use of third-party verification software by most licensees.30 Similarly, Mary Williams of the Gambling Control Commission of the Isle of Man noted that license holders of online gambling websites use various methods of age verification, including large data services such as Experian, to ensure that customers are of legal age. Moreover,

26

See Id. Commission on Child Online Protection, Report to Congress, October 20, 2000, http://www.copacommission.org/report/COPAreport.pdf (last accessed on August 11, 2009), p. 25. Also see European Commission, Background Report on Cross Media Rating and Classification, and Age Verification Solutions, Safer Internet Forum, September 2008, http://ec.europa.eu/information_society/activities/sip/docs/pub_consult_age_rating_sns/reportageverification. pdf (last accessed on August 24, 2009). Smeaton et al., Study into Underage Access to Online Gambling and Betting Sites, 2004; cited in Ryan S. Landes, Layovers and Cargo Ships: The Prohibition of Internet Gambling and a Proposed System of Regulation, New York University Law Review, 82 (2007), at p. 924. British Gambling Commission, Online Mystery Shopping Programme, July 2009, http://www.gamblingcommission.gov.uk/pdf/online%20mystery%20shopping%20programme%20july%20200 9.pdf (last accessed on August 2, 2009). Testimony of Andr Wilsenach, in U.S. House of Representatives, Committee on Financial Services, Can Internet Gambling Be Effectively Regulated to Protect Consumers and the Payments System? 110th Cong., 1st Session, June 8, 2007, at p. 145.

27

28

29

30

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withdrawal of funds requires access to a PIN number, which the gambling site mails to the users postal address, thereby limiting the possibility of unauthorized access to funds by minors. 31 Gibraltars regulatory regime requires licensees to take all reasonable steps to verify that customers are of legal age, although operators are allowed to consider the use of a credit card as a verification of age.32 The United Kingdom requires that licensed gambling sites have policies and procedures to prevent underage gambling, including a warning that underage gambling is illegal, requiring an affirmation from the customer that he or she is of legal age, ensuring that staff are trained in age verification (particularly in the use of secondary forms of identification verified by staff members when initial automated procedures fail), and enabling filtering software to block the website.33 Beyond this, secondary verification may be required, such as searching credit databases for age information, prohibiting unverified users from withdrawing winnings, and freezing the account of anyone not verified within 72 hours of applying to the site. However, these checks are not required if the user deposits funds using a credit card.34 The regulator in Australias Northern Territory requires that players ages be confirmed within 90 days of opening an online gambling account and before withdrawing any funds. Copies of identification must be e-mailed, faxed, or mailed directly to the site operator. If the individual is not confirmed within the 90-day period, he or she must seek permission from the regulators Director of Licensing to re-open the account.35 In the United States, the UIGEA exempts certain forms of gambling, such as horse racing and state lotteries, from its criminal provisions if the applicable state law has a provision for age verification that is reasonably designed to block access to minors.36
31

Testimony of Mary Williams, in U.S. House of Representatives, Committee on Financial Services, Can Internet Gambling Be Effectively Regulated to Protect Consumers and the Payments System? 110th Cong., 1st Session, June 8, 2007, at p. 130. Gibraltar Regulatory Authority, Code of Practice for the Gambling Industry, Issued by the Gambling Commissioner, December 13, 2008, http://www.gra.gi/sites/gambling/downloads/215/generic_code_v1.0.2009.pdf (last accessed on August 6, 2009), p. 14. British Gambling Commission, Conditions and Codes of Practice applicable to: Remote Casino Licenses, Remote Casino Ancillary Licenses, December 2008, at p. 78. See Id. Noted in an August 31, 2009 correspondence with John Sealy, Manager of Information Systems and Technology Services at the Licensing, Regulation and Alcohol Strategy division of the Northern Territory Department of Justice (Australia). Anthony Cabot and John Aristotle Phillips, Age Verification: UIGEA Compliance and Regulation, World Online Gambling Law Report, October 2006, http://integrity.aristotle.com/documents/AgeVerificationLawPublication.pdf (last accessed on August 10, 2009).

32

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34

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3.

Relevant Technologies for Risk Mitigation

Although the anonymous nature of online platforms might increase the risk of underage gambling, available technologies can address such risks. Researchers have outlined several categories of technologies for verifying the age of adults, including comparison of the registrants credentials against public databases such as credit reports and criminal histories, or even biometrics.37 In designing such controls, care would be needed to balance the (intended) exclusion of minors against the (unintended) denial of admission to qualified adults. The use of a credit card can often be an indicator of age, although, as noted in Section 2, some children have access to credit cards, and credit card companies do not allow cards to be used for age verification.38 It is thus likely that any age verification technology would use government-issued identification as its basis, potentially combined with other strategies to increase its effectiveness.39 Exclusion of minors from online gambling can also be aided through technologies routinely used to verify age in other applications today.40 Currently, online liquor stores employ various mechanisms, including a variety of data-matching techniques, to prevent minors from purchasing alcohol online.41 The simplest solution requires a social security number and other forms of identification such as a drivers license, combined with a credit card registered to that individual.42 An age-verification service is used to check the information provided against a database containing credit data, drivers license data, and registered voter information.43
37

Internet Safety Technical Task Force, Enhancing Child Safety and Online Technologies, Final Report to the Multi-State Working Group on Social Networking of State Attorneys, Berkman Center for Internet & Society, Harvard University, December 31, 2008, http://cyber.law.harvard.edu/sites/cyber.law.harvard.edu/files/ISTTF_Final_Report.pdf (last accessed on September 11, 2009) at p. 8. See Supra at footnote 36. See Id. Such as online liquor stores, online sellers of tobacco, and the websites of Hollywood movie studios. See Testimony of Michael Colopy, in U.S. House of Representatives, Committee on the Judiciary, Establishing Consistent Enforcement Policies in the Context of Online Wagers, 110th Cong., 1st Session, November 14, 2007, at p. 53. Boris Reznikov, Can I See Some ID? Age Verification Requirements for the Online Liquor Store, Shidler Journal for Law, Commerce & Technology 4, No. 5 (2007), http://www.lctjournal.washington.edu/Vol4/a05Reznikov.html (last accessed on July 25, 2009). Also see Integrity, Case Study: Age Verification for Online Alcohol Sales, Aristotle Inc., http://integrity.aristotle.com/documents/Online_Wine_Sales-WhitePaper2006.pdf (last accessed on September 10, 2009). See Id. Noted in an August 5, 2009 interview with Phill Brear, Head of Gambling Regulation at the Gibraltar Regulatory Authority.

38

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40

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Aristotle, Inc., a technology consulting firm, produces an identity- and age-verification service called Integrity:Direct, which uses a database of government-issued identification to verify age; the vendor claims the check takes less than 5 seconds, covers 3.4 billion people, complies with U.S. privacy laws, and is not subject to the Fair Credit Reporting Act because it does not use any credit data.44 LexisNexis and its advanced linking technology combines real time access to billions of public records compiled from thousands of public and proprietary sources that can be used to verify age and identity of individuals.45 For a minor to defeat this method of authentication, he or she would have to access an adults government-issued ID card, credit card, and other information. Because this is a foreseeable scenario, this age verification technique must be combined with others. Michigans Liquor Control Commission has approved a knowledge based authentication tool for age verification. This online tool develops questions that only the specific individual would know answers to and checks the answers against public records.46 This system, while robust, imposes potentially significant transaction costs of between 25 cents and one dollar per check, making it a costly solution if used every time a user logs on to a gambling site.47 The LexisNexis service can deliver an interactive, knowledge-based query process to instantly multifactor authenticate individuals at the point of customer contact.48 Other technologies may prove useful to augment traditional verification, such as the use of a PIN number mailed to the address of record of the user, as in the Isle of Man, or requiring the user to enter personal information via his or her home phone. This strategy prevents a minor from simply using his or her parents credit and ID cards and immediately creating an account. If legalization is implemented and matching techniques are used, the U.S.-licensed site operators would be expected to develop and use filters that are discriminating. Regulators could choose where to set the balance between Type I errors (where underage gamblers are not detected) and Type II errors (where gamblers of legal age are excluded). Moreover, with respect to U.S.

44

Integrity, Integrity:Direct, Aristotle Inc., http://integrity.aristotle.com/index2.php?option=com_content&do_pdf=1&id=47 (last accessed on August 11, 2009). Noted in an August 10, 2009 interview with Chris Pinion, National Account Manager at LexisNexis Risk and Information Analytics. See Supra at footnote 41. Also see Tricia Pearson, Can I See Some ID? Why Age Verification Is a Hot Topic for Online Retailers, Shoosmiths, June 24, 2009, http://www.shoosmiths.co.uk/news/2372.asp (last accessed on August 11, 2009). See Supra at footnote 41 Boris Reznikov. Noted in an August 10, 2009 interview with Chris Pinion, National Account Manager at LexisNexis Risk and Information Analytics.

45

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residents, we would expect available data to be of high quality and reliability, making age verification through matching techniques effective.49 Site operators could also be required to provide child-protective software to parents to keep minors from accessing their parents accounts or any online gambling sites. The Nova Scotia Gaming Corporation (NSGC) commissioned and distributed BetStopper, which is a software program designed to help parents prevent children from visiting online gambling websites. Results from the pilot survey were extremely positive and indicated that 92% of parents found BetStopper to be a valuable prevention tool.50 The BetStopper software was provided to families for free by the NSGC. Other widely available Web filtering software, such as Net Nanny, can also be used to block access to gambling sites by children. Net Nanny analyzes keywords and objects on every website visited and assigns points in different content categories, one of which is gambling.51 If a site scores too high in an objectionable category, the software blocks it.52 An administrator, usually a parent, can decide which categories to block and also whether a particular score leads simply to a warning message or to a complete block.53 The software has generally received high reviews, and its filtering technology is resistant to circumvention.54 Other parental control tools are contained within operating systems such as Windows Vista and Mac OS X, some are provided for free by network service providers, and many online safety organizations provide directories to help parents find appropriate protective software.55 A regulator may require that approved filtering software be offered to anyone requesting it. Minors may also have a weak financial motive to gamble online. If a minor usurps an adults payment and identification information, for example, all of the minors winnings would be paid

49

Noted in an August 5, 2009 interview with Phill Brear, Head of Gambling Regulation at the Gibraltar Regulatory Authority. Also noted in an August 21, 2009 interview with Andrew Fritchie, General Counsel of PartyGaming PLC. Nova Scotia Gaming Corporation, World-Leading Software Launched to Protect Nova Scotia Youth, May 29, 2009, http://www.nsgc.ca/pdf/press/Microsoft%20Word%20%20BetStopper%20Media%20Release%20FINALMay% 2028%20w%20photo.pdf (last accessed on September 10, 2009). Net Nanny, Protecting Your Family on the Internet, white paper, http://www.netnanny.com/products/netnanny/protecting_your_family (last accessed on September 10, 2009). See Id. See Id. For a review of the Net Nanny software, see http://internet-filter-review.toptenreviews.com/netnanny-reviewpg2.html (last accessed on September 10, 2009). Federal Communications Commission, Report in the Matter of Implementation of the Child Safe Viewing Act; Examination of Parental Control Technologies for Video or Audio Programming, MB Docket No. 09-26, released August 31, 2009, at 142, http://hraunfoss.fcc.gov/edocs_public/attachmatch/FCC-09-69A1.pdf (last accessed on September 1, 2009).

50

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directly to the adults account.56 For a minor to benefit financially from gambling, he or she would have to have access to his or her own payment mechanism, such as a credit card or bank account, but the demographic information associated with the account would more easily allow the website to verify the users age. Similarly, the regulator could require forfeiture to the government of winnings to gamblers who are discovered to be underage, further lowering the financial incentive for minors to gamble online.57 Regulators could impose harsh penalties on site operators with lax mechanisms to prevent underage gambling. Frequent and widespread mystery shopping, as done in the United Kingdom, can reveal operators with inadequate safeguards in place to curb underage gambling. The regulator can impose penalties on such operators, including monetary fines, the revocation of the gambling license, and even criminal liability. Moreover, to help combat underage gambling, a portion of online gambling tax revenues could be earmarked for educational programs for parents and minors. Given sufficient funds, a regulator may require that youth gambling prevention lessons be incorporated into school curricula. In South Australia, the Dont Bet On It! program was introduced as a way to educate children about the dangers of youth gambling. A 2002 report claimed a small but statistically significant change in student attitudes towards gambling as a result of the curriculum, which includes five lessons, a mock gambling game, and pre- and postactivity surveys.58 The report also describes other educational programs from entities in Australia and in North America, such as the Minnesota Institute of Public Health and Saskatchewan Health in Canada.59 4. Conclusion

The current state of affairs, with U.S. residents accessing online gambling sites with widely varying degrees of regulation, does not provide comprehensive protections to ensure that gamblers are of legal age. Regulatory mechanisms and technological solutions, many of which are currently used in other jurisdictions and industries, can equip online gambling operators with capabilities to selectively exclude minors from engaging in online gambling. Age verification policies would be less effective in the absence of support from minors parents and guardians; therefore, a successful regulatory strategy would provide tools with which parents can limit
56

Jonathan Gottfried, The Federal Framework for Internet Gambling, Richmond Journal of Law & Technology, X, No. 3, at p. 10, http://law.richmond.edu/jolt/v10i3/article26.pdf (last accessed on August 6, 2009). Noted in an August 5, 2009 interview with Glenn Gibson, Manager of Technical and Systems Audit at the Tasmanian Gaming Commission, and Damien Jarvis, Assistant Director of the Liquor and Gaming Branch of the Tasmania Department of Treasury and Finance (Australia). Loris Glass, Gambling Education: Some Strategies for South Australian Schools, funded by the Gamblers Rehabilitation Fund, South Australia, November 2002, at p. 1920, https://www.library.health.sa.gov.au/Portals/0/gambling-education-some-strategies-for-south-australianschools.pdf (last accessed on September 10, 2009). See Id. at p. 2022.

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access to gambling websites by their children. We believe that online gambling can effectively exclude minors when it combines cutting-edge technology with a strong regulatory regime. B. Defrauding of Consumers by Site Operators

Gambling websites, which deal with large amounts of money in a virtual setting, have the potential for fraudulent activity and unfair dealings.60 As discussed below, unregulated gambling sites have been known to defraud customers and steal significant sums of money. 61 However, a system of effective regulation could manage the risks of fraud and ensure fair and legal dealings. 1. The Issue of Fraud by Site Operators

Fraud by site operators can be classified into three broad categories: Individuals can set up unlicensed gambling websites that either refuse to return customers deposits or operate unfair games. Operators can model a fraudulent website after a licensed site and siphon players from the more reputable operator. Insiders within reputable websites can exploit inside information to cheat players without the knowledge of the larger organization.

It is reasonably easy for an individual to set up a fraudulent site, attract as many depositors as possible, and then either shut down the site and take the deposits or continue to run the site with odds or fees swung decidedly in the operators favor. As a sites reputation became tarnished, it would quickly lose its base of players, but it could then simply shut down and open a new site, perpetrating the same fraud over and over again.62 The identity of site owners is often unclear, and the ease of transferring between sites makes this method of fraud highly profitable.63 Reputation is clearly a major attribute of gambling websites. Websites can piggyback on, or usurp, the reputation of a reputable operator or jurisdiction to instill confidence in consumers. For instance, Casino Australia (http://www.casinoaustralia.com/) is an attractive site emblazoned with images of Sydney, koalas, and the national flag but has no other connection with Australia. The online casino is physically located in the Netherlands Antilles and marketed

60

Gerd Alexander, The U.S. on Tilt: Why the Unlawful Internet Gambling Enforcement Act is a Bad Bet, Duke Law & Technology Review, 5 (2008), at 9. See, for example, Financial Crimes Enforcement Network, A Survey of Electronic Cash, Electronic Banking, and Internet Gaming, U.S. Department of the Treasury, 2000, at p. 41; and see Supra at footnote 18 at p. 925. See Supra at footnote 18, at page 925. See Id.

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by a Native American gambling corporation.64 Because gambling websites are often based in countries far from their target customers, they can often avoid legal accountability, and because website creation is relatively simple, a customer can be easily confused about the licenses and controls held by a particular site.65 In addition to fraud by gambling sites themselves, employees or executives of sites may initiate fraud at the individual level without the knowledge of the organization as a whole. In September 2007, players at the poker website Absolute Poker initiated their own investigation into apparent cheating by a player in a tournament. The investigation revealed that a co-owner of the company and a former director of operations had acted in concert to cheat players of amounts between $500,000 and $1 million.66 Another poker website, UltimateBet, was rocked by a cheating scandal in early 2008 triggered by concerns about one online player who could apparently see other players hole cards during play. Investigation revealed that from January 2005 to December 2007, former employees of the company, operating from outside, had exploited security vulnerabilities in the sites software of which only they were aware.67 Since the enactment of the UIGEA, U.S. residents no longer have access to large gambling sites operated by publicly-traded companies; instead, U.S. gamblers look to less transparent offshore site operators that may be more likely to engage in fraud or other deceitful practices. 68 Also, given the current absence of regulatory oversight in the United States, U.S. gamblers have little or no recourse to authorities when site operators defraud them.69 The extent of fraud by site operators is not well documented, but cases have been recorded. A 2000 report by the Financial Crimes Enforcement Network of the U.S. Department of the Treasury claims that [t]here is, in fact, a substantial record of shadow websites collectingdeposits for a period of time and then disappearing, in the process destroying

64

Roger Clarke and Gillian Dempsey, The Feasibility of Regulating Gambling on the Internet, Managerial and Decision Economics, 22 (2001): 125132, at p. 128. See Id. Russell Goldman, Online Poker Players Expose Alleged Fraud, ABC News, October 19, 2007. http://abcnews.go.com/print?id=3752500 (last accessed on July 24, 2009) UltimateBet.com, UltimateBet Issues Statement Regarding Unfair Play, May 29, 2008. http://www.ultimatebet.com/poker-news/2008/may/NioNio-Findings (last accessed on July 24, 2009). Also see UltimateBet.com, Status Update on NioNio Investigation, July 8, 2008, http://www.ultimatebet.com/pokernews/2008/july/Investigation-Status-Update (last accessed on July 24, 2009). As noted in an August 21, 2009 interview with Andrew Fritchie, General Counsel of PartyGaming PLC, U.S. customers are forced to use privately-held sites, which are generally perceived as less reputable. See Supra at footnote 18 at p. 926. Also see Supra at footnote 60 at 1415. Also see Christopher Grohman, Reconsidering Regulation: A Historical View of the Legality of Internet Poker and Discussion of the Internet Gambling Ban of 2006, Journal of Legal Technology Risk Management, 1, No. 1 (Fall 2006): 3474, at p. 62 63.

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consumer confidence.70 In a 2006 survey, the American Gaming Association reported that 55% of respondents agree[d] at least somewhat that online casinos find ways to cheat players.71 The website GamesandCasino.com maintains and publishes a long blacklist of websites that cheat, defraud, or otherwise manipulate their users.72 Finally, in a 2007 survey of Nevadans conducted by the International Gaming Institute at the University of Nevada, Las Vegas (UNLV), 66.9% of respondents (who were not necessarily gamblers) claimed to have strong doubts about the integrity of online gambling as it pertain[s] to the ability to cheat the gambler.73 The survey also includes various anecdotes from respondents about cheating by site operators.74 In addition to outright fraud by site operators, operators may become bankrupt or otherwise insolvent without engaging in questionable business practices. Without adequate financial protection, customers could lose their entire fund balance with the site.75 As shown below, existing controls such as holding customers funds in a trust account or establishing financial reserves can help mitigate against this business risk to customers. 2. Existing Controls in Other Jurisdictions

Most regulatory regimes address the issue of operator fraud. In the United States, a regulatory strategy could combine elements from other regimes and add unique safeguards. Below are descriptions of approaches taken to prevent operator fraud in other jurisdictions: The Gambling Control Commission of Alderney, a Channel Island, requires sites to have provisions enabling the customer to address complaints and disputes to an independent body.76 In the Isle of Man, site operators are required to maintain either financial reserves or a bond to ensure that players are paid their winnings.77

70

Financial Crimes Enforcement Network, A Survey of Electronic Cash, Electronic Banking, and Internet Gaming, U.S. Department of the Treasury, 2000, at p. 41. American Gaming Association, State of the States: The AGA Survey of Casino Entertainment, 2006, at p. 21, http://www.americangaming.org/assets/files/2006_Survey_for_Web.pdf (last accessed on July 23, 2009) GamesandCasino.com, Blacklisted Casinos, http://www.gamesandcasino.com/blacklist.htm (last accessed on September 10, 2009). See Supra at footnote 6 Bo Bernhard at p. 3738. See Id. at p. 4043. Noted in an August 27, 2009 interview with Andr Wilsenach, Chief Executive Officer of the Alderney Gambling Control Commission. See Supra at footnote 30 at p. 142143. See Supra at footnote 31 at p. 124.

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Antiguas and Barbudas regulations require a site operator to maintain investments that have a market valueof not less than the aggregate amount of all its outstanding prizes and monies held on account for players.78 The British Gambling Commission sets forth rules governing licensed gambling website operators, including one that requires that licensees (1) inform customers as to whether their funds are protected in the event of insolvency and (2) be able to provide evidence to the [U.K. Gambling] Commission, if required, showing how they satisfied themselves that their terms are not unfair.79 The U.K. Department of Culture, Media and Sport (the sponsor of the Gambling Commission) publishes the White List, a list of nations hosting online gambling whose licensees are legally permitted to advertise in the U.K, although the list is currently in a state of suspension.80 Tasmanias regulator sets technical standards and uses independent accredited testers to verify compliance before approving new software, and for some types of operations also requires that players funds be held in a trust for the protection of players.81 Gibraltars regulator requires licensees to have strong internal controls and also requires independent testing of gambling software to ensure integrity.82

Although the regulatory schemes described above include provisions to prevent fraud, effective regulation must include strong penalties for noncompliance and safeguards that protect customers in the event of fraud or wrongdoing. They also should mandate ordinary but rigorous due diligence by regulators and owners, including background checks on owners, operators, and

78

Antigua and Barbuda Directorate of Offshore Gaming, Interactive Gaming and Interactive Wagering Regulations, at 184(a). http://www.antiguagaming.gov.ag/files/Antigua_and_Barbuda_Gaming_Regulations-Final.pdf (last accessed July 23, 2009) See Supra at footnote 33 at p. 14. Jamie Wiebe et al., Problem Gambling Prevalence Research: A Critical Overview, report to the Canadian Gaming Association, December 2007, at p. 17, http://canadiangamingassociation.com/media_uploads/pdf/78.pdf (last accessed on July 11, 2009). Also noted in interviews with Matthew Hill, Director of Strategy, Research and Analysis at the British Gambling Commission, Paul Morris, Policy Development Manager at the British Gambling Commission, and Peter Collins, Professor of Public Policy Studies and Director of the Center for the Study of Gambling at the University of Salford (U.K.). Noted in an August 5, 2009 interview with Glenn Gibson, Manager of Technical and Systems Audit at the Tasmanian Gaming Commission, and Damien Jarvis, Assistant Director of the Liquor and Gaming Branch of the Tasmania Department of Treasury and Finance (Australia). See Supra at footnote 32 at p. 13 and 21.

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all staff in key positions. The regulatory regime could also give aggrieved consumers the ability to bring civil lawsuits and other rights of action against the site. 3. Relevant Technologies for Risk Mitigation

An effective regulatory regime must combine strong and competent oversight with an effective method for lodging complaints with the regulator or law enforcement agencies. In the examples of cheating mentioned above, it was only after private investigations by players that the sites themselves and the regulator responded.83 The Kahnawake Gaming Commission, the regulator for both sites noted above, ordered Absolute Poker to institute compliance programs and subject itself to random audits; it also fined the site $500,000.84 Similarly, the Commission ordered UltimateBet to refund any money owed to players who were victims of cheating, modified UltimateBets control system, and fined the site $1.5 million.85 Another potential risk-mitigating factor within a regulatory regime is the use of Mutual Recognition Agreements (MRAs), which are arrangements between nations to recognize each others regulatory standards and controls in a particular area of commerce. 86 Much as the United Kingdoms White List permits or denies advertising on the basis of the quality of a jurisdictions regulatory structure, an MRA could be used as a filter for permitted advertising, for referrals between sites, and even as a way of selectively retaining prohibitions on foreign sites on the basis of quality and integrity rather than the simple fact that they are foreign. Although both monetary sanctions and regulatory oversight are key to effective regulation, technology offers methods to prevent cheating over and above what is available to land- and river-based casinos. PartyGaming Plc is a publicly-traded Internet gambling company regulated in Gibraltar, and its PartyPoker affiliate holds about an 8% share of the worlds market for online poker.87 PartyGamings games and its random number generator are tested by iTech Labs, an independent gaming device tester. It is also a member of the European Gaming & Betting Association and of eCOGRA, both of which publish standards for gaming operators. 88 888.com,
83

Gilbert M. Gaul, Players Gamble on Honesty, Security of Internet Betting, The Washington Post, November 30, 2008, p. A12. Kahnawake Gaming Commission, In the Matter of Absolute Poker Investigation regarding Complaints of Cheating, January 11, 2008. http://www.kahnawake.com/gamingcommission/KGC-AP-0111.pdf (last accessed on July 24, 2009), at p. 4. Kahnawake Gaming Commission, Kahnawake Gaming Commission Imposes Sanctions on Ultimate Bet with Regard to Cheating Incidents, September 29, 2008, http://www.kahnawake.com/gamingcommission/kgc092908.pdf (last accessed on July 24, 2009). See Public Citizen, Mutual Recognition Agreements (MRAs), http://www.citizen.org/trade/harmonization/MRA/ (last accessed on August 10, 2009). As noted in an August 21, 2009 interview with Andrew Fritchie, General Counsel of PartyGaming Plc. Also see http://www.partygaming.com/prty/en/ourgames/overview/poker (last accessed on September 10, 2009). See http://www.partypoker.com/about_us/ (last accessed on September 10, 2009).

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another publicly traded gambling site based in Gibraltar, also uses iTech Labs for verification and is a member of eCOGRA and the Interactive Gaming Council, an online gambling trade group.89 Betfair, an Internet betting exchange based in the United Kingdom, is a member of the Independent Betting Adjudication Service, a third-party adjudicator for gambling disputes.90 4. Conclusion

As demonstrated above, the most effective system of regulation to combat site operator fraud combines strict enforcement with cooperation by the site operators themselves. Reputable operators with brands to protect could not afford to risk damage to their reputations, loss of their licenses, or regulatory sanctions. However, this incentive is not perfect, and the regulator must be fully equipped to detect and punish site operator fraud. Regulations may be similar to those that apply in the bricks-and-mortar industry. We expect that the online gambling industry will support a supervisory approach that includes regulatory monitoring and sanctions to help promote and maintain an industry reputation for integrity. C. Cheating or Defrauding of Players by Other Players

As discussed previously, both Absolute Poker and UltimateBet, two popular online poker websites, were rocked by accusations of cheating in 2007 and 2008.91 The cheaters were players on the site who had acted in concert with employees of the gambling website. These and other high-profile examples demonstrate the potential for cheating online and the basis for fear among online gamblers of being defrauded by other players. However, a system of regulation promises to rein in such fraudulent activity. 1. The Issue of Players Being Defrauded by Other Players

U.S. gamblers currently lack any effective means to seek remedy from other players for fraud. Because players in the United States engage in online gambling outside of legal and regulatory safeguards, they are unlikely to complain to authorities about cheating experienced on a site: Individual players are unlikely to volunteer information that would reveal that they have gambled online.Users who doubt the legality of their own actions are unlikely to snitch.92 Although the extent of player cheating and fraud is not well documented, it is a common concern for online players.93 A 2008 study of Swedish online poker players revealed that one of their
89

See http://www.888.com/ (last accessed on September 10, 2009). See http://content.betfair.com/aboutus/?product=exchange&brand=betfair&region=GBR&locale=en (last accessed on September 10, 2009). See Supra at footnote 6 Bo Bernhard. See Supra at footnote 18 at p. 926. John McMullan and Aunshul Rege, Cheating and Cybercrimes @ Gambling Sites.com, presentation to the Alberta Gambling Research Institute Annual Conference, March 2009, slide 2.

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biggest concerns was being cheated by other players.94 In a 2006 survey, the American Gaming Association reported that 46% of online gamblers believed that other players find ways to cheat.95 Finally, the aforementioned 2007 UNLV survey revealed that 63% of respondents were not at all confident that other players could not cheat them.96 The survey also includes anecdotal evidence from respondents about cheating by players, although evidence on the extent of cheating is generally mixed.97 Cheating by players can take various forms: Poker bots are automated programs that can reportedly play poker at the level of a professional tournament player, using a decision engine utilizing advanced neural network technology.98 These bots, such as PokerSmoke, can memorize play styles, recognize betting patterns, and calculate odds, potentially giving those who use them a distinct edge over other players.99 A simpler form of cheating involves collusion on online poker tables, in which two or more players work together to share information to gain an unfair advantage over unsuspecting players.100 Another form is multitabling, in which a person uses multiple accounts to enter a tournament as two or more different players and garners information in a similar way to collusion; this particular type of cheating is clearly not possible in an offline environment.101

94

Richard T. A. Wood and Mark D. Griffiths, Why Swedish People Play Online Poker and Factors that Can Increase or Decrease Trust in Poker Web Sites: A Qualitative Investigation, Journal of Gambling Issues, 21 (July 2008): 8097 at p. 90. See Supra at footnote 71. See Supra at footnote 6 Bo Bernhard at p. 38-39. See Id. at p. 4043. Mike Brunker, Poker Bots Raking Online Pots? MSNBC.com, September 21, 2004. http://www.msnbc.msn.com/id/6002298/print/1/displaymode/1098/ (last accessed on July 25, 2009). Also see Supra at footnote 93, slide 7. See Id. Bill Rini, The Definitive Guide to Online Poker Cheating, April 16, 2008. http://www.billrini.com/2008/04/16/the-definitive-guide-to-online-poker-cheating/ (last accessed on July 25, 2009). See Supra at footnote 69 Christopher Grohman at p. 63.

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The Absolute Poker and UltimateBet cheating cases, mentioned previously, involved players using superuser accounts that allowed them to see other players hole cards in online poker, making them essentially unbeatable.102 Hackers can potentially alter sites to ensure winnings or swing odds in their favor, as in a case in 2001 in which hackers rigged games on two gambling sites and managed to win $1.9 million in just a few hours.103 2. Existing Controls in Other Jurisdictions

Although the UltimateBet and Absolute Poker cheating scandals involved participation from insiders at the affected poker sites, it is important to note that both episodes were revealed through the investigative work of other players on the sites.104 Although players have an incentive to reveal fraud by other players, some level of regulatory oversight and potential law enforcement involvement is needed to ensure that the site operator takes complaints lodged against players seriously. The regulator could mediate disputes between the site operator and players, independently monitor sites for cheating, and work with site operators to help them prevent cheating. The following are examples of ways that other jurisdictions combat player fraud: The British Gambling Commission requires that licensees put into effect a written procedure for handling customer complaints and disputes and also have arrangements for disputes to be referred to an independent third party if they are not resolved to the customers satisfaction.105 Tasmanias Gaming Commission requires that customer complaints can be made to it and has the power to levy fines and revoke sites licenses as well as settle customer disputes. It also has access to the systems of its licensees.106 Gibraltar also requires that sites have a formal system to handle customer complaints.107

102

See Supra at footnote 83. RSe Consulting, A Literature Review and Survey of Statistical Sources on Remote Gambling, October 2006, http://www.culture.gov.uk/images/publications/RemoteGambling_RSeReport.pdf (last accessed on July 25, 2009), at p. 20. See Supra at footnote 66. See Supra at footnote 33 at p. 15. Noted in an August 5, 2009 interview with Glenn Gibson, Manager of Technical and Systems Audit at the Tasmanian Gaming Commission, and Damien Jarvis, Assistant Director of the Liquor and Gaming Branch of the Tasmania Department of Treasury and Finance (Australia). See Supra at footnote 32 at p. 1718.

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Sites own terms of service often explicitly preclude certain potentially fraudulent behaviors.108 3. Relevant Technologies for Risk Mitigation

As with the issue of fraud by site operators, technology offers solutions to help combat fraud by players. The first line of defense is analysis by other players, who may be in a position to observe aberrant behavior, investigate it, and lodge a complaint with the site operator. However, players may have a hard time detecting cheating as it is occurring, because of the speed and style of online gambling. Site operators, on the other hand, can store large volumes of data on gambling transactions and present them in an easy-to-analyze format, unlike operators of landand river-based casinos. Analysis of hand histories in poker, for example, may allow operators to identify collusion, the use of poker bots, and other unusual gameplay activities. The regulator may require that the site operator provide these data at regular intervals for analysis in the event that an inquiry or red flag is triggered. It might also mandate implementation of pattern recognition software to scan routinely for anomalous betting patterns. Finally, the regulator could provide sites data history to third-party verification companies that conduct their own analyses, including checks for randomness, collusion, and other suspicious patterns. Clearly, players want to know that their online gambling experience is fair. According to the survey of Swedish poker players, [t]he response of the operator to [issues of cheating] played a major role in whether or not they were trusted in the long term.109 Gambling sites, especially reputable ones, have an incentive to control cheating to maintain their good reputation. However, although the revelation of cheating can itself be damaging to a sites reputation, the site can often continue to make money as usual even while players are being defrauded.110 A regulatory structure, therefore, must balance these contradictory incentives. It must combine strong internal controls by site operators with strict regulatory oversight, perhaps by requiring that mandatory hand history reports or other similar data be submitted to the regulator or through the use of regulator-verified poker bot detection software.111 Also, the regulator could maintain a
108

For example, multitabling and collusion are considered cheating according to poker room rules. See Christopher Grohman, Reconsidering Regulation: A Historical View of the Legality of Internet Poker and Discussion of the Internet Gambling Ban of 2006, Journal of Legal Technology Risk Management, 1, No. 1 (Fall 2006): 3474, at p. 63; and Bill Rini, The Definitive Guide to Online Poker Cheating, April 16, 2008, http://www.billrini.com/2008/04/16/the-definitive-guide-to-online-poker-cheating/ (last accessed on July 25, 2009). See Supra at footnote 94 at p. 90. As in the UltimateBet and Absolute Poker scandals. Also see Supra at footnote 98 Mike Brunker. For example, bwin has dedicated staff that deploy [s]tate-of-the art systems [that] are used to analyze hands and to detect chip dumping, collusion or the use of poker bots. From an August 13, 2009 correspondence with Katharina Riedl of bwin (Austria).

109

110

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database of known cheaters, and sites own verification processes could help exclude such gamblers at the point of registration. This strategy also has the benefit of preventing cheaters from skipping easily from one website to another. Regulation could also grant players the right to bring a civil claim against a gambling site for not preventing cheating by its users, providing additional incentives for sites to implement effective controls.112 4. Conclusion

Site operators, players, and regulators share an interest in detecting and protecting against player fraud. This naturally leads to cooperative regulatory oversight. Such oversight would recognize the inherent opportunities in the online environment for comprehensive data storage, allowing a level of analysis to detect fraud that is unavailable in the bricks-and-mortar environment. Consequently, legal, regulated online gambling should provide greater protections against player fraud than does the current environment. D. Involvement of Organized Crime in Gambling Operations

Casino gambling, in which nearly all transactions are in cash, is particularly susceptible to skimming, in which profits are removed by the owners or other insiders before being declared, as well as money laundering.113 Moreover, its illegal status in many jurisdictions implies that those who offer gambling services in those jurisdictions are, by definition, law breakers. Online gambling, however, presents different challenges and opportunities than does its bricks-andmortar counterpart. On the one hand, identities can be easier to conceal online, transactions can occur far from where regulators are located, and members of collaborating crime networks can be located in far-flung locations.114 On the other hand, online transactions are easier to aggregate and analyze, providing richer opportunities to detect the operations of organized crime groups.115 The lack of cash transactions makes auditing and the detection of skimming easier than in a bricks-and-mortar environment. 1. The Issue of Involvement of Organized Crime in Online Gambling

Organized crime has been largely eliminated from bricks-and-mortar casinos.116 In Nevada, for example, the regulatory regime has largely eliminated criminals from the ownership of
112

See Supra at footnote 69 at p. 6768. Jay Albanese, Casino Gambling and Organized Crime: More Than Reshuffling the Deck, in Contemporary Issues in Organized Crime, edited by Jay Albanese (Monsey, New York: Criminal Justice Press, 1995). Also see Kevin B. Kinnee, Practical Gambling Investigation Techniques (New York: Elsevier, 1992), at p. 35. See Supra at footnote 64 at p. 128. As noted in an August 5, 2009 interview with Phill Brear, Head of Gambling Regulation at the Gibraltar Regulatory Authority, online gambling allows a perfect audit trail to be kept. Jay Albanese, Casino Gambling and Organized Crime: More Than Reshuffling the Deck, in Contemporary Issues in Organized Crime, edited by Jay Albanese (Monsey, New York: Criminal Justice Press, 1995), at p. 4 5.

113

114

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casinos.117 Another factor in the Nevada transformation has been the introduction of large, publicly held companies as casino owners, which cannot afford associations with organized crime.118 The same effect may hold true for online gambling enterprises, some of which are already publicly traded. In the past, when organized crime had been involved in bricks-and-mortar casinos, it traditionally controlled the gambling organization itself, usually behind the presence of a front man in cases of legal gambling establishments.119 Similarly, gambling websites could be controlled by organized syndicates. Finally, as discussed more fully in Section F, criminals can use online gambling for the purpose of money laundering. 2. Existing Controls in Other Jurisdictions

In bricks-and-mortar casinos, background checks and verification for site operators and employees are standard procedures across all jurisdictions in the United States. In New Jersey, those who wish to operate a casino are required to obtain a casino license.120 Applicants must prove their financial stability and integrity; the financial integrity of their investors or backers; their good character, honesty, and integrity; and their business ability and casino experience. They must also submit to a criminal background check.121 Each casino employee must obtain a valid casino employee license, which involves providing his or her name, address, and fingerprints; and to consent to a criminal background check, which the New Jersey State Police performs at the applicants expense.122 The State Police are also obliged to notify the New Jersey Division of Gaming Enforcement if a license holder is arrested at any point after the initial background check.123 To eliminate small gambling establishments, casinos in Atlantic City are required to have a minimum of 500 hotel rooms, and all games are tightly regulated and controlled. Also, those that provide a certain amount of ancillary services (such as cleaning, food, construction, and security) to casinos must be licensed and submit to background checks.124 Similarly, Nevada laws impose on operators of gambling establishments licensing requirements that require that the applicant (1) be a person of good character, honesty, and integrity; (2) be a person whose prior reputation and criminal record do not pose a threat to the public interest of
117

See Id. at p. 4. See Id. at p. 78. See Id. at p. 3. New Jersey Permanent Statutes, Title 5, Amusements, Public Exhibitions and Meetings, 5:12-82: Casino license applicant eligibility. Id. at 5:12-84: Casino license applicant requirements. See Id. See Id. See Supra at footnote 116 at p. 10.

118

119

120

121

122

123

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the state or of its gambling regulations; and (3) have sufficient financial resources and business acumen to operate the establishment.125 Employees in general are required to register as gaming employees, to submit fingerprints, and to be subjected to an FBI background check. The Nevada Gaming Control Board is empowered to object to any applicant for any cause deemed reasonable.126 Many jurisdictions across the world that license online gambling include provisions for checks on the sites operators. The following are examples of such provisions: In the Isle of Man, the Gambling Control Commission has the duty [t]o investigate the character and financial status of persons behind online gambling operations.127 The U.K. Gambling Act of 2005 allows the Gambling Commission, when issuing a license, to consider the integrity of the applicant or of a person relevant to the application and to refuse a license to a person convicted of a relevant offence.128 Alderneys Gambling Control Commission has the duty to determine whether an applicant is fit and proper to hold a license. Investigations can include interviews with key individuals, and the Commissioners may also require their own meeting with representatives of the applicant before deciding whether to grant a license.129 The regulator also requires that business associates of site operators and software providers hold licenses.130 Tasmanias Gaming Commission conducts thorough probity investigations on site operators, including credit checks and fingerprint background checks; the checks are also required for employees of the gambling website.131

125

Nevada Revised Statutes, Chapter 463.170. Id. at Chapter 463.335. See Supra at footnote 31 at p. 128. Gambling Act, 2005 Chapter 19 (Eng.), at 7071, http://www.opsi.gov.uk/acts/acts2005/pdf/ukpga_20050019_en.pdf (last accessed on September 11, 2009). See Supra at footnote 30 at p. 140141. Noted in an August 27, 2009 interview with Andr Wilsenach, Chief Executive Officer of the Alderney Gambling Control Commission. As noted in an August 5, 2009 interview with Glenn Gibson, Manager of Technical and Systems Audit at the Tasmanian Gaming Commission, and Damien Jarvis, Assistant Director of the Liquor and Gaming Branch of the Tasmania Department of Treasury and Finance (Australia).

126

127

128

129

130

131

35

The regulator in Australias Northern Territory checks the reputation of operators and their associates and proposed managers, as well as operators financial background, resources, and business ability.132 Gibraltars Gambling Act 2005 prevents the licensing authority from granting a license to a person who is not fit and proper or if granting the license would be against the public interest. The Gambling Act allows the regulator to take into account the licensees character, honesty, and integrity, as well as his or her reputation, business plan, experience, and other factors.133

As can be seen, each jurisdiction considers the exclusion of criminals to be essential to maintaining an effective regulatory regime. 3. Relevant Technologies for Risk Mitigation

Any regulatory regime that wishes to exclude criminals must focus on erecting sufficiently high barriers to entry.134 Simple techniques such as requiring background checks, interviews, and letters of reference can familiarize the regulator with its license applicants and allow it to make a more informed decision on whether to grant a license. This level of investigation of site operators could extend to owners, beneficiaries, business associates, managers, and security personnel.135 Rigorous vetting of new applicants can combine with ongoing compliance checks to ensure that once a license is granted, it is not clandestinely transferred to criminal control. 4. Conclusion

Although criminal control of gambling websites is a possibility, strict regulation would exclude unwanted site operators. It is unlikely that criminals would subject themselves to strict regulatory checks and demanding admission standards. Instead, they may attempt to operate gambling sites without licenses. Regulators can work to educate consumers about the dangers associated with unlicensed websites, and steer them toward licensed, regulated sites which offer protection against criminal activity. At the risk of losing their licenses, legitimate operators would have a strong interest in avoiding ineligible associates as is the case with bricks-andmortar casinos. We would expect legitimate, licensed sites to be receptive to a fair degree of scrutiny because such scrutiny would enhance the reputation of the industry.

132

As noted in an August 31, 2009, correspondence with John Sealy, Manager of Information Systems and Technology Services at the Licensing, Regulation and Alcohol Strategy division of the Northern Territory Department of Justice (Australia). Gibraltar Gambling Act 2005, Schedule 1, at 3, http://www.gra.gi/sites/gambling/downloads/42/gambling%20ord%202005.pdf (last accessed on August 6, 2009). See Supra at footnote 30 at p. 140. See Id.

133

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E.

Money Laundering by Players

A major concern of law-enforcement authorities is money laundering facilitated by online gambling.136 However, many financial analysts believe that the risks of money laundering in online gambling is low because electronic transactions are closely monitored and recorded. 137 A combination of anti-money-laundering regulations, currently in place for bricks-and-mortar casinos as well as other financial institutions, and the use of technology would provide the online gambling environment with better opportunities for detecting money laundering by players than those available in land- and river-based casinos. 1. The Issue of Money Laundering by Players

Money laundering is a process through which proceeds derived from illegal activity are legitimized.138 Money laundering is typically accomplished in three stages: (1) the placement stage, (2) the layering stage, and (3) the integration stage.139 The placement stage is defined as the first entry of illegal money into financial institutions or the retail economy. The layering stage consists of activities meant to hide the trail of money, generally involving the transfer of money among multiple entities. The final stage, the integration stage, is when the illegal funds are reintroduced into the economy to appear as though they were legitimate. It is difficult for law enforcement to detect this reintroduction of illicit funds into the economy without an audit trail established during the first two stages of the laundering process.140 The following (hypothetical) example demonstrates how online gambling websites can be used to launder money: A customer could establish an Internet gambling account under a false name and use illicit funds to conduct a minimal amount of betting. After a few losses, the customer could request repayment from the Internet gambling site and claim them as winnings, thereby creating a legitimate source for the remaining funds.141 The U.S. Department of Justice is concerned that online gambling offers criminals an easy vehicle for money laundering because of its anonymous nature, use of encryption, volume,
136

Government Accountability Office, Internet Gambling: An Overview of the Issues, GAO-03-89, December 2002, at p. 3437. See Id, at p. 3738. Mark D. Schopper, Internet Gambling, Electronic Cash & Money Laundering: The Unintended Consequences of a Monetary Control Scheme, Chapman Law Review, 5, No. 1 (2002): 303-330. Financial Crimes Enforcement Network, The SAR Activity Review Trends, Tips & Issues, May 13, 2008, http://www.fincen.gov/news_room/rp/files/sar_tti_13.pdf (last accessed on August 5, 2009). See Supra at footnote 138. Testimony of John G. Malcolm Before the Committee on Banking, Housing, and Urban Affairs, March 18, 2003, http://www.usdoj.gov/criminal/cybercrime/malcolmTestimony318.htm (last accessed on September 11, 2009). Also see Supra at footnote 136.

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138

139

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speed, international reach, and offshore locations.142 In his testimony before Congress in 2003, Deputy Assistant Attorney General John G. Malcolm noted that e-casinos are an excellent vehicle for money laundering because in addition to using the gambling services offered to hide or transfer money, online gambling websites offer a wide variety of financial services to their customers, including credit accounts, fund transmittal services, check cashing services, and currency exchange services.143 There is little documentation by which to gauge the extent of actual money laundering in online gambling. In 2002, the U.S. General Accounting Office (GAO) examined the vulnerability of online gambling to money laundering and concluded that the views on the vulnerability of Internet gambling to money laundering are mixed.144 Its report provides only hypothetical examples of how online gambling sites could be used to launder money and does not describe any actual cases. A 2005 report prepared for the Interactive Gaming Council in Canada calls evidence of the existence of money laundering in online gambling scant and claims that the Internet Crime Complaint Center had never logged a complaint of money laundering through gambling sites.145 It goes on to claim that Internet gaming does not, in and of itself, contribute to money laundering. Rather, it is the financial transactions that are used to move money on the Internet that may be susceptible to money laundering.146 One can understand money laundering patterns that might occur in online gambling by extrapolating from the patterns of money laundering seen in bricks-and-mortar casinos. Various betting patterns associated with money laundering in bricks-and-mortar casinos have been identified, including the use of hedged bets by colluding players, light betting or minimal play (i.e., using bets that are small relative to the size of deposits and withdrawals), splitting transactions up into units smaller than reporting thresholds, splitting transactions across reporting days, and pressuring staff to not comply with their reporting obligations.147 A problem related to money laundering is that of terrorist financing, in which funds that are intended for terrorist groups are moved through the financial system in an apparently legitimate way. Effective anti-money-laundering provisions must specifically address the risks of terrorist financing, although many techniques to combat money laundering are also effective against

142

See Id. John G. Malcolm. See Id. See Id. NFC Global, Internet Gaming & Money Laundering: Measuring the Scope, Assessing the Risks, Prepared for the Interactive Gaming Council, Vancouver, British Columbia, Canada, August 2005, at p. 4. See Id. American Gaming Association, Suspicious Activity Reporting Policy, http://www.americangaming.org/assets/files/SARC_Policy_(6).pdf (last accessed on July 28, 2009).

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144

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terrorist financing.148 The only known case of money laundering through gambling sites was related to terrorist financing: in 2007, a suspected terrorist named Al-Daour used stolen credit cards to deposit funds at 43 different gambling sites and then withdrew the winnings to various online bank accounts.149 2. Existing Controls in Other Jurisdictions

Congress has enacted legislation to detect money laundering. Under the Bank Secrecy Act (BSA) of 1970, all U.S. financial institutions, including banks, credit unions, securities firms, and casinos, are required to report large currency transactions and suspicious activities.150 The Financial Crimes Enforcement Network (FinCEN) administers these regulations. The casino gambling industry has been covered by the BSA since 1985, and FinCEN has specific regulations that pertain to casino gaming. The BSA requires the reporting of any currency transactions exceeding $10,000 in a single gaming day on a Currency Transaction Report (CTR). 151 Because money launderers can structure transactions such that they never result in a CTR being filed, all land- and river-based casinos are also required to file Suspicious Activity Reports (SARs). Casinos have to file SARs if they know, suspect, or have reason to suspect that a transaction involving $5,000 or more meets certain criteria, including involvement of illicit funds, intention to avoid or prevent proper reporting, exhibiting of abnormal behavior, or use of the casino to facilitate criminal activity.152 The leading online gambling jurisdictions have created regulatory structures that resemble traditional regulation for land- and river-based casinos in the United States. These jurisdictions require some form of anti-money-laundering monitoring, ranging from restricting customers to a single account to identifying and reporting suspicious transactions or players abnormal betting patterns.153 In addition to regulation that combats money laundering in its financial services sector, the Isle of Man has put in place the Anti-Money Laundering Code to prevent money laundering through gambling websites.154 Operators are required to comply with strict anti-money-laundering
148

MHA Consulting, The Threat of Money Laundering and Terrorist Financing through the Online Gambling Industry, report prepared for the Remote Gambling Association, June 2009, at p. 68. See Id at p. 31. American Gaming Association, Money Laundering, AGA Fact Sheet, http://www.americangaming.org/Industry/factsheets/issues_detail.cfv?id=3 (last accessed on September 11, 2009). See Id. See Id. David O. Stewart, An Analysis of Internet Gambling and Its Policy Implications, AGA 10th Anniversary White Paper Series on Internet Gambling, 2006. See Supra at footnote 31 at p. 126127.

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procedures, which include identification of prospective customers, evidence of identity, changes to patterns of transactions, record keeping, records of transactions, retention of records, reporting suspicious transactions, and training.155 In addition, site operators are legally required to report any suspicious transactions to the Financial Crime Unit (FCU). Specialized software can flag these transactions. Similarly, to combat money laundering, Alderney requires operators of online gambling websites to implement business risk assessments, customer due diligence procedures, monitoring of transactions and other activity, suspicious activity reporting procedures, employee screening and training procedures, and record-keeping procedures.156 3. Relevant Technologies for Risk Mitigation

An anti-money-laundering regulatory regime for online gambling may be modeled on the current regulatory structure for traditional bricks-and-mortar casinos. A regulatory framework for online gambling may leverage the technological environment for online gambling and require (1) preservation of an audit trail of transactions for analysis by federal authorities; (2) implementation of customer identification standards; (3) controls to prevent anonymous, structured transactions; (4) establishment of an anti-money-laundering compliance program; (5) training for all appropriate personnel; and (6) compliance with all relevant BSA requirements. 157 The IGC notes that online gambling, with a combination of regulatory oversight and use of technologywhile facing the same threats as real-world gambling facilitiesis in a better position to address these risks.158 For example, all electronic fund transfers can be electronically recorded, thus providing a detailed and automatic transaction trail not currently available in land- and river-based casinos.159 The IGC further notes that a basic requirement to combat money laundering is to know your customer. Stringent player registrations and ongoing verification processes combined with appropriate regulatory oversight and banking regulations help fulfill this requirement. 160 Italys regulatory regime, for example, requires a potential customer to submit a signed contract along with a copy of his or her identification.161 Tasmania requires strong identity verification
155

See Id. See Alderney Gambling Control Commission, The Alderney eGambling Regulations, 2006., http://www.gamblingcontrol.org/userfiles/file/97.pdf (last accessed on August 19, 2009), at Schedule 6, Part VI. See Id. Interactive Gaming Council, Online Gambling Sites Less Susceptible to Money Laundering Than Real-World Counterparts, Winner Online, September 24, 2002, http://www.winneronline.com/articles/september2002/fatf.htm (last accessed on September 11, 2009). See Supra at footnote 115. See Supra at footnote115. As noted in an August 13, 2009 correspondence with Katharina Riedl of bwin (Austria).

156

157

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159

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procedures to be in place on player accounts.162 Moreover, technology can equip site operators with tools to scrutinize inconsistent player behavior, and then capture and report the transaction.163 Another essential anti-money-laundering measure noted by the IGC is to require that gamblers be paid any winnings in the same way in which the money was originally deposited. 164 This system allows an audit to track transfers of funds much more easily and removes the ability of launderers to use an account as a pass-through for funds.165 Also, care must be taken when allowing transfers of funds between players, which could potentially be a conduit for money laundering. Alderneys money laundering guidance suggests that transferred funds be allowed only for gambling and not for withdrawal or that site operators undertake further due diligence on players involved in transfers.166 In addition to a system modeled on requirements for bricks-and-mortar gambling, a regulator can require the same procedures that are required of online merchants, banks, and payment providers. In Europe, online gambling operators have been bound by these requirements since 2003 under the Third European Money Laundering Directive.167 U.S. licensed operators would also be bound by relevant anti-money-laundering requirements. Most nations are also subject to the recommendations of the Financial Action Task Force, an international body formed to combat money laundering and terrorist financing. Each nation may also have its own money laundering regulations, such as the United Kingdoms Money Laundering Regulations, which cover both financial and nonfinancial businesses.168 Although financial businesses are still subject to the most stringent regulation, all of these regulations use a risk-based approach, in which the level of scrutiny of transactions is commensurate with the risk of money laundering in those transactions.169 The most important aspects of financial companies risk mitigation involve three broad activities: (1) know your customer procedures, (2) monitoring for suspicious activity, and (3) procedures for reporting suspicious activity.170 Identity verification can involve both paper and electronic identification,
162

As noted in an August 5, 2009 interview with Glenn Gibson, Manager of Technical and Systems Audit at the Tasmanian Gaming Commission, and Damien Jarvis, Assistant Director of the Liquor and Gaming Branch of the Tasmania Department of Treasury and Finance (Australia). See Id. See Supra at footnote 158. See Supra at footnote 148 at p. 26. Id. at p. 20. Id. at p. 1. Id. Id. at p. 2. Id. at p. 2931.

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164

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and the level of additional identification required rises with the risk in the particular industry and transaction. Suspicious activity monitoring involves standard procedures that are designed to reveal signs of monitoring while retaining privacy protection. All suspicious activity must be reported to law enforcement, which takes over the investigation immediately. Suspicious activity reporting, as part of the regulations, is the responsibility of all company staff members, who must be trained in the signs of money laundering and be able to report their suspicions expeditiously. In the United Kingdom, not reporting suspected money laundering is a criminal offense with a maximum sentence of two years in prison.171 4. Conclusion

Players or groups of players acting in concert may attempt to use legitimate gambling operations for money laundering. To curb such activities, regulators could subject online gambling operators to anti-money-laundering regulations that are currently in place for bricks-and-mortar casinos and for online merchants, banks, and payment providers. The online environment provides better opportunities for detecting money laundering by players or player groups than do bricks-and-mortar casinos. In an effective anti-money-laundering regime, site operators would be required to retain comprehensive data on all deposits, withdrawals, and betting transactions and to make these available to regulators for examination and analysis. Given complete data, most patterns related to money laundering (such as light betting or matched bets placed by collaborators) would be easier to detect than they are in a physical environment (where complete transaction histories are available only in the form of video recordings).172 Software for detecting anomalies and suspicious behavior may be operated easily and routinely on digital databases by operators, regulators, or both. The site operators obligations with respect to their own detection of money laundering would form a part of their ordinary compliance obligations under such a licensing regime. Because of the absence of cash in online gambling transactions, the auditable record that is created, and the regulator-imposed reporting requirements for most transactions, it is likely that site operators can prevent money laundering by players and terrorist financing at least as effectively as can bricksand-mortar casinos.173 In contrast, the current prohibitions related to online gambling forces players to use unconventional forms of payment that leave harder-to-follow audit trails, and may therefore increase the risk of money laundering.

171

Id. at p. 23. As noted in an August 5, 2009 interview with Phill Brear, Head of Gambling Regulation at the Gibraltar Regulatory Authority. As noted in an August 3, 2009 interview with Paul Mathews, Former Senior Vice President of IGT Wagerworks.

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F.

Money Laundering by Site Operators

In addition to money laundering by players, there are concerns about money laundering by site operators.174 The volume, speed, and international reach of Internet transactions, along with the offshore location of many Internet gambling sites, increase the potential for misuse of these sites by operators for laundering money. As such behavior would constitute criminal conduct by site operators, effective management of the problem involves regulatory restrictions designed to keep criminals out of the Internet gambling industry. 1. The Issue of Money Laundering by Site Operators

The GAO reported in 2002 that U.S. law-enforcement officials believed money launderers might develop Internet gambling sites for the sole purpose of laundering money. 175 GAO sited the possibility that a gambling site operator could design software to skim a percentage of customer deposits and cloak the transactions as gaming losses. In reality these deductions would serve as the operators service fee for laundering illicit funds. An alternate scenario might involve a gambler transferring funds to the site operator or to a collaborator within the e-casino by continuing to play until he loses the requisite amount. Conversely, if the site operator wanted to transfer funds to a gambler, the games could be rigged so the gambler won.176 Two recent cases, involving NETeller and playwithal.com, highlight the possibility of online gambling operators using third-party conduits to engage in money laundering, concealing the true nature and purpose of financial transactions. In early 2007, the founders of NETeller, a popular third party payment processor based in the Isle of Man, were arrested and charged with laundering billions of dollars of Internet gambling proceeds.177 In 2006, the Federal Bureau of Investigation (FBI) began investigating how NETeller processed payments and helped facilitate sports bets. NETeller used payment and shell companies to process Automatic Clearinghouse (ACH) transactions, thus hiding the nature of payments made to U.S. customers. To get money out of the United States, NETeller would have a payment service company receive funds on its behalf and transfer the funds to an account controlled by NETeller in Alberta, Canada. In the case involving playwithal.com, a sports betting website, 27 people were charged with numerous counts, including money laundering.178 The defendants were accused of laundering
174

General Accounting Office, Internet Gambling: An Overview of the Issues, GAO-03-89, December 2002, at p. 36. See Id at p. 37. Testimony of John G. Malcolm Before the Committee on Banking, Housing, and Urban Affairs, March 18, 2003, http://www.usdoj.gov/criminal/cybercrime/malcolmTestimony318.htm (last accessed on July 29, 2009). Verrinder, Matthew, NETeller Ex-directors on Money Laundering, January 16, 2007, http://www.reuters.com/article/internetNews/idUSN1622302920070116 (last accessed on September 11, 2009). Online Gambling Operations in Queens Busted, November 16, 2006, http://online.casinocity.com/article/online-gambling-operation-in-queens-busted-68919 September 11, 2009).

175

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and stashing away millions of dollars using shell corporations and bank accounts in Central America, the Caribbean, Switzerland, and Hong Kong. 2. Existing Controls in Other Jurisdictions

The United States has already enacted strict regulations to detect and deter money laundering, and site operators should clearly be forced to comply. Control strategies for this risk thus focus on keeping organized crime, other criminals and criminal behavior out of the industry. 179 As for all the other concerns about criminal conduct by operators, regulators will set a high bar for initial qualification and conduct periodic reviews of key personnel and their associations. Other jurisdictions do this already. The Isle of Man, U.K., and Alderney assess the suitability of license applicants and require them to submit documentation to satisfy the enforcement authorities that they are persons of good character, honesty and integrity.180 Operators in these jurisdictions are also required to provide comprehensive financial statements and internal accounting records for audit.181 In many U.S. states, background checks and employee verification are already standard procedure for bricks-and-mortar casinos. For example, in New Jersey and Nevada, to obtain a license, each casino employee must supply his or her name, address, fingerprints, and consent to a criminal background check.182 Bricks-and-mortar casinos are also required to provide periodic financial reports at a level of detail and in formats specified by regulators.183 3. Relevant Technologies for Risk Mitigation

Effective strategies to combat money laundering by site operators involve frequent and comprehensive auditing, the application of pattern recognition to aggregated financial transaction data, and exclusion of criminals.

179

McCormick, Amanda, Review of Online Gambling Literature, British Columbia Center for Social Responsibility, 2007. Testimony of Mary Williams, in U.S. House of Representatives, Committee on Financial Services, Can Internet Gambling Be Effectively Regulated to Protect Consumers and the Payments System? 110th Cong., 1st Session, June 8, 2007, p. 128. Also see Supra at footnote 128. Also see Testimony of Andr Wilsenach, in U.S. House of Representatives, Committee on Financial Services, Can Internet Gambling Be Effectively Regulated to Protect Consumers and the Payments System? 110th Cong., 1st Session, June 8, 2007, at p. 140141. Testimony of Mary Williams, in U.S. House of Representatives, Committee on Financial Services, Can Internet Gambling Be Effectively Regulated to Protect Consumers and the Payments System? 110th Cong., 1st Session, June 8, 2007, at p. 126127. New Jersey Permanent Statutes, Title 5, Amusements, Public Exhibitions and Meetings, 5:12-82: Casino license applicant eligibility. Also see Nevada Revised Statutes, Chapter 463.335. See Id Nevada Revised Statutes at Chapter 463.156159.

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4.

Conclusion

As with the prevention of fraud and any other criminal conduct by site operators, an effective regulatory regime would seek to bar criminals from entering the Internet gambling industry, and seek to detect and prevent linkages developing between site operators and criminal organizations. Regulators would also develop the capacity to search for laundering patterns among the betting transaction data, as well as among the external financial flows data for regulated sites. Regulators of the online gambling industry would also become natural partners for the broader law-enforcement community seeking to detect and prevent money laundering. G. Violation of Jurisdictional Restrictions or Prohibitions

A key concern of some policymakers is the ability of regulated online gambling sites to adhere to various jurisdictional restrictions and prohibitions.184 For example, with bricks-and-mortar casinos, some states have complete prohibitions (e.g., Utah) while others have legalized most forms of gambling (e.g., Nevada).185 Add to this mix the numerous Native American tribal areas, and a complicated multilayered jurisdictional map emerges. This section does not comment on federalism or the appropriateness of various levels of jurisdictional control over online gambling. Rather, we look at the ability to ensure through federal regulation that restrictions and prohibitions imposed at various other jurisdictional levels continue to be respected. 1. The Issue of Violation of Jurisdictional Restrictions

A central issue in the debate over legalization of online gambling pertains to different jurisdictions abilities to preclude gambling website operators from operating from, or serving customers within, specific states or territories.186 Federal laws, such as the Wire Act and the UIGEA, removed some aspects of states ability to choose legalization and regulation.187 On the one hand, the passage of the UIGEA in 2006
184

In October 2008, Governor Steve Beshear of Kentucky initiated a lawsuit against gambling sites serving customers in Kentucky; a court ordered 141 website domain names to be transferred to the states control. The case was later overturned on appeal in January 2009 and is currently being appealed to the Kentucky Supreme Court. In April 2009, the state of Minnesota sent notice to 11 Internet service providers (ISPs) seeking to force them to block access to gambling sites for Minnesota residents. In June, the state rescinded its order. See Poker News Daily, Minnesota Rescinds Internet Gambling Notices to ISPs after iMEGA Settlement, June 8, 2009, http://www.pokernewsdaily.com/minnesota-rescinds-internet-gambling-notices-to-isps-after-imega-settlement2749/ (last accessed on August 10, 2009). American Gaming Association, States with Gaming, AGA Fact Sheet, http://www.americangaming.org/Industry/factsheets/general_info_detail.cfv?id=15 (last accessed on July 21, 2009). Kevin F. King, Cutting Internet Gamblings Gordian Knot: Geolocation and Federalism on the Internet, Northwestern University Law Review, July 14, 2009, http://ssrn.com/abstract=1433634 (last accessed on July 20, 2009).

185

186

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increased the federal governments control over online gambling and restricts users ability to fund their online accounts, casting a broad net over any state attempts to legalize online gambling.188 On the other hand, states have no recourse against offshore sites that provide gambling services to their residents.189 Despite concerns that the legalization of online gambling would override various jurisdictions rights to regulate gambling, technology can give states that opt out of legalization some assurance that their restrictions will be enforced.190 A well-crafted federal regulatory regime could respect jurisdictional differences with regard to legalization of online gambling. 2. Regulatory Strategy

Proposed legislation provides for the ability of states and Native American tribal groups to opt out of legalization.191 A federal licensing system would need to ensure (1) that site operators adopt and implement systems to enforce any applicable Federal, State, and Indian tribe limitations on Internet gambling and (2) that license applicants have a program to verify the State or tribal land in which the customer is located at the time the customer attempts to initiate a bet or wager.192 Further, currently proposed legislation prohibits licensees only from knowingly accepting bets from jurisdictions that opt out, presumably to prevent state actions against operators for mere negligence.193 It would be possible to press operators further, requiring them to acquire and operate state-of-the-art methods in this area, effectively guaranteeing their knowledge in all but the most unusual of circumstances. A regulatory strategy to solve jurisdictional issues must entail oversight by a regulator that can monitor site operators, including the use of mystery shopper, to ensure compliance. Beyond that, however, the issue of different jurisdictional restrictions or prohibitions is essentially a technical question: does the technology exist to implement such restrictions or prohibitions?
187

See Id. at p. 25. See Supra at footnote 18 at p. 933. See Id. at p. 930. Spencer Bachus, Online Gambling Leads to Crime and Hurts Young, So Why Encourage It? Asks Spencer Bachus, US News & World Report, June 1, 2009, http://www.usnews.com/articles/opinion/2009/06/01/online-gambling-leads-to-crime-and-hurts-young-so-whyencourage-it-asks-spencer-bachus.html (last accessed on July 30, 2009). There is a need to extend the regulatory provisions of this Act to all persons, locations, equipment, practices, and associations related to Internet gambling, with each State and Indian tribe having the ability to limit Internet gambling operators from offering Internet gambling to persons located within its territory by opting out of the provisions of this Act (Internet Gambling Regulation, Consumer Protection, and Enforcement Act, H.R. 2267, 111th Cong. (2009), 5381, 6). See Id. at 5381, 5. Also see Id at 5384(b)(1). See Id. at 5386(a)(1)(A). Also see Supra at footnote 186 at p. 17.

188

189

190

191

192

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3.

Relevant Technologies for Risk Mitigation

Many technologies are available to mitigate the risks of jurisdictional violations of restrictions or prohibitions. To adhere to UIGEA restrictions that prohibit funding of online gambling accounts, some overseas gambling operators, such as PartyGaming, Sportingbet, and Paradise Poker, have used geolocation techniques to selectively deny services to their customers on the basis of their location within the United States.194 Similar technology may also be applied to help address the problem of jurisdictional differences in gambling law within the United States. Geolocation entails using Internet infrastructure information to determine the geographic location of Internet Protocol (IP) addresses associated with Internet-connected devices.195 It is a way of determining the physical location of an Internet user, with varying degrees of accuracy. When an Internet user types a website address into a Web browser, the browser sends an access request to the server of the requested website. This request reveals the IP address of the user, which the requested website forwards to a geolocation provider. The provider, which has built a database of the locations of IP addresses, assesses the location of the user. Public-source geolocation data can often identify the location of IP addresses at the country, state, and even city levels.196 Gambling websites would, of course, require initial registration information from their users, including the users name and address. This is the first line of defense against jurisdictional concerns, because a person attempting to register with a Utah address, for example, would be precluded from opening an account.197 This information can be cross-checked against supplied information, such as credit card information, bank account numbers, drivers license details, or passport information to determine any mismatch in the reported location.198 Players from excluded jurisdictions, or ones whose physical location cannot be verified, can summarily be prevented from opening an account. This process should serve as a deterrent to casual users in prohibited jurisdictions who do not intend to circumvent the laws of their jurisdiction. Subsequently, however, the site must use geolocation to ensure that users, even if they were eligible at registration, are in a permitted
194

See Supra at footnote 60, at 3436. Quova, The Factors of Geolocation, iGaming Business, http://gw.vtrenz.net/index.cfm?method=cMicrositeSecurity.displayLogin&dkey=XOV3IU9JU5 (last accessed on July 21, 2009). D. J. B. Svantesson, How Does the Accuracy of Geo-Location Technologies Affect the Law? Masaryk University Journal of Law and Technology, 2, No. 1 (Summer 2008): 1121, at p. 12. Assuming that the state of Utah, which currently prohibits gambling, would continue to do so under a federal regulatory regime. As noted in an August 21, 2009 interview with Andrew Fritchie, General Counsel of PartyGaming PLC.

195

196

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jurisdiction while gambling. Geolocation software can pinpoint the users location and, if in doubt, flag it for site operators to either further investigate or block access immediately. Critics of geolocation claim that it is inherently unreliable and subject to relatively easy circumvention, citing failure rates in the range of 20% to 30%.199 For example, a wireless access card, a common method of accessing the Internet on a laptop while traveling, may confuse geolocation services, and each service may show the user to be in highly disparate locations.200 The online gambling firm bwin uses a geolocation service, and although the company believes that the service can reliably determine the country in which a player is located, it does not currently rely on results at a state or city level.201 Supporters and geolocation companies themselves, however, insist that the technology is highly accurate. Quova, a market leader in geolocation technology, claimed virtually 100% accuracy in helping Ladbrokes, the worlds largest bookmaker, to block Dutch users from accessing its site.202 Other estimates of accuracy run from 85% to 99%.203 Geolocation technology is already used for a number of purposes, such as restricting access to content, protecting media rights, and delivering location-based content to users. It is used by organizations such as the New York State Lottery, the British Columbia Lottery, Major League Baseball, and the Alaska Permanent Fund.204 It is also used to detect and deter fraud at online retailers by comparing the users location with his or her credit card address, for example, and governments and law enforcement agencies use geolocation to help track Internet criminals.205 Technologies to circumvent geolocation do exist, such as overt and transparent proxies, firewalls, filters and filtering services, Network Address Translators, private address spaces, point-to-point links, tunnels, and Virtual Private Networks (VPNs), that further obfuscate the
199

Statement of Jeff Schmidt, in U.S. House of Representatives, Committee on Financial Services, Can Internet Gambling Be Effectively Regulated to Protect Consumers and the Payments System? 110th Cong., 1st Session, June 8, 2007, at p. 1819. See Id. As noted in an August 13, 2009 correspondence with Katharina Riedl of bwin (Austria). A Dutch court had ordered Ladbrokes, a U.K. bookmaker, to prevent domestic users from accessing its site. See Supra at footnote 195. See Supra at footnote 186 at p. 15. See Supra at footnote 40 at p. 53. Also see Larry Barrett, Major League Baseball Struggles to Reach Fans Online, Baseline, March 7, 2005, http://www.baselinemag.com/index2.php?option=content&do_pdf=1&id=3506 (last accessed on September 4, 2009). Also see Quova, Quova Helps the Alaska Permanent Fund Dividend Division Run Like a Well-Oiled Machine, Quova case study, 2008, https://www.vtrenz.net/imaeds/ownerassets/818/08277_Alaska_casestudy_REV2.pdf (last accessed on September 10, 2009). Quova, The Science of Geolocation, http://www.quova.com/Technology/thescienceofgeolocation.aspx (last accessed on September 4, 2009).

200

201

202

203

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true source and destination of communications.206 In some cases, the user could be on a different continent from the one indicated by their IP address because he or she may be using one of the above technologies that masks the true location. VPN programs, which many people use to access work networks from home or while traveling, effectively mask ones location. In fact, many gateways to the Internet, such as America Online or proxy servers, by their nature offer geographic separation between the IP address and the end user.207 Geolocation software, however, can exploit the physical characteristics of the connection, such as the round-trip delay, to detect these countermeasures and assign a confidence factor, indicating the probability that the reported location is the users actual location.208 Also, the software can determine if the destination address belongs to a cable company, a DSL provider, or a dial-up ISP. Thus, the destination can indicate the users connection type and whether it is too risky to accurately verify the users location.209 In these cases, the customers account can be blocked completely from using the service until his or her location can be determined with greater certainty, or the sites compliance department can flag the account for further review. Further review could involve requiring the user to submit additional information, which then may be subject to manual or real-time verification.210 The regulator may impose specific requirements on the confidence of any geolocation information, on the basis of the confidence factor determined by the software, in essence to tune the thresholds for acceptance, rejection, and further verification.211 For example, the New York Lottery and the British Columbia Lottery use Aristotles verification service for geolocation. Both organizations require nearly 100% confidence scores in order to allow users to participate in their respective lotteries.212 In this way, regulators can have as much assurance as they require in the geolocation system, making it an effective means of excluding individuals in any specific jurisdiction. 4. Conclusion

Beyond the issue of sanctions, licensed sites may have an incentive to be lax with geolocation controls: excluding users from certain states lowers their overall customer base. Therefore, a
206

See Supra at footnote 199 at p. 83. As noted in an August 21, 2009 interview with Andrew Fritchie, General Counsel of PartyGaming PLC. Quova, GeoPoint by Quova, white paper, July 2006, https://www1.vtrenz.net/imarkownerfiles/ownerassets/818/GeoPointbyQuova_WHITEPAPER.pdf (last accessed on July 21, 2009), at p. 7. See Supra at footnote 195. See Id. As noted in an August 3, 2009 interview with Paul Mathews, Former Senior Vice President of IGT Wagerworks. Also see Supra at footnote 162. See Supra at footnote 40 at p. 53.

207

208

209

210

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regulator must ensure that geolocation controls are updated frequently and meet desired standards of quality. Frequent mystery shopping at U.S. sites conducted from locations within restricted states is one option, and violators could risk losing their valuable operating license if they chose to operate lax verification techniques. This combination of oversight and state-of-theart technology should help ensure that various jurisdictions maintain control over their own gambling laws and prevent complex interstate legal disputes. H. Breaches of Data Confidentiality

Online gambling websites often hold personal and confidential information of their customers, including credit card and bank account numbers, names, addresses, and other sensitive information. One of the challenges for a regulator is to ensure that personal information is used only for legitimate purposes and is not disseminated or accessed improperly. 1. The Issue of Data Confidentiality

All online businesses involved in monetary transactions are susceptible to breaches of data confidentiality.213 Breaches can include hackers stealing credit card or other personal information, employees storing or accessing sensitive information improperly, and sites accidentally releasing personal information.214 Although the deliberate theft of data is a significant problem, more than 88% of all cases of data breaches in 2008 resulted from insiders negligence.215 Once released, the data can then be used for various illegal purposes and may lead to identity theft and credit card fraud. Unlike other countries, the United States does not maintain any general data privacy laws at a federal level.216 Instead, individual states have wide latitude to enact laws protecting consumers data, and currently 45 states have laws governing data breaches by companies. 217 Online
213

In January 2009, Heartland Payment Systems, the United States fifth-largest payment processor, announced a data breach caused by hackers that may have compromised up to 100 million credit cards. TJX, a major operator of retail stores, experienced a data breach in 2006 that exposed tens of millions of cards. See Rachel King, Lessons from the Data Breach at Heartland, Business Week, July 7, 2009, http://www.msnbc.msn.com/id/31778540/ns/business-businessweekcom/ (last accessed on July 29, 2009). Identity Theft Daily, Identity Theft News: 2008 Data Breach Count is 69% greater than 2007, Identify Theft Daily, http://www.identitytheftdaily.com/index.php/20080716371/Latest/Identity-Theft-News-2008-Data-Breachcount-is-69-greater-than-2007.html (last accessed on July 29, 2009). PGP Corporation, 2008 Annual Study: Cost of a Data Breach, conducted by the Ponemon Institute, LLC, February 2009, at p. 5, http://www.encryptionreports.com/download/Ponemon_COB_2008_US_090201.pdf (last accessed on July 31, 2009). Dan Kaplan, Leahy, for Third Time, Submits Federal Data Security Law, SC Magazine, July 24, 2009, http://www.scmagazineus.com/Leahy-for-third-time-submits-federal-data-security-law/article/140604/ accessed on July 29, 2009).

214

215

216

(last

217

See Id. Also see National Conference of State Legislatures, State Security Breach Notification Laws, as of July 27, 2009, http://www.ncsl.org/Default.aspx?TabId=13489 (last accessed on September 10, 2009).

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gamblers residing in the United States currently have no protection against breaches of their personal data beyond those implemented by the online gambling site itself. 2. Existing Controls in Other Jurisdictions

In 2003, California became the first state to pass a comprehensive law on notification of data breaches. The law requires companies that experience a breach to notify all data subjects in the most expedient time possible and without unreasonable delay if certain types of personal information are released unintentionally. It is important to note that the data must have been unencrypted to trigger the notification.218 A 2009 bill proposed by Senator Patrick Leahy of Vermont, dubbed the Personal Data Privacy and Security Act, aims to require data brokers and companies to establish and implement data privacy and security programs.219 Leahy notes that more than 250 million records containing personal information have been breached since 2005.220 The law would require companies that store customers personal data to establish internal control policies and to give notice when a breach of data occurs. The bill would preempt state laws on these matters.221 It also would establish an Office of Federal Identity Protection to assist consumers with issues of identity theft and data correction.222 In Europe, most data privacy laws are highly stringentmuch more so than in the United States. The European Unions Data Protection Directive, issued in 1995, introduced strong controls on data privacy and the rights of consumers.223 Among other provisions, it requires that data be relevant to the purpose for which it is kept, stored no longer than necessary, and verifiable by consumers. It also requires that, if data are to be processed (i.e., collected and used), (1) the data subject should have given explicit consent for its use and (2) the processing must be necessary for the performance of a contract, required by a legal obligation, necessary to protect the data subjects life, or necessary to perform a task of public interest. Various jurisdictions across the world that have legalized and regulated online gambling maintain rules on data confidentiality and privacy:
218

See California Office of Privacy Protection, Recommended Practices on Notice of Security Breach Involving Personal Information, May 2008, http://www.oisp.pp.ca.gov/consumer_privacy/pdf/secbreach.pdf (last accessed on July 31, 2009), at p. 8. Office of Senator Patrick Leahy, Leahy Introduces Cybersecurity Legislation, July 22, 2009, http://leahy.senate.gov/press/200907/072209b.html (last accessed on July 29, 2009), at p. 1. See Id. See Id. at p. 5-8. See Id. at p. 9. Data Protection in the European Union, European Commission, United Kingdom, http://ec.europa.eu/justice_home/fsj/privacy/docs/guide/guide-ukingdom_en.pdf (last accessed on September 10, 2009).

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The Isle of Mans gambling regulations specify detailed rules on the way accounts must be managed, privacy of information on account holders and prescribe the penalty for contravention which is 5,000 for each violation.224 Site operators in the Isle of Man are also bound to the rules in the Data Protection Act 2002, the islands legislation concerning data privacy. One of the Acts provisions provides for compensation for [a]n individual who suffers damage by reason of any contravention by a data controller of any of the requirements of this Act.225 lderneys regulatory system requires that [c]ustomer privacy and data protection principles are observed.226 Gibraltar requires that information about a player not be disclosed to a third party except under certain circumstances.227 Gibraltars regulator also requires that data be obtained lawfully, kept and used only for the purposes for which it was obtained, stored safely, and accessible by the customer.228 3. Relevant Technologies for Risk Mitigation

Effective data protection begins with the establishment of internal controls and policies by the gambling website. Betting site 888.com states in its privacy policy that it is committed to respecting your privacy and to complying with applicable data protection and privacy laws and we have therefore provided this Privacy Policy to help you understand how we collect, use and safeguard your PII [personally identifiable information].229 It also states that the sites employees and data processors have an obligation to respect users privacy. Betfairs privacy policy claims the site endeavour[s] to ensure that [its] business practices that involve the use ofPersonal Information are compliant with privacy regulations in the countries where [it] operate[s], and it claims that it has assembled a world class Information Security Management System.230

224

See Supra at footnote 31 at p. 126. Data Protection Act 2002, Treasury of the Isle of Man, at 11(1). See Supra at footnote 30 at p. 144. See Supra at footnote 133 at 30. See Supra at footnote 32 at p. 16. See http://www.888.com/, under Privacy Policy for Users (last accessed on September 10, 2009). See http://content.betfair.com/aboutus/?product=exchange&brand=betfair&region=GBR&locale=en (last accessed on September 10, 2009).

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Maintaining secure computer systems is a demanding task. Although the various technological solutionssecure operating systems, file encryption, network firewallshave their weaknesses the primary failure mechanism for data security is human mistakes and carelessness. 231 Absent regulation, gaming site operators would not bear many of the costs associated with the improper disclosure of personal information. Thus, a regulatory mechanism is needed to align the operators incentives with those of consumers. A significant fine for each consumer record improperly released is one such incentive. With the proper incentives, the gaming site operator will engage in the security engineering, training of staff, and auditing needed to protect consumer records. 4. Conclusion

In an effective regulatory regime, the regulator would require the internal controls and privacy policies described in this section to be present on gambling websites and be highly visible to customers. The regulator would ensure that employees receive training in relevant data protection policies and that players have the ability to access and, if necessary, modify their personal information. It would also establish the types of data that can be stored and the length of time after which the data must be deleted. Finally, the regulatory regime may impose criminal or civil liability on site operators whose data is breached, and it can require regular audits, either by the regulator itself or by independent third parties, of data encryption policies and other protection systems. There is no reason to believe that licensed online gambling operators would be any less able or willing to fulfill these obligations than other online merchants with similar data custody obligations. For more discussion on technological strategies to protect sites integrity and customers personal data, see Section I, Communications and Computer Security Failures. I. Communications and Computer Security Failures

Security of websites, to prevent improper use of or access to sensitive data, is a ubiquitous and serious concern in e-commerce. Hackers can undermine site security, alter a sites behavior, shut it down, access customers confidential information, or use one site as a platform from which to launch broader malicious activities across the web. Online gambling sites would be responsible, in just the same way as other merchant sites, for implementing proper controls and in cooperating with law enforcement agencies in the control of cybercrime. 1. The Issue of Communications and Computer Security Failures

Web server security can be compromised from two directions. The first is over the network (i.e. through internet connections). Second, and perhaps more importantly, a websites servers are also subject to attack or misuse by the gaming sites own employees. A key employee may be able to install software that subverts a system, destroys the integrity of games, interferes with
231

See Ross Anderson, Security Engineering, A Guide to Building Dependable Distributed Systems 2 nd Edition, Wiley, 2008, at p. 17-62.

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customer accounts, or improperly transmits customers personal or financial information. Even an ordinary virus may render a site inoperative, making it impossible for customers to access their accounts or recover their deposits. Phishing attacks, directed at customers through a gambling website, may also be a concern. Attacks may involve unauthorized attempts to login using someone elses account, or exploitation of some security weakness in the web server software itself or in the communications software on the server.232 Protecting gaming websites from intruders is little different from the problem faced by government agencies or online merchants such as Amazon. Many organizations do this quite well as a matter of course, and licensed gambling site operators should be held to a high standard. There are currently no U.S. federal laws regarding data breaches, and the issue is left to individual states. However, acts of hacking and computer fraud are addressed by the Computer Fraud and Abuse Act, originally enacted in 1986, which covers any interstate or international computer communications.233 The Act criminalizes a wide range of computer fraud, including improperly accessing a protected computer with intent to defraud and knowingly transmitting a program or code that causes damage to multiple computers. A 2008 amendment to the law eliminated the requirement for the communications to be interstate or international in cases involving theft and broadened the definition of a protected computer to mean any computer used in interstate or foreign communication. Like other heavily-used websites, gambling sites are susceptible to denial-of-service attacks, which overload a websites servers and force it to shut down.234 The threat of such attacks has been used to extort money from website operators. Perpetrators of such extortion have included organized crime groups from the Middle East and Asia.235 In 2004, British bookmakers alone lost $70 million due to cyber-extortion by just one hacking team, and companies such as

232

For a description of a recent (September 2009) discovery of a security weakness in web server software, see Gregg Keizer, Microsoft promises patch for critical Web server bug, Computerworld, September 2, 2009, http://www.computerworld.com/s/article/9137438/Microsoft_promises_patch_for_critical_Web_server_bug (last accessed on September 9, 2009). See U.S. Department of Justice, Chapter 1 Computer Fraud and Abuse Act, Computer Crime & Intellectual Property Section, http://www.usdoj.gov/criminal/cybercrime/ccmanual/01ccma.pdf (last accessed on July 29, 2009). Denial-of-service attacks use computers to inundate a website with large amounts of internet traffic that eventually slows the site or shuts it down completely. See Jack M. Germain, Global Extortion: Online Gambling and Organized Hacking, Tech News World, March 23, 2004, http://www.technewsworld.com/story/33171.html?wlc=1248627730 (last accessed on July 26, 2009). Also see Jordan Robertson, Tech 101: How a Denial-of-Service Attack Works, Associated Press, July 8, 2009, http://www.usnews.com/articles/science/2009/07/08/tech-101-how-a-denial-of-service-attackworks.html?PageNr=1 (last accessed on July 28, 2009). See Id.

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Canbet, Harrods Casino, Inter Casino Poker, Totalbet, VIP Casino, and William Hill have been the victims of denial-of-service attacks.236 Users of gambling websites are also susceptible to phishing, or the use of fraudulent but crediblelooking website-mimics to deceive the user into releasing personal information or to install viruses and other malware onto their computers.237 Phishing may take many forms including fraudulent or misleading email, website pop-up advertisements, or other forms of electronic communication such as text messaging. Phishing attacks cost consumers more than $3 billion annually in the form of fraudulent credit card charges, withdrawals from compromised bank accounts, time spent rectifying fraud problems, and reduced trust in online commerce.238 Depending upon factors such as the websites payout policy or the ability to transfer funds between players, gambling websites can be attractive targets for phishing.239 2. Existing Controls in Other Jurisdictions

In a licensed regulatory environment, gambling site operators would be expected to play their partjust like any other e-commerce merchantin eliminating their own security vulnerabilities and cooperating with law-enforcement agencies in cybercrime control. Existing U.S. laws (federal and state) regarding computer intrusion would apply, and sites would have recourse to law enforcement support if they suffered attacks. Other nations have legal regimes similar to the U.S. with respect to cybercrime. France, Germany, and the United Kingdom all have laws specifically targeting cybercrime, and the European Union is currently looking to both strengthen its laws on cybersecurity and harmonize the laws of its member states.240 The European Union is also considering a system through which members can report Internet-based attacks to each other and record arrests and prosecutions.241 The Licensing, Regulation, and Alcohol Strategy division
236

See John McMullan and Aunshul Rege, Cheating and Cybercrimes @ Gambling Sites.com, presentation to the Alberta Gambling Research Institute Annual Conference, March 2009, slide 17. Also see John McMullan and David Perrier, The Security of Gambling and Gambling with Security: Hacking, Law Enforcement and Public Policy, International Gambling Studies 7, No. 1 (2007): 4358 at p. 47. Rachna Dhamija et al., Why Phishing Works, Experimental Social Science Laboratory (Xlab), Paper XL06-013 (August 14, 2006): 581590 at p. 581, http://repositories.cdlib.org/iber/xlab/XL06-013 (last accessed on August 3, 2009). Also see Cyveillance, The Cost of Phishing: Understanding the True Cost Dynamics Behind Phishing Attacks, white paper, December 2008, http://www.cyveillance.com/web/docs/WP_CostofPhishing.pdf (last accessed on August 3, 2009). Also see APWG, Phishing Activity Trends Report Q1/2008, JanuaryMarch 2008, http://www.antiphishing.org/reports/apwg_report_Q1_2008.pdf (last accessed on August 3, 2009). See Id Cyveillance. Marvin Fabuli, Online Casinos an Easy Bet for Phishers, Symantec, February 27, 2008, http://www.symantec.com/connect/blogs/online-casinos-easy-bet-phishers (last accessed on August 3, 2009). Palmer, Maija, EU plans tougher cybercrime laws, FT.com, June 14, 2009, http://www.ft.com/cms/s/0/10a407b6-5913-11de-80b3-00144feabdc0.html (last accessed on August 2, 2009). See Id.

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in Australias Northern Territory requires license applicants to submit their information technology security protocols for a risk assessment, and their controls must adhere to Australian and New Zealand AS/NZS 4444 standards for information security.242 The issue of hacking is not completely unfamiliar to bricks-and-mortar casinos. They use quite sophisticated electronic systems, which are vulnerable as well.243 A regulatory strategy for online gambling would require implementation and maintenance of state-of-the-art security controls, cooperation with law-enforcement on cybercrime issues, comprehensive testing of site and account security for the sake of defending consumers privacy and interests, and mandatory reporting of any attacks.244 3. Relevant Technologies for Risk Mitigation

The key technologies for gambling website security are the same as those used by other on-line merchants. These include (1) network firewalls that isolate databases, administrative systems, and development systems from the Internet, (2) high-quality servers with up-to-date security patches, (3) a continuing process of monitoring and logging attempts to break into the system over the Internet, (4) secure database and transactional software, and (5) the use of secure, encrypted protocols for communications between users and the gambling website.245 Intruders who gain access to a users credentials and use those credentials to open a fraudulent connection can be combated in several ways. Many gambling sites work by having users download and install dedicated client software to access the site rather than relying on standard web browsers. This dedicated client software can implement security protocols that resist a variety of exploits such as keystroke loggers and man-in-the-middle attacks.246 For example, the gambling site could use encryption keys based, in part, on information exchanged at registration and stored on the users computer. This approach, however, is not as user friendly as a simple login (e.g., user name and password), as it would make the use of any computer other than the users regular computer more difficult.

242

As noted in an August 31, 2009 correspondence with John Sealy, Manager of Information Systems and Technology Services at the Licensing, Regulation and Alcohol Strategy division of the Northern Territory Department of Justice (Australia). See John McMullan and David Perrier, The Security of Gambling and Gambling with Security: Hacking, Law Enforcement and Public Policy, International Gambling Studies 7, No. 1 (2007): 43-58 at p. 44. See Id. at p. 53. Keys Botzum, WebSphere Application Server V6 advanced security hardening -- Part 1, Overview and approach to security hardening, IBM WebSphere Developer Technical Journal, December 2005, http://www.ibm.com/developerworks/websphere/techjournal/0512_botzum/0512_botzum1.html (last accessed on September 14, 2009) Keystroke loggers are programs that record users keystrokes for the purpose of garnering private information such as passwords. Man-in-the-middle attacks are cryptographic attacks in which an eavesdropper relays messages between two victims. The eavesdropper can read and even alter the messages.

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Another approach is to add a feature to the users password. It is common for high-value websites to put an additional password on a physical device, such as a small keyfob that displays a six-digit number that changes once per minute.247 The user logs in by supplying the user name, password, and the number on the fob, and these are passed through to the server, which authenticates them and permits the user to log in. This technology protects against lost and easyto-guess passwords but not against man-in-the-middle attacks. However, if the site requires the user to employ dedicated client software, that client software can use the 6-digit number as part of the encryption key for establishing the connection between the users computer and the web server; this technique would successfully protect against man-in-the-middle attacks.248 Gambling site operators are already aware of some of these options. For example, PartyGamings privacy policy states that it stores all players personal information in a password-protected database behind a state-of-the-art firewall, and the site itself supports SSL version 3 security with 128-bit encryption.249 It also states that it ensures that affiliates, subsidiaries, agents, and suppliers use secure technology. The site 888.com claims that it uses advanced SSL and PGP protocols for security along with public/private key encryption and firewalls.250 Both sites employ secure, dedicated client software. Other gambling sites also enumerate details about their security policies and procedures, all of which are designed to prevent unauthorized access to personal information. Denial-of-service attacks present a particular challenge to gaming site operators. The harmful traffic usually arises from thousands or tens of thousands of computers that have been infected with a virus that permits the author of the virus to remotely control the infected computer. The individual commanding such a network can direct the entire network to begin loading pages from the gambling website. If the website is designed to serve a thousand active users but ten thousand computers begin loading web pages at ten times the rate of a normal user, service from the website could collapse. Some technological countermeasures are available to the website operatorfor example the website could place limits on the number of new computers from which it will accept connections. However, if the flow of incoming traffic is big enough it will overload the connections between the gambling site and the rest of the Internet. Thus, the ultimate control of denial-of-service attacks must come from web administrators, providers of operating system software, and network service providers.
247

This process is called two-factor authentication. One factor is the normal password which the user types, and the other is the code from the key fob. The interactive role-playing game service World of Warcraft provides such key fobs to its users for a fee of $6.50. See http://www.blizzard.com/store/details.xml?id=1100000622 (last accessed on September 9, 2009). If the 6-digits are used as a shared secret to generate part or all of the encryption key for the communications between the user and the game site, then a man-in-the-middle attack is impossible because the attacker lacks the shared secret. See https://secure.partyaccount.com/about/privacy_s.do (last accessed on August 24, 2009). See http://www.888.com/ (last accessed on August 24, 2009).

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Security failures in computer operating systems are the gateway through which most viruses infect computers. Network service providers have the ability to monitor traffic flows on many different paths and can detect patterns of activity that indicate the beginnings of a denial-ofservice attack. They may also be able to control denial-of-service attacks at locations far from the connection to the gambling site. For this reason, sites must work closely with regulators and government agencies to identify and deal with cybercriminals. Regulators should develop cooperative relationships with private security experts and advocate for cost-effective, industry-wide benchmarks for cyber-security.251 Finally, legislators should consider imposing civil liability on site operators for any harm caused by computer intrusions, at least when site security precautions were not up to the requisite standard.252 Finally, gambling site operators, like all other online merchants, should implement anti-phishing measures to prevent financial harm to consumers and maintain the integrity of their operations. The sites should play their role in helping to educate consumers about safe browsing habits and how to recognize phishing.253 4. Conclusion

Significant international attention is already being paid to cybercrime in general. Website security is a matter of global concern for businesses and government alike, by no means specific to online gambling. According to a Cyberspace Policy Review report released in 2009 by the Cybersecurity Chief at the National Security Council, a growing array of state and non-state actors are compromising, stealing, changing, or destroying information and could cause critical disruptions to U.S. systems.254 The report recommends a coordinated effort by federal, state, and local governments along with security experts in the private sector, and it urges the government to identify procurement strategies that will incentivize the market to make more secure products and services available to the public.255 It goes on to recommend adjustments to liability considerations (reduced liability in exchange for improved security or increased

251

See John McMullan and Aunshul Rege, Cheating and Cybercrimes @ Gambling Sites.com, presentation to the Alberta Gambling Research Institute Annual Conference, March 2009, slide 23. John McMullan and David Perrier, The Security of Gambling and Gambling with Security: Hacking, Law Enforcement and Public Policy, International Gambling Studies 7, No. 1 (2007): 4358 at p. 56. MarkMonitor, Rock Phishing: The Threat and Recommended Countermeasures, White Paper, August 2007, http://www.markmonitor.com/download/wp/wp-rockphish.pdf (last accessed on August 3, 2009), at p. 78. Cyberspace Policy Review, Assuring a Trusted and Resilient Information and Communications Infrastructure, National Security Council, May 2009, http://www.whitehouse.gov/asset.aspx?AssetId=1906 (last accessed on August 2, 2009), p. iii. Also see http://www.whitehouse.gov/cyberreview/. See Id at p. iv-v.

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liability for the consequences of poor security), indemnification, tax incentives, and new regulatory requirements and compliance mechanisms.256 While all online merchants would benefit from increased governmental and law enforcement support, online gambling operators are ultimately responsible for their own sites security. Site operators will naturally be concerned with their reputations for integrity and reliability, but regulation can introduce new incentives to ensure that operators deploy effective security. The regulator might choose to mandate some specific technologies, such as SSL encryption and dedicated client software; and it can sharpen the incentives for effective control by imposing higher levels of liability for any sites that fail to implement adequate precautions. J. Problem Gambling 1. Problem Gambling

We expect that problem gambling behaviors may receive more attention in the upcoming debates than any of the other categories of risk. Therefore, we discuss problem gambling in more detail in Section III below.

256

See Id at p. v.

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III.

SPECIAL ATTENTION TO PROBLEM GAMBLING A. Introduction

Unlike the other nine risks, the potential effect of legalization on problem gambling is less obvious a priori. On the one hand, in a well-regulated online environment, gamblers (including existing U.S.-based online gamblers) would have more access to mechanisms with which to try to curb their problem behavior. These include tools for self-exclusion and self-limits as well as greater awareness of and access to clinical and self-help resources. On the other hand, pathological or addictive gambling behaviors might nevertheless be exacerbated by the increased opportunity to gamble at any time and from anywhere. B. What is Problem Gambling? 1. Terminology

Problem gambling is a term without a specific definition that refers to the fact that some individuals who gamble do so irresponsibly and damage or disrupt personal, financial, or social pursuits.257 The term can apply to a wide spectrum of cases, from less severe ones where individuals experience some degree of gambling-related problems to more severe cases in which individuals are clinically diagnosed with pathological gamblingan impulse control disorder.258

257

Lack of specific definition noted in an August 5, 2009 interview with Phill Brear, Head of Gambling Regulation at the Gibraltar Regulatory Authority. National Council on Problem Gambling, FAQs Problem Gamblers, http://www.ncpgambling.org/i4a/pages/Index.cfm?pageID=3315 (last accessed on July 11, 2009). In 1980, the American Psychiatric Association (APA) first included pathological gambling in the Diagnostic and Statistical Manual for Mental Disorders (DSM). It was described as a chronic and progressive failure to resist impulses to gamble, characterized by undesirable outcomes ranging from borrowing money from family or friends and losing time at work, to being arrested for offenses committed to support gambling. National Research Council, Pathological Gambling: A Critical Review, Washington, DC: National Academy Press (2005), at p. 2. In the most current manual, DSM-IV, the APA lists 10 diagnostic criteria of which five have to be met to make a clinical diagnosis of pathological gambling. See Id at p. 27. Various screening mechanisms have been developed to assess levels of problem gambling, including the South Oaks Gambling Screen (SOGS), the Problem Gambling Severity Index (PGSI) of the Canadian Problem Gambling Index (CPGI), and the National Opinion Research Center DSM Screen for Gambling Problems (NODS). See Michael Belletire et al., Legislating and Regulating Casino Gaming: A View from State Regulators, paper commissioned by the Regulation, Enforcement and Internet Subcommittee of the National Gambling Impact Study Commission, 1999, at p. 11. Also noted in interviews with Peter Collins, Professor of Public Policy Studies and Director of the Center for the Study of Gambling at the University of Salford (U.K.), and Sam McQuade, Graduate Program Coordinator at the College of Applied Science and Technology at the Rochester Institute of Technology.

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2.

Prevalence Rates and Trends

Worldwide: Most research indicates that about 1% of the adult population worldwide experiences severe problem gambling.259 Moreover, studies indicate that severe problem gambling rates globally have stabilized over time at about 1%.260 United States: Various studies have been conducted to estimate the prevalence of problem gambling in the United States. According to the National Council on Problem Gambling, about 1% of the U.S. adult population meets the criteria for pathological gambling in a given year. Another 2% to 3% would be considered problem gamblers.261 In a meta-analysis of 120 previously conducted prevalence studies in the United States and Canada, researchers at the Division of Addictions at Harvard Medical School derived point-in-time estimates of problem gambling rates. They noted that 1% to 2% of the adult population met criteria for lifetime pathological gambling.262 A more recent estimate from a nationally representative survey in the United States found lifetime pathological gambling rates within the general population of 0.4%.263 In an interview in mid 2009, Howard J. Shaffer, an addiction expert at Harvard University, noted that despite the substantial growth in gambling opportunities and overall gambling volume over the last two decades in the United States, the rate of problem gambling among the adult population has stayed roughly constant. Shaffer also stated that the incidence of problem gambling in the United States had declined slightly since the 1970s, from 0.7% to 0.6%.264 Online Gambling and the Incidence of Problem Gambling: Some studies have claimed an association between increased gambling exposure and increased incidence of problem
259

Jamie Wiebe et al., Problem Gambling Prevalence Research: A Critical Overview, a report to the Canadian Gaming Association, December 2007, at p. 2, http://canadiangamingassociation.com/media_uploads/pdf/78.pdf (last accessed on September 10, 2009). See Id. Also see D. A. LaPlante and H. J. Shaffer, Understanding the Influence of Gambling Opportunities: Expanding Exposure Models to Include Adaptation, American Journal of Orthopsychiatry, 77, No. 4 (2007): 616623 at p. 619. See Supra at footnote 257. Also noted in a June 5, 2009 interview with Keith Whyte, Executive Director of the National Council on Problem Gambling. Howard Shaffer et al., Updating and Refining Prevalence Estimates of Disordered Gambling Behaviour in the United States and Canada, Canadian Journal of Public Health, 92, No. 3 (2001): 168172 at p. 169. Also see Howard Shaffer et al., Estimating the Prevalence of Disordered Gambling Behavior in the United States and Canada: A Meta-Analysis, Boston: Presidents and Fellows of Harvard College, 1997, at p. iii. Also see Howard Shaffer et al., Estimating the Prevalence of Disordered Gambling Behavior in the United States and Canada: A Research Synthesis, American Journal of Public Health, 89, No. 9 (1999): 13691376 at p. 1370. N. M. Petry et al., Comorbidity of DSM-IV pathological Gambling and Other Psychiatric Disorders: Results from the National Epidemiologic Survey on Alcohol and Related Conditions, Journal of Clinical Psychiatry, 66, No. 5 (2005): 564574 at p. 564. As noted in a June 10, 2009 interview with Howard Shaffer, Director of the Division on Addictions and Associate Professor of Psychology in the Department of Psychiatry at the Cambridge Health Alliance.

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gambling.265 In addition, commentators have suggested that the increased accessibility inherent in online gambling magnifies such risks.266 However, more recent studies specific to online gambling, most conducted since the advent of legal and regulated online gambling, have indicated that online gambling does not inherently encourage excessive gambling. 267 For example, researchers at Harvard Medical School studied real-time betting activities of 48,000 Internet players over two years and found that their betting levels in Internet sports gambling and casino games were moderate. Most gamblers placed fewer than four bets per day, and sports gamblers tended to moderate their play based on their wins and losses; i.e., they played less often when they lost money and more often when they won money.268 Also, a large-scale British study in 2007 found no increase in the rate of problem gambling in the United Kingdom since 1999, despite a large increase in the number of new gambling opportunities (although the number of people who had gambled in the past year decreased between 1999 and 2007).269 C. Potential Effects of Legalization of Online Gambling on Problem Gambling

Some researchers and policymakers have expressed concerns about the impact of online gambling on problem gambling.270 They fear that legalization of online gambling might spur excessive gambling and problem gambling incidence by facilitating (1) unlimited access and availability of gambling platforms; (2) anonymity, which would allow gamblers to participate without fear of stigma; (3) gambling under the influence; (4) decreased perception of value of
265

See Brian Rush et al., Mapping the Prevalence of Problem Gambling and Its Association with Treatment Accessibility and Proximity to Gambling Venues, Journal of Gambling Issues, 20 (2007): 193214. As noted in interviews with Howard Shaffer, Director of the Division on Addictions and Associate Professor of Psychology in the Department of Psychiatry at the Cambridge Health Alliance, and Simon Holliday, Director of H2 Gambling Capital (U.K.). Richard LaBrie et al., Assessing the Playing Field: A Prospective Longitudinal Study of Internet Sports Gambling Behavior, Journal of Gambling Studies, 23, No. 3 (2007): 231243. Also see Richard LaBrie et al., Inside the Virtual Casino: A Prospective Longitudinal Study of Actual Internet Casino Gambling, European Journal of Public Health, 18, No. 4 (2008): 410416. Also see Debi LaPlante et al., Sitting at the Virtual Poker Table: A Prospective Epidemiological Study of Actual Internet Poker Gambling Behavior, Computers in Human Behavior, 25, No. 3 (2009): 711717. See Real-Time Betting Analysis of Internet Casino Gambling, Responsible Gaming Quarterly, 6, No. 2 (Fall 2008), at p. 9, http://www.americangaming.org/assets/files/RGQ_Fall_08.pdf (last accessed on August 10, 2009). Also, as noted in interviews with Peter Collins, Professor of Public Policy Studies and Director of the Center for the Study of Gambling at the University of Salford (U.K.), Bo Bernhard, Director of Gambling Research at the UNLV College of Hotel Administration, and Charles Wellford, Professor of Criminology and Criminal Justice at the University of Maryland, College Park, the availability of new forms of gambling does not necessarily lead to increased incidence of problem gambling. See Supra at footnote 13, Heather Wardle et al. at p. 9-10. Martin Owens and Guy C. Clark, Internet Gambling Deserves a New Chance, The Debate Room, Businessweek, 2007, http://www.businessweek.com/debateroom/archives/2007/09/internet_gambli.html (last accessed on September 10, 2009). Also see Michael P. Scharf and Melanie K. Corrin, On Dangerous Ground: Passive Personality Jurisdiction and the Prohibition of Internet Gambling, New England Journal of International and Comparative Law, 8, No. 1 (2002).

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money; and (5) isolation.271 A notable example of this concern is the 1999 assertion by the National Gambling Impact Study Commission that the three main reasons to prohibit online gambling are abuse by underage gamblers, addiction by pathological gamblers due to its high speed and instant gratification, and the potential for criminal activities.272 Policymakers are also concerned about negative spillovers to the rest of society, including increases in crime, lost work and school hours, and increase in personal debt. However, the only reason cited in the Safe Port Act (the sponsoring legislation of the UIGEA) for banning financial transactions to and from online gambling sites is that it leads to debt collection problems for U.S. financial institutions.273 The following sections describe and analyze mechanisms through which legalization could affect the level of problem gambling in the United States. We identify several mechanisms by which legalization is commonly expected to increase the incidence of problem gambling and two mechanisms by which regulation might be expected to alleviate problem gambling. 1. Potential Adverse Effects of Legalization

The following section describes several mechanisms by which legalization is commonly expected to increase the incidence of problem gambling. a. Removal of Legal Deterrence

Potential Effect: It is commonly believed that current legal restrictions on online gambling have deterred would-be gamblers from engaging in the Internets version of gambling. Therefore, legalization may accentuate problem gambling by eliminating any legal inhibitions would-be gamblers have toward online gambling. In the 2007 UNLV survey of Nevadans, researchers found that approximately 12% of non-online gamblers (defined as those respondents who had not gambled online, but who may or may not have otherwise gambled) would be more likely to participate in online gambling if it were licensed and regulated by the state of Nevada.274
271

See Id Scharf and Corrin. Also see Supra at footnote 25 at p. 50. Also Griffiths notes that among other factors, increased access to gambling provided by online gambling might facilitate the development of gambling related issues. M. D. Griffiths, Internet Gambling: Issues, Concerns and Recommendations, Cyberpsychology & Behavior, 6, No. 6 (2003): 557568; cited by Sarah E. Nelson et al., Real Limits in the Virtual World: SelfLimiting Behavior of Internet Gamblers, Journal of Gambling Studies, 24 (2008): 463477, DOI 10.1007/s10899-008-9106-8. Also The Committee on the Social and Economic Impact of Pathological Gambling notes that More people are gambling, and they are wagering more. As a result, there is increased concern about pathological gambling. The Committee further notes that With the increased availability of gambling and new gambling technologies, pathological gambling has the potential to become even more widespread. National Research Council, Pathological Gambling: A Critical Review (National Academy Press, Washington, DC, 2005), at p. 3. National Gambling Impact Study Commission, Final Report, 1999, at p. 5-4 to 5-6, http://govinfo.library.unt.edu/ngisc/reports/finrpt.html (last accessed on September 10, 2009). See Supra at footnote 69 at p. 62. See Supra at footnote 6 Bo Bernhard at p. 25, 46. Note N = 1,000. Also 96.3% of responders were non-online gamblers; that is, they stated that they had not gambled online in the last five years.

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Mitigating Considerations: It can be argued that the lifting of the prohibition itself is unlikely to have any significant impact on would-be gamblers willingness to gamble online, because gamblers in the United States are generally ignorant or completely confused about existing legal restrictions.275 Support for this argument is found in the survey mentioned above, in which researchers discovered that 53.7% of responders were unclear regarding the legal status of online gambling. Approximately 17% thought online gambling was legal, and the remaining 29.5% thought it was illegal.276 This result indicates general confusion among gamblers in the United States about current legal restrictions.277 In addition, 87.9% of the responders noted that the current legal status of online gambling did not affect their desire to gamble online, whereas 4% indicated that their desire to gamble online was very much affected by its current legal status. Moreover, the absence of any enforcement against online gamblers until very recently may have diluted the deterrent effect of legal restrictions on would-be gamblers inclination to gamble, leading one to argue that complete removal of such restrictions in the future would not have a major impact on the behavior of would-be gamblers. 278 b. Introduction of Trustworthy Brands

Potential Effect: Legalization may lead to increased comfort with gambling online, because U.S.-based sites, with trusted brands and subject to strict regulation, would offer a range of protections to gamblers that many offshore sites do not.279 Moreover, greater competition in the sector, with gambling platforms offering better deals to would-be gamblers, might lead to increased volumes and greater incidence of problem gambling. Researchers indicate that security concerns and legitimacy are two main reasons cited by gamblers for not gambling online.280 Currently, Online Casino City, a guide to online gambling websites, lists 1,906 gambling websites from 70 different jurisdictions, 42 of which have sites

275

As noted in a June 5, 2009 interview with Keith Whyte, Executive Director of the National Council on Problem Gambling, Americans are generally ignorant of the legal status of online gambling, and many do not believe they will be prosecuted for gambling online. Researchers further noted that 54% of non-online gamblers were unclear about the current status of online gambling, whereas 16% deemed it legal and the remaining 29% deemed it illegal. 276 See Supra at footnote 6 Bo Bernhard at p. 26. Gaul notes that even as bettors around the world gamble millions of dollars online, confusion reigns about the legal status of those bets and the companies that handle them. See Supra at footnote 83. Also, in a June 10, 2009 interview, Bo Bernhard, Director of Gambling Research at the UNLV College of Hotel Administration noted that the legal status of online gambling is very unclear in peoples minds in the United States. See Supra at footnote 14. Section 2b discusses responsible gambling practices and safeguards that may be offered by regulated online gambling websites. See Supra at footnote 19, Sally Monaghan.

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that allow players from the United States.281 The majority of these websites are privately owned, and many are located in countries with no reporting requirements.282 In such situations, where consumers are uncertain and have limited experiences with providers, brand associations are known to be particularly influential.283 In a recent survey, researchers at the University of Lethbridge found that the general reputation of the website was the most common reason identified by online gamblers for choosing to gamble at one Internet site over another.284 Thus, the introduction of branded providers that are inherently perceived to be trustworthy might attract more gamblers to participate in online gambling.285 Mitigating Considerations: It can be argued that gamblers most likely to be influenced by the availability of trusted brand-name sites are those who gamble already, perhaps in the casino environment, and hence know the brands.286 Although these gamblers may indeed shift their business, this shift would represent displacement, not overall growth. Further, the displacement would be from bricks-and-mortar to online gambling, which can offer more options and protections for problem gamblers than can land-based casinos.287
281

As of September 14, 2009. See Online Casino City, Online Gaming Site Owners, http://online.casinocity.com/ownership. Also note, amongst these 1,906 sites are included 34 sites based in the United States, most of which involve skill games, free poker tournaments in which players can win real money, or state-sponsored lottery or sports betting. Gaul notes that in a joint investigation, the Washington Post and CBSs 60 Minutes found that many Internet gambling sites operate in a shadowy world of little regulation and even less enforcement, See Supra at footnote 83. Stevie Watson et al., The Legalization of Internet Gambling: A Consumer Protection Perspective, Journal of Public Policy & Marketing, 23, No. 2 (2004): 209213, at p. 211. Robert Wood and Robert Williams conducted two surveys. The first survey was a random digit dial telephone survey of 8,498 Canadian adults conducted from January 2006 to June 2007. The second survey was an online self-administered survey of 12,521 adults from 105 countries, conducted from June to December 2007. See Robert Wood and Robert Williams, Internet Gambling in Comparative Perspective: Patterns, Problems, and Interventions, University of Lethbridge, Presentation to the Alberta Gambling Research Institute Annual Conference, March 2009. As noted in an August 4, 2009 interview with Simon Holliday, Director of H2 Gambling Capital (U.K.), the legalization of online gambling would probably increase the number of online gamblers. Also, the previously cited UNLV study revealed that 12% of non-online gamblers would be more likely to participate in online gambling if it were licensed and regulated by Nevada. Although some of these respondents may fear legal repercussions, some may be unwilling to gamble online due to a lack of credible, branded providers, because a large portion of respondents had doubts about the integrity of online gambling. See Supra at footnote 73. MGM Mirage, a large U.S. bricks-and-mortar casino operator, set up an Internet gambling site based in the Isle of Man and marketed the site using MGMs brand name and credibility. See Richard McGowan, The Gambling Debate (Westport, CT: Greenwood Press, 2008), at p. 43. Wiebe and Lipton note that If players value such regulation, then the unregulated operators will be at a competitive disadvantage. Jamie Wiebe and Michael Lipton, An Overview of Internet Gambling Regulations, submitted to the Ontario Problem Gambling Research Centre, August 2008, at p. 15.

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c.

Increased Accessibility

Potential Effect: One of the most common critiques of online gambling is the increase in access and availability inherent in Internet-based gambling platforms.288 Many believe that increased access to gambling and 24-hour-a-day availability may exacerbate problem gambling. 289 In addition, online gambling also facilitates (1) anonymity, allowing gamblers to participate without fear of stigma; (2) gambling under the influence; and (3) decreased perception of the value of money, thereby elevating the risks of problem gambling. Potential risks posed by the frequency and speed of gaming, variety of games, and smaller permissible bet size on the Internet are frequently cited.290 Mitigating Considerations: U.S. residents already have online gambling options available to them all day, everyday, and from anywhere. So the addition of U.S.-licensed sites would not alter that particular reality.291 Furthermore, as discussed in Section 2b below, regulation can assuage these concerns. Responsible gaming features and safeguards, including links to problem gambling help-lines and websites, self-exclusion programs, and self-imposed time and money limits, are some common features that can be enforced to curb problem gambling. In fact, some have suggested that problem gamblers may benefit the most from the legalization of online gambling, because they would gain access to the tools required by the regulator.292 d. Easier Flow of Funds if UIGEA Restrictions are Lifted

Potential Effect: Absent UIGEA restriction, U.S. residents would be able to make deposits to and withdrawals from online sites with greater ease. The UIGEA was intended to stop the transfer of funds from U.S. gamblers to online gambling websites. Instead of criminalizing gambling itself, the UIGEA was intended to prevent U.S. residents from gambling by restricting the role of financial institutions in transmitting payments to and from gaming operators. Mitigating Considerations: Currently, enough workarounds have been designed, and are actively promoted to consumers by offshore online gambling sites, to render the existing restrictions largely ineffective. U.S. gamblers primarily use services provided by offshore financial intermediaries unrelated to gambling sites, such as e-wallets, that allow customers to get around the restrictions placed by the UIGEA. An e-wallet is an online account in which money can be deposited and used in commercial transactions. The e-wallet draws on a consumers bank or
288

See Supra at footnote 69 at p. 61. Also noted in August 7, 2009 interview with Jamie Wiebe, Director at the Centre for the Advancement of Best Practices of the Ontario Responsible Gambling Council. Michael Smeaton and Mark Griffiths, Internet Gambling and Social Responsibility: An Exploratory Study, CyberPsychology & Behavior, 7, No. 1 (2004): 4957, at p. 50. See Supra at footnote 69 at p. 61. See Supra at footnote 153 at p. 15. As noted in an August 27, 2009 interview with Andr Wilsenach, Chief Executive Officer of the Alderney Gambling Control Commission.

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credit card and routes the funds to the merchant, in this case an online gambling website. The most widely used e-wallets facilitate billions of dollars in commerce annually and are based and regulated offshore.293 The UIGEA restrictions have not produced the intended deterrence to online gambling and may have unintentionally led to the surfeit of unregulated offshore intermediaries, which act as alternatives to regulated U.S.-domiciled financial institutions. Removal of these restrictions is therefore expected to have limited impact on the incidence of problem gambling. In addition, as discussed in Section E, legalization would give regulators an opportunity to gain better oversight on such international money transfers when routed through regulated financial institutions. It would also provide consumers with the protections already available to credit card holders in the event of fraud, disputes, and complaints. e. Advertising

Potential Effect: Currently, the U.S. Department of Justice (DOJ) has the authority to prohibit the advertising of illegal Internet gambling websites. In 2003, the DOJ issued letters to the National Association of Broadcasters and other media groups noting that allowing advertising for online gambling websites may be considered aiding or abetting illegal gambling operations.294 Legalization of online gambling may, however, facilitate resumption of advertising in support of the online business.295 The high level of exposure to land- and river-based gambling and state lottery advertisements has contributed to gamblings normalization and perception as an ordinary and harmless activity.296 Various marketing strategies, including pop-up promotions, free or practice games, and direct email campaigns, are already being used to promote online gambling.297 Some advocates suggest that such advertising could lure would-be and existing gamblers to participate in online gambling, thereby leading to greater incidence of problem gambling.298

293

Todd notes that the UIGEA does not seem to have had an impact on online gambling in the United States. Aaron Todd, NETeller Exit Impacts U.S. Internet Gambling Market, onlineCasinoCity, Jan. 18, 2007, http://online.casinocity.com/news/news.cfm?ArticleId=70015 (last accessed on September 11, 2009); cited by Gerd Alexander, The U.S. on Tilt: Why the Unlawful Internet Gambling Enforcement Act is a Bad Bet, Duke Law & Technology Review, 5 (2008), at 6. See Supra at footnote 60 at 1112. It should be noted, however, that the FTC and the various state attorneys general would in all likelihood retain jurisdiction over advertising online and the FCC would retain jurisdiction over advertising on broadcast and cable media. See Supra at footnote 19 Sally Monaghan. See Id. See Id.

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Mitigating Considerations: A note of caution is needed about the links that connect increased advertising for online gambling with increased problem gambling. First, the connection between increased advertising and aggregate growth of online gambling volume is likely and is supported by forecasts of increased online gambling post legalization.299 However, no research has been done to establish how much of the increase in online gambling is displacement of already existing land-based gambling versus new gamblers or increased activity by existing gamblers. Second, the connection between increased online gambling and increased incidence of problem gambling is also not established. Early research indicates that, at least in mature markets such as the United Kingdom, access to additional gambling opportunities in general and the addition of online gambling opportunities in particular do not appear to increase the incidence of problem gambling.300 Some regulations have been enacted to limit the advertisement of gambling products across various jurisdictions. In the United Kingdom, the introduction of the Gambling Act brought new restrictions on gambling advertising and subjected it to regulation by the Department for Culture, Media and Sport (DCMS), the British Gambling Commission, and the Advertising Standards Agency, as well as its former regulatory bodies, the Broadcast Committee of Advertising Practice (BCAP) and the Committee of Advertising Practice (CAP). 301 The various regulations include provisions prohibiting advertising to minors or vulnerable adults, among others. In addition to these rules, however, the gambling industry has issued a voluntary code for socially responsible advertising, which specifically requires that advertisements include the address of the United Kingdoms problem gambling help website and encourages operators to include responsible gambling messages in their advertisements.302 The code also introduces a watershed time of 9 p.m., before which any newly permitted forms of gambling cannot be advertised, although the code does allow for the advertising of sports betting around televised
299

As noted in an August 4, 2009 interview with Simon Holliday, Director of H2 Gambling Capital (U.K.). Also, in a note to investors, the investment bank Goldman Sachs predicted a legalized online gambling market in the U.S. worth $12 billion (more than double the estimated size of the current market). See Jon Parker, US to legalize online gambling; worth $12bn, Goldman Sachs predicts, eGaming Review, June 29, 2009, http://www.egrmagazine.com/news/industry/168682/us-to-legalise-online-gambling-worth-and3612bngoldman-sachs-predicts.thtml (last accessed on August 26, 2009). Also, in an analysis provided to a payment processing firm, PricewaterhouseCoopers estimated the federal revenue effect of legalized online gambling to range from $13.0 billion (with a higher number of states opting out of the legislation) to $25.9 billion (with a lower number of states opting out) for the period 20102019. See PricewaterhouseCoopers, Estimate of Federal Revenue Effect of Proposal to Regulate and Tax Online Gambling Executive Summary, prepared for UC Group, April 24, 2009, http://www.safeandsecureig.org/media/pwc09.pdf (last accessed on August 28, 2009). See Supra at footnote 293. Simon Fielder and Dominic Hodgkinson, United Kingdoms Gambling Industry Adopts Voluntary Code on Advertising Standards, Pillsbury Winthrop Shaw Pittman LLP, September 2007, http://www.pillsburylaw.com/siteFiles/Publications/AD40F0C315922BF5A969E8BF6379B2E4.pdf (last accessed on August 7, 2009). See Id.

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sporting events.303 In Australia, advertising restrictions are determined by the states/territories; most prohibit advertising to minors and the use of misleading statements, while some have no specific regulations.304 The National Gaming Board of South Africa has set forth guidelines regarding advertising, prohibiting, among others, advertising to minors and advertising that may encourage excessive gambling.305 The U.S. could impose whatever targeted restrictions on advertising deemed necessary or appropriate. 2. Potential Benefits of Legalization

The following sections describe two mechanisms through which regulation could reduce problem gambling. Regulators could implement (1) public policy measures designed to educate the public on the dangers of problem gambling and (2) efforts to provide resources to those affected by problem gambling.306 a. Access to Funding to Increase Awareness of Problem Gambling

If the United States decides to legalize and tax online gambling, significant revenues may accrue from the imposition of taxes and license fees.307 Australia, Costa Rica, Great Britain, Aruba, and Antigua are some of the many countries that have recognized tax benefits from legalizing online gambling.308 The United States could use tax and license revenues to substantially boost publicly funded prevention, counseling, and treatment programs as well as research on gambling addiction.309 Currently, statutes in some states require that information regarding problem gambling be provided to persons participating in any form of legalized gambling. At least three states require that telephone helplines be maintained for problem gamblers.

303

See Id. See Advertising Federation of Australia, Gambling, http://www.afa.org.au/public/content/ViewCategory.aspx?id=509 (last accessed on August 7, 2009). Mpande Advisors, Report on the Regulation of Interactive Gambling, prepared for the National Gambling Board of South Africa, October 2005, at p. 50 and 67. See Supra at footnote 153. Also see Supra at footnote 60 at 1112. Researchers have estimated that at a flat tax rate of 6.25%, online gambling could generate more than $750 million annually. See Supra at footnote 69 Christopher Grohman at p. 68. See Id. See Supra at footnote 258 Michael Belletire at p. 1213. Also see General Accounting Office, Internet Gambling: An overview of the Issues, GAO-03-89, December 2002; cited by Gerd Alexander, The U.S. on Tilt: Why the Unlawful Internet Gambling Enforcement Act is a Bad Bet, Duke Law & Technology Review, 5 (2008), at 9.

304

305

306

307

308

309

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Advocates for problem gamblers have been very vocal about the under-funding in existing budgets for prevention, counseling, and treatment services and observe that most health insurers currently do not cover these services.310 Only 25 states provide any funding for problem gambling programs.311 Availability of tax dollars from online gambling revenues and licensing fees could be used to substantially bolster problem-gambling awareness and treatment programs, and to provide educational supports for parents and higher-educational institutions dealing with underage gambling. b. Wider Implementation of Responsible Gambling Features

Legalization of online gambling could lead to the introduction and wider implementation of regulations that give online gamblers tools for controlling their own gambling behaviors.312 Online gamblers today have access to a variety of online gambling options. However, research indicates the general lack of responsible gambling practices and safeguards offered by these online gambling websites. A 2004 exploratory study of 30 U.K.-based Internet gambling sites found that very few sites engaged in socially responsible practices. 313 Of the 30 sites, 26 had no reference to a problem gambling help resource; further, 20 sites showed no evidence of social responsibility and 29 sites did not seem to give an option to self-exclude from the site. Various types of responsible gambling practices have been advocated, including links to problem gambling helplines and websites, self-exclusion programs, and self-imposed time and money limits. 314 Some common elements of regulatory structures across leading online gambling jurisdictions include (1) requiring operators to provide players with mechanisms to set their own
310

Franklin discusses lack of federal funding for treatment or awareness of problem gambling, lack of insurance parity for problem gamblers, and limited or lack of funding from most states in the United States. Joanna Franklin, Problem Gambling in the U.S From the Beginning into 2001. Presentation available at Responsible Gambling Council, http://www.responsiblegambling.org/articles/Problem_and_Pathological_Gambling_A_view_from_the_States.p df (last accessed on September 10, 2009). Also Winslow discusses the lack of state funding for problem gambling services in Colorado and other states in the United States. Kyle Winslow, A Problem for Gamblers, The American Prospect, March 10, 2008, http://www.prospect.org/cs/articles?article=a_problem_for_gamblers (last accessed on September 10, 2009). As noted in a June 5, 2009 interview with Keith Whyte, Executive Director of the National Council on Problem Gambling. See Supra at footnote 153 at p. 15. See Supra at footnote 25. As noted in a June 10, 2009 interview with Howard Shaffer, Director of the Division on Addictions and Associate Professor of Psychology in the Department of Psychiatry at the Cambridge Health Alliance. Also, as noted in a June 10, 2009 interview with Bo Bernhard, Director of Gambling Research at the UNLV College of Hotel Administration, Nova Scotia recently introduced voluntary loss limits as a self-regulatory device in its land-based gaming operations. Also as noted in an August 5, 2009 interview with Phill Brear, Head of Gambling Regulation at the Gibraltar Regulatory Authority, gambling websites regulated by Gibraltar have responsible gaming features such as cool-off periods and self-exclusions mechanisms.

311

312

313

314

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betting limits or limit the deposits they make to their online gambling accounts; (2) requiring site operators to allow gamblers to self-exclude from participating in gambling with the operator; (3) permitting family members to petition to exclude a gambler from a website; (4) banning extension of credit to players; (5) requiring operators to display prominent links to support and counseling services.315 In addition to these, the European Gaming and Betting Association lists approximately 50 provisions related to mitigating problem gambling.316 U.S. regulators could use this list as a menu from which to identify and evaluate various safeguards. The list includes requiring registration pages to offer self-diagnostic tests designed to help would-be gamblers understand their own attitudes and vulnerabilities, and requiring operators to impose speed-ofplay, compulsory time-outs, or player-loss-rate caps.317 Aristotle, Inc., mentioned previously, has produced the Integrity Self-Exclusion List (SEL), an international database of people who have chosen to exclude themselves from bricks-and-mortar and online gambling.318 If an excluded gambler attempts to open an account, Integrity will not return an approval code from its verification system.319 Finally, gambling sites can train staff to identify spending patterns that indicate problem gambling and to contact the gambler directly.320 In assessing the general effectiveness of responsible gaming features in the context of online gambling, one 2008 study by researchers at Harvard University demonstrated that responsible gaming safeguards can be effective in the Internet gambling environment. With self-limits, online gamblers reduced their frequency of playboth the number of days on which they placed bets and the number of bets they placed per betting day. The amount they wagered per bet did not change significantly, although the online gamblers did reduce the total amount they wagered. 321 In a large-scale survey of online gamblers, when asked about the usefulness of including
315

See Supra at footnote 287 at p. 1012. Also Grohman notes that the United States could set up a protocol such that banks or other financial institutions must monitor deposits onto sites and report habitual or problem gamblers to proper authorities. In addition, he notes that the government could empower families to monitor problem gamblers by installing monitoring chips in computers. See Supra at footnote 69 Christopher Grohman at p. 67. Also see Supra at footnote 25. Also see Supra at footnote 153 at p. 15. Also see Australia: Uniform Standards for the Regulation of Interactive Gaming, The National Working Party on Interactive Gaming, Exposure Draft, April 5, 2001, at p. 22. EGBA Standards Benchmark Study: Overview, European Gaming & Betting Association, 2008, Table 2, at p. 1113. See Id. Integrity, Self-Exclusion List (Online Gaming), Aristotle, Inc., http://integrity.aristotle.com/index2.php?option=com_content&do_pdf=1&id=52 (last accessed on August 11, 2009). See Id. As noted in an August 5, 2009 interview with Phill Brear, Head of Gambling Regulation at the Gibraltar Regulatory Authority. Sarah E. Nelson et al., Real Limits in the Virtual World: Self-Limiting Behavior of Internet Gamblers, Journal of Gambling Studies, 24 (2008): 463477, http://www.divisiononaddictions.org/html/reprints/selflimits.pdf (last accessed on September 11, 2009), at p. 7.

316

317

318

319

320

321

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responsible gambling features, such as self-imposed time limits, self-exclusion, regular financial statements, and regular self-assessments tests, online gamblers indicated that they would find it quite useful. The Executive Director of the National Council on Problem Gambling, Keith Whyte, testified before the U.S. Congress as follows: The graphical and interactive structure of the internet provides a revolutionary opportunity to create informed consumers with access to a variety of information designed to encourage safe choices and discourage unsafe behavior.... The technology also exists, unlike for other forms of gambling, to allow players and operators to set limits on time, wagers, deposits, etc...as well as to exclude themselves.322 D. Concluding Remarks

Legislative restrictions have failed to prevent U.S. gamblers from engaging in online gambling. Rather, those restrictions have led to additional business for Internet gambling operators beyond the regulatory reach of the United States. The current environment lacks responsible gaming features and safeguards offered to gamblers and limits publicly funded resources to educate the populace about problem gambling. We believe that regulators should be able to design sufficient protections to prevent any significant growth in problem gambling that results from legalization. Operators licensed within the United States should be required to offer a best-in-the-world range of services and resources for problem gamblers as well as to prevent underage gambling. Moreover, a proportion of the tax revenues and licensing fees derived from the U.S.-based industry could be used to substantially bolster the level of support for educational programs and services. According to Andr Wilsenach, head of the Alderney Gambling Control Commission, problem gamblers would receive clear-cut benefits from regulated online gambling, since landand river-based gaming does not provide the tools that are possible in an online environment.323

322

Statement of Keith Whyte, in U.S. House of Representatives, Committee on Financial Services, Can Internet Gambling Be Effectively Regulated to Protect Consumers and the Payments System? 110th Cong., 1st Session, June 8, 2007, at p. 120. From an August 27, 2009 interview with Andr Wilsenach.

323

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APPENDIX A Table 1 provides an overview of the 10 risks, providing for each: an indication of protections afforded under the current U.S. regulatory framework; an indication of the natural regulatory structure and strategy for control; and comments regarding relevant technologies and tactics, and the respective role of other parties.

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TABLE 1: Major Categories of Risk Related to Online Gambling

Category 1. Gambling by minors Existing Protection No effective protection. Offshore sites range from well regulated to completely unregulated. Natural Regulatory Structure & Strategy Industry's short-run incentives: supervisory . Industry's long-run/strategic view: cooperative . Relevant Controls & Technologies (Strongest form) Positive id matching at player registration against existing databases of known adults. Range of weaker forms of age verification available at player registration. Provision of child-protective software for parents, to keep minors off their parents accounts. 2. Consumers defrauded by site operators No effective protection. Offshore sites range from well regulated to completely unregulated. Supervisory: Enforcement focus aimed at disreputable operators. Exclusion of bad actors. Vetting applicants and monitoring existing licensee behavior. Licensee oversight that includes software audits, mystery shopping, and betting pattern monitoring by regulator. Available complaint procedures: players report directly to regulators and have access to U.S. courts. 3. Players cheated by other players Detection mostly by other players. Remedies unavailable if sites deny the problem. Naturally cooperative: Public and industry's interests both served by preserving integrity of games. Comprehensive data retention by sites. Routine operation of pattern recognition systems for anomaly detection. Complaint procedures available for players to report anomalies to operators and to regulators. Regulatory oversight of complaint investigation and disposition. 4. Involvement of organized crime No effective protection with respect to offshore activities. Supervisory: Enforcement focus aimed at disreputable operators. Exclusion of bad actors. 5. Money laundering by site operators Offshore operations subject to international cooperative enforcement efforts. Supervisory: Enforcement focus aimed at disreputable operators. Exclusion of bad actors. 6. Money laundering by players No effective protection. Short-run incentives: supervisory. Long-run/strategic view: cooperative. Vetting applicants and monitoring existing licensees/operators for criminal backgrounds, criminal associations, and hidden ownership interests. Vetting applicants and monitoring existing licensees/operators for criminal backgrounds, criminal associations, and hidden ownership interests. Anti-money-laundering laws apply. Comprehensive data retention by sites. Details of every transaction recorded (not possible in casinos). Pattern recognition by operators as part of a compliance operation, and by regulators as part of oversight audit operation.

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TABLE 1 (continued): Major Categories of Risk Related to Online Gambling

Category 7. Violation of jurisdictional restrictions or prohibitions Existing Protection No effective protection. States have no remedy with respect to offshore sites. Natural Regulatory Structure & Strategy Short-run incentives: supervisory. Long-run/strategic view: cooperative. Relevant Controls & Technologies Right of government to prohibit or restrict operators within state, and services offered to residents by operators outside of state. Federal regulation of licensees that obliges them to respect list of state exclusions/restrictions. Residence validation at player registration. Geolocation monitoring for each player session (e.g., by ISP analysis). Regulatory audits of operators software controls. Mystery shopping/testing by states exercising rights to restrict. Federal and state remedy against licensed operators through federal or state law.

8.

Breaches of data confidentiality

No effective protection. Offshore operators outside U.S. jurisdiction.

Short-run incentives: supervisory. Long-run/strategic view: cooperative.

Licensees subject to all U.S.-based requirements regarding data confidentiality. Licensees subject to criminal sanctions and civil liability for breaches/abuses. Data-protection controls subject to audit.

9.

Communications and computer security failures

No effective protection. Offshore operators outside U.S. jurisdiction.

Short-run incentives: supervisory. Long-run/strategic view: cooperative.

Principal responsibility for state-of-the-art security should rest with site operators. Civil liability for site operators with respect to any harm to consumers. Regulators role in auditing site security software/systems.

10.

Problem gambling behaviors

No effective protection. Offshore sites range from well regulated to completely unregulated.

Short-run incentives: supervisory. Long-run/strategic view: cooperative.

Site-imposed limitations & controls. Self-imposed exclusion options. Self-imposed limiting options. Taxes and license-fee revenue distribution can extend & enhance counseling & support services.

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List of Individuals Interviewed Name Parry Aftab Executive Director Wired Safety Bo Bernhard Director of Gambling Research UNLV College of Hotel Administration Michael Bolcerek Senior Vice-President of Business Development Aristotle Phill Brear Head of Gambling Regulation Gibraltar Regulatory Authority Peter Collins Professor of Public Policy Studies, Director of the Center for the Study of Gambling University of Salford (U.K.) Philip J. Cook Senior Associate Dean for Faculty and Research, ITT/ Terry Sanford Professor of Public Policy, Professor of Economics and Sociology Duke University Kelli Emerick Executive Director Secure ID Coalition Andrew Fritchie General Counsel PartyGaming PLC Glenn Gibson Manager, Technical and Systems Audit Tasmanian Gaming Commission (Australia) Date of Interview 05/27/2009

06/10/2009

08/10/2009

08/05/2009

06/10/2009

06/10/2009

08/06/2009

08/21/2009

08/05/2009

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Damien Jarvis Assistant Director Liquor and Gaming Branch Tasmania Department of Treasury and Finance (Australia) Matthew Hill Director of Strategy, Research and Analysis British Gambling Commission (U.K.) Simon Holliday Director H2 Gambling Capital (U.K.) Joseph Kelly Professor SUNY Buffalo Business Law Paul Mathews Former Senior Vice President IGT Wagerworks Sam McQuade Graduate Program Coordinator College of Applied Science and Technology, Rochester Institute of Technology Katharina Riedl bwin (Austria) Paul Morris Policy Development Manager British Gambling Commission (U.K.) Chris Pinion National Account Manager LexisNexis Risk and Information Analytics Sue Schneider Founder Interactive Gaming News John Sealy Manager, Information Systems and Technology Services Licensing, Regulation and Alcohol Strategy Northern Territory Department of Justice (Australia)

08/05/2009

06/12/2009

08/04/2009

06/01/2009

08/03/2009

06/03/2009

08/13/2009

06/12/2009

08/10/2009

08/17/2009

08/31/2009

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Howard Shaffer Director of Division on Addictions Associate Professor of Psychology, Department of Psychiatry The Cambridge Health Alliance, Harvard Medical School Charles Wellford Professor of Criminology and Criminal Justice University of Maryland, College Park Keith S. Whyte Executive Director National Council on Problem Gambling Jamie Wiebe Director Centre for the Advancement of Best Practices Ontario Responsible Gambling Council (Canada) Andr Wilsenach Chief Executive Officer Alderney Gambling Control Commission

06/10/2009

06/17/2009

06/05/2009

08/07/2009

08/27/2009

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FACING THE LOTTERYS FUTURE:

Implications and Strategies Regarding Internet Sales
Prepared for the Massachusetts Treasurers Online Products Task Force December 4, 2012 Amended January 8, 2013

Contents
A. INTRODUCTION ............................................................................................................... 8 HOLISTIC PERSPECTIVE IN MASSACHUSETTS ..................................................................................8 THE GAMBLING LANDSCAPE.................................................................................................... 11 COMPETITION AND CONVERGENCE ........................................................................................... 12 CULTURAL ADAPTATION: NEW PARAMETERS.............................................................................. 14 B. EXECUTIVE SUMMARY................................................................................................... 17 C. RECOMMENDATIONS .................................................................................................... 22 1. SEEK LEGISLATIVE APPROVAL FOR ONLINE PLAY .......................................................................... 22 2. LOTTERY SHOULD PURSUE ONLINE PLAY ................................................................................... 23 3. LOTTERY SHOULD BE SOLE INTERNET GAMBLING PROVIDER IN MASSACHUSETTS .............................. 24 4. AGGRESSIVELY FIGHT THREAT FROM INTERNET/SWEEPSTAKES CAFES.............................................. 26 5. ISSUE RFP THAT EMPHASIZES OPENNESS, CREATIVITY .................................................................. 27 6. PURSUE PHASED ENGAGEMENT STRATEGY................................................................................. 29 a. Phase 1 ......................................................................................................................... 30 b. Phase 2 ......................................................................................................................... 30 c. Phase 3 ......................................................................................................................... 31 d. Phase 4 ......................................................................................................................... 32 e. Phase 5 ......................................................................................................................... 32 f. Other Considerations.................................................................................................... 33 7. ENCOURAGE NEW GAMES, THEMES UNDER LOTTERY BRAND ...................................................... 34 8. ENCOURAGE RESPONSIBLE COMPETITION, INCUBATE MASSACHUSETTS BUSINESSES .......................... 35 9. DEVELOP, IMPLEMENT LICENSING REQUIREMENTS FOR VENDORS .................................................. 36 10. REQUIRE REGISTRATION PROCESS THAT ASSURES INTEGRITY, BENEFITS RETAILERS............................. 39 11. EMPHASIZE GEOLOCATION ACCURACY, MINIMIZATION OF UNDERAGE GAMBLING ............................ 41 12. IMPLEMENT INTERNET RESPONSIBLE GAMBLING STANDARDS ADOPTED BY NATIONAL COUNCIL ON PROBLEM GAMBLING, CREATE DIRECTOR OF RESPONSIBLE GAMING ........................................................ 42 13. ENHANCE TECHNOLOGY BASE THROUGH INTERNAL RESOURCES AND VENDOR RELATIONSHIPS ............. 43 14. TREAT INTERNET MARKETING DIFFERENTLY THAN CONVENTIONAL MARKETING; INCREASE ADVERTISING AND CONDUCT REGULAR RESEARCH................................................................................................... 45 D. LEVERAGING THE INTERNET: BRICK-AND-MORTAR LOTTERY RETAILERS ARE ONLINE ASSETS .................................................................................................................................. 48 1. USING ONLINE TO BOOST RETAIL SALES: EXAMPLES FROM OTHER INDUSTRIES ................................. 51 2. DEVELOPING MULTI-CHANNEL STRATEGY FOR MASSACHUSETTS STATE LOTTERY .............................. 53 3. LOYALTY PROGRAMS: ADVANCING SALES, PUBLIC POLICY............................................................. 55 4. CASINO CUSTOMER LOYALTY PROGRAMMING ............................................................................ 57 E. CURRENT SITUATION IN MASSACHUSETTS .................................................................... 60 1. BACKGROUND ...................................................................................................................... 60 2. SUCCESS FACTORS................................................................................................................. 60 3. OVERVIEW OF LOTTERY OPERATIONS IN MASSACHUSETTS ............................................................ 63 a. Consequences of a Unique Mandate............................................................................ 65 4. THE LOTTERY PLAY EXPERIENCE ............................................................................................... 74 1. 2. 3. 4.

Report for the Massachusetts Treasurers Online Products Task Force

SALES AGENTS...................................................................................................................... 75 COMMERCIAL CASINO EXPANSION ........................................................................................... 77 F. SURVEY OF MASSACHUSETTS STATE LOTTERY RETAILERS .............................................. 78 G. SOCIALSPHERE RESEARCH ............................................................................................. 89 1. QUALITATIVE FOCUS GROUP RESEARCH .................................................................................... 89 2. QUANTITATIVE SURVEY RESEARCH ........................................................................................... 92 H. STAKEHOLDER VIEWPOINTS .......................................................................................... 93 1. THE TREASURERS PUBLIC FORUMS: LISTENING TO STAKEHOLDERS ................................................. 93 2. LOTTERY VENDOR: VESTED INTEREST VIEWPOINTS ...................................................................... 98 I. ONLINE ENGAGEMENT STRATEGY ............................................................................... 101 1. IMPLEMENTATION STRATEGY................................................................................................. 101 2. PHASED ENGAGEMENT STRATEGY .......................................................................................... 102 3. PRODUCTS/GAMES ............................................................................................................. 105 J. ONLINE ENGAGEMENT ANALYSIS: DEFINING STRATEGY, IDENTIFYING ISSUES ............. 107 K. PAYMENT, REGISTRATION AND VERIFICATION ............................................................ 112 1. PAYMENT VEHICLES............................................................................................................. 112 2. REGISTRATION PROCESS ....................................................................................................... 113 3. KNOW YOUR CUSTOMER ...................................................................................................... 116 L. TRADITIONAL LOTTERY SALES, BEFORE AND AFTER CASINOS ...................................... 120 1. DELAWARE ........................................................................................................................ 120 2. PENNSYLVANIA ................................................................................................................... 121 3. RHODE ISLAND ................................................................................................................... 125 4. CONCLUSION ..................................................................................................................... 126 M. LOTTERY SALES: ONLINE SALES IMPACT ..................................................................... 127 1. BRITISH COLUMBIA ............................................................................................................. 127 2. AUSTRIA............................................................................................................................ 128 N. SUBSTITUTION AND CANNIBALIZATION ISSUES ........................................................... 130 1. SUBSTITUTION EFFECT IN MASSACHUSETTS .............................................................................. 132 a. Previous Literature ..................................................................................................... 132 b. Inter-Industry Relationships ....................................................................................... 133 2. ONLINE GAMBLING ............................................................................................................. 135 a. Anecdotal Evidence .................................................................................................... 136 3. EXPERIENCES IN EUROPE ...................................................................................................... 138 4. SUBSTITUTION EFFECT: UNDERSTANDING THE CONCERNS ........................................................... 141 a. Concern: Online Gambling Expenditures Divert Expenditures Away from Other (NonGambling) Industries ........................................................................................................... 142 b. Concern: Online Gambling Expenditures Come at Expense of Massachusetts New Casinos ................................................................................................................................ 142 c. Concern: Online Gambling Expenditures Come at Expense of Retail Lottery Ticket Sales 143 5. SUBSTITUTION, CANNIBALIZATION: SUMMARY.......................................................................... 145 O. PROJECTING MASSACHUSETTS LOTTERY SALES ........................................................... 146 1. LOTTERY SALES PROJECTIONS STATUS-QUO ........................................................................... 148 2. LOTTERY SALES PROJECTIONS PHASED ENGAGEMENT STRATEGY................................................ 149

5. 6.

Report for the Massachusetts Treasurers Online Products Task Force

LOTTERY SALES PROJECTIONS ALL INTERNET INITIATIVES EFFECTIVE JULY 1, 2013 ........................ 151 P. ONLINE LOTTERY PRODUCTS ....................................................................................... 154 1. SOCIAL GAMES ................................................................................................................... 154 Q. GAMING VS. GAMING: TWO INDUSTRIES CONVERGE .................................................. 159 1. DEMOGRAPHICS OF GAMING ................................................................................................ 161 R. MOBILE GAMING......................................................................................................... 166 S. IMPLEMENTATION COSTS............................................................................................ 172 T. LEGAL, REGULATORY ISSUES........................................................................................ 178 1. LICENSING ISSUES................................................................................................................ 180 2. INTERNET/SWEEPSTAKES CAFES............................................................................................. 182 U. TECHNOLOGY ISSUES................................................................................................... 185 V. PUBLIC POLICY ISSUES ................................................................................................. 188 W. PROBLEM GAMBLING ................................................................................................ 190 1. BACKGROUND .................................................................................................................... 190 2. PROBLEM GAMBLING AND THE INTERNET ................................................................................ 192 3. MASSACHUSETTS POLICY ...................................................................................................... 196 4. STANDARDS FOR ONLINE PLAY .............................................................................................. 198 5. OPPORTUNITY FOR RESEARCH, TOOLS AND TREATMENT ............................................................. 199 6. CONCLUSION ..................................................................................................................... 202 X. ECONOMIC DEVELOPMENT ......................................................................................... 203 1. MASSACHUSETTS AS GAMES-DEVELOPMENT HUB ..................................................................... 203 2. TOURISM .......................................................................................................................... 210 Y. INTERNET GAMBLING: BACKGROUND ......................................................................... 211 1. EARLY DEVELOPMENT .......................................................................................................... 211 2. PROLIFERATION OFFSHORE ................................................................................................... 212 3. LEGALIZATION IN THE UNITED KINGDOM ................................................................................. 214 4. PROHIBITION IN THE UNITED STATES....................................................................................... 216 a. Unlawful Internet Gambling Enforcement Act ........................................................... 217 5. EVOLUTION OF THE ONLINE LOTTERY ...................................................................................... 219 Z. CURRENT STATE OF ONLINE PLAY: INTERNATIONAL .................................................... 221 1. GLOBAL ............................................................................................................................ 221 2. EUROPE ............................................................................................................................ 226 b. International Lottery .................................................................................................. 230 c. European Internet Lottery Adoption .......................................................................... 231 3. EUROPE, NORTH AMERICA: NOTING THE DIFFERENCES .............................................................. 237 a. Different Culture/Organizational Models .................................................................. 237 b. Different Competitive Threats Driving Lotteries to Internet Sales ............................. 238 c. Different Treatment of Laws with Regard to Internet Lottery ................................... 239 d. Differences in Organizational Structure of Operators................................................ 240 e. Profit Motive, Shareholder Expectations.................................................................... 241 AA. CURRENT STATE OF ONLINE PLAY: NORTH AMERICA ................................................. 244 1. COMMERCIAL GAMING ........................................................................................................ 245 2. INDIAN GAMING ................................................................................................................. 245 3. LOTTERY............................................................................................................................ 249

3.

Report for the Massachusetts Treasurers Online Products Task Force

POKER: EMERGING AS POINT OF ENTRY................................................................................... 250 a. Poker Considerations .................................................................................................. 254 b. Players Other Games ................................................................................................. 258 5. LEGALIZATION EFFORTS ........................................................................................................ 260 BB. INTERNET PLAYER DEMOGRAPHICS ........................................................................... 265 1. DEMOGRAPHICS THE NORTH AMERICAN INTERNET GAMBLER ................................................... 265 2. LOTTERY DEMOGRAPHICS ..................................................................................................... 270 3. MASSACHUSETTS STATE LOTTERY PLAYER DEMOGRAPHICS ......................................................... 273 CC. US LOTTERY OUTLOOK AND ADOPTION OF INTERNET SALES ..................................... 275 1. CURRENT PLANS/OFFERINGS ................................................................................................ 276 2. BARRIERS TO LAUNCH OF INTERNET CHANNEL .......................................................................... 277 3. ROLE OF CASINOS IN INTERNET ADOPTION ............................................................................... 278 4. US LOTTERIES AND THE INTERNET IN 2012 .............................................................................. 279 a. Illinois Lottery ............................................................................................................. 280 b. Delaware Lottery ........................................................................................................ 284 c. District of Columbia Lottery........................................................................................ 285 d. Minnesota Lottery ...................................................................................................... 286 e. Georgia Lottery........................................................................................................... 287 a. Maryland Lottery ........................................................................................................ 289 5. CANADIAN INTERNET LOTTERIES ............................................................................................ 291 a. Atlantic Lottery Corporation....................................................................................... 292 b. British Columbia Lottery Corporation......................................................................... 292 c. Loto Quebec................................................................................................................ 295 ABOUT THIS REPORT........................................................................................................... 296 DISCLAIMER ................................................................................................................................ 297 APPENDIX ........................................................................................................................... 299

4.

Table of Figures
Figure 1: Recommended phasing of Lottery online games ....................................................................... 30 Figure 2: New England lottery advertising budget vs. ticket sales, FY2011 ............................................... 46 Figure 3: Sample lottery advertising ......................................................................................................... 47 Figure 4: Williams-Sonoma, online and in-store sales .............................................................................. 52 Figure 5: FY 2012 Massachusetts State Lottery sales by product (through September) ........................... 61 Figure 6: 2011 Massachusetts State Lottery sales by product .................................................................. 62 Figure 7: 2010 Massachusetts State Lottery sales by product .................................................................. 62 Figure 8: FY 2012 Lottery sales per capita, peer group ............................................................................. 63 Figure 9: Massachusetts State Lottery sales by residency status .............................................................. 80 Figure 10: Massachusetts State Lottery retail business volume by season ............................................... 80 Figure 11: Massachusetts State Lottery retail business volume by time of day ........................................ 81 Figure 12: Massachusetts State Lottery retail business volume by time of day, type of business ............ 81 Figure 13: Massachusetts State Lottery customer likelihood to purchase other merchandise................. 82 Figure 14: Massachusetts State Lottery customer purchase behavior by type of business ...................... 82 Figure 15: Massachusetts State Lottery customer purchase of ancillary merchandise............................. 83 Figure 16: Lottery retailers who hire dedicated employees by type of business ...................................... 83

Report for the Massachusetts Treasurers Online Products Task Force

Figure 17: Lottery customer average spend by purchase behavior .......................................................... 84 Figure 18: Recommended phasing of Lottery online games ................................................................... 102 Figure 19: Contribution to sales if 5% of group played $5 more on multistate games per week ............ 109 Figure 20: Representative gaming know-your-customer checks for online gambling ............................ 117 Figure 21: Delaware Lottery sales data, 1991-2010 ................................................................................ 121 Figure 22: Pennsylvania Lottery sales and PA casino revenue (2002-2011)............................................ 122 Figure 23: Pennsylvania per-capita lottery sales and casino revenue, 2002-2011 ............................... 123 Figure 24: Pennsylvania and select neighboring states lottery sales, 2002-2011 ................................... 123 Figure 25: Pennsylvania and select neighboring states per-capita lottery sales, 2002-2011 .................. 124 Figure 26: Rhode Island lottery sales (total and per-capita), 1998-2012 ................................................ 125 Figure 27: British Columbia Lottery total and per-capita sales/revenue, 2008-2012 ............................ 128 Figure 28: Austrian Lottery total and per-capita sales/revenue, 2006-2010 ........................................ 129 Figure 29: Studies on the relationships among gambling industries ....................................................... 134 Figure 30: Summary of intrastate industry relationships ........................................................................ 134 Figure 31: State lottery revenues, selected states, 2001-2011 ............................................................... 136 Figure 32: Per-capita lottery sales, selected states, 2001-2011 .............................................................. 137 Figure 33: Paddy Power sportsbook turnover (volume) 2003-2008 ....................................................... 140 Figure 34: Paddy Power sports book gross gaming revenue (GGR) 2003-2008 ...................................... 140 Figure 35: UK National Lottery retail and interactive sales growth 2003/4-2011/12 (M) ..................... 141 Figure 36: Massachusetts State Lottery total and per-capita sales, 2003-2012 ................................... 146 Figure 37: Forecasted CPI growth, through 2017.................................................................................... 147 Figure 38: Per-capita sales and cannibalization assumptions ................................................................. 148 Figure 39: Massachusetts State Lottery sales projections at status-quo ................................................ 149 Figure 40: Massachusetts State Lottery sales projections under phased Internet engagement strategy150 Figure 41: Mass. Lottery sales projections, by type, under phased Internet engagement strategy........ 151 Figure 42: Massachusetts State Lottery sales projections, all Internet phases effective July 1, 2013..... 152 Figure 43: Mass. Lottery sales projections, all Internet phases effective July 1, 2013, by type .............. 153 Figure 44: Monthly traffic rankings for Illinoislottery.com, October 2011 through August 2012 ........... 154 Figure 45: Social casino global revenues ................................................................................................. 156 Figure 46: Monetized social gaming and online gambling growth ($ in billions) .................................... 160 Figure 47: Age breakdown of social gamers ........................................................................................... 161 Figure 48: Types of mobile games played (at least once per month)...................................................... 162 Figure 49: Mobile games played previous 30 days ................................................................................. 163 Figure 50: Mobile game play location ..................................................................................................... 163 Figure 51: Social game player demographics .......................................................................................... 164 Figure 52: Global mobile gambling revenues 2003 2015E (in Euros) ................................................... 168 Figure 53: Preferred devices for mobile gaming US and European Countries, 2012............................... 170 Figure 54: Percentage of mobile gamers within age group purchasing virtual goods 2011 .................... 171 Figure 55: BCLC capital expenditures as a percentage of lottery revenues, 2001-02 2011-12............. 175 Figure 56: BCLC lottery and eGaming expenditures and eGaming revenues 2005-06 2011-12 ........... 176 Figure 57: Gambling-behavior continuum .............................................................................................. 192 Figure 58: Internet (or interactive) gambling as a proportion of global GGR....................................... 221 Figure 59: Global Internet gross gambling revenue breakdown by product type, 2011 ......................... 222 Figure 60: Global Internet gross gambling revenue trends, by product type .......................................... 223 Figure 61: Global Internet gross gambling revenue, by region ............................................................... 224 Figure 62: Global Internet gross gambling revenue growth 2005-10, by region ..................................... 225 Figure 63: Global Internet gross gambling revenue growth 2005-10, by product type .......................... 225 Figure 64: European Internet gambling revenue contribution by country.............................................. 226

Report for the Massachusetts Treasurers Online Products Task Force

Figure 65: UK Internet gambling expenditures per capita () ................................................................. 227 Figure 66: Italy Internet gambling expenditures per capita () ............................................................... 227 Figure 67: Italy Internet gambling product trends .................................................................................. 228 Figure 68: UK Internet gambling product trends .................................................................................... 228 Figure 69: UK Internet gambling revenue vs. penetration rate ............................................................... 229 Figure 70: European online gambling regulatory changes 2009-2012 .................................................... 230 Figure 71: European average interactive sales per capita, 2007-2010.................................................... 233 Figure 72: European state-owned lottery average game mix 2010 ........................................................ 234 Figure 73: FY 2012 Massachusetts State Lottery sales by product (through September) ....................... 235 Figure 74: Revenue share by product type, Finland lottery FY 2011 ....................................................... 236 Figure 75: US legal gambling industry market share by segment, 2009.................................................. 246 Figure 76: United States poker participation rates, 2003-2009 .............................................................. 253 Figure 77: North American Internet poker revenues, 2003-2015E ......................................................... 254 Figure 78: Poker-lobbying expenses in the US ........................................................................................ 256 Figure 79: US poker revenue reported by four major providers, 2005-6 ................................................ 257 Figure 80: Internet poker player weekly lottery spend ........................................................................... 259 Figure 81: Expected effect of Internet poker availability on lottery purchases ...................................... 259 Figure 82: By age group, Internet gamblers vs. traditional casino gamblers .......................................... 266 Figure 83: By education level, Internet gamblers vs. traditional casino gamblers .................................. 266 Figure 84: Types of online games played among North American Internet gamblers ............................ 267 Figure 85: Most frequently visited Internet gambling sites by all active gamblers ................................. 268 Figure 86: US Internet penetration rates by state June 2010 .............................................................. 268 Figure 87: Internet usage frequency by demographic group - 2008 ....................................................... 269 Figure 88: Proportion of Core (Joe) lottery players to Non-Core (Jack) players ............................... 271 Figure 89: Lottery play currently vs. one year ago among those who play lottery ................................. 271 Figure 90: Profile of gamblers in the United States, 2006 ....................................................................... 272 Figure 91: Massachusetts State Lottery frequency of play by age group ................................................ 273 Figure 92: Map of US lottery states ........................................................................................................ 275 Figure 93: North American Internet lottery/gaming comparison grid .................................................... 291 Figure 94: British Columbia Lottery Corp. retail sales trends 2006 - 2012 .............................................. 294

Report for the Massachusetts Treasurers Online Products Task Force

A.

Introduction

The Commonwealth of Massachusetts Treasurers Online Products Task Force (Task Force) retained Spectrum Gaming Group (Spectrum, we or our) to facilitate the Task Force in achieving its responsibilities concerning the possible implementation of Internet play for the Massachusetts State Lottery. Our recommendations are based on considerable research and analysis and reflect Spectrums best insights and advice. Our goal is to provide the Task Force with the highest quality information upon which to base its own recommendations. This introduction provides the necessary basis for the following section of our report, which details a series of recommendations. All of our recommendations have one critical assumption: That Internet gambling is conducted on an intrastate basis, except for perhaps poker and horse racing. If federal law were to permit interstate lottery and casino play, it could dramatically alter all forms of gambling throughout the country and thus require a completely different analysis of the Massachusetts State Lotterys online strategy.

1.

Holistic Perspective in Massachusetts

The core theme of Spectrums report can be summarized in two words: One Commonwealth. That theme emerged early in our research and analysis regarding whether the Massachusetts State Lottery State Commission should develop an online gambling channel, and if so, how. As our research progressed and we examined a widening array of issues and options, the theme became more pronounced. Upon completion of our analysis, the central role of that theme became obvious. Massachusetts Treasurer Steven Grossman set forth certain overarching goals that should guide our research: Any online gambling efforts that may be considered should enhance and not hurt the 7,400 retailers who presently sell lottery tickets, and who are a major factor behind the success of the Massachusetts State Lottery (Lottery). Any online gambling initiatives should enhance and not diminish the value of the planned casino licenses to be awarded by the Massachusetts Gaming Commission.

Additionally, Treasurer Grossman made it clear that he expected Spectrum to be in full listen mode throughout our research, making every effort to hear, understand and address the wide variety of concerns and aspirations of all interested stakeholders. Indeed, we have endeavored to enthusiastically abide by those precepts, which remain central to our findings. We start by noting that such a broad mandate is rare among lotteries, which traditionally are measured by ticket sales and by how much they return to their respective state treasuries. If a lottery helps a retailer sell more milk, gasoline or other non-lottery products, that is generally not taken into account as to whether a lottery is successful. Moreover, if a

Report for the Massachusetts Treasurers Online Products Task Force

lottery helps its casino industry to attract more capital investment, employ more people or generally be more successful, that does not generally earn plaudits for the lottery. At the same time, we note that while such mandates may be rare they are also rather productive. A strict adherence to Treasurer Grossmans mandates would not only be good public policy for Massachusetts, but would also fuel continued success for the Lottery itself. Indeed, we believe that one aspect that sets the Massachusetts State Lottery apart from other lotteries in North America is a culture that is willing to challenge conventional wisdom and question the status quo. That willingness ingrained into the Lotterys culture is one reason why this study was commissioned in the first place. As our research was underway, certain singular aspects of Internet gambling, as well as certain aspects of policy in Massachusetts became clear. Among these are: The Lottery has developed a powerful network of more than 7,400 retail agents throughout the State, allowing it to generate $4.75 billion in annual sales. If it were a private company, that level of revenue would nearly place it in the Fortune 500.1 Yet, despite that scale of operations within a single state, the Lottery like most of its counterparts across the nation has little presence on the Internet. Internet wagering despite its success in Europe, Canada and elsewhere remains something of a black box for a state lottery, in that there is no reliable predictor of its impact in terms of revenue or on the State in general. As our report will detail, professionals in the field of problem gambling are concerned that there is little precedent on how the availability of online wagering may impact that vulnerable segment of the population. The initiative to study the potential of online wagering occurs at the same time that the Commonwealth is embarking on a significant land-based gambling initiative, with three planned destination casino resorts plus a slots-only casino to be licensed in coming months.

Those three examples are emblematic of the challenges facing this initiative. From the standpoint of Spectrum, we determined to look at all these challenges as opportunities to help ensure the success of any such initiative. With that in mind, we developed the following principles to guide our recommendations and findings: The established network of retailers who have an abiding interest in maintaining a cooperative relationship with the Lottery should be viewed as an asset that could benefit the Lotterys online initiative, while they benefit in return.

Based on revenue, the 500th company in the Fortune 500 is Molina Health Care, with annual revenue of $4.77 billion. http://money.cnn.com/magazines/fortune/fortune500/2012/full_list/401_500.html (accessed July 29, 2012)

Report for the Massachusetts Treasurers Online Products Task Force

While the precise nature of how online play would impact the Commonwealth or be embraced by the public is unknown, it is equally true that the nature of online play in which every important aspect of every transaction will be known, and measured allows the Lottery to continually fine-tune, refine and adapt to changing circumstances, and to respond to new insights that would be gleaned from the expected stream of data. The convergence of an online lottery and casino gambling in the State may create a challenge, but it should also be viewed as an opportunity. In our experience, no other state has had two such simultaneous initiatives with which to grapple, and we suggest that one unified policy can be developed to enhance both initiatives.

Of course, the overarching finding that is at the heart of our research can be summed up thusly: The status quo is not a viable option. This is true, regardless of the equally undeniable finding that many stakeholders have a vested interest in the status quo, and an understandable fear of the unknown consequences of online wagering. The Lottery has historically operated under a business-to-business model (B2B), and online wagering is, by definition, a businessto-consumer (B2C) model. By any measure, this will alter the historic and successful relationship, and retailers fear that their supplier will become their competitor. Still, we must note that the lottery population is aging, and coming generations of adults cannot necessarily be expected to adopt the same spending habits of their forebears, and this is particularly true as new technologies are quickly adopted and just as quickly replace previous technologies. The Lottery should be guided by the following: By shifting from a pure B2B to a combination of B2B and B2C, the Lottery needs to keep the interests of its business customers in mind, and all reasonable steps should be taken to ensure that online complements, and does not replace, in-store sales. The nature of online wagering is such that it will create a torrent of streaming data about customers, which can be analyzed to form a portrait of customer preferences, concerns and problems. No one can accurately or reasonably project how that portrait will be formed and the Lottery must approach online wagering as methodically as possible, learning from each step before taking the next step. Additionally, the Lottery must develop and maintain a willingness to identify new policies, as well as to alter or eliminate existing policies once these opportunities and problems surface. That requires an unprecedented level of flexibility in its operations. The Lottery should recognize that online wagering in 2018, 2019 and beyond will look far different than it will in 2013 and 2014. New games will have been developed, and new technologies will emerge, while new adults who are now

Report for the Massachusetts Treasurers Online Products Task Force

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adolescents will come of age, with different preferences, goals and habits than those of their forebears.

2.

The Gambling Landscape

Legalized gambling throughout the United States over the last 20 years has evolved to become a major public-policy issue at the state level. The gambling debate and subsequent policy discussions have intensified in many states including Massachusetts over the last year, due to the confluence of several critical factors: State officials seeking additional sources of revenue to close budget deficits; State officials seeking to retain gambling dollars being spent across state lines as casino gambling expands; A shrinking pool of new, attractive domestic casino markets; Efforts to support the ailing horse-racing industry through the installation of racetrack slot machines; and A December 2011 US Department of Justice opinion that allows Internet gambling on an intrastate basis.

The latter bullet point has exacerbated what has become a state-by-state, company-bycompany rush to the inevitable. Just as written messages, retail commerce, and research are routinely conducted via the Internet, so, too, will all forms of gambling be available online in the United States in some states to start, in almost all states ultimately. This has already happened elsewhere in the world, most notably in Europe, where Internet gambling is estimated to be a US$118.2 billion business in 2012.2 The experience in Europe which is the worlds largest and most mature Internet gambling market informs much of our analysis. Europe is also significant because many of the operators and suppliers based in Europe and surrounding regions, including the Middle East, are targeting the United States as a prime market for their goods and services. That, in turn, leads us to a critical cautionary note: The experience in Europe is of limited value to the US market, including lotteries, because the gambling industry in the United States has already evolved in a way that is markedly different from its counterpart in Europe. The United States is home to two major gambling industries lotteries and casinos that are roughly equal in size, at about $60 billion in annual revenue each when US state lotteries are measured by net ticket sales.3 The size and the nature of these industries demands that online gambling be adopted in the United States with a different approach.
2 3

H2 Gambling Capital estimate of 2012 Internet gross gambling revenue. La Fleurs 2012 World Lottery Almanac

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Notably, that cautionary note is not universally accepted or shared. Many European operators and suppliers with whom we have met, or whose experience we have studied, are clearly under the impression that what works in Europe will likewise work well in the US. We believe that such an approach is short-sighted and represents potential lost opportunities.

3.

Competition and Convergence

Online gambling policy within Massachusetts is being developed in coordination with policies regarding other forms of gambling, and with due consideration to what is occurring outside the borders of the state. While the future delivery mechanism of gambling is known, the relationship among and possibly the integration of each states various forms of gambling is unknown. Yet this relationship will be critical to the economic performance of all forms of gambling in a state. State lotteries will be early adopters of Internet gambling. Ultimately, many states will offer video lottery games via the Internet that will from a consumer standpoint be no different than a casinos online slot machine offerings, or significantly from different a casinos physical slot machines, for that matter. How, then does a state ensure that both its lottery and casino industry forms of gambling in which a state has a large, vested interest coexist when offering the same product? Lotteries themselves will confront new, Internet-specific concepts that are largely not present in the lottery world. One concept well known in the casino industry is time on device. This concept, used to gauge the popularity of a slot machine, is baked into the concept that gambling is a form of entertainment, as much as it is a form of risk-taking. Players seeking entertainment will view the time they spend at a machine, or before a computer screen, as the time they are purchasing with their gambling budget. This concept is foreign to lottery players, who as presently constituted are purchasing an opportunity to win. Lottery players do not purchase time on ticket. Recognizing, and ultimately adopting, the new-gambling issues and realities will likely be a factor in whether the Massachusetts State Lottery develops a successful online channel. Such recognition means, for example, that pay tables may have to be tweaked, or that sufficient emphasis has to be placed on the creativity of the player experience. It also ties into the notion that if an online lottery is to be successful it must tap into the desires of adults who do not presently play existing lottery games, i.e., such adults seek a different type of gambling experience. Such issues become even more challenging to address because no state has a cohesive, overarching policy concerning legalized gambling. Lotteries, commercial casinos, Indian casinos, racetracks, and charitable gambling typically look out for their own good and typically answer to different authorities. In fact, their competing economic interests are a source of

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ongoing friction both among each other and among their supporters in statehouses across the country. Such interplay is now of great importance for the Commonwealth of Massachusetts, where its highly successful lottery is exploring Internet-based play at the same time that the state is preparing to launch a land-based casino industry in which private companies may be investing $2.5 billion. Operating in largely separate spheres, each form of gambling should provide handsome financial rewards for the Commonwealth. When there spheres overlap i.e., they offer similar games of chance there is the potential for harm, or what is widely known in the gaming industry as cannibalization. Cannibalization of Lottery revenue due to the opening of casinos in the State is not a new issue. Indeed, Spectrum analyzed this extensively in its 2008 report Comprehensive Analysis: Projecting and Preparing for Potential Impact of Expanded Gaming on Commonwealth of Massachusetts. We noted, among many issues, that Lotteries are largely a convenience-driven product, with little social interaction. Casinos particularly destination resorts are centered on the entertainment experience. At the same time, studies have shown that the demographics of these two forms of gambling are markedly different.4 However, we also noted that certain lottery games such as keno might be more vulnerable to cannibalization since they have social elements not present in more traditional lottery games. The prospect of Internet gambling makes cannibalization a particularly important issue since the possibility exists that both the Lottery and the forthcoming casinos could both, theoretically, develop online offerings that would compete directly against each other. In such a scenario, cannibalization is a certainty although it would theoretically cut two ways. While addressing this internal challenge, the Commonwealth must be mindful that gambling is expanding throughout and around New England: Rhode Island is contemplating adding live table games and a possible third, Indian casino. New Hampshire is expected to reconsider legislation that would add one or more casinos one of which could be located at Rockingham Park, just 30 miles north of Boston. Maine opened its second casino in June 2012 Connecticuts two Indian casino resorts are becoming more aggressive in developing online strategies while protecting their brick-and-mortar market share.

Comprehensive Analysis: Projecting and Preparing for Potential Impact of Expanded Gaming on Commonwealth of Massachusetts, Spectrum Gaming Group, August 1, 2008, p. 124

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A highly successful racetrack operation opened in New York City last fall and the State of New York is now considering legislation that would legalize table games and possibly add more gambling locations.

How Massachusetts responds to the internal and external challenges will shape its gambling-related proceeds for decades. The Commonwealth, through Treasurer Grossman, has taken an important first step with the creation of the Treasury-Lottery Online Products Task Force to gain a comprehensive, strategic assessment of the current landscape of online lottery products and play throughout the country and its short- and long-term fiscal and societal implications ... The Online Products Task Force (Task Force) subsequently retained Spectrum Gaming Group on March 8, 2012, to assist it in executing its mission. Specifically, Spectrum was retained to facilitate the Task Force in achieving its responsibilities, including (a) examination of the legal and regulatory frameworks governing online lottery/gaming and advising on the state of the law with respect to Massachusetts; (b) assessing the economic implications of online lottery products and play for Massachusetts taking into consideration, without limitation, such matters as (i) the Lotterys current business, consumers and agents, (ii) the anticipated development of brick and mortar casinos in the Commonwealth, and (iii) other online lottery/gaming initiatives underway globally or under consideration nationally; (c) investigating the prospect for and means to cultivate new technological and business opportunities here in Massachusetts in connection with any expansion into online lottery products; (d) evaluating the human and social issues accompanying online lottery products and play and means for addressing them; and (e) advising as to legislative and regulatory measures needed to position the Lottery for the introduction of online products, while protecting its assets and safeguarding the interests of our citizens. Among other tasks, Spectrum executives and associates have interviewed myriad stakeholders from elected officials to lottery retailers in developing a report that focuses on recommendations designed to help ensure that the Commonwealth develops an online gambling program that advances public policy and addresses the needs of such stakeholders.

4.

Cultural Adaptation: New Parameters

The development of an online channel offers the potential to change the Massachusetts State Lottery in profound ways, as it would for any lottery that seeks to implement online gambling in a proper means that protects and enhances the public interest. First, lotteries that evolve from the existing brick-and-mortar distribution channel by adding an online channel should recognize that such moves will add requirements and pressure to become more of a regulatory agency, which can be a profound change for agencies that have historically focused on the marketing and sales aspects of lottery operations.

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Spectrum has worked with lotteries that have evolved into effective regulatory agencies, in such states as Maryland and Delaware, where lotteries were vested with oversight of casino operations. While such examples are not precisely on point with respect to this proposed change in Massachusetts, the transitions have been successful, and we believe that the Massachusetts State Lottery will similarly adapt with ease. In part, becoming more of a regulatory agency requires a focus in such areas as licensing standards and adopting rules that to which vendors must adhere. Potentially more important, however, is the notion that lotteries must become even more attuned to such issues as underage gambling and problem gambling. We suggest that public pressure may be such that the bar will be higher. For example, lotteries provide instant games based on brands developed elsewhere, from popular movies to comic strips. Such games have largely escaped criticism, but that may not necessarily hold for an online brand. For example, would a Three Stooges game popular with instant games work as an online brand, or would it be perceived as potentially targeting an under-18 demographic? As another example, the Pennsylvania Lottery had its own mascot, a groundhog named Gus. Would such a mascot work in an online environment, or would it become another Joe Camel, the mascot once used by Camel cigarettes but since abandoned, since it was viewed as targeting underage smokers? Such questions and potentially such concerns should be addressed much earlier in the process, if the Massachusetts State Lottery proceeds with an online offering. We cannot predict precisely how far the bar will be raised on such matters, but we expect that it will indeed be raised. Similarly, this report makes it clear that moving online will put the Lottery on a path of convergence with casinos, but will also put it on a path of a convergence with the existing games industry (which is not regulated, and does not constitute gambling). The games industry5 has developed its own unique concepts, goals and terminology that may prove to be anathema for lotteries that are concerned with not targeting underage gambling and with not exacerbating problem gambling. For example, game designers seek to develop games that grow in popularity by prompting players to continually return to improve their scores and skills, and because they enjoy the experience. That concept is referred to as a compulsion loop. The concept is summarized well in the following: At the center of a game design are its core compulsions, things to do that, in turn, inform the core game mechanics. Fulfilling these compulsions should yield incremental rewards, in the form of story advancement, new game elements, etc. These rewards

This industry is also known as the gaming industry, but we need to make a distinction for purposes of this analysis, to avoid confusion with the gambling industry, which is also known as the gaming industry.

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should drive the player to continue playing, and unlock further rewards, etc. This cycle is commonly referred to as a compulsion loop. 6 While such concepts are perfectly acceptable and non-controversial with respect to games, the very word compulsion would likely be alarming if established as a goal for a form of legal gambling. Moreover, as we note later in the report, while the potential convergence of an online lottery and a games industry offers tantalizing prospects, a variety of challenges need to be considered including such issues as people who play games at work, as well as the core issues of underage gambling and problem gambling. Time on device is an important concept for online play, and indeed time is a valuable commodity that the Lottery can offer to potential players, but such policies should be tempered by the public policies of not encouraging either underage gambling or problem gambling.

The effect of playing video games: What do designers want? http://www.oecd.org/edu/ceri/39530650.pdf (accessed August 27, 2012)

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B.

Executive Summary
Policy Implications

The Massachusetts State Lottery Commission should engage the Internet channel just as the vast majority of businesses across the country and around the world are doing now. Establishing an Internet presence will keep the Lottery relevant and render play more accessible and convenient, while attracting and interacting with a new, younger, more affluent customer demographic which ultimately represents the future customer base. Commercial retail operations ignore the Internet at their own peril and recent US business history is littered with the carcasses of companies that failed to develop an online products strategy. A defensive threat also exists that if the Lottery does nothing, then it cedes the field to other actors who will not be as obligated to provide for the general good of the Commonwealth. The key consideration in any online engagement is for the Lottery is to pursue a carefully articulated strategy and assure that online lottery product sales do no harm to existing stakeholders but rather provide a net benefit to the Commonwealth. Because the primary goal of the Lotterys original mandate is to provide for the greater benefit of the Commonwealth, the Lottery should be granted the exclusive right to offer Internet games of chance within the state. This will provide maximum benefit for Massachusetts citizens in terms of revenue reinvested in local communities across the state. An important corollary of state lottery exclusivity is that monopolization of the Internet gambling channel will function to minimize the influence of less well-regulated offshore operators and allow the implementation of an online strategy to be conducted with maximum consideration given to social responsibility issues and to ameliorating any potentially negative impacts on the widespread network of traditional lottery retail agents. Absent this official oversight from a trusted and proven state agency, Internet gambling could develop commercially in ways that most likely would not produce the same level of benefit to the Commonwealth as a whole. The Massachusetts State Lottery enjoys widespread brand recognition, high levels of public trust, a widespread network of retail sales agents, and the majority of revenues generated from Lottery sales benefit municipalities across the state. In addition, the Lottery is well positioned and highly motivated to protect the financial interests of its retail agent network during any implementation of online product sales and into the future. This recommendation indeed, this entire report recognizes that two agencies regulate gambling in the Commonwealth. Casino gambling is regulated by the Massachusetts Gaming Commission. If the casino industry is authorized in the future to conduct any form of online gambling, that would clearly fall under the full purview of the Gaming Commission. We are not suggesting that the Massachusetts State Lottery Commission should regulate the casino industry. If, going forward, different entities including the Lottery are authorized to conduct online

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wagering, we recommend that marketing efforts be coordinated in an effort to optimize the overall benefit to the Commonwealth. If exclusivity is not granted through enabling legislation, we recommend that joint ventures with, or licensing through, the Lottery be mandated or encouraged for Internet gambling enterprises seeking to operate in Massachusetts. Such combined efforts could include partnering with the Lottery to operate within the state, utilizing a common platform maintained by the Lottery, or providing a percentage of revenue to the Lottery as a condition of licensure. We also recommend that the Treasurer take a strong stand against any federal Internet gambling legislation that would restrict the Lottery from implementing online products in the future, and work with the heads of other US lotteries to protect states rights in the field on Internet gaming. Finally, in the area of policy, Spectrum recommends that the Task Force strongly support vigorous and effective enforcement of recently enacted H.3765, which regulates the quasigambling enterprises known as Internet/sweepstakes cafs. These establishments constitute a potential competitive threat to both retail and Internet Lottery sales as well as to land-based casino operations. Internet cafs offer a gambling-like product that competes directly with legalized gambling and should be closely controlled. Retail Agent Protections By engaging the Internet, the Lottery, which has previously followed a business-tobusiness model by selling exclusively through retail agents, now begins to market directly to consumers. This brings the Lottery into potential competition with its most important asset the retail sales agents. The Lotterys network of 7,400 retail locations has been essential to the historical success of lottery sales and these small businesses provide employment and support local economies across the Commonwealth. Every effort must be made to ensure that Internet lottery sales will not adversely impact retail lottery sales and to utilize the established retailer network as a potent sales force for new online products that will effectively benefit all stakeholders in Massachusetts. These retailer protections may include but not be limited to the following measures: Phased online products implementation strategy Scratch games not carried to the Internet New online products developed as alternatives Lottery pre-paid cards pre-loaded in small dollar amounts for Internet play available for purchase only at traditional retail outlets. Retailer commissions earned on the sale of online products via pre-paid cards. Expanded advertising to communicate new and traditional sales channels. Online promotions that stimulate foot traffic to traditional retailers.

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Annual review to assess impact of Internet sales on traditional sales

Experience in international jurisdictions including Europe, Australia and Canada shows that online products will attract a different type of player than the traditional lottery ticket purchaser. This online product purchaser is generally younger, better educated, and higher income than traditional ticket purchasers. As a result, international jurisdictions show little evidence of online product sales cannibalizing traditional retail sales and multiple instances of retail sales increasing after the introduction of online products. Nonetheless, the Massachusetts lottery market is substantially different from international jurisdictions, most notably in its reliance upon instant games for the majority of ticket sales. The Lottery since its inception has benefitted from the enthusiastic support of a widespread network of retail sales agents; this longestablished partnership should be preserved and strengthened in any Internet sales strategy. Therefore, in order to protect traditional sales for the most successful US lottery on a per-capita basis, it will be necessary to provide retailer protections such as those suggested above and to carefully monitor the impact of any online product sales upon brick-and-mortar retail sales to assure that the existing sales network is not impacted. One of the most effective means for protecting retail sales is the utilization of pre-paid play cards for funding online Lottery purchases. These cards would be pre-loaded in small amounts and would be available for purchase only at authorized Lottery retailers. These preloaded play cards would fund play through player accounts via a code number input from each pre-paid card. Meanwhile retail agents would receive a commission on the sale of each card sold at that location. Requiring a pre-paid card to fund the purchase account would adversely impact the overall convenience of Internet registration. However, the physical age-verification check performed by the retailer at point of purchase would possibly avoid the need to provide a Social Security Number during the online registration process, which the Task Forces qualitative research has shown to be a barrier to purchasing online products. Pre-paid cards could be reloaded from lottery winnings or from other sources such as bank account transfers or credit cards, but simply allowing the cards to expire and the player to purchase a new card would drive the most foot traffic to retail locations. There are many other ways that the Lottery can support retail business sales traffic, including the development of promotions for the online-play channel which involve redemption at a physical retail location. The Lottery should continue the current 5 percent commission for retail sales agents on all Internet purchases, with the commission going to the retail location where the play card was purchased. Additionally, the Lottery might consider providing the ability for patrons to designate a preferred retailer during the online registration, as Loto-Quebec intends to do, although this plan may not benefit all retailers as equally as pre-paid cards would. Phased Implementation A gradual and phased approach to implementing online products makes the most sense for several reasons. The Massachusetts State Lottery currently has no online products and if it
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decides to engage the Internet as a sales channel it will take time to develop the capabilities and products as well as the internal knowledge base to move forward successfully. Furthermore, the Lottery has shown that it will not make such a decision lightly and will carefully weigh the potential impact before acting. For these reasons alone a gradual approach appears to constitute the wisest strategy. In addition, phased implementation of online products will minimize any potential negative impact on retail sales and give the Lottery the time to recognize any such impact and initiate remedial actions. A phased approach has been followed by almost every lottery that offers online product sales and has proven especially successful for industry leaders such as the Finnish and British Columbian lotteries. For Massachusetts, the early phases should focus on the products most easily translatable to online sales: multi-state lotto and keno. In addition, the Lottery should develop new online products in the casual and social gaming categories such as arcade games. Middle phases can concentrate on adding new types of draw-based games and instant games. While implementing online products, the Lottery should be careful not to simply transfer its existing inventory of games which have proven successful in the brick-and-mortar retail sales outlets to the Internet. Instead, careful attention should be given to developing new types of online products that will not directly compete with retail versions. Finally, as the Lottery becomes more proficient in operating, administering and marketing online products, it can consider a wider variety of online offerings provided that legislative and market conditions as well as public perceptions allow, possibly including casino-style games, poker or even sports betting should it become legal at the national level. Online lottery, by definition, includes mobile lottery products and the rapid growth in the utilization of mobile devices (smartphones, laptops, tablets, etc.) and associated rapid growth in mobile gaming argues for a strong mobile product strategy in any online product implementation. Many international lotteries are developing new games specifically designed to be played on mobile devices. The Lottery should also prepare for the introduction of a mobile product inventory as an element of its online product implementation. Implementation Costs Implementing online products will come at a substantial cost. International lotteries that have successfully entered this market have approached it as a startup venture and spent heavily to launch online product sales. Camelot was allocated a total of $141 million when taking the UK National Lottery online in 2002, including $72 million for operations and technology, $45 million for advertising, and $25 million for rebranding retail locations. The British Columbia Lottery Corporations capital spending, most of which supported the eGaming venture, exceeded 10 percent of total ticket sales during the most intense phases of online product implementation, approaching $100 million in expenditures, and averaged 7 percent over the past 11 years. The BCLCs online products venture did not reach break-even revenue until four years after beginning investment and two years into offering online products after sales hit $20 million.

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While the BCLCs implementation has been successful, generating a total of Cdn. $65.6 million through interactive sales in fiscal 2011-12, substantial investment continues, on the order of $11 million annually to maintain PlayNow.com, and $44 million budgeted for the next fiscal year to install a new customer account management system. The sobering reality is that the Massachusetts General Court must budget significant implementation funds or allow the Lottery to retain profits in order to enter the market for online lottery sales, and ongoing budget will need to be increased to support online product sales. Vendors In order to select the most qualified supplier as well as to control implementation costs, the Massachusetts State Lottery should initiate an RFP process to identify a primary technology vendor who will provide the fundamental platform upon which Internet operations will be transacted. We recommend utilizing a single vendor for the operating platform to assure reliability and consistency, but securing multiple vendors for platform associated applications, site content and game development to assure competition and greater innovation in new product development. The Massachusetts State Lottery has previously followed a unique course among US lotteries in retaining control over the management of backend operating systems. This traditional approach should certainly continue, with the Lottery maintaining complete operational control and decision making authority, but with a primary vendor integrating the platform software upon which the online products would run. The Lottery should require primary technology vendors to be certified or licensed and to undergo background checks as a means to assure working with reputable partners and avoid potential negative surprises. We recommend that Lottery vendors be subject to the same suitability standards as those required by the Massachusetts Gaming Commission. In selecting vendors, the Lottery should also give priority to Massachusetts-based firms in awarding contracts for Lottery-related game and equipment development as an incentive to foster economic growth within the State. Conclusion Online play is expanding rapidly, both in the United States and throughout the world. A robust Internet gambling industry currently exists in Europe, boasting global reach and myriad products. This diverse industry is operated by private online casino and land-based casino companies, state lotteries, independent lotteries, and state monopoly casinos. A comprehensive online strategy embracing Internet lottery, casino games, social games, and poker now exists in Canada and it appears that full expansion in the United States is now a question of when rather than if, as more than one state lottery already offers Internet purchase of lotto games.

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C.

Recommendations

Based on our research, Spectrum makes the following recommendations for the Massachusetts State Lottery:

1. Seek Legislative Approval for Online Play

The US Department of Justice (DOJ) opinion of December 23, 2011, opens the door to state lotteries providing intrastate online sales, with two caveats. The first caveat is that betting on sports is deemed to remain an unlawful practice under this interpretation of the 1961 Wire Act. Second, state lotteries can offer games that are legal under state laws. In practice this means that each state must pass enabling legislation specifically permitting online Lottery products, as well as any other Internet gambling products. Following up on this opinion, a legal analysis produced by Greenberg Traurig earlier in 2012 in response to a Lottery request for information determined the answers to three strategic questions summarized as follows:7 The MSLC currently is not authorized to sell products over the Internet based on the DOJ opinion along and will still require authorization by the state legislature in order to do so. The DOJ opinion limits the scope of online Lottery product sales to in-state residents over age 18. No individual or entity that is not the MSLC is currently authorized to sell gambling products over the Internet or other electronic communications media with the exception of certain horse racing and dog racing enterprises already so empowered.

Based on this legal analysis and our own extensive research on the subject, Spectrum recommends that the MSLC should seek to have enabling legislation approved that would allow the Lottery to sell game play via the Internet. This would allow the Lottery to diversify its product offerings, reach a broader base of customers, and engage new demographic segments. We further recommend that the Lottery be the only entity so permitted to offer online products within state boundaries in order to provide the greatest benefit to the Commonwealth. These recommendations, and others, are discussed below.

Overview of Federal and Massachusetts Law Concerning Internet Lottery Games, Greenberg Traurig, 2012

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2. Lottery Should Pursue Online Play

The most fundamental question that this report was designed to address is: Should the Lottery pursue online play? We addressed that question in part by rephrasing it: Should the Massachusetts maintain the status quo in its distribution system? The issue then is whether the Lottery should expand its distribution channels to use the Internet, or should it be satisfied with the status quo. Our research leads us to the conclusion that maintaining the status quo is not a viable option simply because the status quo will change, regardless of what policies the Lottery elects to pursue, or not pursue. Lottery players are aging, and one fundamental tenet of marketing is that an aging customer base is a telltale sign that new customers are not entering the market in sufficient numbers to replace existing customers as they get older. Speaking at the recent World Lottery Summit 2012, held in Montreal, Terry Rich, CEO of the Iowa Lottery, noted that traditional lotteries in the United States are an offline business in an online world. As this report notes in great detail later, the Internet offers a variety of new opportunities that are simply not present in the brick-and-mortar world, while existing opportunities will only diminish in the absence of a material online presence. The Internet is fundamentally reshaping the business model in numerous industries, for better or worse, from newspapers to hotels to traditional retailers. Coming generations are not likely to be satisfied with a distribution system that does not include a significant online presence, nor can they be expected to embrace an existing lottery distribution in the same way that their forebears did in the pre-Internet era. In developing this core recommendation, we examined a corollary question: Should the Lottery be an early adopter of online wagering, or should it let other states take the early lead, and then learn from their experience? Clearly, the possibility of letting others move first, which would allow Massachusetts to replicate their effective steps and avoid their mistakes, has enormous appeal. Since state lotteries target sales within their own borders, there is little to no risk of an early adopter grabbing market share among Massachusetts adults. Still, the benefits of waiting are outweighed by two other factors: By adopting online gambling sooner rather than later, the Lottery would play a lead role in developing the Commonwealths overall gambling policy. Because casinos are still in the planning stage, this creates an opportunity to develop a unified strategy. By adopting a highly flexible, carefully calibrated strategy that allows the Lottery to respond to new information and new technologies as they appear, the Lottery can learn quickly from its own experience as well as the experience in other states and respond quickly.

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By becoming an early adopter, the Lottery can stimulate economic development by encouraging games developers to locate in Massachusetts.

As noted in our introduction, the development of online play is so pioneering and so new, that no entity can claim to possess an accurate roadmap to the future that identifies all revenues and pinpoints all potential pitfalls and opportunities. Flexibility and adaptability will be key components of a responsible online strategy.

3. Lottery Should Be Sole Internet Gambling Provider in Massachusetts

As the Commonwealth considers a move to offer legal online wagering, the inevitable question is: How many entities should be allowed to offer online gambling? The situation in Massachusetts is such that the Lottery is best positioned to be the sole provider. As the Commonwealth prepares to license casinos, the ability of these future casinos to offer online gambling will surely be an issue, as it will in every state that offers tribal or commercial casinos. Gaming policies in states are largely shaped by the status quo. Online gambling in states that have casinos but no lottery (such as Nevada) will evolve differently than it will in states that have a lottery but no casinos (such as Georgia), which would be different in states that have lotteries but tribal-only casinos (such as Oklahoma and Connecticut). Because Massachusetts is currently a lottery-only state, with the planned casinos still in the pre-application phase as of this writing, the Commonwealth has a unique opportunity to shape the status quo, rather than be shaped by it. Spectrums recommendation was developed after addressing some fundamental questions: Should there be intrastate competition among gambling sites? Would intrastate competition create unnecessary complexities and confusion, or would it promote healthy competition? Would intrastate competition help or hurt lottery retailers? Could online intrastate gambling be sufficiently segmented, so that different providers can offer differing products designed to reach disparate audiences? If the Lottery is designated as the sole provider, could that adversely impact the value of casino licenses?

With all those questions in mind, we recommend that the best approach would be a solesource provider, with the Lottery best equipped to fill that role, for the following reasons: Intrastate competition is likely to generate unnecessary confusion among consumers, with few benefits that we can perceive. For example, providers may compete on the

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basis of payout percentages, but that would not necessarily advance public policy in that it would likely not increase employment, tax revenue or other policy goals. The Lottery is clearly best equipped to make sure that its online offerings are developed with the interests of its retailers in mind. We suggest that the Lottery is also well equipped to protect the interests of the future Massachusetts casino industry. While the Lottery made it clear to Spectrum that it wants to protect the value of casino licenses, we also note that the future casinos have an important mandate to protect the value of the Lottery. Indeed, that mandate is written into the casinos governing statute, which states that enhancing and supporting the performance of the state lottery and continuing the Commonwealths dedication to local aid is imperative to the policy objectives of this chapter.8 While the future casinos have a mandate to protect the Lottery, they do not have a mandate to protect the 7,400 retailers who have been, and will remain, key stakeholders in this process.

Thus, we recommend that the best approach to online gambling in Massachusetts would be for the Lottery to take the lead in developing online wagering, with the ultimate goal of coordinating all online gambling policies in the Commonwealth. The Lottery should begin its online gambling channel independently of casinos, which are still a long way from opening. Once casinos become fully operational and stabilized in their marketing efforts, which would likely occur in 2017 or beyond, the Lottery would have an opportunity to market the casinos to its online database. The broad brushstrokes of such a marketing strategy would allow casinos to develop offerings for lottery players that could include such rewards as free or reduced rate hotel stays, meals, entertainment or other casino-related offerings. In turn, the casinos would gain access to new players without incurring more traditional marketing costs. We note that such a strategy could encompass offers to both online and traditional lottery players, thus creating additional benefits for both retailers and their existing customers. If coordinated effectively, such a marketing effort would: Allow the future casino industry to have access to a database of adults with a demonstrated propensity for games of chance. Promote visitation at casinos, which would in turn create opportunities for additional employment.

M.G.L. c.23K, section 1(4)

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Lead to a likely increase in online lottery play, since such wagers would have more value; i.e., players can earn points through their online play that would be redeemable at casinos, thus increasing the perceived value of a future loyalty program.

An important caveat: Spectrum believes, as stated earlier, that online play requires significant flexibility going forward, as the Lottery learns more from actual experience, and as rapidly changing technologies, new games and consumer tastes continue to evolve. We do not know, at this writing, what may be negotiated with respect to online gambling between the governors office and the Mashpee Wampanoag,9 although we suggest such negotiations consider the interests and goals of the Lottery, with an eye toward coordinating these policies as described here. Similarly, we do not know what the future casino licensees may seek to do in this realm in the future either. However, based on present circumstances, we believe that the Commonwealth would be best served by vesting the Lottery with the sole authority to offer legal online gambling. This recommendation indeed, this entire report recognizes that two agencies regulate gambling in the Commonwealth. Casino gambling is regulated by the Massachusetts Gaming Commission. If the casino industry is authorized in the future to conduct any form of online gambling, that would clearly fall under the full purview of the Gaming Commission. We are not suggesting that the Massachusetts State Lottery Commission should regulate the casino industry. If, going forward, different entities including the lottery are authorized to conduct online wagering, we suggest that marketing efforts be coordinated in an effort to optimize the overall benefit to the Commonwealth.

4. Aggressively Fight Threat from Internet/Sweepstakes Cafes

One potential challenge to the exclusivity of both the Lottery and commercial casinos in Massachusetts and nationally are Internet/sweepstakes cafes. Internet/sweepstakes cafes offer games of chance with prizes in conjunction with other services, such as Internet access time, wireless phone minutes, or gift cards. The American Gaming Association opposes these establishments as a threat to land-based casinos, and in June 2011 Massachusetts Attorney General Martha Coakley issued a permanent regulation banning the operation of establishments where a gambling purpose predominates over the bona fide sale of bona fide goods or services in this case, Internet/sweepstakes cafs. The attorney general said that many establishments that offer these services are actually fronts for illegal online gambling, including unlawful lotteries, online slot-machine games, sweepstakes, and other forms of gambling.

Feds reject casino compact between Mass. and tribe, Associated Press, October 12, 2012 http://www.boston.com/news/local/massachusetts/2012/10/12/feds-reject-casino-compact-between-mass-andtribe/1M8NyTkrXnqlaq07HCopmK/story.html

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House Speaker Robert A. DeLeo, one the states leading supporters of expanded gambling, recognized the threat of Internet cafes to existing state-sanctioned gambling and last year introduced legislation that would subject anyone running an Internet cafe to a fine of $250,000 per computer terminal or a prison term of 15 years (H.3765). The legislation was approved by the Governor, August 1, 2012. The Task Force needs to be fully cognizant that without proactive enforcement of the statute, these establishments will remain a threat to statesanctioned gambling, and particularly, expanded gambling in the form of lottery online products. Spectrum recommends the Task Force strongly support vigorous and effective enforcement of recently enacted H.3765. The issue of Internet cafes cannot be separated from the issue of authorizing legal online wagering. The issue has arisen in other states that are considering legal online wagering, and the same concern has been expressed. Indeed, as we note later in this report under Legal Issues, New Jersey Gov. Chris Christie vetoed legislation that would authorize Internet wagering because it did not address this issue.

5. Issue RFP that Emphasizes Openness, Creativity

A critical first step toward online Lottery play would be to develop a request for proposals (RFP) that solicits bids from private vendors to develop the platform and associated functions to make online gambling a reality. The RFP should be developed with these core principles in mind: The platform should have an open architecture that allows independent game developers to produce new Lottery online games. The platform should be developed with maximum flexibility to allow for changes in technology, and shifts in consumer behavior and tastes. The provider of this platform should offer a turnkey operation, providing all essential functions including payment processing and all necessary know-your-customer functions, such as identity, age and geolocation verification. Such systems should be state-of-the-art, with the burden on the bidder to demonstrate that its offering includes the best available technology in these areas. The provider must work within the framework of the Lotterys existing system and fully coordinate all functions so that the Lottery maintains its requisite level of control. Within that framework, the vendor would provide its expertise in online play, know-your-customer protocols and other aspects unique to online play.

More specifically, the RFP should include the following: A responsible-gaming policy that would be independent of, and would enhance, the Lotterys own policies.

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Certification of all systems and functions by a recognized independent testing laboratory. Development of hybrid freemium10 free-play sites in which adults can register and play for fun, or for money if they so choose. Development of social-gaming strategies and capabilities, including an opportunity for players to communicate with each other, as well as with the Lottery. An open architecture system in which a wide variety of game developers can create games to be provided on the Lottery site. Online products so developed can be posted on the site in free play versions for market testing. Plans to develop and implement a loyalty program that recognizes and rewards regular customers who play both online and the traditional lottery.

The basic qualifications for consideration should include the following: Experience in platform development. Experience in developing gaming platforms could be considered, but should not be viewed as essential. Experience in website security, including an ability to address all key security areas, such as fraud detection, hacking, and prevention of distributed denial of service. Demonstration of good character, honesty and integrity. Ability to maintain and grow the site, based on actual experience and demand growth. A history of working cooperatively with clients to produce systems that will provide the maximum flexibility for and benefit to the client rather than the vendor.

A free-play site, developed concurrently with the gambling site, could provide useful testing of new games, as well as an ability to identify new players for potential conversion. The successful bidder should be compensated based on a percentage of sales. The precise percentage could be part of the bid, which would allow for price competition as well as creativity with the potential for sliding scales. The Lottery, however, should make it clear that this is just one criterion, and the lowest bid would not necessarily be the winning bid, as higher percentages that are part of a more creative overall proposal may result in greater incremental revenue to the Lottery.

10

Freemium is a relatively new but increasingly common portmanteau. The New York Times defined it as offering basic products or services free but charging a premium for advanced features or functionality: Drilling Down: Does the freemium model really work? June 11, 2012 http://boss.blogs.nytimes.com/2012/06/11/drilling-downdoes-the-freemium-model-really-work/

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We recommend that the successful bid should be awarded for a period of at least five years in order to help ensure that the provider would have a sufficient opportunity to recognize an appropriate return on investment. This assumes that a successful vendor would seek at least a 20 percent return on its investment, thus ensuring a full payback, at a minimum. The successful bidder would, directly or through a sub-contracting arrangement, develop a loyalty program that recognizes and rewards regular customers who play both online and the traditional lottery. Online sales will require registration and establishment of an account on the Lottery website, for the first-time lottery purchasers will no longer be anonymous and many will want to be recognized for their patronage. We recommend that the Lottery issue the RFP with the goal of instituting a loyalty program for online and offline customers that ideally would be implemented in conjunction with the onset of Internet sales. As noted under the earlier recommendation, it should also be developed with the possibility of future cooperation with Massachusetts casinos in mind. If the Lottery is concerned that such an RFP, as contemplated, would make it too dependent on one vendor, it could issue a different, yet related RFP for the development of the loyalty program. Such a plan would have the added benefit of allowing and encouraging firms that specialize in either platform development or loyalty-program development to more readily participate in the process.

6. Pursue Phased Engagement Strategy

Spectrum recommends a phased implementation approach to online lottery sales for two primary reasons. First, to test the public reception for new online products and measure their market performance and, secondly, to allow sufficient time to develop the internal resources necessary to manage and operate fully fledged Internet operations and marketing. While many of the platform providers can quickly implement a full suite of online products, we recommend phasing in products gradually, starting with new games that will not infringe upon the appeal of traditional lottery games sold by retailers while continuously monitoring the online products, fine tuning operations, and assessing public reactions to online sales. We recommend a five-phased implementation strategy beginning with a gentle initial entry to the market, starting with casual online games and social games that would feature more time on device than traditional transactional lottery products.

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Figure 1: Recommended phasing of Lottery online games

New Casual & Social games Lotto & Keno Draw & Draw-based games Instant & "scratch" games Casino style games & Poker

Source: Spectrum Gaming Group

a. Phase 1
The games offered in Phase 1 would follow both freemium and subscription models by offering of play for fun, play by subscription payment, or play for free with payment for additional levels and capabilities. These new and casual games would present an innovative inventory of new online products designed to have the least amount of substitution versus traditional lottery games. They would also comprise games more likely to attract a new customer to the Lottery. While new casual and social games are the least threatening to traditional retail lottery sales, it is also true that they would generate only limited revenue streams, at least initially. Bingo is also an option for implementation in Phase 1 because it is a social-style game with a multitude of versions readily available as online products. However, the benefits of implementing Lottery-sponsored bingo should be carefully weighed against the potential for any negative impact on current charitable gambling operations within the State. Bingo is an extremely popular online product in Europe, both for commercial and lottery Internet sites but the Lottery may not wish to compete in this arena with established charitable-gaming interests.

b. Phase 2
Phase 2 would entail online sales for multistate lotto games, which to date has been the default market entry for the small number of US lotteries currently permitting online product sales as well as a more certain and substantial Internet revenue stream. The two US lotteries that have initiated online products to date Illinois and Minnesota offer multistate lotto games for sale via the Internet by opening an electronic account using a major credit card. Two of the US lotteries planning to offer Internet sales in the near future, Georgia and Delaware, will also offer multistate lotto and in-state weekly draw games online through electronic player accounts, but the funding mechanism will be a pre-paid card (titled the iHope card in the case of Georgia). Because these products are ideally suited to Internet sales and widely popular across the

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customer base, they are immediate candidates for early inclusion in any Internet lottery engagement strategy. The reason that we recommend them for Phase 2 is that they are also, along with keno, products that are more susceptible to cannibalization of retail sales. The Task Force may feel more inclined to include these products in the first phase of implementation so long as the caveat regarding potential cannibalization is considered. While some traditional lottery customers may find it more convenient to order lotto tickets from home, it is also reasonable to assume that many more players will participate in regular lotto drawings if they can purchase tickets 24/7 and in the final minutes before the drawing. We remain cautious, in that the added convenience of Internet lotto sales could negatively impact foot traffic at Lottery retailers; we advise the Lottery to continue to monitor retail sales in Illinois and other Internet lottery locations. However, utilization of a pre-paid card should assure that local lottery retail agents continue to earn commissions on sales, even those transacted over the Internet. Keno is also included in Phase 2, because it is well suited to a computer-screen interface. We do not believe that Internet keno will significantly cannibalize land-based keno, based on experience in other online jurisdictions. Instead, we expect Internet keno will expand the market for that game. However, because keno generated 17 percent of total Lottery sales in 2011, implementation of an Internet version should be measured to assess the impacts. Delaware can serve as a possible benchmark when it offers online keno in January 2013.

c. Phase 3
Phase 3 would entail the online implementation of selected in-state draw games as well as the development of new, Internet-only sweepstakes drawings. In addition, this phase would see the implementation of new draw-based games similar to those offered in successful overseas Internet lotteries. The UK National Lottery, operated by Camelot, offers (among a wide range of conventional lotto drawings) a full product line of multi-decision-point transactional products that are based upon draw-game logic, similar to pull tabs, but can take five minutes to play and thus provide more of a play experience with time on device than traditional draw products. A good example from the Camelot inventory is Monopoly, based on the popular board game. Customers pay to enter the game, choose a personal piece to move about the board, and encounter a number of separate decision points where they can win. This game does not compete with any traditional lottery games and generates entirely incremental revenue for the UK National Lottery. The example of Australia shows that online draw games can demonstrate revenue growth in parallel with traditional retail draw game sales. Australian law prohibits instant games on the Internet, and Internet sales reflect a preponderance of draw game gross revenue. Within that environment, online sales grew over the most recent seven-year period at a compound annual

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growth rate (CAGR) of 4.4 percent, while brick-and-mortar sales grew at a CAGR of 3.3 percent.11

d. Phase 4
Phase 4 would be reserved for instant and scratch games to become Internet products. However, we would strongly caution against placing traditional instant games on the Internet for two reasons. First, instant games are the major profit center for traditional sales, generating 69 percent of gross revenue for the Lottery. 12 They are the most successful class of products developed by the Lottery. Traditional sales must be protected from any potential online cannibalization. Second, instant scratch games, once transferred to the Internet and viewed on a video screen, may become indistinguishable from virtual slot machines, where a series of symbols are uncovered with the winning outcome determined by the final symbol appearing in the sequence. Internet scratch games also open the potential for increasing problem gambling exposure as the frequency of play is likely to be much higher. Instead, we recommend developing entirely new instant games with more of an experiential component featuring longer time on device similar to the draw based games described above, or else incorporating online video lottery terminals (VLT) or Internet slot machines into the online product mix.

e. Phase 5
Phase 5 effectively moves online products beyond traditional lottery games and into the realm of casino-style games of chance. In this phase, which the Lottery may choose to execute a full suite of games over the Internet, just as the British Columbia Lottery Corporation and a number of European lotteries currently offer, and which the Delaware Lottery apparently intends to oversee. If the Lottery were to enter this phase, the available products include slot machines, casino-style table games, poker, and any other games of chance played against the house. This recommended phased rollout is conservative, providing flexibility to accelerate, combine or modify based upon an informed assessment of market conditions and opportunities. Regarding potential timelines, if enabling legislation were passed to allow the Lottery to pursue online sales by the end of 2012, it would be reasonable to expect at least six months for the RFP process to complete and a primary platform provider to be determined. The implementation phases outlined above are notionally estimated to take approximately six months each, beginning in July 2013 and completing roughly January, 2013 but actual implementation of the phases would be at the discretion of the Lottery.

11

Bill Thorburn, Chief Executive Tatts Lotteries at Tatts Group, speaking at World Lottery Summit 2012, September 10, 2012
12

La Fleurs 2012 World Lottery Almanac

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f. Other Considerations
Mobile online options should be rolled out as soon as practicable, as mobile gambling will without question be a high-growth adoption channel. Mobile-device utilization is growing faster than the rate of Internet utilization, and mobile Internet access is expected to overtake fixed Internet access by 2015. 13 Our recommended phased approach allows more time to examine and benchmark other state lotteries, such as Illinois, which have implemented online lotto sales. Implementation should include developing test markets within Massachusetts to determine the degree of any substitution behavior that might occur online. Still, by following our recommended strategy that all online Lottery wagering be purchased through a play card obtained only at a retail sales agent, this should reduce the negative impact upon retailers, and if new customers are engaged, there could be a positive financial impact for the retailer. The threat of cannibalization becomes greater if direct online credit card purchases the most convenient form of Internet commerce are permitted in the enabling legislation. Scratch games, once transferred to the Internet, have the ability to closely resemble slot machines, which have dramatically evolved themselves in recent years from offering only spinning symbols to offering far more complex player experiences. On most scratch tickets, the game is played by rubbing latex covering off the underlying symbols or numbers with the winning outcome determined by the final symbol uncovered. Viewed on a computer screen this format will not differ greatly from a video slot machine, and on the Internet the frequency of play is likely to be much higher. The Illinois Lottery is now implementing online draw games but at the time of writing this report does not intend to implement online scratch games. 14 These factors should argue for a measured approach in adding scratch games to the online product selection and also consideration to different payout tables for many instant games. Poker should be considered for implementation in later phases as a potential product for online Lottery. Poker revenues may be limited due to competition with established offshore sites and their high-powered marketing programs. Experience in British Columbia shows that the Lottery, even when granted an official monopoly on Internet poker play, may expect to generate only a plurality in market share and this plurality is generally the low end of the market. However, poker, because it is played on a peer-to-peer basis, is fundamentally a social game and its inclusion on the Lottery website will promote community aspects and increase the stickiness, or length of time spent by visitors to the Lottery website. Experience in offshore gambling sites also shows that Internet poker players often play side games simultaneously with their poker play, thereby generating multiple revenue streams.

13 14

Internet Trends, Mary Meeker, D10 Conference presentation, May 30, 2011, Kleiner, Perkins, Caufield, Byers Remarks by Michael Jones, Superintendent, Illinois Lottery, European iGaming Summit, October 17, 2012

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Casino games and other red games of chance where wagers are made against the house should only be considered in the later phases of implementation and included as Lottery games only if demand exists. Consider a play-for-free site in the early phases to evaluate player interest in and public reactions to hard games such as casino slots and table games as well as other for money games of chance played against the house. One wild card in this product implementation is sports betting, an online product that has proven remarkably popular and profitable in European markets. Currently sports wagering is the one gambling area specifically proscribed in the Department of Justice opinion of December 23, 2012 as unlawful under the 1961 Wire Act. However, recent challenges to the federal Professional and Amateur Sports Protection Act (PASPA) of 1992 by New Jersey and other states appear to be gaining strength and many legal experts in the field, such as I. Nelson Rose, contend that the federal government will face a difficult challenge in defending an existing law that allows grandfathered sports betting in four states in the Union but outlaws the same practice in the other 46 states. Depending upon the outcome of these legal challenges the Lottery should be prepared to consider sports betting as a potential future online product option if it ever becomes legal. Finally, consider implementing fantasy sports betting in the early phases. Fantasy sport betting is currently a $1 billion industry nationwide, offered as a for-money social game in 27 states, and is legal under the Unlawful Internet Gambling Enforcement Act of 2006 and PASPA.15 While fantasy sports is a crowded field with competitors including CBS Sports, Yahoo, ESPN and Cantor, there are many platform providers and an opportunity exists for Lottery-branded fantasy competition with cross marketing to traditional Lottery products.

7. Encourage New Games, Themes under Lottery Brand

A critical question is whether the Lottery should make existing games and brands available online, or require new games online so that its offerings and its customer base would be decidedly different from the existing customer base for existing draw and instant games. Initially, the Lottery should be careful in taking steps to protect its retailers by: Not offering draw games online, and Not using existing brands that are common in instant games for its online offerings.

Scientific Games, in meetings with the Lottery Working Group and in subsequent interviews, has suggested that the use of brands from the library of existing instant games should be encouraged in any online offering. The company which is the worlds largest supplier of instant games has suggested that the familiarity of existing brands would foster more sales
15

Fantasy Sports Becoming Big Business for Cantor, Chris Sieroty, Las Vegas Review-Journal, September 15, 2012

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online, and would in turn prompt more in-store sales as online customers stop by retailers. Scientific Games also suggests that such a strategy would not promote cannibalization of existing lottery sales. Such conclusions may be counter-intuitive, since existing Lottery customers would be among those who are most familiar with existing brands. Still, such suggestions should not be dismissed out of hand, since many instant-game brands enjoy familiarity and brand equity elsewhere, from old television shows to slot machines. The latter point would support the notion that such brands can be transferred from one medium or platform to another. The Lottery, however, is not in a position to take anyones word for whether transferred brands will or will not cannibalize sales through other channels. The nature of online wagering would allow such theses to be tested scientifically, with controlled and variable elements. Test marketing can be conducted on individually branded games that are co-branded with instant games to determine the precise impact on sales. The Lottery should pay attention to how the Georgia Lottery (discussed later in the report) is approaching this issue. The Georgia Lottery has determined not to transfer existing brands, viewing that as a potential affront to its network of retailers. Rather, the Georgia Lottery is promoting its own brand and logo which will be omnipresent to online players. The same logo and brand would then be visible at retailer sites, which will present the possibility of encouraging online players to become retail customers, particularly for draw games with attractive jackpots. We recommend that the Lottery promote its own brand across platforms, with the offering of new games online that are not co-branded with existing instant games. The Lottery can also test existing brands carefully to determine the level of potential cannibalization.

8. Encourage Responsible Competition, Incubate Massachusetts Businesses

The process for considering and approving new games for online play should give a clear advantage, and place a premium, on firms that have a presence in Massachusetts. This criterion should be an integral part of the approval process when evaluating proposals for new games. Online play will allow the Lottery to foster economic development by establishing a market for new game development among in-state technology firms. A recent survey by the Massachusetts Digital Games Institute at Becker College in Worcester demonstrates that the State is home to a vibrant game-development industry 124 companies, a number which has expanded 78 percent since 2009, and directly employs 2,041 people and generates $234 million in salaries alone.16 The majority of these developers are creating products for mobile devices (51

16

MassDiGI, MA Digital & Video Game Industry Cluster Census & Econometric Survey Results, September 17, 2012

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percent), the fastest growing platform in the game industry, as well as web-based (45 percent), desktop (35 percent), and console (13 percent) platforms.17 We recommend that the Lottery take advantage of this native resource by encouraging in-state software and game designers to develop new game products and mobile apps for the Lottery through some form of preferential treatment, which could include a greater share of revenue for their game, or a less-costly licensing process. The Lottery should set certain reasonable standards for game developers that seek to place content on the Lotterys online platform. Such standards should include: Developing games that will be popular, but will target adult demographics. Avoiding attributes that would encourage compulsive, irresponsible or underage play.

Any proposal for a new game should delineate the target demographic and outline how it would address the responsible-gaming requirements. Beyond that, Spectrum strongly suggests that the Lotterys online endeavor offers an opportunity to meet another important policy goal: Assisting the formation and development of new or existing private businesses in the Commonwealth. The existing technology industry, fueled in large measure by the presence of and cooperation with major universities and institutes, can be further enhanced by giving preferential treatment to developers that have a physical preference in the State, or promise to have one. This would provide and enhance a virtuous cycle of growth: The existence of a technology industry would fuel the development of new providers, while the development of new providers would enhance the presence and quality of the existing technology industry. Additionally, the presence of in-state games developers would facilitate easier communication between developers, the Lottery and the platform provider.

9. Develop, Implement Licensing Requirements for Vendors

Spectrum recommends that the Lottery adhere to a strict and comprehensive licensing process for vendors, designed to ensure integrity and to foster public confidence and trust in gambling operations and the regulatory process. It is axiomatic in the casino industry that a rigorous licensing scheme will effectively promote public confidence and trust while ensuring the integrity of its participants. Of equal importance, the absence of effective controls will have the opposite effect and enable people with disreputable backgrounds to gain a foothold in the industry. Historically, the casino industry attracted the attention of myriad people with unsavory backgrounds and reputations. Gaming regulatory agencies worldwide ought diligently to prevent their infiltration into legalized

17

Ibid

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gambling operations and, by all measures, succeeded. The linchpin of effective regulation is a comprehensive licensing system. We note that, for most of the existing and potential major lottery vendors, licensing is viewed as acceptable and not burdensome, as these vendors have experience in multiple forms of gambling, and we expect that many of the vendors seeking to do business in this area already have licenses that would meet generally accepted standards. However, that would not be true for all vendors, particularly those whose existing operations are primarily overseas. We suggest that the Lottery would not want to be in a position of doing business with an entity that is later found to have been unlicensable in another gambling market. The vigilance of regulatory oversight is a continuing and never-ending process. The method universally employed to successfully thwart the entrance of such unsavory persons is an effective licensing system, which necessarily entails strict licensing criteria and thorough background investigations. The fundamental principle is that those entities and individuals who are in a position to exercise influence or control over casino operations are required to undergo a thorough and rigorous background examination to assess their suitability. Applicants are required to satisfy stringent licensing standards pertaining to an affirmative demonstration of good character, honesty and integrity, as well as financial stability, responsibility and integrity. Significantly, the burden of proof is placed upon the applicants to establish their suitability by clear and convincing evidence. We note that the Massachusetts Gaming Commission, through its comprehensive statute and recently promulgated regulations, will be employing such a licensing scheme. In our opinion, it is imperative for the Lottery to implement a comparable licensing scheme to those commonly utilized by online gambling regulatory agencies. In this regard, we are mindful that an overriding concern of the Lottery in expanding its regulatory purview to encompass Internet gambling operations is to prevent the intrusion of nefarious and unscrupulous influences. This laudatory objective may only be achieved by implementing a strict licensing system. Absent such a licensing system, the potential entry of such unwanted individuals and entities will be greatly enhanced. Moreover, the publics confidence and trust in the overall regulatory process will be significantly eroded. We emphasize that the same policy concerns traditionally inherent in the online gambling industry are equally applicable to the Lotterys potential Internet operations. These concerns will be satisfied only if the persons and entities that have the ability to control or significantly influence the business operations and decision-making of the gambling licensees and applicants are subject to strict regulatory scrutiny and oversight. In practice, all partners, officers, principal employees, directors and shareholders having a greater than 5 percent interest of an entity applying for licensure should be included within the scope of licensing requirements for a particular applicant entity. In addition, holding companies

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of the applicant entity and their officers and directors should also be required to demonstrate suitability as part of the license application process. A holding company is generally defined as any entity that owns, has the power or right to control, or has the power to vote any significant part of the outstanding voting securities of the applicant or licensee. There should be effective regulatory oversight over any person having a financial interest in a gambling licensee or applicant or any person able to exercise a significant influence over the management or operation of a gambling establishment or a business licensed by the Lottery. The Lottery will need to promulgate regulations that support the implementation of a strict licensing scheme. The practical ramifications are that this process likely would take several weeks to complete. Alternatively, the Lottery may endeavor to promulgate emergency regulations that would reduce the time factor and enable the Lottery to proceed expeditiously. Significantly, the regulations should require the applicants to pay a substantial license application fee to cover all administrative costs. In addition, the applicants would be responsible for paying for the costs of the background investigation. The regulations may allow for a certain degree of reciprocity for those entities and individuals that have received a license or finding of suitability or qualification from an American gambling regulatory agency in the recent past, but we would recommend that no reciprocity be found if the license were granted more than three years ago. In our judgment, such a time gap would necessitate a new examination of the entitys or individuals probity. We note that the Massachusetts gaming statute, M.G.L. c. 23K, allows for some reciprocity with other gaming jurisdictions for gaming vendors. In addition, if the entity or individual were licensed by the Massachusetts Gaming Commission, reciprocity should apply to avoid a duplicative background investigation. Conversely, if an entity or individual were found unsuitable by the Gaming Commission, such a finding should extend to the Lottery. We note that it would be extremely unsettling to allow for a situation where an entity or individual could be found unsuitable by one agency and nevertheless allowed to participate in a related aspect of gambling by another regulatory agency in the same state. Next, the Lottery would need to determine if it is appropriate, given present staff limitations, to outsource, through the issuance of an RFP, the conducting of the background investigations to experienced third-party independent contractors who would serve as agents of the Lottery. Alternatively, the Lottery could outsource this service to the Massachusetts Gaming Commission, although that agencys current staffing likely would not be able to provide any needed assistance in the foreseeable future. In this regard, we note that the Gaming Commission has issued an RFP seeking experienced third-party contractors to perform the background investigations of the various applicants for a gaming license. Thus, the Commission would be following the same course of action as its sister agency in deciding to outsource this critical function.

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The regulatory costs would include increased staffing for the Commission. However, the substantial investigative costs would be borne by the applicants, as it is common practice to pass these costs along. It is also noteworthy that comprehensive background investigations generally take several months to complete. For smaller vendors, such as game developers, the Lottery could lower the cost and simplify the process by allowing for registrations, which generally are limited to criminal background checks for qualifying individuals. In summary, it is noteworthy that the newly constituted Massachusetts Gaming Commission will operate through a strict licensing system to accomplish the goals and objectives enunciated in the gaming statute. Similarly, the Lottery should embrace the concept of strict regulatory oversight over Internet operations, through an effective licensing system, to preserve and maintain the integrity of its operations and the publics perception of that integrity. We recommend that the Lottery adopt licensing standards as rigorous as those adopted by the MSLC. We emphasize that the risk inherent in not implementing such a strict licensing scheme is to allow inroads into the Lottery industry by unsavory individuals and entities. Further, the absence of a comprehensive licensing process may seriously erode public confidence and trust in the Lotterys online efforts, especially when compared directly to the recently enacted online gambling regulatory system. For more information, see the Licensing sub-section within the Legal Issues section of this report.

10. Require Registration Process that Assures Integrity, Benefits Retailers

Leveraging the Internet will transform the Lotterys relationship with many of its customers because the formerly anonymous purchase process will now require a registration process that will collect personal information and establish an electronic account, for the first time allowing the Lottery to generate knowledge of its (Internet) customer. This knowledge will be invaluable for marketing purposes, for preventing fraud, and in identifying customer needs. Moreover, online product purchasing will create a history of player behavior and product preferences. On the other side of the equation, the Lottery will now be expected to verify that customers actually are who they claim to be and to protect their identities and the privacy of their information. The key to establishing this knowledge base will be the online registration process. It will be necessary to establish a registration process for each customer account. This process will collect basic customer information and also ensure that online purchasers are of legal age to play Lottery games and that they actually reside in Massachusetts. The registration process should be rigorous enough to assure accurate identification but not so complicated and time consuming as to discourage registration. Ideally, the Lottery will strike a balance between the intrusiveness and complexity of the customer identification and age verification requirements and the convenience of the process. Information required at registration to set up an account

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should include customer first name, last name, middle initial, residence location (i.e. street address city, state, and ZIP code), email address, and date of birth. Optional information requirements at registration could include Social Security Number, phone number, and contact approval. Financial institution information would not be required unless credit card usage was permitted under any enabling legislation. If credit cards are allowed for initial or replenishment purchases, customers could provide this information during the initial registration. If pre-paid cards are used to fund patron accounts as Spectrum recommends customers would have to take the extra step of purchasing a prepaid card at a physical Lottery retail location. Registration could take place either before or after purchase of the pre-paid card. The pre-paid play card purchased at the retailer would fund the account and be drawn down through subsequent transactions. Depending upon the selection of the manufacturer and the determination of the characteristics of the pre-paid card system, a numeric code derived from the pre-paid card may also be needed at logon to activate the funds and link them to the player account for online lottery purchases. Registration for online accounts could also occur on site at the Lottery retail location, but this may prove problematic given the limited floor space and high volume of foot traffic found at many retail establishments. Online account registration through self-service Lottery terminals could also be considered as an option. Purchase of the play card would require proof of age verification, just as current Lottery purchases are verified at the retail agent location by presenting a valid drivers license or similar identification. Retailers would benefit from the player card in multiple ways. First, the requirement for a player card would drive additional foot traffic through Lottery retail locations. Second, cards could be replenished at the retail location. Third, retailers would receive the normal 5 percent commission on sale of each play card. There could also be consideration for ongoing commissions for the originating retailer on all subsequent purchases for the life of the card. Purchase of online products would require logging on to the Lottery website to access the customer account by entering a unique password for each prospective online purchaser. Geolocation tools would be employed by the platform provider to assure that the player is currently located within state boundaries. Preliminary age verification would be conducted at the retailer location during card purchase. Additional age verification measures should be added at registration. Preserving the retail sales network and benefitting Lottery sales agents is a key element of the online engagement strategy. Our recommended registration process provides for continued agent commissions via the pre-paid play cards. An alternative procedure is currently being implemented by Loto-Qubec, in which customers will have the option of identifying a preferred retailer when they purchase Internet products. Designated retailers then receive the same commission they would if the products were sold in their store. Even if a customer does not designate a retailer, a percentage of the purchase goes into a pool where all retailers are reimbursed for commissions, pro-rated on the basis of their relative product sales. This system

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has proven popular among retailers in Quebec; however, there are disadvantages in this system compared to the pre-paid card option. For example, designating preferred retailers for all ongoing Internet purchase commissions opens opportunities for abuse in the system and even possible corruption. This system also appears to favor retail locations that enjoy greater foot traffic and more corporate resources that the smaller and more local retail establishments.

11. Emphasize Geolocation Accuracy, Minimization of Underage Gambling

As noted elsewhere in this report, Treasurer Grossman and the Task Force have made it clear that priorities for online gambling will include the following: Preventing underage gambling Making sure that wagers are conducted by adults who are physically within the borders of Massachusetts

Based on interviews with technology providers and based on our own experience, we conclude that 100 percent compliance will be impossible. That said, the Lottery should retain vendors who follow industry best practices for verifying each players age, identity, and location. The Lottery should address this in four ways: Drafting an RFP that requires bidders to provide state-of-the-art technology, and adopt best practices with respect to these issues. Require bidders hardware, software, peripheral devices and communications systems for age, identity and geolocation pass third-party verification testing by an accredited testing company. Make clear, as appropriate, in advertising and other forms of communication that the Lottery views these as essential priorities. Aggressively pursue all legal avenues to deal with violators and conspicuously and continuously post notices to this effect.

The latter point would require an independent legal opinion as to whether existing statutes are sufficient or need to be revised to criminalize the act of knowingly allowing or encouraging either underage gambling or wagering across state lines. We not only suggest that all laws be as effective and appropriate as possible, but that prosecutors adopt an aggressive posture toward such acts.

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12. Implement Internet Responsible Gambling Standards Adopted by National Council on Problem Gambling, Create Director of Responsible Gaming
Any recommendation regarding responsible-gaming practices must be built on a foundation of commitment by the Lottery. The Lotterys current responsible-gaming program is, in effect, outsourced to the Massachusetts Council on Problem Gambling through referrals, consultations and grants. With the implementation of online play, however, the Lottery will become a gaming operator and therefore should be impelled to become proactive in all matters of responsible gaming. Accordingly, Spectrum recommends that the Lottery adopt and implement the National Council on Problem Gamblings Internet Responsible Gambling Standards (NCPG Standards), which the NCPG adopted in April 2012 to address the unique aspects of online play.18 The NCPG developed the Standards based not only the experience of its staff and state affiliates, but also in consultation with responsible-gaming codes and research from16 international organizations with experience in Internet play. The NCPG in particular noted the work of the Responsible Gaming Council, an independent, progressive and highly regarded organization based in Ontario. The NCPG Standards are divided into eight categories: Operator Policy Staff Training Informed Decision Making Assisting Players Self-Exclusion Advertising and Promotion Game and Site Features Research

Spectrum believes that the NCPG Standards are comprehensive, reasonable and, importantly, flexible from the standpoints of both the operator and the player. The implementation of responsible-gaming practices is important not only for the direct benefit of players, but also for public confidence in the Lottery and its new online operation. We note that the Commonwealths Expanded Gaming Act of 2011 (which authorizes casinos) is unusually progressive and thorough in addressing issues of problem gambling, requiring substantial effort by both the Commonwealth and licensed operators in awareness, treatment,
18

See NCPG Standards, Exhibit #2 in the Appendix

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prevention and research. The gaming consultants19 to the Massachusetts Gaming Commission (MGC) have recommended that the MGC create a full-time position devoted to responsible gaming and related research; this position would report directly to the MGC executive director. It is evident that Massachusetts has made responsible gaming an important part of its overall public policy. Spectrum believes that the Lottery, as an online gambling operator, should hold itself to the same or similar standards that the Commonwealth will require of its licensed casino operators. Accordingly, Spectrum recommends that the Lottery also either create a new position of Director of Responsible Gaming or, at a minimum, ensure that such responsibilities are incorporated into another position without compromise. The Massachusetts Gaming Commission is further required to develop an ambitious, annual problem-gambling research agenda. We recommend that the Lottery cooperate with the Commission in this regard by providing aggregate play data and funding. Finally, we recommend that the Lottery promote its responsible-gaming standards for online play in various player-facing communications, including a continuously displayed link while on the play page so patrons are aware of the tools and help available.

13. Enhance Technology Base through Internal Resources and Vendor Relationships
The Lottery published a Technology RFR earlier this year and has recently engaged an advisor in response to that request. The selected candidate will be well qualified to address specific technology issues, but we have recommendations that can be made at this time, including enduring an open architecture, certifying vendors, investing in know your customer technologies such as geo-location and age verification, developing data analytics capabilities, and establishing a mobile strategy. Engaging the Internet channel will require new technology and substantial investments in hardware, software, and personnel. We recommend selecting a single firm as the primary platform provider and multiple firms as secondary technology and content providers. Any vendor selected as the primary platform provider through the RFP process should have the scope to provide the majority of hardware and software equipment necessary to operate Internet product sales. However, this vendor should also possess the flexibility to scale their technology to the needs and control of the Massachusetts State Lottery which has traditionally been heavily involved in establishing and owning the back end systems which run the Lotterys operations. Secondary providers can be required to deliver the majority of technology required to run their applications through a system operated by the Lottery.

19

Spectrum Gaming Group and the law firm of Michael & Carroll PC are gaming consultants to the Massachusetts Gaming Commission.

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However, it will still be necessary for the Lottery to invest in key technologies and qualified personnel to manage the new online channel as well as assure the integrity of these operations and protect them against fraud. Such hardware investment may require substantial modification or replacement of existing equipment in order to maintain compatibility with the primary online platform and secondary content. It will also be advisable to ensure that the chosen primary platform has an open architecture for easier application development. Qualified personnel will be required to manage the new channel. Obvious needs for trained personnel will be in the areas of information systems, marketing, and game development. It will be important for the Lottery to acquire a minimum number of key personnel experienced in online operations. Fully developed Internet lottery operations in other jurisdictions include staff positions for an executive level head of the e-gaming division, director-level positions for business development, marketing, project management, and operations, and manager level positions for marketing, e-gaming operations, business development, player relations, and data analytics. These key resources can then be used to educate current staff in the new techniques of online operations. With a strong technology industry within the state, qualified personnel and potential vendors and game designers should be available locally. The Lottery can also reach out to educational institutions for current technical expertise and potential future human resources. Responsible-gaming and verification software will be critical to successful operations in the Internet space and therefore the Lottery should require its vendor(s) to fully invest in the most accurate and effective tools required for player identification, age verification, geolocation, and responsible gaming. For example, the most accurate geolocation products utilize multiplelocation technologies including IP, mobile GPS and Wi-Fi, and cell-tower-triangulation capabilities. While the use of multiple technologies is often more expensive, it is also more accurate, reducing the location triangulates to a point instead of a radius. The profusion of data produced by Internet sales will present opportunities for the Lottery to develop its own internal data analytic capabilities which can support marketing and responsible-gambling efforts. Development of these capabilities will also promote expert management of the vendor technology. Online product sales will require expansion of the Lotterys mobile capabilities. The usage of mobile devices will soon exceed PCs as the primary mode for Internet access. Experience in other markets has shown that mobile devices are fastest-growing delivery channel for online wagering products. The fastest growing categories in the area of mobile games are the casual and social games recommended for Phase 1 of our implementation strategy. We recommend that Lottery develop a mobile strategy and implement mobile product-purchase options as soon as possible, preferably in the earliest phases of any implementation process.

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14. Treat Internet Marketing Differently than Conventional Marketing; Increase Advertising and Conduct Regular Research
Experience in other jurisdictions demonstrates that Internet marketing requires different skill sets compared to conventional marketing. While the basic principles of marketing apply across all sales channels, the products, delivery systems, and measurement metrics will be different online and will require experienced personnel with expertise in Internet marketing techniques, preferably experience in online gambling marketing techniques. Internet marketing staff will also need to conduct regular assessments of online product popularity and performance in order to fine-tune the product mix and identify successful online games. Experience in European and Canadian venues with Internet lottery play shows that the majority of customers accessing Lottery products via the Internet are entirely new customers, reflecting a younger, more educated, and more affluent demographic that is much more attuned to the Internet and to using mobile devices. Thus, migrating Lottery products to the Internet presents an opportunity to implement new marketing strategies that will engage previously lowfrequency customers as well as entirely new customers in playing new online games. Because online lottery is new in the US, little is known about the gaming behavior of these potential new customers and how they may react to new Lottery products. We recommend that the Lottery place high importance on conducting regular research to better understand the wants and needs of these potential new online lottery customers. To maximize the success of an online engagement strategy, the Lottery should establish a budget and institute an ongoing research program designed to explore lottery customer and non-customer characteristics (demographics, psychographics, and technographics) with the goal of better understanding the wants and needs of Commonwealth citizens regarding the Lottery. Similarly, Internet sales and marketing will require increased advertising expenditures to maximize the effectiveness of the online channel. Budget for increased advertising expense to publicize the Internet channel and create interest in new games and capabilities. Anecdotal experience in British Columbia and multiple European jurisdictions shows that enhanced advertising for Internet lottery products actually increases sales at retail locations, evidently by creating greater awareness of the traditional lottery and putting its products into the consideration set of younger and previously unengaged players. The Lottery has a small advertising budget relative to its sales. Its FY 2011 media advertising budget was $2.0 million, smaller than all but one of the New England states, and only marginally greater than Vermonts $1.44 million.20 The lottery advertising budgets of Rhode Island, New Hampshire, and Maine are all larger than Massachusetts, and these are dwarfed by

20

La Fleurs, 2012 World Lottery Almanac

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the ad budgets of Connecticut and New York. 21 When viewed as a percentage of sales, the Massachusetts State Lotterys ad budget is less than one basis point, at 0.0005 percent.22 In Canada, the average ad budget as a percentage of sales across Atlantic, British Columbia, Quebec, Ontario, and Western Canada is 1.5 percent.23 Figure 2: New England lottery advertising budget vs. ticket sales, FY2011
FY 2011 Media Advertising Budget ($M) 1.44 2.00 2.31 1.44 3.20 10.61 92.08 FY 2011 Ticket Sales ($M) 95.54 4,416.29 230.59 95.54 228.87 136.85 6,758.65 FY 2011 Media Advertising Budget as % of FY 2010 Sales 1.4% 0.0005% 1.0% 1.5% 1.4% 2.1% 1.4%

Vermont Massachusetts Rhode Island Vermont New Hampshire Connecticut New York
Source: La Fleurs

While recognizing that the Lotterys high prize payout structure impacts this comparison, it is evident that advertising expenditures are comparatively low in regard to regional lotteries. A 2009 Frost & Sullivan white paper cited a 2004 increase in advertising expenditures to $5 million for boosting Massachusetts State Lottery revenues to a then-record-setting $4.3 billion in fiscal year 2004.24 We recommend, at a minimum, doubling the budget for advertising to at least a full basis point (i.e., 1/100th of a percent) of ticket sales for a minimum of three years. At a maximum, increase advertising to a full percentage point, the equal of Rhode Island. There are two reasons for this recommendation: first, to effectively advertise the new sales channel, and second, to bolster traditional retail sales during the implementation period in order. Internet sales will necessarily require increased Internet advertising to create a presence on the medium. North American lotteries that have established an online presence are planning to spend between 5 percent and 10 percent of their advertising budgets on the Internet. Canadian lotteries that are in the process of moving to online sales, such as Atlantic Canada and LotoQuebec each plan to spend 7.8 percent of their total advertising budget on Internet advertising. 25 Massachusetts plans to spend $150,000, or 7.5 percent, of its total ad budget on Internet advertising. We recommend keeping that proportion of the advertising budget but increasing the total budget, as stated above.

21 22 23 24 25

La Fleurs, 2012 World Lottery Almanac Ibid Ibid Frost & Sullivan, US Lotteries: Achieving Strong Results in a Weak Economy, 2009 La Fleurs, 2012 World Lottery Almanac

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Figure 3: Sample lottery advertising

FY 2012 Ad Budget 416,477 1,016,579 1,992,584 2,766,724 150,000 4,609,500 % Ad Budget 6.4 7.8 7.8 5.5 7.5 10.8 FY 2011 Ad Budget 258,359 997,867 2,405,495 3,021,622 6,000 2,375,365 % Ad Budget 1.7 7.7 9.7 5.8 0.3 5.4 FY 2010 Ad Budget 100,000 N/A 2,061,738 2,016,000 N/A 2,549,152 % Ad Budget 0.5 N/A 6.8 3.9 N/A 5.9

British Columbia* Atlantic Canada* Loto-Quebec* Ontario* Massachusetts~ Illinois~

Source: La Fleurs

*Amounts in Canadian dollars

~Amounts in US dollars

One of the most frequent suggestions documented in our 2012 retailer survey for the Lottery was to increase advertising for lottery products as a means of increasing sales. Many of these suggestions also mentioned including pictures of recent prize winners with the name of the store where the winning ticket was purchased, location, hours of operation, and primary product offerings. Internet marketing presents multiple opportunities for promoting lottery sales through the online channel by experimenting with Internet promotions to find the most effective marketing programs for lottery players online. We recommend exploring cross-marketing efforts with traditional Lottery partners via the Internet as well as marketing alliances with new Internetbased partners. In addition, as noted earlier, look for opportunities for cross-marketing with new land based casinos. For instance, each casino should host a Lottery retail location, new Lottery games could feature casino brands, Lottery promotions could offer casino tie-ins, and joint advertising opportunities should be pursued. Both industries operate in the gaming space and land-based commercial casinos present opportunities for offering tangible rewards for online play while stimulating traditional lottery sales through casino retail outlets.

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D. Leveraging the Internet: Brick-and-Mortar Lottery Retailers are Online Assets

Spectrums research leads us to the clear conclusion that the Lotterys 7,400 retailers should be considered an asset that can help generate increased online and physical sales, in part by leveraging their locations. That conclusion is based on a number of observations developed during the course of our research, including: In various industries, online purveyors increasingly view land-based operations as strategic marketing assets that, if leveraged properly, can increase online sales. More and more industries are developing multi-channel marketing strategies. Indeed, state lotteries often because of concerns regarding legality are largely an exception to this trend, with most clinging to the traditional single-channel strategy.

Lotteries have much in common with other retail industries that have traditionally relied solely on brick-and-mortar sales, even though a lottery ticket does not fall into the categories of either goods or services, but is rather the purchase of an opportunity. Yet, despite that clear difference, the concerns expressed by retailers who do not want to alter the present arrangement are clearly parallel with concerns expressed by other retailers at a similar point in their evolution from brick-and-mortar to a combination of online and store sales, or what is often referred to as bricks and clicks. Notably, the suggestion that a significant physical presence in the retail world is an asset for online sales is growing in acceptance, but is not universally accepted. In one sense, that suggestion is counter-intuitive: Why bother with physical locations, and their relatively high attendant costs, when customers can be reached easily and broadly online? The practical reality, however, shows that a marriage between online and brick-and-mortar can be mutually beneficial by increasing sales in both channels. Last year, Ron Johnson, a former Apple executive who became CEO of retail J.C. Penney Corp., said in an interview with Harvard Business Review: It varies a lot by category, but only about 9 percent of US retail sales are online today, and that rate is growing at only about 10 percent a year. And a lot of that buying is from the online businesses of physical retailers like J.C. Penney and Apple. In reality, whats growing is physical retailers extension into a multichannel world. Its not as though theres a physical retail world and an online retail world, and as one grows, the other declines. Theyre increasingly integrated. But physical stores will remain the main point of contact with customers, at least for the stores that take the lead in this integrated environment.26
26

Retail isnt broken. Stores are, December 2011, Harvard Business Review http://hbr.org/2011/12/retail-isntbroken-stores-are/

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That sentiment should resonate with lottery retailers. Similarly, lottery retailers are hardly alone in expressing their concerns about the impact of online sales on physical sales. In April 2005, Harvard Business School hosted a Retail and Luxury Goods Conference. Speakers at that event noted the same sentiment that is involved in the issue of online lottery sales: Is it competition or cooperation? Susan Vobejda, senior director of brand management at Gap Inc., told a panel on multi-channel retailing that new online efforts by organizations that previously relied on physical stores are seen as a competitor by the store merchants. She said, however, that the reality is that, over time, the Internet can drive sales at physical stores. 27 Lottery retailers who are understandably concerned about the impact of online lottery sales on their present business model should ultimately embrace this concept as well, in part because their existing business model faces multiple threats. Such threats range from a general aging of current lottery players to the potential growth of online sales for other products that are now staples for convenience stores and other lottery retailers. For example, in the UK, which has already established a significant online gambling presence, grocery retailers are moving quickly to sell their products online. Online grocery sales in the UK grew by more than 21 percent in 2010, and are expected to increase at an annual rate of 5.4 percent by 2015.28 In the UK, online grocery sales are 2 percent of the annual total for all grocery sales, which is twice the percentage held in the United States. Still, the United States is growing in this segment as well, with major retailers from Wal-Mart to Kroger to Safeway offering services from home delivery of groceries to in-store pick-up.29 Long-term, that is a real threat to convenience stores as well, which underscores one of our core theses: The status quo is changing, regardless of what the Massachusetts State Lottery elects to do with respect to online gambling. With that in mind, our analysis rests on the principle that a carefully conceived online strategy could help lottery retailers address these non-lottery challenges while cementing their existing role as a crucial foundation for the Lottery. A variety of trends support that principle. Our research notes, for example, that an increasing number of online companies are seeking a presence in the real world, in part by adopting what has been termed pop-up stores, which give a presence to online retailers, and can serve as promotional and marketing centers, effectively serving as billboards. Trendwatching.com, which claims to have coined the phrase
27

Prosper with multi-channel retailing, April 2005, Harvard Business Review http://hbswk.hbs.edu/item/4757.html
28

Online grocery sales will double within 5 years, March 11, 2011, The Telegraph http://www.telegraph.co.uk/finance/newsbysector/retailandconsumer/8374998/Online-grocery-sales-will-doublewithin-five-years.html
29

US online grocery sales pack new punch, September 14, 2010, by Jonathan Birchall, Financial Times http://www.ft.com/cms/s/0/46471360-c030-11df-b77d-00144feab49a.html#axzz209rAZpxc

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pop-up retailing, noted this: From individual designers teaming up, to real estate agents making better use of vacant properties, to big brands looking to add a bit of cool and agility to their otherwise fixed locations and massive flagship stores: Pop-up retail could do the trick. And lets not forget the dozens of online pure-plays dying to get a bit of offline visibility... (How about Amazon.com Christmas stores in Dsseldorf and London?) Expect more pop-up retail appearing in the months to come.30 Rena Tom, a retail-industry blogger, crystallized this thought: I love the trend of bringing online shops into brick and mortar storefronts, galleries and other public spaces. Present & Correct, the dreamy online stationery shop, created a temporary collection of items atop cardboard school desks within gallery House of Propellors. Conversely, Playtype is a concept store launched to celebrate the opening of the online type foundry. Also featuring every type of typographical merchandise, the popup space provides font files on USB sticks. A clever take on font buying, a transaction that is usually a strictly virtual experience. Both examples show that online stores can easily spring into the real world through collaboration with other storefronts or by dreaming up limited edition concept spaces. Another way online shops are embracing the pop-up idea is by creating limited edition products or curated collections. 100 Layer Cake, a wedding blog and directory, is a great example of how an online pop-up can work. From table linens to photography packages to honeymoon deals, the site presents the products beautifully while the countdown creates a feeling of urgency and exclusivity. I think this idea could work particularly well when focused on a holiday like Christmas.31 While pop-up retailing is built on the concept that the physical locations are temporary, online merchants are increasingly turning to the real world in a more permanent way, as noted in a recent Bloomberg News story: Dot-com companies including Google and Amazon are reportedly trying out physical retail stores as a way to attract new consumers. Could the shift to bricks-and-mortar stores be a sign of the times to come for online retail? Amazon is reportedly opening up a boutique location in Seattle that will sell its line of products, and Google has announced that it will be testing a physical retail location in Dublin. With Apples retail-focused strategy, it appears that other tech giants might be taking a hint to help mass market its products to consumers. There is a growing realization amongst the leading bricks-and-mortar retailers that the in-store customer and the online shopper are not distinct, siloed groupings there is a

30 31

Pop-up retail, http://trendwatching.com/trends/POPUP_RETAIL.htm (accessed June 25, 2012) Pop-up retail, by Chloe Douglas http://renatom.net/2012/04/11/pop-up-retail/ (accessed June 25, 2012)

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very substantial overlap, said Dr. Windsor Holden, principal analyst at Juniper Research, Hampshire, England. This rather belated recognition has certainly benefited companies such as Barnes & Noble, which is using the mobile device as a hub with which to marry the physical and digital worlds, he said. So a number of online companies are arguing that the introduction of a physical channel can enable them both to widen their user base and to provide existing customers with an additional purchasing channel.32 In the case of the Massachusetts State Lottery, while the presence of retailers can prove to be a marketing boon for online sales, this does not provide all the answers needed to address the real, legitimate concerns of existing lottery retailers. A related, essential question is: Can an online presence for the Massachusetts State Lottery have a positive impact on retailer sales? For that, we look to other examples of how brick-and-mortar retailers have managed to leverage a growing presence on the Internet to increase their overall sales, including sales at physical locations.

1. Using Online to Boost Retail Sales: Examples from Other Industries

Lotteries are not alone in being slow to embrace the Internet as a means of growing sales. Wal-Mart, the worlds largest retailer, had been less than eager to embrace online sales (which account for about 2 percent of its overall sales), and is only now beginning to make noticeable strides in that area. One critical factor in that evolution in Wal-Marts attitude has been the growing competition from Amazon.com.33 Wal-Mart discovered through a survey that half its customers shop at Amazon, double the percentage from five years earlier.34 Armed with such data, Wal-Mart has stepped up its efforts to increase its online presence, and has spent $300 million in acquisitions and has hired 200 people to reach that goal. Jeremy King, chief technology officer at @WalmartLabs said: Amazon is always in our sights. In the US, Amazon is a very big competitor. My biggest issue is playing a catch-up game.35

32

What dot-com companies move to bricks-and-mortar stores could mean for retailers, by Lauren Johnston, Mobile Commerce Daily, June 19, 2012 http://www.mobilecommercedaily.com/2012/02/15/what-dot-comcompanies%E2%80%99-move-to-bricks-and-mortar-stores-could-mean-for-retailers.
33

Wal-Mart gears up online as customers defect to Amazon, By David Welch, March 20, 2012, Bloomberg Businessweek http://www.businessweek.com/news/2012-03-20/Wal-Mart-gears-up-online-as-customers-defectto-amazon.
34 35

Ibid. Ibid.

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While retailers such as Wal-Mart may be laggards online, they are discovering that their physical presence is an asset that pure online players cannot duplicate. Sometimes, the success that physical retailers have when they create an online channel can be quick and stunning. Williams-Sonoma, a home-goods retailer, managed to avoid any semblance of cannibalization by growing sales in both channels in 2010, despite a sluggish economy. Comparable-store sales grew by 5.2 percent, while online sales grew by 27 percent.36 The companys online and store sales for the past three years are illustrated in the following table: Figure 4: Williams-Sonoma, online and in-store sales
($ in thousands) Net Revenues Online In-Store Total 2009 $1,224,670 $1,878,034 $3,102,704 % of Total 39.5% 60.5% 100.0% 2010 $1,452,572 $2,051,586 $3,504,158 % of Total 41.5% 58.5% 100.0% 2011 $1,632,811 $2,088,084 $3,720,895 % of Total 43.9% 56.1% 100.0%

Source: Williams-Sonoma 2011 Annual Report

Such growth has been driven, in part, by a carefully crafted marketing strategy that focused on areas such as search-engine optimization, mobile applications and social media.37 Not all retailers, however, can expect such stellar results as they endeavor to move from a single brick-and-mortar channel to a multi-channel strategy. J.C. Penney has yet to find an online strategy that works. Internet Retailer reported: Fresh from proclaiming a four year plan aimed at revitalizing its brand by improving the in-store experience, J.C. Penney Co. Inc. yesterday reported another year of stagnant web sales along with declining overall revenue in 2011. For the full year ended Jan. 28, J.C. Penney, No. 20 in the Internet Retailer Top 500 Guide posted: Web sales of $1.5 billion, representing essentially no change from fiscal 2010. Online revenue has been around $1.5 billion for J. C. Penney since 2007. Total sales of $17.3 billion, a 2.8% drop from $17.8 billion last year. Comparable-store sales increased 0.2%.

Internet Retailer calculates that the web comprised 8.7% of total sales in 2011 compared with 8.4% in 2010.38

36

Online sales help drive Williams-Sonomas profit, March 15, 2011, Market Watch, Wall Street Journal http://articles.marketwatch.com/2011-03-15/industries/30764060_1_williams-sonoma-online-sales-pottery-barnkids.
37 38

Ibid.

J.C. Penney treads water on the web, Internet Retailer, February 24, 2012 http://www.Internetretailer.com/2012/02/24/jc-penney-treads-water-web.

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Still, even such a dismal report regarding overall sales did contain a significant bright spot that could bode well for lottery retailers: Even though J.C. Penney made a clear push to grow online sales, its retail stores did not report a decline in sales, and actually grew by a small amount. J.C. Penney has announced that it will offer free family portraits through November and over the Thanksgiving holiday in an effort to draw more shoppers into its stores. Increasingly, brick and mortar retailers are finding that they must develop effective web strategies simply in order to compete and survive. Big box stores such as Best Buy are facing extinction due to a growing proportion of shoppers who walk through their stores looking at the products and comparing prices with online merchants. This trend is even more pronounced during the holidays. Forrester Research estimates that online shopping accounts for only 7 percent of US retail sales in 2012, but expects that to grow to 16 percent during the Christmas shopping season.39 Accordingly, land-based retailers including Macys Nordstrom, and Target are advertising that they will match online prices this holiday season and all of these retailers are changing their websites from independent sales operations into integrated strategic elements for growing sales across all channels.40

2. Developing Multi-Channel Strategy for Massachusetts State Lottery

The Massachusetts State Lottery is nearly a $5 billion industry that has developed based on the strength of only one distribution channel. At the same time, most of its retailers are equally dependent on that one channel. That situation exists in lotteries throughout the United States, yet lotteries are not the only industry that has grappled with this issue. Nor are lotteries the only industry that has faced the difficult question of: Can a multi-channel system be developed without sacrificing sales in any one channel? The answer to that question is particularly relevant to lotteries, which deploy independently owned private operators to serve as agents. A major department store, for example, may be less concerned about cannibalization since it would be merely substituting sales in one channel for another, while sales in either one inure to the benefit of the parent company. That situation does not exist for the Massachusetts State Lottery, hence the bar is set much higher: A multi-channel solution must be developed that does not cannibalize sales at the existing channel or, better yet, enhances such sales. Examples can be found in other industries where this question has already been addressed. Scott A. Neslin and Venkatesh Shankar, two marketing professors, drafted a 2007 white paper on this issue that, among other things, suggests the value in developing unified, coordinating marketing programs across channels. They note:
39 40

The War Over Christmas, Businessweek, November 5 November 11, 2012. Ibid.

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These programs can take the form of standard integrated marketing communications tactics such as the consistent use of the same logo or value proposition in all the channels. Another promising area is cross-channel promotions. For example, a firm may offer Internet purchasers a discount if they pick up the ordered items at the store. Once in the store, the customer may purchase additional items. An inter-channel cross-selling promotion might entail a coupon offered to Internet users for purchasing an item in a retail store. The objective of such a promotion could be to increase store traffic. Going the opposite way, a retail store may offer a customer at the checkout counter a coupon that can be used for online purchases. The firms motivation for such a promotion is to migrate the customer to use a lower cost channel, namely, the Web.41 That latter point is clearly not a goal of the Massachusetts State Lottery. Here, the goal is to grow overall sales through a multi-channel strategy by some combination of: Broadening the demographic base Increasing purchases per customer Enhancing customer satisfaction and loyalty, which in turn would also increase purchases.

With that in mind, Neslin and Shankar go on to raise the following points: What we know is that customers do self-select channels according to their preferences. There is also empirical evidence that multichannel availability may enhance loyalty although some studies suggest that increased Internet usage may erode loyalty . If multiple channels enhance loyalty, then using multiple channels as a customer satisfaction and delight strategy may be appropriate because the enhanced loyalty may be derived from customers freedom to use the different channels. What we need to know are answers to the following questions. Do multichannel customers perceive better service and experience greater satisfaction or delight than do single channel customers? Is the multichannel usage and customer satisfaction relationship causal? That is, does multichannel usage beget higher customer satisfaction, or are more satisfied customers naturally willing to use different channels?42 While their paper is well researched, it does not provide satisfactory answers to the questions raised, at least not for purposes of this analysis. Still, this does raise an interesting question for the Lottery: Can a multi-channel system be developed that both enhances loyalty and grows sales, in part by generating more sales through more loyal customers?

41

Key Issues in Multi-channel Customer Management: Current Knowledge and Future Directions, by Neslin and Shankar, submitted to Tenth Anniversary Special Issue of The Journal of Interactive Marketing, Aug. 28, 2007, p. 8.
42

Ibid. p. 11.

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3. Loyalty Programs: Advancing Sales, Public Policy

Loyalty programs have been developed for a variety of B2C (business to consumer) industries over the years, from airlines and hotels to casinos and restaurants. The programs have had varying degrees of success, and created varying degrees of frustration, satisfaction and loyalty among consumers. Their common elements center on the notion that the most loyal customers (the smaller percentage of customers that generate the largest percentage of sales and profitability) should be recognized, rewarded and encouraged to maintain and enhance their spending and loyalty. Another common element is that the more knowledge that a business can obtain about its customers will allow it to tailor its offerings to that knowledge, whether that entails knowledge about when purchases or made, or knowledge about which goods or service enjoy a strong positive (or negative) correlation in sales. Effective loyalty programs vest their customers with a sense of ownership, a view that past purchases are a form of savings, a deferred reward that will be collected at a later date. Michael Lewis of Emory University, writing nearly a decade ago in the Journal of Marketing Research, crystallized a dilemma facing managers seeking to develop or improve a loyalty program: A special characteristic of loyalty programs is that their attractiveness may change dynamically with a customers decisions. As purchases are made, both the customers investment in the program and the customers likelihood of earning a reward increase. Conversely, when a customer decides not to purchase in a given period, the likelihood of earning a reward decreases, because the customer moves no closer to the reward threshold, and the time left to earn rewards shrinks. The assessment of a programs attractiveness is further complicated because customers usually have imperfect knowledge of their future requirements and of the marketing policies of the firm. These dynamic factors are a challenge in the modeling of customer response to loyalty programs.43 Our analysis in this section begins by identifying the key attributes of the present lottery distribution system that offer the potential to build loyalty: The Lottery currently has no legal gambling competition within Massachusetts The Lottery has an extraordinarily deep distribution system through its 7,400 retailers

43

The Influence of Loyalty Programs and Short-Term Promotions on Customer Retention, Journal of Marketing Research, August 2004, p. 282.

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The nature of legal online gambling requires and generates detailed, accurate information about players, from their demographics to their playing preferences to their location.

In Spectrums experience, gamblers are generally promiscuous in their spending habits. Physical casinos in close proximity to each other generally share customers, and customers are often swayed by the value of the offer they receive. So, an absence of online options would inure to the benefit of the Lottery. At the same time, loyalty whether to the brand, or to the best offer can be maintained by a combination of limited competition and a robust loyalty program that takes into account the interests of both the lottery and its retailer network. A 2000 report by McKinsey & Company warns that loyalty programs are not necessarily as profitable as their proponents assume. The report notes that these programs, despite their number and apparent popularity with customers, often fail to increase customers loyalty. In fact, 79 percent of customers in casual apparel and 70 percent in grocery say they are always seeking alternatives to their current retailerspercentages that far exceed the percentage of customers actively seeking alternatives in other categories. Nor do consumers who join a loyalty program necessarily increase their spending.44 Still, a loyalty program that is based on extensive, accurate customer spending patterns and related data holds more promise for success, based in large measure on our experience in gaming. This conclusion is based on outside research as well. For example, a 2010 report in the Journal of Interactive Marketing notes (correctly in our view) that a combination of customized coupons and amassed loyalty points can collectively have a very positive impact on loyalty and spending: Loyalty programs, specifically points programs, seem to have a positive short-term impact on different aspects of customer behavior, including purchase frequency, basket size, lifetime duration and share of wallet One major finding from multiple studies is that the impact of loyalty programs is more pronounced among light or moderate users rather than heavy users Studies have also identified that loyalty programs have a longterm effect of increasing customer spending with a retailer, although the long-term effect is still smaller than the short-term effect . Customized coupons differ from points programs in the sense that they are personalized for individual customers, and the retailers do not explicitly communicate to the customers the type of behaviors that are rewarded. Therefore, customized coupon campaigns have the ability to delight customers because of the unexpected nature of the rewards. In addition to rewarding customer behavior, customized coupon campaigns can also allow

44

Do you know if your loyalty program is working? McKinsey & Company, November 2000, by James Cigliano, Margaret Georgiadis, Darren Pleasance, and Susan Whalley. https://www.mckinseyquarterly.com/The_price_of_loyalty_949

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retailers to advertise their products, especially those in their assortment that are differentiated from competition.45 The concept of a loyalty program that rewards customers for their level of play has never, in our experience, been fully implemented by lotteries. The concept of an online program, however, lends itself to such a plan, in large measure because all wagers will be recorded. Additionally, the Massachusetts situation lends itself to a loyalty program because such a program can be coordinated: With the forthcoming casinos in Massachusetts, to reward lottery players with free meals, rooms and other amenities. With retailers, who can develop their own rewards system to encourage on-site visits. The specifics of retailer rewards program need to be customized to the business model of each retailer, or group of retailers, but certain common elements would likely be incorporated: Customers could receive offers based on their geographic location Spending patterns would also be evaluated to encourage both non-lottery sales, as well as overall lottery sales Rewards would be based on encouraging both online and brick-and-mortar sales The development and coordination of loyalty programs between the Lottery, casinos and the retailer community should be designed to boost overall sales, as well as to: Enhance the potential value of Massachusettss forthcoming gaming licenses Encourage participation by retailers who would then develop plans to encourage instore visitation. Casinos have historically relied on loyalty programs as essential marketing tools to identify and cultivate players.

4. Casino Customer Loyalty Programming

As a component of an overall strategic marketing plan, an effective customer loyalty program provides a means to generate (or improve upon) customer loyalties, gather information, and drive incremental revenue and/or visitation from customers. However, in our experience and with respect to online gambling, a successful customer loyalty program can only be as successful as the delivery of customer service at the brick-and-mortar level of the organization (i.e., data-

45

CRM in Data-Rich Multichannel Retailing Environments: A Review and Future Research Directions, Journal of Interactive Marketing, 24 (2010), p. 129.

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driven processes and customer-service/human-relations go hand-in-hand). This may be a critically important relationship the Massachusetts State Lottery must consider. This section of the report will show how casino operators view loyalty programs. While clearly different from lotteries, casinos offer valuable lessons in this area because: The casino industry has evolved to become heavily reliant on developing and maintaining robust loyalty programs. The casino industry in the United States is presently also examining opportunities in online gambling, thus creating possibilities of both competition and/or cooperation with lotteries. This is particularly relevant in Massachusetts as it is simultaneously developing a brick-and-mortar casino industry while examining the possibilities of online gambling for the Lottery. Online gambling represents a significant potential departure for the Lottery because it offers the opportunity to broaden its customer base, and create entirely different customer experiences, all of which increases the possibility that its customer base will overlap with that of casinos.

An interactive customer loyalty program can benefit both the provider and consumer. Through effective data-mining, a casinos marketing initiatives can go from one-way (casino to customer) offerings into two-way transactions (where customer tastes, preferences, and overall feedback are directed back to the casino thus marketing initiatives are tailored to customer wants and needs). According to Gary Loveman,46 from Diamonds in the Data Mine published in the Harvard Business Review in May 2003:47 Harrahs Entertainment [now known as Caesars Entertainment] has the most devoted clientele in the casino industry a business notorious for fickle customers. Weve increased customer loyalty, even in the current challenging economy, in two ways. First, we use database marketing and decision-science-based analytical tools to widen the gap between us and casino operators who base their customer incentives more on intuition than evidence. Second, we deliver the great service that consumers demand. In short, weve come out on top in the casino wars by mining our customer data deeply, running marketing experiments, and using the results to develop and implement finely tuned marketing and service-delivery strategies that keep our customers coming back. From the same article and with respect to customer relationships (i.e., human interaction, brick-and-mortar aspect), Loveman notes:
46

Loveman currently serves in three distinct capacities with Caesars Entertainment: Chairman of the Board, Chief Executive Officer and President. 47 Diamonds in the Data Mine, by Gary W. Loveman, Harvard Business Review, May 1, 2003

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Deep data-mining and decision-science marketing would be worth little in driving samestore sales growth were it not for another simultaneously applied and extremely critical ingredient an absolute focus on customer satisfaction. The following are some examples of benefits (to both the casino and customers) that may accrue from having an effective customer loyalty program, along with multiple service-points (i.e., multiple casinos) in a market: Hassle-free gambling experience throughout multiple same-market operations Simplified experience ability to interact with one entity (telephone, web-based) while benefitting from having multiple unified casinos in market Branding exists, and recognized, in market Common database results in common offerings for customers: No loss, or cost (real or perceived), to customer by playing at multiple casinos equivalent benefits accrue from playing at all casinos Customer earns rewards from play at all casinos and can redeem at all casinos Loyalty as with airlines and hotels customer loyalty programs, which have various tiers and plateaus resulting from membership, the casino may be able to develop a common system applicable to all casinos, which may then yield incremental visitation (as customer may not split visits or spending to other regional competitors) The gambling operator, through the existing database, is keenly aware of market/trade area customer tastes and preferences this proprietary insight can be seamlessly applied to all casinos in the market: Ensures quality level and product offering is at a quality level and attractiveness expected by local residents, Loyalty program tailored to local residents designed to increase visitation to all casinos in the market (ensures little incentive for market/trade area residents to expatriate gambling dollars to other jurisdictions)

Again, we believe these aforementioned benefits could accrue to both the casino operator and consumer experience, or adults in the area.

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E.

Current Situation in Massachusetts

1. Background

Established by the legislature in 1971, the Massachusetts State Lottery provides revenue for all of the 351 municipalities throughout the state. The original weekly drawing, The Game, began in March 1972. In May 1974, Massachusetts introduced the first scratch ticket, Instant Game, in cooperation with Scientific Games, an invention that revolutionized the US lottery industry.48 Today the Lottery introduces about 25 new instant game products each year. The Lottery is overseen by a popularly elected official, the State Treasurer, and governed by a five-member commission (MSLC, or Massachusetts State Lottery Commission) established by the Legislature. The MSLC includes the State Treasurer as Chairperson, the Secretary of Public Safety, the State Comptroller, and two gubernatorial appointees. The Commissioners oversee Lottery operations and provide final approval for the types of games, prices, prize structure, methods of payment, and licensing of sales agents. 49 The Lottery enjoys generally positive public perceptions, with 60 percent citizens indicating a favorable opinion. 50

2.

Success Factors

The Massachusetts State Lottery is arguably the most successful and innovative state lottery in the United States. The strengths of the Lottery include ownership and management of the information technology infrastructure supporting the games, revenues that lead the nation by a wide margin on a per-capita basis; high payout ratios on instant games; innovative and popular instant game offerings; and a highly involved, motivated and supportive network of sales agents. The Lottery is not among the largest lotteries in the nation when measured by total revenue, where it ranks moderately due to Massachusetts relatively small population of 6.7 million. However, the Lottery generates the highest revenue per player of any lottery nationwide, posting an average of $666 per capita in 2010.51 The most important single success factor is instant games. The Lottery relies heavily on instant game products, which currently constitute 69 percent of all sales by revenue, or $3.1 billion out of the $4.6 billion in total revenues generated in 2011. 52 This reliance on instant games has long been a success characteristic of the Lottery and the proportion of revenue

48 49 50 51 52

Lotteryinsider.com Lotteryinsider.com MSLC Annual Tracking Study, May 8, 2011 La Fleurs 2010 World Lottery Almanac Sales data by product, 1st quarter, 2012, Massachusetts State Lottery.

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generated by instant game products has remained relatively constant going back at least to 2003.53 Massachusetts is the world leader in per capita sales of instant tickets. Only two lotteries in all of Europe make it in the top 25 and one does not encounter an Australian lottery on the list until No. 43. The following chart demonstrates the Lottery product market for 2010-present: Figure 5: FY 2012 Massachusetts State Lottery sales by product (through September)
Mass Cash 1%
MegaMillions 1% Powerball 2% Numbers Game 7% MegaBucks 1% Daily Race 1% Cash Winfall 0% Lucky For Life 0%

Keno 17%

Instant Games 69%

Source: Massachusetts State Lottery

53

Christiansen Capital Advisors, Analysis and Recommendations for the Massachusetts State Lottery, MSLC RFR Lot #526, 2003

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Figure 6: 2011 Massachusetts State Lottery sales by product

MegaMillions 2% Powerball Mass Cash Cash Winfall MegaBucks 1% 2% 1% 1% Raffle 0% Daily Race 0%

Numbers 7%

Keno 17%

Instant Game 69%

Source: Massachusetts State Lottery

Figure 7: 2010 Massachusetts State Lottery sales by product

BGMegaMillions 2% Powerball Mass Cash 1% 1% Cash Winfall 1% Daily Race 1% MegaBucks 1%

Numbers 8%

Keno 17%

Instant Game 68%

Source: Massachusetts State Lottery

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The reason that instant game products perform so well in Massachusetts is because the Lottery offers higher payouts than its competitors, paying out, on average, $0.72 on the dollar compared to the US average of $0.645 in 2006; some lotteries have payouts in the mid-50s. That Massachusetts enjoys the highest per-capita sales revenue and also offers the highest payouts on instant games of any US lottery are not unrelated. Core players, the key constituency for instant game products, obviously perceive a better deal for the player and this is paying off for Massachusetts in higher Lottery revenues per player. This strategy, although executed in the transactional milieu of instant games, is similar to the low-hold strategy prevalent in casinos, where higher revenues depend upon more time on device. In both situations, lower hold percentages generate higher sales volume which generates greater revenue and also a more frequent and satisfied customer.

3.

Overview of Lottery Operations in Massachusetts

A comparative operational study of the Lottery yields several marked characteristics which distinguish the Lottery from its American peers and from those lotteries across the globe which have deployed various lottery Internet sales protocols. Unique is an overused term which most lottery administrators invariably apply to their own lottery operations. However, in the case of Massachusetts, the term aptly fits. The facts and the data paint a clear picture of a lottery environment and lottery organization that is quite unlike any other either here or abroad. The success of Massachusetts has been demonstrated critical measure of per-capita sales where the Massachusetts State Lottery has maintained a dominant lead over more than a decade relative to other state lotteries, as illustrated in the following table, which compares the leading US state lotteries in sales per capita for the fiscal year 201254: Figure 8: FY 2012 Lottery sales per capita, peer group
Population (millions) Massachusetts Georgia New York New Jersey Connecticut Pennsylvania Michigan Ohio
Source: La Fleurs

Lottery sales (billions)* $4.77 $3.83 $7.01 $2.75 $1.08 $3.48 $2.41 $2.73

Sales per capita $725 $391 $360 $312 $302 $273 $244 $237

6.6 8.9 19.5 8.7 3.5 12.6 9.9 11.5

*Does not include VLT sales

An interconnected series of bold public policy choices, unique operational priorities and unusually experienced, talented management, all deployed in a jurisdiction where the spotlight
54

La Fleurs Magazine, September/October 2012.

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on lottery and public administration is extremely intense, have together created and defined this Lottery as different and all together more successful than most. The differences begin with mission. The primary, stated mission of the Lottery is to raise revenue for Massachusetts cities and towns. This in itself is a unique charge for a state-run lottery.55 Yet as described by various observers and stakeholders, the de facto mission of the Lottery has broadened over time and today the Lottery is understood to serving multi-faceted purposes which include regulatory, entertainment, revenue, and business-development objectives. Like many of its counterparts in the northeast US, the Lottery is the heir to a long tradition of public and private small-scale gambling activity in the state. Public lotteries authorized by the Commonwealth have been a part of the fabric of Massachusetts since the time of the Puritans. Lotteries were used to finance a number of Massachusetts most revered civic and institutional landmarks, including development of Harvard College. 56 Later, in the 19th Century, public-sponsored lottery gambling declined and private or street gaming particularly in the growing urban centers emerged. Illegal and unregulated, street gaming took hold in Massachusetts with a prevalence that, most experts agreed, equaled its Northeastern neighbors and likely far exceeded what was found in most other states.57 When modern lotteries were created in the 1960s and 70s, their mission was generally understood to be forged from these two historical elements: to raise revenue for a public purpose by, in part, diverting interest and attention away from the private street gaming activities.58 To achieve these purposes the Lottery embarked on an ambitious program to offer safe, secure and regulated products through as many physical retail outlets as could reasonably be recruited and supported. In the process a partnership with thousands of Massachusetts retailers was created and an additional mission evolved: to serve and support the businesses (most of them individually owned small and medium businesses) who served and supported the growth of the Lottery. Armed with potent tools, including the most generous prize payout of any lottery in the nation, these retailers helped the Lottery created a relationship of trust and loyalty with end players which is widely admired and unlike any other in the industry. 59

55 56

Teresa LaFleur, ed., La Fleurs World Lottery Almanac, (Rockville, MD: 1 TLF Publications 1998), 23.

State Legislatures to benefit from Mega Millions, an interview with Professor Charles Clotfelter, National Public Radio, 3/2/12
57

See Dwight Strong, New England: The Refined Yankee in Organized Crime, The ANNALS of the American Academy of Political and Social Science vol. 347 no. 1 (May 1963) 40-50.
58

Charles Clotfelter, Phillip Cook, Selling Hope: State Lotteries in America (Cambridge: Harvard University Press, 1989), 40.
59

Interview with M. Scott Bowen, Commissioner Michigan State Lottery, (April 30, 2012).

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This retailer/player loyalty in turn created yet another mission-like responsibility, one which is keenly felt by Lottery retailers and management: to stay current in an increasingly complex, competitive gambling environment so as to consistently provide players with state of the art products and service. Today the Lottery represents a Commonwealth asset of tremendous current and future value. This asset has been created by successfully weaving together and serving all of these evolving, diverse mission strands. Understanding each leads to a proper understanding of the uniqueness and the value of the Lottery and helps identify the context and ways in which a properly crafted Internet sales program could best protect and enhance the value of the Lottery as a public asset.

a. Consequences of a Unique Mandate

Massachusetts is the only state that specifically earmarks its profits to be distributed to cities and towns.60 This produces several operational ramifications which may prove to be relevant with regard to Internet sales. The cities-and-towns mandate has created concentric rings of Lottery stakeholders and observers who are highly interested in the Lottery program and its success. This is unusual. In most other US states, lottery revenues are directed to the states general revenue fund, where they are dwarfed by, and mingled with, general tax receipts and then largely forgotten about. In several European jurisdictions private operators retain revenues and the public is benefited in the form of a business operations tax. As far as public interest and awareness is concerned these taxes on lottery operators have no greater significance than a tax collected on any number of general or specific businesses. The result is a general public ignorance or apathy with regard to where the money goes and how the Lottery performs. The situation in Massachusetts is altogether different. In the Commonwealth, the general public and the playing public are more aware of where the money goes and generally provide more support for the institution no doubt because of this understanding. 61 Lottery revenues can become important topics and factors in budget making in every city and town across the commonwealth. This creates a significant amount of lottery-related discussion in local public discourse and in local and regional news outlets.62 This revenue-driven interest no doubt leads to more and deeper media coverage of lottery issues than is the case in other states. In most other states lottery is publicly relevant only during times of scandal or extremely high jackpots. In these states choices made by lottery administrators rarely elicit much public interest or comment.

60 LaFleur, 23. 61 Annual Tracking Survey & Brand Assessment, The Massachusetts State Lottery, conducted by SocialSphere (5/18/11), 4. 62 See e.g. State counts on Lottery to support Cities and Towns WCVB Channel 5 Boston, (3/27/12).

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By contrast, the lottery decision-making process in Massachusetts generally receives more scrutiny and more coverage in the media.63 Likewise, local political leaders throughout the state whose job in office can be made easier or more difficult depending on Lottery performance are more apt to have opinions on the Lottery and to share these opinions with their friends and political relations on Beacon Hill. Again this contrasts with the situation in most other states where lottery revenues are irrelevant to local concerns and lottery operational issues less a source of interest to state and local elected officials as a result. The uniqueness of where the lottery money goes has contributed to making the Massachusetts State Lottery a more localized, from the ground-up-oriented organization, characterized by a greater reliance upon (and sensitivity to) grass roots operational factors than is often the case with other lotteries. This orientation has been further solidified by a series of public policy and administrative choices concerning how lottery products are offered to the public and how Lottery products are advertised and promoted. (The significance of these choices is discussed in greater detail below). This ground-up, decentralized orientation is unique and it creates a unique environment in which to consider and apply what have, here to fore, been largely top-down, centralized Internet lottery sales solutions. Public Accountability We noted that many lotteries in Europe operate as private entities under license to the sponsoring government. In such an environment lottery leadership is accountable to shareholders and to a regulatory authority which, in most cases is largely distant from and unknown to the larger public. Most North American lotteries are run as direct agencies of government. Some, such as Georgia, Tennessee and Kentucky, operate under special quasi-corporate frameworks which provide somewhat more day-to-day managerial flexibility to respond to market conditions.64 Yet even in these American lottery corporations day-to-day lottery managers are government employees reporting to government-created oversight bodies. Regardless of organizational structure, the common denominator with regard to oversight and accountability is that absent a miss-step or the occasional large jackpot, lottery operations do not receive significant attention from the press, the public or within government. In the vast majority of states, lotteries report to and through one of the gubernatorialdirected revenue agencies or to the governor directly. Governors tend to have broader operational portfolios and, as a result tend to focus relatively less interest and attention on lottery operations.

63Interview with Paul Sternburg, Executive Director Massachusetts State Lottery. (March 22, 2012)
64

The National Gambling Impact Study Commission, State Lotteries at the Turn of the Century, (Durham, NC: Duke University, April 23, 1999), 9.

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Massachusetts is an exception to this rule. By statute, the Lottery reports to the State Treasurer. Lottery makes up an important part of the Treasurers operational portfolio. Further, since the State Treasurer is an independently elected political position, this office and the portfolio of responsibilities which reside in it have a larger media and public profile than is the case with appointed Finance authorities in other states. On top of this, the Treasurer and the Lottery in Massachusetts operate in an intense media market, which makes it relatively difficult in our view to develop financial decisions that would not also receive political scrutiny. The bottom line is that the Massachusetts State Lottery today is arguably the most scrutinized, most accountable, most politically sensitive/responsive and most profitable lottery in the nation. This position informs all aspects of lottery operations, including decisions relating to the possible launch of new Internet sales channels. Operates Own System In 43 of the 44 lottery jurisdictions in the United States, the day-to-day central gaming network is maintained and operated by a third-party contracted vendor.65 These networks constitute the heart and soul of a modern lottery operation. In many states the provision of services surrounding the central gaming network has grown to include many standard lottery management functions including field sales support, ordering, warehousing and delivery of tickets. In these situations, it is debatable whether it can be said that the state operates the lottery, for in fact the majority of operating functions are actually undertaken by a vendor. Once again, Massachusetts proves to be an exception to the general lottery industry rule. Here the Commonwealth owns, operates and maintains its own central gaming system. This has been the case since centralized lottery gaming systems were first introduced in the late 1970s.66 According to administrators, this approach saves money but does have some operational drawbacks, particularly involving the ability to stay current with new technologies. States that are served by large vendors have access to the research and development efforts which these companies provide. On the flip side, administrators believe that by operating its own system the Lottery could be positioned to respond more quickly and more precisely to particular marketing imperatives and opportunities that present themselves in the Massachusetts market. 67 Internet-focused vendors have attested to the benefits of an open architecture or open platform Internet sales system in which a variety of optimized, customer-facing Internet sales protocols are able to securely connect to a states centralized gaming system. 68 In this way, the sales approach which the Lottery has utilized to great effect in the physical bricks-and- mortar
65 66 67 68

LaFleur, 427. Interview with Paul Mandeville, Assistant Executive Director, Massachusetts State Lottery, (May 1, 2012). Ibid. Presentation by lottery industry vendors to Massachusetts State Lottery, (April 19, 2012).

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environment (e.g., entering into sales agency relationships with as many entities who can possibly provide an effective contact with an end customer) would be applied to the Internet as well. A grocery store that has developed a robust following with customers on the Internet or an Internet retailer of books and electronics could, under this type of approach, also sell Internet lottery products on behalf of the Lottery, increasing the Lotterys ability to reach and effectively serve Internet-based customers. Variations on this approach, employing affiliate sales development and referral programs have been used successfully for several years in the Australian market.69 Traditional lottery suppliers that now offer lottery Internet sales solutions tend to prefer a closed-system approach in which consumers interface only with one Internet site powered by the supplier. They are less likely to support the concept of splitting margins with customeraggregating retailers or affiliates, maintaining that in a monopoly environment there is no need to share the outreach and the profit with any parties other than the Lottery and the supplier.70 Further, they note that transaction-processing costs that either do not exist or are less expensive in traditional lottery transactions must be taken into account. Whatever approach may be optimal for all stakeholders, the likelihood is that, given the overall operational dependence of North American lotteries on their traditional suppliers, the operational model favored by the supplier will find an audience and market in North America. Indeed this is the model that has been rolled out in British Columbia and in Illinois, where the company that operates the closed-system Internet protocol is also a majority owner of the new private management company which runs day-to-day operations of the Illinois Lottery. However, given that Massachusetts is not as dependent on a traditional lottery supplier, the possibility is stronger here than elsewhere that an open platform approach favored by others in the industry could be viewed to be an appropriate fit for the Commonwealth. Payout/Focus on Instant Scratch Product Over the span of decades, Lottery management established and executed a strategy to raise the prize payout on the instant scratch ticket category significantly beyond that which was routinely offered in other states. The payouts were moved up over time as part of credibly differentiating the games from one another. Each of the scratch products had different levels of top prizes and credible winning-prize amounts. This allowed more scratch games to be merchandised effectively at POS (point of sale) in the retail location and thus helped cross play among games. The scratch game product line did not have a legislative restriction on its payout, as did the draw games, so the payouts were allowed to improve over time as part of the game development and differentiation. In addition to the initial variation in payout across individual

69 70

Mike Veverka, Jumbo Interactive Ltd., Presentation at the PGRI Smarttech Conference, New York March, 2012 Presentation by lottery industry vendors to Massachusetts State Lottery, April 10, 2012.

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scratch products, the payouts/available prizes were also used to differentiate between the price points. There has historically been a differentiation between the payouts of the scratch tickets at each price point; as the mix of product sales has become stronger with the higher priced scratch games (and the $1 game sales are a smaller part of the overall sales mix), the average payout numbers across all scratch games has increased. This approach formed a foundational pillar of a broader instant-ticket-focused sales and operational strategy, which subsequently transformed the lottery industry in North America. Consider the following: In 1994, instant tickets accounted for only 37 percent of total lottery sales across the United States, with terminal-based draw games accounting for the rest. Sales ratios within individual states during that period reveal an even more dramatic contrast. In Pennsylvania instant ticket sales accounted for 18 percent of total sales, and in New York instant tickets accounted for just 11 percent of sales. 71 At the time, Massachusetts was a lonely pioneer; sales in the instant ticket category accounted for 70 percent.72 Fast forward to today, and we see nothing short of a revolution in lottery operations Today, the ratio of instant ticket sales to terminal sales nationally is the mirror reverse of the situation in 1994: 63 percent of traditional lottery sales nationwide are instants, with terminal draw games accounting for the balance.73 Over the past decade, Massachusetts has retained and, in fact, intensified its focus on instant tickets, with the sales ratio today standing at 69 percent.74 The instant ticket product is so different from the terminal product in so many different ways that the ramifications of this extreme sales differential have been felt across every area of lottery operations. Further, this differential has made broad lottery to lottery comparisons more suspect and less relevant, until and unless these significant product variations are understood and taken into account An example would be to compare two traditional tea companies, Lipton and Red Rose. Let us assume that 25 years ago, both tea companies focused on and sold what are effectively the same products: loose and bagged teas. Comparisons between the companies would be apt. However, Lipton subsequently extended its brand into the prepared, bottled beverage market. Today, this product line accounts for the vast majority of that companys sales. Red Rose offers a bottled product but the traditional loose and bagged tea remains that companys focus and the primary driver of that companys sales. Technically, both companies remain tea companies but, with such a wide difference between what each respective tea company actually sells, an attempt to meaningfully compare the two or an attempt to predict issues and results for one based on the experience of the other is irrelevant and perhaps even misleading.
71 72 73 74

LaFleur, 360-365. Ibid. Ibid. Massachusetts State Lottery Commission, Statement of Operations, September, 2012.

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So it is with lotteries. One can only safely characterize and compare one lottery to another in so far as the product sales ratio of those two lotteries are somewhat aligned. In the case of Massachusetts, the Lotterys intense focus on a particular product line has made it harder to make apples-to-apples comparisons, contrasts and predictions for this Lottery, based on experiences elsewhere. Further, this defining emphasis on one product line has created a series of key operational differences which must be understood and accounted for as new operational paradigms are considered. These include the following salient attributes: Retailer Network As noted earlier, the network of licensed lottery retailers within Massachusetts operates and performs in ways which are unlike any other in the industry. It begins with financial considerations. In short, the different Massachusetts approach to the instant ticket has proved to be a tremendous financial benefit to Massachusetts retailers. It stands to reason that since retailers are compensated on the sale and upon the cashing of a ticket, a merchandising strategy designed to stimulate sales churn will work very much to the benefit of the retailer. In the United States the average lottery retailer operates within a sales territory containing 1,419 potential customers. This average retailer sells $271,001 in lottery products per year. In Massachusetts the average retailers sales territory is far smaller in population (822), yet from this smaller base the Massachusetts retailer sells $546,660 per year in lottery products, or more than double the US average. For this, the Massachusetts retailer receives an average yearly commission of approximately $37,000,75 which was more than double the 2010 US average of $16,692.76 Aside from direct commission benefits, the Massachusetts approach has also provided derivative financial benefits for Massachusetts retailers. By elevating the relative importance of the instant ticket and by supporting it with more winning experiences, the Lottery has created a product that draws customers to a store at any and all times and encourages them to stay within the retail environment. Consider the merchandising ramifications of the alternative strategy deployed in those jurisdictions where the terminal-based draw games still dominate. There, the customer is socialized toward a static, confined activity; i.e., the customer purchases a ticket to a draw set for a future date certain, he or she puts the ticket in his pocket, goes home and does not engage or shop again until several days later when that draw is over and a new sales opportunity is available. In contrast, the instant product works around a customers preference and timing. Rather than one, life-changing, long-odds mega-prize, the instant scratch product is designed to deliver more multiples of smaller winning experiences. All of this works to drive customers to a
75 76

Massachusetts State Lottery Commission Information Packet 1972-2012. La Fleurs, 277.

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store, increase the time they spend there and the likelihood that they will purchase other, highermargin items from the retailer. Indeed research bears this out. A study by the National Association of Convenience Stores found that the frequent lottery customer spends more than twice per store visit as non-lottery customers ($7.07 as opposed to $3.47) and that lottery customers purchased at least one other non-lottery item in 95 percent of their store visits.77 Despite the considerable space and labor which a retailer must devote to merchandising scratch tickets, as well as the increased risk of shrinkage from theft, thousands of Massachusetts retailers saw fit to embrace the Lotterys (then-) unique merchandising approach. Successfully executed statewide, this approach enabled the Lottery to create what is widely regarded to be the strongest, most engaged retailer network of any North American lottery. Less Advertising The success of the Massachusetts approach has produced billions of dollars for Massachusetts retailers and tens of billions of dollars for the Commonwealth. In addition, the approach has likely indirectly saved the Lottery hundreds of millions in what would otherwise be standard lottery marketing expenses. US lotteries collectively report spending over a half-billion dollars annually on lottery advertising.78 In neighboring New York, slightly less than $100 million is spent each year to advertise and support lottery sales.79 Lotteries are nearly always the largest public advertiser80 and sometimes the largest overall advertiser in the state in which they operate. In vivid contrast, Massachusetts spent merely $2 million in appropriated Lottery-advertising last year. 81 The national average ratio of appropriated lottery advertising spending to overall sales is exactly 1 percent.82 If this national expenditure average were applied to Massachusetts, lawmakers and taxpayers in the state could expect to spend approximately $44 million each year in advertising instead of the $2 million. The $2 million equates to 0.0005 percent of the Lotterys gross sales for fiscal 2011. In explaining the need for large advertising appropriations, Lottery administrators in other states point to a highly competitive retail environment and the need to get the Lotterys message out to consumers via a variety of mass marketing and media techniques. This imperative is no less important or less challenging in Massachusetts. By and large, lottery

77 78 79 80 81 82

National Association of Convenience Stores, NACS Lottery Study, (1997), www.nacsonline.com. La Fleurs, 301. Ibid. Clotfelter, Cook, 201. La Fleurs, 301. Ibid.

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administrators have risen to the challenge in admirable fashion. Overall neutral/positive consumer awareness of Lottery is an impressive 85 percent, and 70 percent of adults age 34-55 report making a lottery purchase within the last year. 83 What is more impressive is that the Lottery has accomplished this objective by vastly different and all together less expensive approaches. Third-party comparative research on state lottery advertising approaches is sparse, but it would appear that whereas in most states the lottery players source of information and contact with the product is from the state directly, in Massachusetts this role is more likely than not fulfilled by a lottery retailer. Retailer penetration relative to population is deeper in Massachusetts than any other state, and only Vermont comes close to Massachusetts ratio of retailer to population served. 84 As a result there is little chance that a customer looking to purchase a lottery ticket within the Massachusetts would be frustrated in their search. Site visits (announced and unannounced) by Spectrum executives and associates to Massachusetts retail locations revealed general agent practices that were considerably more robust and developed than is found in most markets in other states. 85 In Massachusetts, the lottery displays at retailers tend to be larger and more prominently located within the store. Signage, both exterior and interior, is more extensively and effectively utilized and often includes materials provided by the Lottery as well as materials devised by the retailer of their own initiative. Based on our interviews with Lottery officials and our examination of comparable practices in other states, we believe the Lotterys point-of-sale advertising shows signs of being stretched too thin and that an overall ad appropriation of only $2 million may be too small to adequately support the number and type of retailers that the Lottery is mandated to support. However, the combined efforts of the Lottery and retailers in getting the message out via retailer locations have helped the Lottery compensate to some, unquantifiable degree for its relatively small advertising budget. Looking ahead, the Lottery could find itself in an intensely competitive situation in the online space. Should it be offering online products while the states bricks-and-mortar casinos operators also offer online products (casino or lottery, or both), the Lottery would likely find itself at a substantial competitive disadvantage unless its overall advertising budget were

83 84 85

SocialSphere, 7, 10. LaFleur, 279.

Site visits to lottery retailers were conducted in the following communities: Boston, South Boston, Marlborough, Attleboro, Braintree, Revere, Gloucester, Beverly, Newbury, Salem, Salisbury, Methuen, Haverhill, Worcester, Pittsfield, Springfield, North Adams, Great Barrington and Lee.

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increased. That possibility lends support to our recommendation that the Lottery be the sole provider of legal Internet wagering in Massachusetts. Composition of Sales Network The make-up of the retailer network within the state is highly relevant to the Lotterys success. Lottery managers appreciate that not all lottery retailers will support the program with equal commitment and results. Further, an owner-operated Mom & Pop location might offer a more effective sales outlet for lottery than a chain location, despite changing macro demographic and retailing trends that would otherwise advantage the chain location, because an owneroperator might be expected to place more value on the lottery franchise. At the same time, chain operators may be considered less willing to devote considerable resources and attention to lottery product protocols (merchandising, accounting etc.), which are time consuming and which differ considerably from one state to the next. As a result, an owner-operated location, where lottery is a principal product, could be expected to serve as a more comprehensive and effective merchandiser of lottery products. This presumption appears to be borne out in the numbers. The lists of top-selling retail locations from the top-performing lotteries in the nation show a disproportionate representation of single location, owner-operator locations.86 Frequently these Mom & Pop locations sell three to five times more in lottery than nearby chain locations, despite the fact that the chain locations operate from newer, higher-traffic locations.87 This is illustrated well in Massachusetts. Nine out of the top-10-selling retail locations are owner-operated.88 Some of the nations top-selling individual locations are found in Massachusetts, including the top-selling lottery retail outlet in North America, Teds State Line Mobil in Methuen, which we visited as part of our research. Indeed several locations in nonheavily populated, non-heavily trafficked locations in Methuen, Salisbury and Attleboro routinely sell more lottery tickets per year than high profile lottery sales locations in Atlantas Hartsfield Airport and New Yorks Penn Station. The relative value to the Lottery of a strong base of owner-operator locations is borne out even as one moves beyond the ranks of top-selling locations. Nationally, the percentage of lottery sales realized at locations classified as chains is 53.1 percent. This percentage is growing each year as chain retailers generally continue to expand their reach and footprint. The percentage of sales realized at locations clearly classifiable as owner-operator locations is 42.8

86 87 88

See e.g. Annual Sales reporting from the New York and Massachusetts Lotteries. Ibid. Ibid.

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percent and shrinking as such Mom & Pop locations succumb to general retail competition from the major chains.89 However, the numbers in Massachusetts paint an entirely different picture. By the same classification analysis, sales in Massachusetts from chain-type locations account for only 24 percent of the statewide total while sales from owner-operator locations account for nearly 76 percent of the statewide total.90 The benefit to Mom & Pop retailers from such results is obvious. The benefit to the Lottery is found in the retention of the strongest, most motivated type of retailer on the front ranks continuing to present and merchandise the product in the most effective means possible. The benefit to the Commonwealth is found in the productive survival of many small businesses which, had they been operating under conditions commonly found in other lottery states, may not have survived. That this has likely been achieved by creatively and effectively managing and leveraging a state asset is a public-policy success story.

4.

The Lottery Play Experience

Historically, Massachusetts State Lottery games have been designed, introduced, and marketed to offer distinctive play experiences and value propositions for players. This has been a critical element of encouraging cross-play and maintaining a high level of engagement in the product mix and limiting cannibalization from new game introductions. In addition, the structure/design of the products has built a high level of respect and trust in the games and the Lottery brand overtime; this is true of both the consumers as well as the retailers. Each game has a unique value proposition, which encourages cross-play to obtain the different play experiences. Many of the games have a high degree of impulse purchase associated with them; retailers and the Lottery understand this dynamic and have invested in strong POS merchandising of the games as well as placed an emphasis on eye-pleasing scratch ticket designs. Mega Millions and Powerball offer the chance to dream about the impact of a truly life-changing jackpot. These jackpots are understood on a rational level to be unwinnable, but the ticket price is worth the fantasy value of thinking about winning. There is, however, a core set of players that are loyalists with regular, planned purchases; these are the players that traditionally have specific numbers that they play consistently for every drawing. This core of loyal players has eroded overtime, driven initially by the introduction of quick-pick numbers that made play more accessible to a wider group of players (especially spontaneous players) as well as jackpot fatigue in which higher and higher jackpot levels are required to build excitement. As a result, player interest in these games is dependent on the jackpots and play levels are linked to
89 90

See LaFleur, 291 Ibid.

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jackpots rather than a stable and loyal play pattern; exposure to the jackpot and purchase stimulation tends to be at retail (especially given the lack of advertising presence and the medias jackpot fatigue which limits free press). These games are attractive to a broad player base and appeals to all demographic segments; most residents have some level of experience with at least one of these games. The Daily Number has a loyal and more defined player base. Players have established play patterns in terms of style and timing. There is limited spontaneous play of this game and it tends to be fairly intimidating to the uninitiated Numbers player. The player base tends to be more urban, older, male, and appreciate the complexity/play options offered by the game. Prizes tend to change your day or week. The Scratch game offers the players both instant feedback on the outcome of the game as well as a positive and engaging entertainment experience. Traditionally, the experience of playing has been an important part of the ticket value: this experience includes credibility of the game in terms of decent chances of winning a reasonable prize as well as a scratching experience/play mechanic that delivers good value for the ticket price. Players often have spoken about enjoying the play: seeing an exciting range of prizes that are worth playing to win, varying the scratch pattern/participating in the play of the game, the realistic play mechanic that fits the theme and not knowing the outcome until the last scratch. Play tends to be spontaneous and impulsive, with limited planned/destination play. The strong retail presence and merchandising as well as word-of-mouth at retail are significant sales drivers. Players have historically had the hardest time estimating their actual play of these games since play levels are so impulse driven and their schedule of play varies. It is not unusual for the amount of the total non-lottery purchases to impact the decision to buy a ticket, with players using the change to buy games or a discussion at check-out about the winning experiences of specific games to drive a sale.

5.

Sales Agents

Spectrum professionals interviewed Lottery sales agents and retailers in different parts of the state. These interviews coupled with the results of our survey provide valuable insights into the role that retailers play with respect to the demonstrated success of the Lottery. Just as significant, we gained insights into the role that the Lottery plays in the lives and aspirations of these retailers. Many sales agents are first-generations immigrants to the United States. They view retailing in general, and the Lottery in particular, as important rungs on the ladder toward economic success and independence. It is evident that any potential alteration in the relationship between these retailers and the Lottery could represent a threat to their individual aspirations. While we suspect that the present Lottery distribution system was not designed as an economic ladder for retailers and their families, it has nonetheless evolved into precisely that. Removing that ladder would not only prove detrimental to these retailers, but our initial research indicates that such a move is neither necessary nor advisable.
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Lottery sales agents occupy a variety of locations, ranging from spots that are easily accessible by car to small locations shoehorned between various other stores that are easily accessible by foot traffic. Lottery players who frequent such locations range from workers in downtown Boston to neighborhood residents. In some locations, the Lottery drives sales of other products, while in other spots the other products or simply the location drive lottery sales. In some instances, depending on the size of multistate jackpots, both phenomena take place at the same location. With all that in mind, we note that the present distribution system has evolved into an elaborate and highly effective marketing system, in which 7,400 locations throughout the state are positioned to reach Lottery customers with a promotional message, at a time and place where such customers are amenable to receiving such messages. Such a system could clearly benefit online sales as well, as long as online and existing lottery products are designed, marketed and sold as complementary products. The sales agent network should, if at all possible and practical, be strengthened by online sales, rather than have online sales cannibalize and replace retail sales. Many sales agents see little threat to their current lottery sales from any future online capability. These retailers know their regular customers well and see little change in their current purchase behavior, evidently convenience and impulse driven, based upon the availability of Internet ticket sales. Several Lottery sales agents mentioned that they had greater concerns with the prospect of impending online gambling negatively impacting retail lottery sales than they worried about the effect of Internet lottery. However, while little fear of online sales was observed among these sales agents, it was also clear that most can see little upside from the prospect of Internet lottery sales and have yet to conceive of means where this new sales channel could augment incremental revenues. The sales agent enterprises visited in downtown Boston comprised a range of business types, including small convenience stores, liquor stores, tobacconists, and larger multiline retail shops. Many of these very small businesses depend upon Lottery sales for a substantial portion of their annual revenue, and it also quickly became apparent that a large number of them depend upon a few key local employers, key demographics, or nearby residential establishments in their neighborhood for the majority of their customers. Obviously major shifts in consumer purchase behavior regarding online Lottery tickets would severely impact these businesses. Interestingly, several of the sales agents interviewed expressed concerns over the negative effects of credit card purchases, which are assumed to be a necessity of Internet lottery sales. Some merchants refuse to accept debit card payment for Lottery tickets something that is currently legal. They maintain an ambivalent outlook on the ability to use credit cards for lottery purchases, not just due to the added fees that would be charged but out of genuine concern for the financial situations of the purchasers or possible disputes between spouses over purchases made on credit.

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6.

Commercial Casino Expansion

A major, complicating factor for the Lotterys Internet strategy development is the fact that Massachusetts recently legalized casino gambling, allowing three resort casinos and one slots-only casino. The timing of this development complicates the Lottery strategy for two primary reasons. First, in addition to calculating the effect that Internet sales will have upon traditional Lottery sales, the Lottery must also take into account the impact that commercial online gambling will have upon statewide gambling budgets and how that will affect future lottery revenues. Second, the Lottery must be careful not to do anything in the short term which might negatively impact the value of the casino licenses yet to be awarded. Beyond these nearterm complications, commercial online gambling also presents longer term questions regarding how to integrate commercial online gambling into Lottery marketing strategies in order to maximize revenues going forward.

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F.

Survey of Massachusetts State Lottery Retailers

The Task Force commissioned a survey of retail sales agents in May 2012. This was a self-administered, informal paper survey in which all responses were voluntary. It was quickly organized and distributed by the Lotterys sales network. A total of 3,976 completed surveys more than half of the states 7,400 Lottery retailers were received over the three-month period, far exceeding our expectations. This large sample of the retailer population provided a confidence interval, or margin of error, of 1.06 at the 95 percent confidence level, or 1.39 at the 99 percent confidence level. This was not a scientific survey and many of the questions were subjective or qualitative but the breadth and depth of responses yields an accurate picture of the retailer population and their reactions toward the prospect of online Lottery products. The majority of retailers responding to this survey are corporations (69.1 percent) and the minority sole proprietorships (21.2 percent) or partnerships (4.6 percent). Five percent list themselves as Other types of businesses, which include fraternal associations, public and private membership clubs, and a number of charitable organizations. Most of the retailers are convenience stores (55.8 percent), followed by liquor stores (23.4 percent), gas stations (10.9 percent), and groceries (9.4 percent). The above categories are restrictive, as many of the retailer locations combine more than one classification, such as gas stations offering convenience stores and restaurants offering bars or package goods. The enterprises illustrate a wide variety of businesses and associations: cafeterias, delicatessens, pizzerias, cafs, coffee shops, ice cream stands, meat markets, pharmacies, tobacconists, newsstands, bakeries, bookstores, bowling alleys, repair shops, phone stores, hotel lobby shops, ethnic grocery stores, herbal product stores, clothing stores, vegetable stands, video stores, dry cleaners, laundromats, hardware stores, appliance stores, taverns, pubs, bars, lounges, motels, social clubs, gentlemens clubs, check cashing operations, ticket sellers, health clubs and gyms, pool halls, fish markets, wine shops, veterans posts, express delivery stores, post offices, flea markets, car washes, and even golf courses and a yacht club. The number and breadth of small businesses partners retailing Lottery products and their interconnection with local communities across the state is remarkable. The average length of time that a retailer has been in business is 24.6 years. The most frequent response (mode) among retailers, as well as the statistical median (midpoint) in the data distribution both equal 20 years of operation. The newest businesses began within the past few months while the oldest business was founded long before Revolutionary times. In fact, 41 of the responding Lottery retailers, or 1 percent of the sample, can boast more than 100 years of operation. The average length of time that the current owner has operated the business is 13.8 years, while the median is 10 years and the most frequent response for length of ownership is only two years.

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The importance of the Lotterys retailers to the economy of Massachusetts is emphasized by the numbers of people employed by the survey respondents: 19,293 total employees in the sample. This includes 13,555 full-time and 5,676 part-time workers. The average number of workers at a single location is 5.75. The most median number of workers is three and the most frequent response is two. The fewest number of workers at a retailer location is zero, indicating that multiple owners or operators did not count themselves as employees, while the largest number of people working at a single respondent was 400 (at a large convenience store chain). The total number of employees is obviously a conservative figure given that 32.3 percent of survey participants declined to answer this question, which would add at least another 1,283 workers to the already impressive total and twice that many if multiplied by the median or mode. It would be reasonable to estimate that this sample population of Lottery retailers maintains an employee base of between 20,000 and 25,000 persons. The importance of Lottery ticket sales to these thousands of small businesses is revealed when we ask retailers to estimate what proportion of their total sales is composed of Lottery sales. While responses indicate that this estimation is somewhat subjective, often stated as a round number or a range with 5 to 10 percentage points difference, it is also a question for which business managers and owners would have a credible answer. There is also some indication that this is a sensitive question for some retailers to answer or that some respondents did not feel qualified to comment as more than half of all completed surveys failed to answer this particular question. The average (mean) proportion of Lottery sales to total retail sales is 29.8 percent. The median response is 25 percent, and the most frequent response is 20 percent. The smallest proportions of Lottery sales to total business sales reported in the survey were fractions of one percent while 16 percent of all responses estimated Lottery sales at more than 50 percent of total business sales. A very small number of retailers (nine) reported that Lottery sales make up 100 percent of their total revenue, These findings are a powerful illustration of what the Lottery means to the financial health of its retail partners in Massachusetts with more than one-quarter of gross sales being generated by Lottery products. Responding retailers believe that the majority of customers purchasing Lottery tickets at these locations are Massachusetts residents. On average, 85 percent of customers are in-state residents, 9 percent are estimated to be out-of-state residents who regularly purchase Lottery tickets, and 5 percent are thought to be tourists who are temporary visitors and not regular purchasers.

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Figure 9: Massachusetts State Lottery sales by residency status

90% 80% 70% 60% 50% 40% 30% 20% 8.7% 84.8%

10%
0%

5.4%

In-state Residents

Out-of-state residents

Tourists

Source: SGG Survey of Massachusett State Lottery Retailers

According to the retailers surveyed, business volume appears to be stronger, on average, in the summer and winter than it is in the spring and fall. Figure 10: Massachusetts State Lottery retail business volume by season
27% 26.6%

26.2%
26% 25% 24% 23% 22% 21% 20% Spring Summer Fall Winter 22.7% 22.9%

Source: SGG Survey of Massachusett State Lottery Retailers

On average, the retailers busiest with Lottery sales in the afternoon (36 percent) and evening (33 percent). Morning hours generate 23 percent of volume and early morning hours only 6 percent of business volume.

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Figure 11: Massachusetts State Lottery retail business volume by time of day
40% 35% 30% 25% 22.8% 33.4% 36.3%

20%
15% 10% 5% 0% Morning Afternoon Evening Midnight-5AM
Source: SGG Survey of Massachusett State Lottery Retailers

6.2%

The volume of sales also varies by the type of business, with restaurants and motels are busier with Lottery sales in the evenings. As shown below, the most numerous retail locations experience their greatest volume of Lottery sales in the afternoon and evening. This is most apparent for groceries and liquor stores, while convenience stores and gas stations sell more tickets in the morning. Figure 12: Massachusetts State Lottery retail business volume by time of day, type of business
45% 40% 35% 30% 25% 20% 20% 15% 10% 5% 0% Convenience Store Morning Grocery Afternoon Liquor Store Evening Midnight-5AM Gas Station 7% 4% 1% 9% 27% 31% 33% 27% 31% 42% 38% 38% 32% 30%

26%

Source: SGG Survey of Massachusett State Lottery Retailers

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More importantly, more than two-thirds of responding retailers say that Lottery customers are more likely to purchase other products when they come into the store. These incremental sales are a vital source of ancillary revenue for the Lotterys retail partners. Figure 13: Massachusetts State Lottery customer likelihood to purchase other merchandise
80%
60% 40% 32% Are such customers more or less likely than other customers to purchase other products? 68%

20%
0% More Likely Less Likely
Source: SGG Survey of Massachusett State Lottery Retailers

Queried for greater granularity on this issue, retailers were asked to estimate the proportions of customers who purchase only Lottery tickets during a visit versus the proportion that purchases both Lottery and non-Lottery products, and the proportion that purchase no Lottery products. Responding to this subjective question, retailers across the full survey population report that almost four-fifths of their customers purchase products in addition to lottery tickets during a typical visit. Only 23 percent will purchase solely Lottery products, while 39 percent purchase only non-Lottery products and another 39 percent will purchase both. Looking at Lottery purchase by retailers type of business shows that convenience stores and gas stations generate the greatest proportion, on average, of exclusively Lottery purchases, while grocery and other establishments (restaurants, taverns, social clubs, etc.) are more likely to experience a higher proportion of exclusively non-Lottery purchases. Figure 14: Massachusetts State Lottery customer purchase behavior by type of business
60%

52% 50%
40% Mean 31% 30% 20% 10% 0% Convenience Store Grocery Liquor Store Gas Station 17% 15%
Purchases of only Lottery tickets Purchases of Lottery and non-Lottery products Purchases of only non-Lottery products

47% 37% 31% 24% 39% 35% 42%

50% 45%

25% 25%

Other

Source: SGG Survey of Massachusett State Lottery Retailers

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The types of products purchased along with Lottery tickets are primarily tobacco, soft drinks, and snacks, followed by alcoholic beverages and groceries. Other products include a variety of merchandise specific to the type of business, such as gasoline at gas stations, meals and food items at a restaurant, etc. Figure 15: Massachusetts State Lottery customer purchase of ancillary merchandise
30% 25% 20% 15% 10.2% 10% 5.2% 5% 0% Groceries Snacks Soft drinks Alcoholic beverages Magazines Tobacco Products Other 3.4%

23.8%
20.5% 21.1% 15.8%

Source: SGG Survey of Massachusett State Lottery Retailers

Only 7 percent of retailers responding to the survey report that they have hired employees specifically for the purpose of assisting with Lottery sales. Those businesses most likely to hire dedicated employees to handle Lottery sales are restaurants and bars, followed very distantly by convenience stores and gas stations. Figure 16: Lottery retailers who hire dedicated employees by type of business
100% 85% 80% 60% 40% 20% 6% 0% Convenience Store Grocery Liquor Store Gas Station Restaurant Bar/Lounge 4% 4% 5% 73% 87% 85% 67% 50% No Yes

33%
25%

Source: SGG Survey of Massachusett State Lottery Retailers

Among the small minority who have hired additional employees to address Lottery sales, the median number of employees added is two, the average number of hours worked is 30, and the median wage figure is $9.00 per hour.
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Other questions asked the retail agents to estimate how often their customers play and what they spend on Lottery purchases. While these are subjective questions and will not yield statistically reliable results, they do offer an insight into how retailers perceive their customers devotion to and investment in the Lottery. When asked to estimate the average purchase value for lottery and non-lottery purchases, retailers gave an average figure of $15 for Lottery tickets only, $26 for purchases of both Lottery and non-Lottery products, and $20 for non-Lottery only purchases. Using these estimated figures as a rough guide, we can postulate that each exclusively-Lottery customer is worth $15 per visit and customers who also purchase Lottery products are worth a $6 premium to retailers. Figure 17: Lottery customer average spend by purchase behavior
$30 $25.61 $25 $20.03 $20 $15 $10 $5 $0 Those purchasing only Lottery Those purchasing Lottery and Those purchasing only nontickets non-Lottery products Lottery products
Source: SGG Survey of Massachusett State Lottery Retailers

$14.47

Retailers estimate that, on average, more than 300 of their customers play the Lottery at least once a week. This average may be somewhat high due to a few high outlier estimates, but the mode (most frequent) response for weekly Lottery customers was 100. Retailers report that weekly customers spend an average of $35.55 on Lottery purchases each week, which translates roughly to $5 per day. Again this result may be influenced by some very large outliers, but the mode response is $20. The frequency of regular customer play is impressive. More than three-quarters of regular customers (78.6 percent) are estimated to play three times a week or more, while another 19 percent play one to two times per week. Retailers say only 2 percent of their regular lottery customers play less frequently than weekly. While Lottery retailers are widespread and closely integrated into the fabric of local economies across the state, they do not as a rule enjoy many high-technology benefits. Only 22.5 percent of responding retailers say that they have a website, and the vast majority of these websites are simple placeholders that advertise location, product offerings, and hours of operation. Retailers

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who are part of a larger corporation are those most likely to have a website while sole proprietors are much less likely to have one. Similarly, only 11.5 percent of those responding currently have any kind of loyalty program. The final section of the survey contained open-ended questions related to retailers role in the Lottery partnership, their perceptions of the Lottery, and any suggestions they might have in regard to Internet lottery sales. Responses to these qualitative questions reveal that most retailers feel a strong responsibility to promote the Lottery, both for their own interests and for the greater good of the Commonwealth, while protecting the Lottery by screening to prevent underage play. Retailers generally perceive the Lottery in a positive light as an industry leader that provides a superior opportunity to win for players and has been a reliable business partner. Retailers take seriously their social responsibility to ensure that underage persons not be allowed to purchase Lottery products. The majority of responding retailers report that their staff asks for identification on a weekly basis. Actually turning away a minor trying to purchase a Lottery product is only a rare occurrence, but responses clearly show that the vast majority of retailers are strictly enforcing the Lotterys age-verification policies. Perceptions of the Lottery are generally strongly positive, especially in comparison to other state lotteries. Many retailers describe in favorable terms their working relationship with the Lottery sales representatives. Most will favorably compare the Massachusetts State Lottery to other state lotteries in terms of its games, payouts, and customer service in the retailer relationship. Excellent customer service. Knowledgeable staff.

One open-ended question asked what makes the Massachusetts State Lottery unique compared to other lotteries. Answers to this question most frequently mentioned the higher payouts offered in Massachusetts, as well as the perception that the Massachusetts State Lottery is uniquely successful and a leader among other state lotteries. The Massachusetts State Lottery gives away the highest percentage of winners than any other state! Many people say that Massachusetts lottery has better winning odds than other states. Other states follow Massachusetts.

On the other hand, some retailers believe they are doing much of the work for the Lottery with little return and would like their commissions increased. Others have specific service complaints, usually related to the difficulty in acquiring the equipment they desire to make selling Lottery products more efficient and less of a drain on their limited resources. That being said, negative comments are a small minority of the overall qualitative feedback from retailers. Increase our percentage on commission. It takes my employees away from registers to help lottery.

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They have no commitment to agents who put their business on the line by having an inadequate system that only benefits the Lottery. Agents take all risk with scratch tickets system. Should be a more secure with machines that disburse tickets and keep track of sales.

One recurring complaint, however, is that the Lottery does not do enough advertising compared to other states. Retailers responding to this question indicate that they want to see more advertising of Lottery products to drive more frequent sales, but many also reveal the desire to advertise their own businesses through the Lottery. Not sure. Dont know enough about other states other than the Ct. State Lottery advertises on TV for everything they do. The only time Mass does is during sports games or the Wheel of Fortune ticket. They are all the same. They do not advertise the new games very well.

Retailers clearly see themselves as key business partners to the Lottery, filling the role of front-line customer representatives, promoters, and instructors in the business of playing the games. Many retailers also see their role as serving their regular customers to the best of their ability, helping them to make informed purchase decisions, and offering them the chance to experience a lifechanging win. We are at the center of information for new games (rules), new tickets, mail in promotions, etc. We instruct people how to play, claim winners, etc. I characterize the role we play as very important. We explain each new ticket and each new game that comes out. We advertise everything. We have been told on more than one occasion how people like coming here because they know whats coming up. Always pushing new lottery games and scratch tickets. Let customers know popular games and scratch tickets that are winning more often. They sell themselves for customers who are informed for those that are new or a new game comes out, we are very important. My role is large because I am basically the sales men for lottery I feel that it is my responsibility to increase sales for the lottery. To promote the MA Lottery products by offering customers a chance to change their lives.

Lottery retailers offer many ideas for improving the Lottery as well as numerous requests for specific equipment and more advertising or promotional items. One of the most common requests from retailers was for more winners or improved odds that would benefit customers and increase future sales. A subset of that frequent comment is for the Lottery to provide more small wins as well

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as big jackpots on draw games and keno. In addition, some retailers question whether payout rates have declined over time. Not sure. Dont know enough about other states other than the Ct. State Lottery advertises on TV for everything they do. The only time Mass does is during sports games or the Wheel of Fortune ticket. At one time payouts were reasonable. Now it is questionable.

Requests for equipment include new Lottery terminals, self-service scanners, touch screen devices, and keno monitors. Promotional requests include signage and advertising. Mass lottery needs to have touch screen which mostly every state has. We have been with the Mass. Lottery since inception. However, we cannot after many, many requests obtain from the Lottery a checking machine for tickets, or a more modern instant ticket machine. We have had numerous service calls which would more than likely have cost less with a new or newer instant ticket machine. By installing keno screen & Internet will be a very big deal.

One of the most important qualitative questions asked retailers for suggestions on how the Lottery can help their businesses through Internet offerings. Here, responses often revealed a profound need for promoting retail businesses through the Internet. Many retailers request assistance from the Lottery in advertising and promoting their own businesses through the Lottery website. Others want to see the Lottery use the Internet to make their local retail operations more efficient through automation and 24/7 access to retailer account information. Additionally, multiple retailers suggest improving the ease of navigation and usability of the current Lottery website. Offer online lottery where agents can advertise their store by punching in store # then play to win. Im all for making things efficient. It would be great to have a terminal that would take the tickets and the money without having to pay a dedicated employee. Give our location & hours of operation. A better way to navigate through the website. Some customers complain that it is tough to use. Make the site user/elderly friendly.

The last major question on the survey asked retail agents if there is anything else that they wish to add regarding their business and the sale of Lottery products over the Internet. Here the majority of verbatim responses oppose the concept of Internet Lottery sales for the obvious reason that by utilizing the online channel the Lottery changes the traditional partnership relationship by now selling direct to consumers over the Internet and becoming a competitor. Retail agents freely
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express their fundamental concerns that the prospect of Lottery B2C sales direct to consumers will adversely impact their Lottery revenue. None. I do not want to see Internet Lottery. This (Internet Lottery) will greatly hurt my business if lottery products can be sold over the Internet. This will hurt all sales in my store. If lottery goes to the Internet for betting it will hurt all of us little stores. It is hard enough to compete with bigger stores as it is. If the Lottery sells over the Internet - we may as well go out of business! No one will need to go to the store anymore!

A minority of retailers apparently sees the Lotterys migration to the Internet as inevitable and looks for opportunities to increase their business volume when this may happen. Such opportunities include continuing to receive commissions from their customers when they purchase online Lottery products, having the Lottery assist with Internet advertising by posting retailer locations, product offerings, hours or operation, and contact information on the Lottery website. Most importantly, a number of retailers see benefit in advertising on the Lottery site the volume and magnitude of prizes won at their locations. Others want to have Internet access to their Lottery accounts in as a means of better referencing inventory and store sales data. Info on our lottery inventory. Access & accounts. By having the store name on their sites and telling people how much big prizes people won here at our store. Picture of the people who won more than $1,000 with our store name.

These comments heard in the retailer survey, both positive and negative, are entirely consistent with the feedback observed in the Treasurers Public Forum meetings. A total of 3,855 of these retail agent surveys were scanned into electronic (PDF) format and are available for review of the qualitative comments in detail. The key findings emerging from this survey are the importance of these small businesses to the Massachusetts economy, the mutually supportive nature of the longstanding relationship between the Lottery and its retailers, they need for continued cooperation and sales support from the Lottery, and the concerns that retailers have regarding the Lotterys investigation of the potential of online products. Retailers want to continue their mutually beneficial relationship with the Lottery and see it continue to prosper in the future. If the Lottery decides to move to online sales, retailers want that migration to happen in a way that will continue to mutually benefit both the Lottery and the thousands of small businesses that comprise its sales network.

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G.

SocialSphere Research

The Treasurers Online Products Task Force wanted to fully explore the attitudes and perceptions of Massachusetts residents regarding the question of Internet lottery sales as a crucial element of the process. Treasurer Steven Grossman defined the issue as follows: I want to know who our lottery customers are and who they are not demographically And I want to know what they think about all of this. In response to this need to know more about the current attitudes of Commonwealth residents, the Massachusetts State Lottery commissioned primary research through an RFP process. SocialSphere, a Massachusetts based research and political strategy firm, was eventually contracted to conduct the primary research which took place in two phases. Phase one involved initial qualitative focus group research to identify the issues and develop segmentation profiles for the next phase. Phase two involved quantitative survey research, conducted over the Internet, to generate statistically reliable findings that could be projected on to the population state-wide. The results of this research are detailed below.

1. Qualitative Focus Group Research

Four focus groups with Massachusetts residents on the evenings of August 21 and 22, 2012. As a preliminary step, SocialSphere conducted a segmentation analysis on existing data compiled over 10 years of ongoing satisfaction tracking research conducted over the Internet. Results of segmentation analysis on the amalgamated Lottery player database produced behavioral profiles for four general player groups: Heavy, Younger Players - Players under the age of 40 who spent at least $17 on the Lottery per week; Light, Younger Players - Players under the age of 35 who spent less than $10 on the Lottery per week; Heavy, Older Players - Players over the age of 50 who spent at least $17 on the Lottery per week Older, Online Game Players - Light and Lapsed Players (have not played the Lottery in the past month) who regularly played some kind of online games.

Participants were selected based upon the four main player profiles noted above and recruited by a focus group facility in Boston. Two sessions were held each evening, one at 5:30 pm and another at 7:30, and all sessions were personally moderated by John Della Volpe, cofounder of SocialSphere. The sessions opened with a brief introduction and explanation of the ground rules, and then explored participants play behavior and preferences as well as their Internet utilization. Perceptions of the Massachusetts Lottery were investigated as well as perceptions of the concept of online Lottery products and likelihood to participate. Finally, four

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potential online product concepts were tested for reactions. Focus group participants received a cash stipend for their attendance. The broad objectives of the focus groups were listed as follows: Understand how current players and key audiences think about the possibility of the Lottery selling products online; Understand how current audiences that do not regularly play the lottery think about possibility of selling Lottery products online; and Assessing various potential models for Lottery play online;

Four generic concepts were tested in the groups. In the absence of specific, developed concepts for online gaming, SocialSphere used various existing online lottery products available in other jurisdictions and developed by gaming vendors to test player reactions to various potential play options. Concept one addressed the process of registration for online play in order to generate reactions to information requirements and verification protocols. The stimulus was a slide showing two registration pages for Mega Millions Internet purchase from the Illinois Lottery. Concept two addressed the process for a mobile PowerBall application from the Iowa Lottery. The stimuli were three pictures illustrating the process for ordering and scanning a mobile Powerball QR code ticket. Concept three consisted to two images illustrating two different examples of online single-player interactive games and was designed to stimulate discussion of game play. Concept four comprised an image of an Internet bingo screen supplied by an online lottery supplier and was designed to generate discussion around the subject of online multiplayer interactive games. SocialSphere listed the major findings from the qualitative research in the following paragraphs which are taken verbatim with emphasis included from their report: Communication is Key o When players - and some non-players found out about the specifics of how lottery products could be sold online, they tended to have a very positive reaction however, the concept of online lottery products is one that many players had difficultly conceptualizing without further information. As such, any potential positive reactions to the concept should not be taken as given - they must be effectively communicated. Funding, Security, and Preventing Problem Gaming is a Concern o Negative conceptions exist about the dangers of people being able to wager at home, and strong sentiment existed that there is some need for precautions to

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be in place. While players offered up some potential solutions to alleviate some of these concerns, there was some belief that purchasing Lottery products from home could be too easy, and that fraud, children playing, or overdrawn credit accounts may be inevitable if not properly accounted for. Mobile May be the Lowest Hanging Fruit o When talking with players about game play scenarios, the idea of being able to play in the doctors office or while on the go seemed to be the most intuitive to many players, and this largely contextualized potential online lottery products into a competitive set (i.e., Bejeweled, Words with Friends) that are used as distractions. Gift Card Funding Concept has Potential as a means of funding, allowing players to buy cards in stores that can fund accounts attracted both players and non-players. o Players liked the fact that such a method of funding would allow them to set explicit limits on how much they play (because funding their account would not be linked to their credit card), and that they would not have to provide significant personal information to play online or via a mobile device. Additionally, it also has a potential to deal with the issues involving current MA Lottery agents. Idaho Lotterys Mobile Powerball was the Best of the Concepts Tested o Of the four potential concepts tested, Idahos mobile Powerball - in many ways the simplest concept tested - was the one that resonated best with players. Players seemed to understand both how they would use it and saw a need for it in their current Lottery playing patterns. While much of the favorable reaction may just be current players substituting their current in store play with online play, the concept was favorably received, and potential exists for it to draw incremental revenue. Players were Favorably Disposed to the Concepts Once They Saw the Potential Games o Players, particularly heavy players, had favorable reactions to all the concepts that were presented to them once the games concepts were shown and explained. For non-players, though, there was very little indication that there would be incremental revenue as a result of showing the various game concepts. In particular, the social interaction aspect of games like Bingo appealed to players. Privacy Details During Registration Are a Concern for Some Players

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o While players generally trust the Lottery, they are weary of giving up what they feel is highly personal and sensitive information. In particular, players were very hesitant to disclose their Social Security number during the registration process (as the Illinois model would require them to do). Some Players Would Potentially Play Online Lottery Games In Addition to Their Current Play o Though many players simply viewed the sale of online Lottery products as a replacement or substitution for their current Lottery play, some saw the sale of online Lottery products as a distinct, new game that they - or other players that they know - would play in addition to and in different situations from their current Lottery play. Attracting Non-Players and Light Players Will be Difficult o In the non-player group, even after being presented with the full game concept, only 2 of 8 participants said that they would consider playing MA Lottery games online. While there may be potential incremental revenue from current non-Lottery players, projections need to be conservative in their estimates of the likely play levels that will come from current nonplayers. Game of Skill vs. Game of Chance Distinction and Barrier Will be an Important One to Understand o For many current online gamers (i.e., Bejeweled and Farmville), playing games is attractive because they are games of skill and present players with ways and opportunities to either play against other players or actively challenge themselves. Since lottery games are, by law, games of chance, it is not clear that they can ever attract current online gamers who view skill as a critical part of their gaming experience.

2. Quantitative Survey Research

Based upon the segmentation profiles developed in the initial qualitative phase, SocialSphere conducted a quantitative survey of 1,000 Massachusetts residents recruited through the Internet. Results of this survey have been reported to the Task Force but to date no written report has been made available for the purposes of this document.

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H.

Stakeholder Viewpoints
1. The Treasurers Public Forums: Listening to Stakeholders

The Treasurers Online Products Task Force held two public forum meetings designed to solicit feedback and guidance from the general public and any interested parties on the pertinent issues regarding Internet lottery. The first public form took place on May 30, 2012, in Boston. The second meeting was held in the Horace Mann Center, at Westfield State University in Westfield on June 28, 2012. In addition to the Task Force members, approximately 40 people attended the May 30 session in Boston and 20 attended the June 28 session in Westfield. These public feedback sessions were majority-populated with retail store owners and employees and retail association representatives. Others attending these sessions included technology company representatives and problem-gambling professionals. There was strong overlap between the two sessions in terms of both attendance and the opinions expressed. Treasurer Grossman made it clear to all in attendance that the Lottery was in listen mode during these sessions. At the start of the initial meeting, Treasurer Grossman framed the discussion in his opening remarks, emphasizing that Massachusetts has the most successful lottery in the United States by almost every metric, with, by far, the highest per-capita lottery sales. If the lottery were a private organization, it would be the eighth largest in Massachusetts. Treasurer Grossman further stressed that the Lotterys success is owed to the 7,400 lottery agents in Massachusetts and said that the most important priority is to protect the Lottery. The Treasurer also said that a new phenomenon in Massachusetts must be recognized: the gaming legislation that was passed in November 2011, in conjunction with the important decision that was issued by the Department of Justice indicating that lotteries can sell lottery products online to instate adults. This has opened a new avenue of competition. While it is not a given that Massachusetts will enter the online marketplace, Treasurer Grossman indicated that we have a public obligation to explore this avenue. Treasurer Grossman concluded by sharing that this will not be an easy decision as there are issues of concern, including problem gaming and security. The majority of attendees came to speak in opposition to the Lottery engaging in online sales. These attendees either represented retail store associations such as the New England Convenience Stores Association and the Massachusetts Package Stores Association, or else they owned or are employed by various 7-Eleven, Cumberland Farms and Tedeschi franchises.91 Among these individuals strong opposition to Internet Lottery sales was heard, especially among the retail agents and their trade group representatives.

91

Ibid

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Problem-gambling professionals as well as a few retail employees expressed grave concern that increased 24/7 access to Lottery products could increase problem gambling incidence but also some optimism that additional tools would be available for intervention and prevention. Tech representatives spoke of significant opportunities for economic development and growth in good jobs as well as the expectation that online Lottery sales would not cannibalize existing retail sales but rather bring in a new and previously unengaged younger demographic. The speakers were largely comprised of Lottery retailers and their representatives, who generally sought to make it clear that the prospect of online sales appeared to be a potential threat, and that it could undermine the present partnership arrangement by turning the Lottery into a competitor of its own agents. Profound fears and emotional reactions were expressed among multiple retailers that the Lottery might change its traditional relationship as a sales partner and begin to compete directly with small retailers for lottery customers through the Internet. There was an expectation that online Lottery product sales would inevitably lead to decreased traffic in convenience stores and lost sales revenue, but there was also an observable feeling of inevitability that this was going to happen eventually given the directions in which both society and technology are moving. The comments heard from participants whose voices were raised in opposition to Internet Lottery sales during the meetings can be summarized into the following issues: The existing and very successful partnership between the Lottery and its agents would be degraded by the introduction of online Lottery products, and the Lottery would become a powerful competitor to retail agents by selling directly to customers via the Internet. The introduction of online products would erode traditional Lottery ticket sales for convenience store owners and liquor store owners. This could result in mass layoffs and a higher unemployment rate. The introduction of online products could create a jobless casino industry, when the gambling legislation was passed to create jobs. Lottery ticket sales are an important element of Massachusetts convenience store sales in, contributing anywhere from 25 percent to 53 percent of their revenue and making Lottery ticket sales the primary or secondary source of revenue for most convenience stores. Lottery ticket purchasers also purchase additional products while visiting convenience stores. Many retail agents are concerned that the technology utilized with Internet Lottery sales would be unable to perform accurate age verification or address problem gambling the way these issues are handled in the retail locations through person-toperson interaction. Given that Lottery customers gambling budgets are limited, online products would cannibalize traditional retail sales and commissions, so that the 5 percent commission
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formerly earned at traditional retail locations would in future go to online banks or directly to the Lottery instead of the local business owners. Concerns that other states offering online products will compete with Massachusetts State Lottery revenue are not credible since only two states have introduced online lottery products to date (Illinois and Minnesota) and online play will be is restricted to in-state residents.

Frank Ansellotti, executive director of the 700-member Massachusetts Package Store Association, summarized and crystallized the concerns for those lottery agents who primarily sell alcoholic beverages: We understand how the Lottery works. It may not be the most profitable item that a retailer works with, but it creates spin-off business. We certainly want to see that relationship continue and grow. I never thought I would see the day where, in my mind, I am thinking that the Lottery as a division of the state becomes a competitor of its agents. That would be my greatest concern. Ansellotti also emphasized that retail clerks are trained to help ensure that all sales are legal, and that all purchasers are of the minimum Lottery age, just as they are with ensuring that purchasers of alcoholic beverages are adults as well. Steve Ryan of the New England Convenience Stores Association made it clear that his organization is opposed to the concept of online gaming, which he characterized as a jobless casino. He noted that the 2,000 convenience stores in Massachusetts generate $40,000 in commissions alone for the average store, plus ancillary sales. Dennis Lane of the 7-11 Franchise Owners Association noted that agents are trained to say good luck when we sell a ticket, and congratulations when we cash a ticket. Lane emphasized that a Lottery ticket is a gallon of milk. A lottery ticket is a loaf of bread. A lottery ticket is a candy bar. For his members, it is the No. 1 or No. 2 source of revenue. He said: I would feel that after giving them 38 great years, that I was being kicked in the teeth. I would rather see the resources be spent enhancing the games that we sell on behalf of the Lottery in our stores. Lane also expressed a view that reflected the sentiments of many in attendance: A computer does not have a relationship with a customer. We have a relationship with people who play the lottery. In his experience, a majority of those adults who buy milk will buy a Lottery ticket, while 40 to 50 percent of folks who buy Lottery buy other things. A number of those who spoke at the sessions, as well as those who engaged in one-onone conversations with Lottery or Spectrum representatives, expressed the view that the social atmosphere often present when Lottery tickets are sold in person will disappear in an online environment. For example, Steve Boyd, owner of a Tedeschis franchise in Plymouth who has been selling Lottery tickets for 20 years, said the Lottery experience at his store is often a genuine social interaction. We have fun with it. We enjoy it. To see those people at home, doing it by themselves, is kind of sad.

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A number of similar sentiments were expressed throughout the hearings, with a strong emphasis on the theme that online gambling would hurt the existing, functioning relationship between the Lottery and its retailers. Some of the sentiments expressed were: Please dont try to fix something that is not broken. The Massachusetts State Lottery, for the first time, would become a competitor. How many Massachusetts jobs will be lost? There is no additional discretionary income out there. An online system cannot guarantee age verification, as the kids are more computer savvy than we are. Were in love right now. Dont fall out of love. We have a personal relationship (with our customers). That goes a long way. When we remodel our stores we pay close attention to where we place your machines. We sell gasoline, (and) 50 percent of those people who buy gasoline do not even come inside the store. (The Lottery gets them inside the store.) If we cut down the transaction foot traffic within the locations, that is what everything is derived from. Keep the jobs in the communities. There is a camaraderie we stand to lose that. We understand that growth has to occur but we want to grow ours as well, and that is through foot traffic that is encouraged by having your products available in our locations.

The sentiments expressed at the Boston and Westfield forums captured a number of similar views, with an overarching sentiment of concern regarding an unknown, untested business plan that could undermine an existing, working plan. Still, we should note that it would be neither accurate nor fair to characterize retailers or their supporters as unwilling to explore or consider new concepts designed to capture new, younger demographics and/or generate more instore sales. Some, indeed, suggested using social media such as Facebook and Twitter to create buzz surrounding the Lottery at opportune moments, such as during periods of high, available jackpots. Others noted that other brands in disparate fields have not shied away from confronting issues of changing demographics to reach a new audience. For example, the case study of Harley-Davidson was brought up, as an example of a brand that is unwilling to rest on its previous reputation and demographics. Harley, as has been widely reported, is a brand that is often associated with younger, free-spirited, open-road appeals that are largely male-oriented. Notably, Harley reported a median age of 47 in 2008 (the most recently available year), and its average has been rising by six months per year, for the past 20
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years.92 That formula in which the average age keeps rising is a prescription for future irrelevance, as it shows that younger, newer customers are not replacing older ones. It is a phenomenon we have seen in industries such as newspapers, and indeed is an issue that lotteries must confront as well. Not all voices heard in the public forums were opposed to the concept of the Lottery leveraging the Internet as a sales channel and developing an inventory of new and innovative online products. In the first session in Boston, two of the speakers represented high-tech firms with an interest in developing online products, and these attendees spoke of the potential for economic development, the creation of new high paying jobs, and the necessity for the Lottery to engage new demographic segments with new products delivered electronically. Tim Lowe, Executive Director of the Massachusetts Digital Games Institute, spoke to the possibilities presented by mobile gambling because there are currently 4 billion mobile phone users and 1 billion smartphone users. Lowe indicated that this represents a strategic opportunity for Massachusetts and that online/mobile gambling can strengthen the existing partnership between the Lottery and the Lottery agents. He suggested selling prepaid online lottery cards or accounts at retail locations. He also indicated that reliable technology has already been developed for age verification, geolocation, and various security issues and is currently in use in other regulated online gambling jurisdictions internationally, including for online lottery products. Another proponent of online Lottery products who spoke at the initial meeting was Timothy Parilla, Internal Counsel for Cambridge Interactive Development Corporation, an Internet software company based in Massachusetts that currently operates Everest Poker and Everest Casino on European-facing sites. Parilla was able to speak from his own experience about the positive impact of online gambling on the job market, and suggested that the Task Force must consider the job creation that would occur in the technology sector if online products were introduced. New employees would be needed to develop the games, test the integrity of the games, support the platforms, etc. He also countered some of the testimony from Lottery retailers by saying that there is no evidence Internet sales would take business from traditional Lottery agents or land-based casinos, because the Internet player is a new customer who would play at home versus going to the casino or purchasing scratch tickets from lottery agents, while traditional Lottery and casino customers would continue to visit brick and mortar locations. Paul Sternberg, Executive Director of the Massachusetts State Lottery, closed the first public forum by reiterating that enabling legislation will be necessary for any online products to be sold and that the report being created by the Task Force will include a recommendation as to whether or not an online effort is desirable, but that the Lottery Commission cannot act without legislative approval. With that in mind, we believe that the insights gleaned from participants at
92

http://business.library.wisc.edu/resources/kavajecz/10_Fall/HarleyDavidson_Presentation.pdf (accessed July 26, 2012)

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these public forums with a particular emphasis on Lottery retailers point out the basic parameters that the Lottery should work within, and the path it should follow: Protect the interests of retailers by treating them as partners and assets, but do not assume that the status quo can be maintained.

2.

Lottery Vendor: Vested Interest Viewpoints

The Treasurers Online Product Task Forces Working Group conducted meetings with a large number of potential platform and technology suppliers regarding the benefits and disadvantages of online lottery products. Our initial round of interviews with major lottery suppliers reveals common assumptions: Online lottery sales will prove to be a significant generator of incremental revenue Cannibalization of existing games would be almost non-existent Younger demographics will be attracted to the online product Retailers can still play a meaningful role in lottery games

The vendors interviewed for this analysis have included revenue projections for Massachusetts State Lottery online play. These projections lack consistency when compared to one another, with wide variation between potential revenue estimates. This is due in part to differing assumptions and timeframes but, viewed in the aggregate, they represent an indicator for future sales. All of the vendor estimates assume maximizing revenues by offering a complete suite of new lottery and casino games online, including bingo and poker. They also assume that the Lottery would move quickly in introducing a host of new online products. Following are highlights of the vendor revenue projections: GTECH estimated incremental revenue between $245 million and $551 million in a base case, assuming that Internet sales grew to 10 percent of total lottery sales over five years. Scientific Games estimated a total of $924 million in incremental revenue, assuming Internet sales grow to 10 percent for draw games and 15 percent for instant games after three years. Intralot estimated $1.72 billion in incremental revenue in a base case after 10 years with the majority ($1.2 billion) coming from instant games offered over the Internet. Paddy Power estimated between $220 and $260 million in incremental revenue after three years. Betware estimated between $370 and $545 million in incremental revenue with no timeline specified.

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Of course, the vendor revenue projections are likely to be overly optimistic in illustrating the potential for Internet sales and do not take into account the Lotterys engagement strategy or timeline for introducing new online products. We provide what we believe are more accurate projections later in this report. During the interviews, the vendors cited the experience in Europe in supporting some of their assumptions, but Spectrum has some concerns as to the relevance of this data, in part because both online gambling and lottery distribution systems and products are not uniform between the United States and Europe. Differences, sometimes subtle, can be discerned between how vendors view the future implementation, evolution and policies that could be established in Massachusetts. GTECH, for example, is comfortable with the affiliate system as it has evolved in Europe. Affiliates are effectively online lottery agents, driving players to the lotterys site in return for a commission. Scientific Games is more skeptical of the benefits of such a system, and believes that in a relatively small, intrastate environment such as Massachusetts, in which the Lottery would hold a presumed monopoly, the advantages of an affiliate system finding players in an otherwise crowded marketplace would largely disappear. Moreover, the disadvantages creating a new set of online agents that would compete with the existing network of land-based retailers would grow. Further, developing a new commission system for online sales would likely erode margins, as online transactions would incur costs from banks and other processors that need to be taken into account. We concur with that view. The vendors also pointed to significant demographic differences between land-based and online players, a differential that would support their notion that cannibalization would be minimal to non-existent. That differential, while profound, supports the notion of minimized cannibalization, but also reveals potential future problems, starting in as little as five years. If older, more traditional lottery players do not gravitate toward online in great numbers (as expected) and continue to support the traditional lottery, and if younger, online players do not gravitate toward the traditional lottery as they age, then the traditional lottery and perhaps its attendant system of retailers would, by definition, begin to decline and wither. The vendors have provided interesting and potentially viable suggestions as to how to involve retailers in the online process, including banner ads offering, say, coupons for free tickets available only at retailers. Each such suggestion, however, needs to be evaluated in light of costs to the Lottery, and in light of the level of potential benefit to the retailer. Scientific Games, in particular, pointed out that online games should mirror traditional games to the greatest extent as a way to spur more online sales, and that view makes sense from the standpoint of promoting proven games with proven themes to an audience that may have some existing level of familiarity. However, that suggestion also runs counter to the suggestion that online offerings should differ as much as possible from traditional games as a means of protecting retailers.

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Such suggestions need to be fully evaluated, including on the basis of whether vendors such as Scientific Games which have a significant stake in the status quo regarding instant games are putting forth suggestions that are independent of their own self-interest.

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I.

Online Engagement Strategy

1. Implementation Strategy

If it endeavors to implement Internet play, Spectrum believes the Massachusetts State Lottery should pursue this channel in phases. We recommend a soft initial entry starting with new online products and social games. Multistate lotto games (Powerball and Mega Millions) and keno are the products that may be most susceptible to cannibalization of retail sales by online sales. Carefully consider putting these products online and test-market to determine the degree of substitution that will occur upon introduction of Internet sales. Illinois and Minnesota have already initiated Internet sales of multistate lottery products. Benchmark these jurisdictions to gauge the magnitude of potential substitution behavior as well as any lessons to be learned for successful implementation. The Lottery must be careful to protect the current base of successful and innovative products that have been developed and proven successful over time. Current instant and draw games should not be immediately transferred to online channel. Instead, seek to craft new instant and draw games which may be analogous but will not compete directly with offline games but will present Internet purchasers who are current customers with relatively familiar Lottery games. The Lottery should develop completely new types of games that will be games of chance but offer more time on device and engage new or infrequent Lottery customers and attract a younger, more affluent, and more mobile demographic. Development of these new draw and instant game versions offers the opportunity to foster economic growth within the state by offering opportunities to game developers. Poker may be a potential future Lottery game even though it is usually classified as a game of skill. Poker revenue may be limited due to the difficulty for the Lottery to compete with established offshore sites and their lucrative marketing programs. However, poker, since it is played peer to peer, is fundamentally a social game and its inclusion on the Lottery website will promote community aspects and increase the stickiness, or length of time spent on the site by visitors. We recommend market testing new games by initially providing play for free versions and encouraging trial of new games by offering free-play versions of for money games. Free play versions could also be used in later implementation phases to evaluate customer interest in, and public reactions to, hard games such as casino slots and table games as well as other for money games of chance. Consider casino-style slots and table games for implementation in the later phases of Internet implementation. We also recommend that the Lottery be prepared for the introduction of sports betting if it eventually becomes legal at the federal level. In the meantime, the Lottery can implement fantasy sports as a social game provided that monetization avoids direct betting on team outcomes.

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2. Phased Engagement Strategy

Spectrum recommends a phased implementation approach to online lottery sales for two reasons. First, in order to have the ability to test the publics reception for new online products and measure their market performance. Second, to allow sufficient time for the Lottery to develop the internal resources required to manage and operate fully fledged Internet operations and marketing. While many of the platform providers can quickly implement a full suite of online products, we recommend phasing in products gradually, starting with new games that will not infringe upon the appeal of traditional lottery games sold by retailers while continuously monitoring the online products, fine tuning operations, and assessing public reactions to online sales. We recommend a five-phased implementation strategy beginning with a gentle initial entry to the market starting with casual online games and social games that would feature more time on device than traditional transactional lottery products. Figure 18: Recommended phasing of Lottery online games
New Casual & Social games Lotto & Keno Draw-based games

Instant & "scratch" games?

"Red" & Casino style games?

Source: Spectrum Gaming Group

The games offered in Phase 1 would follow both freemium and subscription models by offering of play for fun, play by subscription payment, or play for free, with payment for additional levels and capabilities. These new and casual games would present an innovative inventory of new online products that would offer the most minimal chance of substitution versus traditional retail lottery product sales. They would also comprise games more likely to attract a completely new customer for the Massachusetts State Lottery. While new casual and social games are the least threatening to traditional retail lottery sales, it is also true that they would generate only very limited new revenue streams, at least initially. Bingo is also an option for implementation in Phase 1 because it is a social-style game with a multitude of versions readily available as online products. However, the benefits of implementing Lottery-sponsored bingo should be carefully weighed against the potential for any negative impact on current charitable gambling operations. Bingo is a popular online product in

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Europe, both for commercial and lottery Internet sites, but the Massachusetts State Lottery may not wish to compete directly in this arena with established charitable gambling interests. Phase 2 would entail online sales for multistate lotto games, which to date has been the default market entry for the small number of US lotteries currently permitting online product sales as well as a more certain and substantial Internet revenue stream. The two US lotteries that have initiated online products to date Illinois and Minnesota offer multistate lotto games for sale via the Internet by opening an electronic account using a major credit card. Two of the US lotteries planning to offer Internet sales in the near future, Georgia and Delaware, will also offer multistate lotto and in-state weekly draw games online through electronic player accounts but the funding mechanism will be a pre-paid card (titled the iHope card in the case of Georgia). Because these products are ideally suited to Internet sales and widely popular across the customer base, they are immediate candidates for early inclusion in any Internet lottery engagement strategy. The reason that we recommend them for Phase 2 is that they are also, along with keno, products that are more susceptible to cannibalization of retail sales. The Treasurers Online Products Task Force may feel more inclined to include these products in the first phase of implementation so long as the caveat regarding potential cannibalization is considered. While some traditional lottery customers may find it more convenient to order lotto tickets from home, it is also reasonable to assume that many more players will participate in regular lotto drawings if they can purchase tickets 24/7 and in the last minutes prior to the drawing taking place. We remain cautious that the added convenience of Internet lotto sales could negatively impact on foot traffic at traditional retail establishments; we advise the Lottery to continue to monitor retail sales in Illinois and elsewhere for evidence of any change in traditional lottery sales for these products. However, utilization of a pre-paid card should assure that local lottery retail agents continue to earn commissions on sales, even those transacted over the Internet. Keno is also included in Phase 2, because it is well suited to a computer-screen interface. We do not believe that Internet keno will significantly cannibalize land-based keno, based on experience in other online jurisdictions. Instead, we expect Internet keno will expand the market for that game. However, because keno generated 17 percent of total Lottery sales in 2011, implementation of an Internet version should be measured to assess the impacts. Delaware can serve as a possible benchmark when it offers online keno in January 2013. Phase 3 would entail the online implementation of selected in-state draw games as well as the development of completely new, Internet-only sweepstakes drawings. In addition, this phase would see the implementation of new draw-based games similar to those offered in successful overseas Internet lotteries. The UK National Lottery, operated by Camelot, offers, among a wide range of conventional lotto drawings, a full product line of multi-decision point transactional products that are based upon draw game logic, similar to pull tabs, but can take up to five minutes to play and thus provide more of a play experience with time on device than traditional draw products. A good example from the Camelot inventory is Monopoly, based on the popular

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board game. Customers pay to enter the game, choose a personal piece to move about the board, and encounter a number of separate decision points where they can win. This game does not compete with any traditional lottery games and generates entirely incremental revenue for the UK National Lottery. The example of Australia shows that online draw games can demonstrate revenue growth in parallel with traditional retail draw game sales. Australian law prohibits instant games on the Internet and Internet sales reflect a preponderance of draw game gross revenue. Within that environment, online sales grew over the most recent seven-year period at a compound annual growth rate (CAGR) of 4.4 percent, while brick-and-mortar sales grew at a CAGR of 3.3 percent.93 Phase 4 would be reserved for instant and scratch games to become Internet products. However, we would strongly caution against placing traditional instant games on the Internet for two reasons. First, instant games are the major profit center for traditional sales, generating 69 percent of gross revenue for the Massachusetts State Lottery.94 They are the single most successful class of products developed by the Lottery and traditional sales must be protected from potential online cannibalization. Second, instant scratch games, once transferred to the Internet and viewed on a video screen, may become indistinguishable from virtual slot machines, where a series of symbols are uncovered with the winning outcome determined by the final symbol appearing in the sequence. Internet scratch games also open the potential for increasing problem gambling exposure as the frequency of play is likely to be much higher. Instead we recommend developing entirely new instant games with more of an experiential component featuring longer time on device similar to the draw based games described above, or else incorporating online video lottery terminals or Internet slot machines into the online product mix. Phase 5 effectively moves online products beyond traditional lottery games and into the realm of casino-style games of chance. In this phase, which the Massachusetts State Lottery may choose to execute, a full suite of all types of online gambling products would be offered over the Internet, just as the British Columbia Lottery Corporation and a number of European lotteries currently offers, and which the Delaware Lottery apparently intends to oversee. If the Lottery were to choose to enter this phase the available products include slot machines, casino-style table games, poker, and any other games of chance played against the house. This recommended phased rollout is a conservative approach that allows the Lottery a great deal of flexibility to accelerate, to combine, or modify based upon its informed assessment of market conditions and opportunities. Regarding potential timelines, if enabling legislation were passed to allow the Lottery to pursue online sales by the end of 2012, it would be reasonable to expect at least six months for the RFP process to complete and a primary platform
93

Bill Thorburn, Chief Executive Tatts Lotteries at Tatts Group, speaking at World Lottery Summit 2012, September 10, 2012
94

La Fleurs 2012 World Lottery Almanac

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provider to be determined. The implementation phases outlined above are notionally estimated to take approximately six months each, beginning in July 2013 and completing roughly January, 2013 but actual implementation of the phases would be at the discretion of the Massachusetts State Lottery Commission. Mobile online product options should be rolled out as soon as practicable, in Phase 1 if at all possible, as mobile gambling will, without question, be a high-growth adoption channel. Mobile device and smartphone utilization is growing faster than the rate of Internet utilization, and mobile Internet access is expected to overtake fixed Internet access by 2015. 95 If the Lottery decides to begin offering online products over the Internet, it effectively enters the electronic gambling business and electronic products can be delivered through any Internet channel, be it desktop PC, smartphone, tables, or other mobile device. Such a phased approach allows more time to examine and benchmark other state lotteries, such as Illinois, that have implemented online lotto sales. Implementation should include developing test markets within Massachusetts to determine the degree of any substitution behavior that might occur online. Still, by following our recommended strategy that all online Lottery wagering be purchased through a play card obtained only at a retail sales agent, this should reduce any negative impact upon retailers, and if new customers are engaged, there could be a positive financial impact for the retailer. The threat of cannibalization becomes greater if direct online credit card purchases the most convenient form of Internet commerce are permitted in the enabling legislation.

3. Products/Games
Instant games make up the majority of Massachusetts State Lottery revenue and it would be prudent not to offer successful existing games through the online channel. Spectrum recommends developing a line of new instant games in order to protect existing revenue and engage new customers. These new instant games can be analogous to the most popular existing games but should not constitute direct copies so as to avoid substituting online games for offline games. There is an ongoing convergence of non-money games and gambling on the Internet, as sites such as Zynga offer non-cash casino games on Facebook and online casinos offer social and skill games interactively. The Lottery should explore this trend and foster the creation of new social and role-play games that are compatible with the Lotterys charter but are designed to encourage customers to spend time on the site. These games could include social media aspects such as in-game chat and competition between players in order to create an online destination. Poker should be considered for implementation in later phases as a potential product for online Lottery. Poker revenues may be limited due to competition with established offshore sites
95

Internet Trends, Mary Meeker, D10 Conference presentation, 5/30/2011, Kleiner, Perkins, Caufield, Byers

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and their high-powered marketing programs. Experience in British Columbia shows that the Lottery, even when granted an official monopoly on Internet poker play, may expect to generate only a plurality in market share and this plurality is generally the low end of the market. However, poker, because it is played on a peer-to-peer basis, is fundamentally a social game and its inclusion on the Lottery website will promote community aspects and increase the stickiness, or length of time spent by visitors to the Lottery website. Experience in offshore gambling sites also shows that Internet poker players often play side games simultaneously with their poker play, thereby generating multiple revenue streams. Poker, as an online offering, depends highly on the potential pool of players available for games at all hours of the day, referred to as the liquidity of the market. With an adult population of 5.2 million, the prospect of sufficient liquidity is an open question. At this writing, federal legislation is being considered that would allow Interstate online poker, but that is an unknown. A similar unknown at this point is whether different states across different time zones would be able to pool their poker resources, as is being done among certain provinces in Canada. Casino games and other red games of chance where wagers are made against the house should only be considered in the later phases of implementation and included as Lottery games only if demand exists. Consider a play-for-free site in the early phases to evaluate player interest in and public reactions to hard games such as casino slots and table games as well as other for money games of chance played against the house. That, of course, raises an expected question: If the Lottery offers casino-style games, does it mean that the Lottery is competing against casinos directly? Our analysis and experience do not support a conclusion that it would foster undue competition. Rather, we note that the experiences are vastly different more akin to drinking beer at home vs. drinking beer in a bar or tavern and it offers casinos another opportunity, through joint marketing, to cost-effectively identify and incent table players Finally, depending upon the outcome of ongoing state challenges the federal Professional and Amateur Sports Protection Act of 1992, consider the introduction of sports betting provided it becomes legal. Also consider implementing fantasy sports betting in the early phases. Fantasy sport betting is currently a $1 billion industry nationwide, offered as a for-money social game in 27 states, and is legal under the Unlawful Internet Gambling Enforcement Act of 2006 and PASPA.96 While fantasy sports is a crowded field with competitors including CBS Sports, Yahoo, ESPN and Cantor, there are many platform providers and an opportunity exists for Lottery-branded fantasy competition with cross marketing to traditional Lottery products.

96

Fantasy Sports Becoming Big Business for Cantor, Chris Sieroty, Las Vegas Review-Journal, September 15, 2012

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J. Online Engagement Analysis: Defining Strategy, Identifying Issues

Clearly, the overall US gambling industry is changing quickly. During the past decade, technological developments have enabled gambling to move online, whether governments allow it or not. If Internet gambling is not allowed within a state, people can find opportunities in other states or other countries. The availability of online will continue to expand. Indeed, numerous companies are developing applications for smartphones that enable individuals to play casino games from their phones from anywhere. States, casino companies, lotteries, etc., will all have to adapt to these types of changes. So the question for a particular state is how to regulate it in a way that ensures safety for its citizens and benefits the citizens the most through an efficient tax framework. As part of this report, Spectrum was asked to address the question: What if the Massachusetts State Lottery takes no action with respect to Internet wagering, and elects to maintain the status quo? That is indeed the position being taken in multiple jurisdictions that are simply not pursuing the issue. Others are pushing forward while encountering political opposition. Maryland, for example, has some lawmakers opposing such efforts in part because of opposition from retailers. Maryland Community News reported recently: Maryland state lottery tickets probably wont be sold online this summer, after lawmakers scratched funding from the state budget that would have allowed the expansion to Internet sales beginning July 1. Instead, the State Lottery Agency can use $500,000 of its budget to create a proposed platform and regulatory structure for online sales. The final report on those preparations must be submitted to the General Assembly budget committees and the State Lottery Commission by Dec. 15. After the budget committees receive the report, they could release the $167,119 needed for three employees to run the program. Gov. Martin OMalleys (D) budget called for the program to start at the beginning of fiscal 2013 on July 1 and estimated revenue of $2.2 million from online sales for the year. The full revenue figure is still assumed in the so-called doomsday budget, which was passed after lawmakers failed to agree on a full, three-bill budget package before the end of the session.

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It is the second year in a row that plans for online lottery sales have been delayed by the General Assembly.97 Notably, the decision to eliminate funding for online lottery sales came despite a December 2011 report from the Maryland Lottery that argued strongly in favor of an online presence. The report noted: Many well-known brands have successfully integrated an online sales channel with brick-and-mortar locations including Apple, Best Buy, Babies R Us, Verizon Wireless and Under Armour, to name a few. Implementing marketing and sales strategies such as e-coupons, promo codes, daily deals, social gaming, promotional overlays and player loyalty programs can accomplish integration and drive traffic to retailers to not only increase lottery participation and sales but also sales of the retailers other products. It is a point of emphasis for the SLA to collaborate with brick-and-mortar retailers to launch creative marketing concepts that would help both sales funnels thrive. Digital promotions are slowly replacing weekly circulars, particularly among younger consumers.98 While the status quo would clearly have some support in any state, we do not recommend this for Massachusetts because online gambling efforts will be pursued elsewhere regardless of what policy position the Lottery adopts. If online gambling is pursued by Massachusetts casinos, or by lotteries or casinos in nearby or distant states, Massachusetts and its Lottery could be impacted regardless. At the same time, demographics of lottery players and annual sales of traditional lottery products do not illuminate a pathway to growth. Further, consumer expectations have changed/are changing, in that they expect to be able to use the Internet for purchasing virtually all goods and services to the Internet-practicable extent from shoes to prom dresses to movie tickets to hotel reservations to theme-park tickets. Businesses that do not adapt to the changing times may be left behind, particularly as the generation raised on the Internet become adults. Clearly, it is practicable to purchase gambling games online. The crucial challenge for the Lottery in moving to Internet sales is how to enter the Internet space without adversely impacting current retail sales and the agents that depend upon them. Multiple Internet lottery vendors said in presentations to the Working Group this year that the introduction of Internet sales in Europe and Canada had minimal impact on retail sales and, in some cases, had a positive impact. While these assurances from vendors must be assessed carefully, it is evident that by engaging the Internet these gambling operators attracted a

97

Online Lottery Sales Doubtful This Year in Maryland, by Danielle Gaines, Maryland Community News, April 23, 2012 http://www.gazette.net/article/20120416/NEWS/704169954/1007/online-lottery-sales-doubful-this-year-inmaryland&template=gazette
98

Maryland Lottery: Report on Plans for Online Sales of Traditional Lottery Games, December 15, 2011, p. 25 http://dlslibrary.state.md.us/publications/JCR/2011/2011_25.pdf

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previously under-represented demographic and converted a larger proportion of the total population from non-customer or infrequent customer status to regular lottery play. The introduction of Internet lottery sales and new types of online games can potentially engage more of the non-players and infrequent players. The difficult question is how much of the core player population will migrate to the online channel and what effect online sales will have on retail sales. As noted earlier, Independent Lottery Research, (ILR) a marketing research consultancy now branded Independent Gaming Research, was heavily involved in conducting research preceding the Illinois Lotterys market entry. ILR has developed demographic profiles for two major segments of lottery players who they term Joe and Jack. Joe is the core player who regularly purchases lottery tickets while Jack is the infrequent player. While they share similar demographic profiles and each spends roughly the same amount when they play, Joe, the core player, is a much more frequent customer, purchasing lottery tickets about five times more frequently than Jack, the non-core customer.99 According to ILR, distribution of these two segments within the player base is analogous to the Pareto rule, with 78 percent Jacks and only 22 percent Joes. ILR maintains that influencing 5 percent of Jacks, the Non-Core players, to spend $5.00 more per week on multistate lotto games can increase sales by $90 million annually while influencing Joes, the Core players, to spend the same amount more will increase sales by less than one-third that amount.100 Clearly, attracting players who are infrequent or non-lottery customers is the most advantageous path to growing revenues near term. Accessing the Internet channel and offering greater convenience for purchasing traditional lottery products as well as new and different online products which appeal to infrequent players can be an advantageous means for inducing more Jacks to play regularly. Figure 19: Contribution to sales if 5% of group played $5 more on multistate games per week

$5 more per Joe

$27 Million

$5 more per Jack

$90 million

$0

$10

$20

$30

$40

$50

$60

$70

$80

$90

$100

Source: Independent Lottery Research

99

International Lottery Research, Changing Wheels of Fortune Building A New Player Base, NASPL presentation. Ibid.

100

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Vendor presentations also mention the issue of liquidity when addressing Internet poker. Liquidity, simply defined, is a term describing the amount of traffic generated by a site, or the number of users on the site at any given time. More broadly, liquidity represents the critical mass of players needed to attract new players to the site. Liquidity is particularly crucial to Internet poker, where a player expects to be able to find an open seat at a table at his preferred price point as soon as he or she logs on and not have to search for an open table or wait for a new table to form. Liquidity is also important for online casino and bingo sites in order to give players the impression that there are other people to play against. Given the states relatively small population, many vendors believe that Massachusetts has the minimum liquidity to support one effective Internet poker network. The US Census Bureau estimates the population of the state at 6,587,536 as of 2011, with 21.7 percent under the age of 18.101 That translates into an adult population of 5,158,041 and applying the Internet poker penetration rate of 1.86 percent used in the Gage Report conducted for the California Online Poker Association102 yields an active Internet poker player estimate of roughly 96,000 persons in Massachusetts. Several vendors suggested that given the small size of the intrastate pool of players, Massachusetts should look to multistate compacts in order to pool liquidity between multiple state lotteries. We asked Eamonn Toland, president of Paddy Power North America, to share his views on poker liquidity. He wrote: In terms of population size no-one really knows the minimum for poker. Sweden has been pointed to as a successful market with multiple technologies for 9m people. Leading industry players are not targeting states with a population less than 5m people for poker. Certainly for states below that point serious consideration needs to be given to having all licensees on the same poker platform, even if they compete to get players on their respective skins. The same constraint does not apply to online casino, and arguably its a much more lucrative opportunity for a state of any size.103 Liquidity will also be an issue for social games. Although not nearly as critical to success as with Internet poker, it will remain important to assure that a sufficient mass of players is available for a pleasing multi-player experience. Another important lesson from the European Internet gambling experience is the effect on profit margins from a hypercompetitive market. While it is likely that Internet gambling in the US will develop somewhat differently than it has in Europe, the extreme competition for online
101 102 103

US Census Bureau, Massachusetts Quick Facts, 2011 Fiscal Impact of Legalizing Online Poker in California, January 2011 Email from Eamonn Toland, October 1, 2012

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players utilizing myriad affiliates and liberal free-play bonus promotions has had a deleterious effect on player loyalty. Hyper-competition between multitudes of Internet gambling sites has caused the better players to become more promiscuous and inflated the costs of player acquisition and retention, consequently narrowing margins and diminishing profits. While undoubtedly competition is a good thing, too much competition in the Internet space has proven costly in European jurisdictions, especially for Internet poker.

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K.

Payment, Registration and Verification

1. Payment Vehicles

The most efficient and profitable means for funding online product purchases would be to allow credit card purchases directly on the Massachusetts State Lottery website. This method would be the fastest, easiest, and most convenient process for the customer and the most lucrative for the Lottery since the only expense, other than setting up the electronic account system, is from credit card service fees. This is the payment method adopted by the two US lotteries currently offering online play, Illinois and Minnesota. However, this method raises ethical questions regarding the use of credit for gambling purposes which may not constitute good public policy. Furthermore, this system does not provide for cash purchases unless personal debit cards are also included, and it would present problems for identity and age verification. While straight credit card payments are the standard of the industry in e-commerce and would present the most customer-friendly option to funding purchase of online lottery products, the sheer convenience of credit cards would also represent the greatest potential for substitution of traditional retail lottery with online purchases. Therefore, this payment vehicle may not be the best solution for Massachusetts. Another US lottery that intends to implement online product sales, the Georgia Lottery, is prohibited by state law from accepting credit cards for any lottery purchases. Georgias solution, explained by Director Kurt Freedlund, Senior Vice President and General Counsel, will be to utilize a pre-paid debit card, provided by Discover, to fund Internet purchases. This card, named the iHope card, will be available only at existing Georgia Lottery retail outlets and retail agents will realize their standard commission on every dollar of pre-paid card sales. Delaware plans to utilize a similar pre-paid card system when implementing Internet lottery sales in January, 2013. These pre-paid card payment vehicles offer a number of advantages over credit cards. First, because it is pre-funded there will be fewer issues with customers buying lottery tickets on borrowed money. Second, they can be sold in smaller monetary amounts than credit cards allow and the Lottery can choose to cap the maximum value offered. Pre-paid Lottery play cards could be offered at the retail locations in branded displays and feature a variety of pre-loaded initial values (such as $5, $10, $25, $50). Customers could walk into the retail sales location, purchase a play card, and take it to a computer or mobile device where they could then register and play. Most importantly, if the Lottery requires funding of online purchase accounts solely through such pre-paid payment vehicles and restricts sale of these cards to registered lottery outlets, then retail agents will continue to earn a commission on the Internet sales. While this requirement will necessarily have an adverse impact on the breadth of sales and will probably retard the rate of adoption of Internet purchases, it will minimize the impact on traditional retail

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sales, and retail agents will be protected and their relationship with the Lottery strengthened through the implementation of online product sales.

2.

Registration Process

Leveraging the Internet will transform the Lotterys relationship with many of their customers because the formerly anonymous purchase process will now require a registration process that will collect personal information and establish an electronic account, for the first time allowing the Lottery to generate knowledge of their (Internet) customer. This knowledge will be invaluable for marketing purposes, for preventing fraud, and in identifying customer needs. Moreover, online product purchasing will create a history of player behavior and product preferences. On the other side of the equation, the Lottery will now be expected to verify that customers actually are who they claim to be and to protect their identities and the privacy of their information. The key to establishing this knowledge base will be the online registration process. It will be necessary to put a registration process in place as a first step in setting up an electronic customer account. This process will collect basic customer information and also ensure that online ticket purchasers are of legal age to play Lottery games, and that they reside in Massachusetts. The registration process should be rigorous enough to assure accurate identification but not so complicated and time consuming as to discourage registration. Ideally the Lottery will strike a balance between the intrusiveness and complexity of the customer identification and age verification requirements and the convenience of the process. Information required at registration to set up an account should include customer first name, last name, middle initial, residence location (i.e. street address city, state, and ZIP code), email address, and date of birth. Optional information requirements at registration could include Social Security Number, phone number, and contact approval. Financial institution information would not be required unless credit card usage was permitted under any enabling legislation. Social Security Numbers may be necessary to perform the age verification process under the most effective software applications. However, initial qualitative research shows that the Social Security Number requirement is perceived as the single most intrusive aspect of the online account registration process and would undoubtedly limit the adoption of online lottery product purchasing. If the pre-paid play card is used to fund all Internet Lottery transactions, then the Social Security Number requirement may be eliminated, provided that age and identity verification are performed at the retail location, just as they are currently for traditional lottery purchases; however, it is impractical to ask Lottery retailers to perform this function. Completing the registration process would establish a customer account with the Lottery which would have a personal account number as the unique identifier. If credit cards are utilized to fund the customer accounts, customers could set up the funding process at the same time that they establish their online purchase account. If pre-paid cards are used, as Spectrum recommends, customers would have to take the extra step of purchasing a pre-paid card at a Lottery retail location in order to fund the account. The pre-paid play card purchased at the
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retailer would fund the account and be drawn down through subsequent transactions. Depending upon the manufacturer and characteristics of the pre-paid card system eventually chosen, a numeric code derived from the pre-paid card may also be needed at logon to activate the funds and link them to the player account for online lottery purchases. Registration for online accounts could also occur on site at the Lottery retail location but this may prove problematic given the limited floor space and high volume of foot traffic found at many retail establishments. Online account registration through self-service Lottery terminals could also be considered as an option. Purchase of the play card would require proof of age verification, 18 years or older, just as current Lottery purchases are verified at the retail agent location by presenting a valid drivers license or similar identification. Retailers would benefit from the player card in multiple ways. First, the requirement for a player card would drive additional foot traffic through Lottery retail locations. Second, cards could be reimbursed or repurchased at the retail location. Third, retailers would receive the normal 5 percent commission on sale of each play card. There could also be consideration for ongoing commissions for the originating retailer on all subsequent purchases for the life of the card. Purchase of online products would require logging on to the Lottery website to access the customer account by entering a unique password for each prospective online purchaser. Geolocation tools would be employed by the platform provider to assure that the player is currently located within state boundaries. Age verification would be conducted at the retailer location during card purchase. Additional age verification measures should be added at logon if the Lottery so decides or if required by the enabling legislation. Examples of registration processes from other jurisdictions are detailed below. These examples are drawn from the British Columbia and Austria in order to provide some geographic diversity and because these two lotteries post relatively transparent information. Salient online gambling registration rules for Austrias win2day lottery are as follows:104 The minimum age for registration on win2day is 18. On registration, first name, surname and date of birth must be stated. The data are checked via an inquiry agency. There must not be more than one win2day account for each combination of first name, surname and date of birth. The licensor has made it a mandatory requirement that a bank account must be stated.

104

http://www.lotterien.at/olg/CS_win2day_GB.htm?sessionID=35972110-1401-583d149-f37e-8f00c2fc8778 (accessed August 17, 2012).

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Player must define their limits in terms of finances and time upon first registration. If limits are raised, the new limits will only take effect after 72 hours of reflection. Players may bar themselves from games for a certain period. Self-barring is possible for one, three, six and twelve months.

Additionally, payment options are specified as follows:105 The gambling deposit can be topped up using the Internet or mobile phone. The EuroBon (a pre-paid voucher), which can be bought from all Austrian betting outlets and selected distribution agencies as well as Paybox, a provider independent payment mode for mobile communications and the Internet, are available for that purpose. Payment can also be made using MasterCard (with or without Secure Code), VISA (with or without Verified by Visa) and Diners Club or online banking, Mastro Secure Code and paysafecard.

In the example of the British Columbia Lottery Corporation (BCLC), the registration process on the PlayNow.com site requires the following information:106 Before play is permitted on PlayNow.com the user must be a Registered Player. To be a Registered Player: o The minimum age is 19 o Must be a permanent resident of BC and physically located in BC at time of registration o Not enrolled in a voluntary self-exclusion program at any BC gambling facility (i.e., any BCLC operated facility) o Must have a current Canadian Visa or MasterCard. On registration, first name, surname and date of birth must be stated, along with email address, daytime phone number, and credit card information. The data are checked via a credit reporting agency, where credit card information (or credit profile) must validate the other personal information provided There must not be more than one PlayNow.com account for each Registered Player Registered Player must define their weekly transfer limits upon registration, while Registered Player cannot deposit more than the weekly transfer limit within a sevenday period.

105 106

Ibid. PlayNow.com registration page, https://www.playnow.com/playnow?action=GoRegister.

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Preserving the retail sales network and benefitting Lottery sales agents is a key element of the online engagement strategy for Massachusetts. The registration process described above provides for continued agent commissions on Internet product sales via the pre-paid play cards. An alternative procedure is currently being implemented by Loto-Qubec where customers will have the option of identifying a preferred retailer when they purchase Internet products. Designated retailers then receive the same commission they would if the products were sold in their store. Even if a customer does not designate a retailer, a percentage of the purchase goes into a pool where all retailers are reimbursed for commissions, pro-rated on the basis of their relative product sales. This system has proven popular among retailers in Quebec, however, there are disadvantages in this system compared to the pre-paid funding card option. For example, designating preferred retailers for all ongoing Internet purchase commissions opens opportunities for abuse in the system and even possible corruption. This system also appears to favor retail locations that enjoy greater foot traffic and more corporate resources that the smaller and more local retail establishments.

3.

Know Your Customer

Entry into online games would fundamentally alter the Lottery-customer relationship, in that the Lottery would change from a wholesaler to a retailer. That is, the Lottery would transform into a gambling operator selling directly to, and communicating directly with, its customers instead of relying solely on retailers for these functions. With this change, the Lottery would assume three new, customer-facing responsibilities born either by the elimination of the retailer or by the very nature of online play itself: Geolocation and residence. The Lottery will be responsible for ensuring that online Lottery play is taking place only among people located within Massachusetts borders and, if legally relevant, by Massachusetts residents. This is an entirely new responsibility, as traditional lottery products may be played anywhere so long as they are purchased in Massachusetts. Identify/age verification. Currently the province of retailers, the Lottery will assume the ultimate responsibility of assuring that online players are at least 18 years old and that they are who they say they are; i.e., there is no identify fraud. Problem gambling. Currently with a passive role regarding problem-gambling issues among customers (awareness, referral), the Lottery will be in a position to provide online customers with a variety of tools to monitor and restrict their gambling expenditures. Further, the Lottery will be collecting a trove of data that should prove valuable to researchers in the problem-gambling field.

While the first two responsibilities noted above are required by law, the extent to which the Lottery chooses to offer tools to help with problem-gambling issues may be guided by its own policies and goals as well as emerging best practices from other online gambling operators

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and problem-gambling organizations. (We address that issue in a following chapter of this report.) Location and age verification, while not one in the same, nevertheless do use similar know-your-customer (KYC) technology to answer critical questions, including: Is the customer who he purports to be? Is he a resident? Is he located within the gaming jurisdiction? Is he of legal gambling age?

The intrinsic, data-driven nature of the Internet makes age and location verification a straightforward and objective process, with multiple checkpoints along the registration, deposit and wagering processes. The following presentation slide from Paddy Power North America, whose parent company is a prominent online gambling operator based in Ireland, provides a useful snapshot of commonly used verification processes and tools. Figure 20: Representative gaming know-your-customer checks for online gambling

Source: Paddy Power North America, 2012 presentation

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Paddy Power, like any credible provider of age, residency and location technology, cautions that no verification system is foolproof. There will always be those seeking to break the law, manipulate the technology, or deceive the system, but the tools available in online gambling systems are generally superior to human judgment (i.e., a lottery retail cashier or casino security) because they rely on and capture verifiable data. As Paddy Power advises: Perfect is the enemy of good put the best possible framework in place and adopt a risk-based approach to issues. An operator of online play such as the Massachusetts State Lottery should employ registration and geolocation processes that meet industry best practices at the time of implementation. At present, customer-identity verification checkpoints include the personal information cited in the figure above. In addition, operators through their own system or through age- and identity-verification companies can access government records and/or credit records to cross-check identities. (Credit checks are used for purposes of identification only, not to evaluate a patrons credit history.) It is important to note that the burden of proof of identification is on the patron not on the operator. Any credible verification system will reject a patron if the necessary data cannot be verified. If the online checks fail to verify a patrons age, identity or location, the Lottery should have an option of allowing patrons to physically present documents such as a Passport, drivers license, tax notice or utility bill at authorized Lottery offices as the proof needed to establish an online-play account. Further, the Lottery should make it known to patrons as other online operators do that they are not free and clear once they have been approve for wagering. The Lottery should reserve the right to request age or identity documentation from a client at any time and to suspend a patrons account until the verification is provided. The Lottery should also reserve the right to void all transactions and return all deposits to anyone who is discovered to be under age 18. The Lottery should establish a framework with the relevant Commonwealth law enforcement department to seek prosecution of those online patrons who commit identity, location or age fraud. The Lottery should post these enforcement warnings conspicuously during the registration process and at each log-on. It is also important to note that, due to the rapid pace of technology improvements, verification systems currently in use may not necessarily be the industry standard at the time of the Lotterys online-play implementation. In any event, the Lottery should have an abundance of bidders to provide its online-play platform; that competition will, in Spectrums opinion, ensure that the Lottery will be able to choose from the best providers of age, identify and location verification systems. Importantly, the Lottery should require that the bidders hardware, software, peripheral devices and communications systems for age, identity and location pass third-party verification testing by an accredited testing company.

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With respect to location verification i.e., that the patron is wagering within Massachusetts borders there are two primary methods to identify where the device is located: The IP address and a wireless/satellite signal: The IP (Internet protocol) address is a unique number assigned to Internet-connected computer. This address can identify the location of users through any Internet device that has a land-based connection. Global positioning satellite signals can be used determine accurate location of mobile devices employing GPS (global positioning system). GPS is even more effective when assisted by GSM (Global System for Mobile communication) wireless network data. Mobile devices that are connected to a Wi-Fi land connection while also on a mobilephone network can provide even greater location accuracy through Wi-Fi/cell tower triangulation.

The most effective geo-location products utilize a mix of multiple technologies including all of the above and more to attain the most exact location fix possible and shrink the radius of the circle to a point. Experts, however, caution that location verification is an inexact science. Youre going to get it wrong some of the time, John Summers, a vice president with Cambridge-based Akamai, a global Internet services firm, advised the Working Group in an August 23, 2012, presentation. For instance, Summers said, it is possible that a New Hampshire border resident might be able to play the Massachusetts State Lottery online based upon geolocation alone. Multiple technologies are important, in addition to increasing the accuracy or geo-location, for minimizing the opportunity for fraud because single technologies can be fooled or spoofed by hackers. For example, GPS spoofing or hijacking involves broadcasting a stronger GPS signal with misleading location information which overrides or hijacks the legitimate signal and tricks the GPS tracker into believing that the user device is somewhere else. University of Texas researches used GPS spoofing to successfully hijack a drone aircraft in a Department of Homeland Security demonstration earlier this summer.107 The intent of any geolocation system is to minimize the margin of error. Two important actions, as noted above, will help to reduce the chance of location error: require locationverification providers to undergo testing by an independent testing laboratory, and engage in a robust identity check to ensure that the patron is a Massachusetts resident. So long as the Lottery engages in the best practices for verifying a patrons identify, age and location, it cannot be reasonably or likely legally responsible for those who choose to cheat its stringent controls.

107

GPS Hijacking Catches Fed, Drone Makers Off Guard, Lorenzo Francheschi-Bicchierai, Wired Magazine, July 19, 2012.

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L.

Traditional Lottery Sales, Before and After Casinos

In this section, we examine impact to traditional lottery sales following entry of casino gambling in Delaware, Rhode Island, and Pennsylvania. Each of the three states had a wellestablished lottery in place before casinos. We believe relevant similarities exist (or existed) in each of these three states with respect to the potential casino landscape in Massachusetts: Each states casinos are geographically dispersed. Initially, casinos in each of these states had limited gambling offerings (i.e., slots/VLTs only in Delaware and Pennsylvania until live table games became operational during summer of 2010; Rhode Island does not offer table games). The Delaware and Rhode Island casinos are direct functions of their lotteries; Pennsylvanias are not.

The casino landscape in each state: Delaware has three casinos. The first two opened in late 1995 and the third opened in latter half of 2006. Importantly, at inception (and until 2010) each casino offered only VLTs. The entire population of Delaware is within a reasonable one-hour drive of one or more of Delawares casinos. Pennsylvania has 11 casinos, with the first opening in November 2006. The 11 casinos are located in seven metropolitan statistical areas. The two most populous metropolitan areas (Philadelphia and Pittsburgh) are collectively home to six of the casinos. Some 83 percent of Pennsylvania adults are within a reasonable one-hour drive time of an in-state casino. Rhode Island has two casinos, both at pari-mutuel facilities and both commenced operations in 1992. The entire population of Rhode Island is easily within a reasonable one-hour drive of either casino.

1. Delaware
The following table shows total sales results for Delaware Lottery over the last two decades, segmented into five-year periods. The data are for fiscal years ended June 30. The first five-year period (1991-95) show sales exclusively from traditional lottery offerings, as casinos were not operational until FY1996. Each of the three successive five-year periods shows lottery sales inclusive of revenue/impact from VLTs.

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Figure 21: Delaware Lottery sales data, 1991-2010

Delaware Lottery Lottery Sales, avg. annual ($M) FY 1991-1995 1996-2000 2001-2005 2006-2010 1991-1995 1996-2000 2001-2005 2006-2010 1991-1995 1996-2000 2001-2005 2006-2010 Traditional (Instant/Draw) $90.1 $117.5 $108.2 $122.7 100.0% 28.3% 16.7% 17.0% $129 $155 $132 $140 Video (VLTs) $0.0 $298.1 $540.7 $595.2 0.0% 71.7% 83.3% 82.6% $0 $393 $660 $681 Sports Betting & Table Games $0.0 $0.0 $0.0 $2.8 0.0% 0.0% 0.0% 0.4% $0 $0 $0 $3 Total DE Lottery $90.1 $415.6 $648.9 $720.7 100.0% 100.0% 100.0% 100.0% $129 $548 $792 $825

Lottery Sales as % of Total

$ per Capita

Source: Delaware Lottery, Demographicsnow.com

As illustrated, on a per-capita basis traditional lottery sales have been greater with instate casinos than without them. From 1991-1995 average annual per-capita sales were $129; over the first five-year period with casinos operational (1996-2000) average annual per-capita sales from traditional lottery were at $155, or 20.3 percent higher. Over the last decade, which includes casino competition beginning neighboring Pennsylvania in 2006, on a per-capita basis traditional lottery sales still remain greater than they were without any casino competition (whether in-state or in Pennsylvania).108 Traditional lottery sales have averaged $142 annually on a per-capita basis over the 15-year period with casinos, or 10.4 percent greater than the five-year period without them.

2.

Pennsylvania

The following table shows annual lottery sales and casino revenue over a 10-year period (2002 to 2011), segmented into two five-year periods (i.e., pre-casino and post-casino years). The first two casinos opened in Pennsylvania in the latter half of 2006 (FY2007), while through FY2011 there were 10 casinos in operation.

108

New Jerseys casinos (all in Atlantic City) have been operational since 1978; Marylands first casino did not begin operating until September 2010 (Delaware FY2011).

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Figure 22: Pennsylvania Lottery sales and PA casino revenue (2002-2011)

Pennsylvania FY 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2002-2006 2007-2011
Variance

Lottery Sales & Casino Revenue ($M)

PA Lottery $1,934.2 $2,133.0 $2,352.1 $2,644.9 $3,070.3 $3,076.3 $3,089.2 $3,088.2 $3,065.7 $3,207.9 $2,426.9 $3,105.5
28.0%

Casinos $0.0 $0.0 $0.0 $0.0 $0.0 $466.0 $1,503.6 $2,008.4 $2,626.8 $3,415.8 $0.0 $2,004.1
n/a

Lottery + Casinos $1,934.2 $2,133.0 $2,352.1 $2,644.9 $3,070.3 $3,542.3 $4,592.8 $5,096.6 $5,692.6 $6,623.7 $2,426.9 $5,109.6
110.5%

$ per Capita

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2002-2006 2007-2011

$156 $172 $189 $212 $245 $245 $245 $244 $241 $251 $195 $245

$0 $0 $0 $0 $0 $37 $119 $159 $207 $267 $0 $158

$156 $172 $189 $212 $245 $282 $364 $403 $448 $518 $195 $403
106.9%

Variance 25.7% n/a Source: Pennsylvania Lottery, Pennsylvania Gaming Control Board, Demographicsnow.com

As illustrated, on a per-capita basis among the two five-year periods, lottery sales have been greater with in-state casinos than without them. From 2002-2006, average annual per-capita sales were $195; they were $245, or 25.7 percent higher, after casinos opened. It is important to note that prior to the most recent year presented (2011), the greatest percapita sales value over the nine-year period occurred in 2006 (at $245), which was the final year of lottery sales before the first casino opened. From this peak, overall per-capital lottery sales were stagnant in 2007-2008 and receded in 2009-2010 before rebounding in 2011. While it is difficult (or may even be impossible) to prove a causal relationship exists among the decline in per-capita lottery sales and growth of casinos, this stagnation/decline in per-capita lottery sales did occur over a four-year period of rapid expansion of casinos in Pennsylvania; however, this was also a period of economic recession. The following graphic illustrates the 10-year trend/juxtaposition of per-capita lottery sales and per-capita casino revenue in Pennsylvania.

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Figure 23: Pennsylvania per-capita lottery sales and casino revenue, 2002-2011
Per-capita Sales/Revenue $300 $250 $200 $156 $172 $189 $212 $159 $119 $37 $207 $251 $245 $245 $245 $244 $241

$267

$150
$100 $50 $0 2002 2003 2004 2005 Lottery Sales 2006 2007

2008

2009

2010

2011

Casino Revenue

Source: Pennsylvania Lottery, Pennsylvania Gaming Control Board, Demographicsnow.com

The following table provides the 10-year trend of lottery sales in Pennsylvania compared to lottery sales data in three neighboring states (where casino expansion activities did not occur, were limited, or in the case of New Jersey were operational and well established prior to this period).109 The red line indicates when the first casino opened in each state, where relevant. Figure 24: Pennsylvania and select neighboring states lottery sales, 2002-2011
Lottery Sales ($M) / Fiscal Year 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2006-10 2006-11 Pennsylvania Sales $1,934.2 $2,133.0 $2,352.1 $2,644.9 $3,070.3 $3,076.3 $3,089.2 $3,088.2 $3,065.7 $3,207.9 0.0% 0.9% Var.
10.3% 10.3% 12.4% 16.1% 0.2% 0.4% (0.0%) (0.7%) 4.6%

Maryland Sales $1,306.5 $1,322.2 $1,395.4 $1,485.7 $1,560.9 $1,577.3 $1,673.0 $1,698.1 $1,706.6 $1,714.4 2.3% 1.9% Var.
1.2% 5.5% 6.5% 5.1% 1.1% 6.1% 1.5% 0.5% 0.5%

New Jersey Sales $2,068.5 $2,073.8 $2,186.7 $2,273.8 $2,405.9 $2,350.9 $2,538.5 $2,503.3 $2,605.1 $2,636.4 2.0% 1.8% Var.
0.3% 5.4% 4.0% 5.8% (2.3%) 8.0% (1.4%) 4.1% 1.2%

Ohio Sales $1,983.1 $2,078.2 $2,154.7 $2,159.1 $2,220.9 $2,259.4 $2,325.1 $2,417.7 $2,490.2 $2,601.0 2.9% 3.2% Var.
4.8% 3.7% 0.2% 2.9% 1.7% 2.9% 4.0% 3.0% 4.4%

MD/NJ/OH Sales $5,858.2 $5,974.7 $6,260.9 $6,466.0 $6,760.5 $6,753.2 $7,137.4 $7,216.1 $7,408.4 $7,558.9 2.3% 2.3% Var.
2.0% 4.8% 3.3% 4.6% (0.1%) 5.7% 1.1% 2.7% 2.0%

Source: Pennsylvania Lottery, Maryland Lottery, New Jersey Lottery, Ohio Lottery. Red line indicates pre-/post-casino activities.

As illustrated, during its first four years coexisting with in-state casinos, the Pennsylvania lottery had a statistically flat level of sales growth while collectively the three neighboring states depicted experienced average annual sales growth of 2.3 percent. While sales for the Pennsylvania lottery rebounded to a then-record level in 2011, the average annual growth with
109

New Jersey had casinos in Atlantic City since 1978; while Maryland casinos (VLTs) became operation in FY2011; and no casino opening in Ohio.

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casinos (2006-2011) still lags the neighboring states (at 0.9 percent for Pennsylvania compared to 2.3 percent overall for the three neighboring states).110 The following table provides the 10-year trend of lottery sales in Pennsylvania compared to lottery sales data in three neighboring states on a per-capita sales basis. Figure 25: Pennsylvania and select neighboring states per-capita lottery sales, 2002-2011
Lottery Sales ($M) / Fiscal Year 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2006-10 2006-11 Pennsylvania per Capita Growth $156 $172 9.9% $189 9.9% $212 12.1% $245 15.7% $245 (0.1%) $245 0.1% $244 (0.4%) $241 (1.1%) $251 3.9% -0.4% 0.5% Maryland per Capita Growth $242 $243 0.3% $255 4.6% $269 5.6% $280 4.2% $280 0.2% $295 5.2% $297 0.6% $296 (0.4%) $294 (0.4%) 1.4% 1.0% New Jersey per Capita Growth $244 $243 (0.2%) $255 5.0% $264 3.5% $278 5.3% $271 (2.7%) $291 7.5% $286 (1.8%) $296 3.6% $298 0.6% 1.6% 1.4% Ohio per Capita $174 $182 $189 $189 $194 $197 $202 $210 $216 $225 2.7% 3.1% Growth
4.6% 3.5% 0.0% 2.7% 1.6% 2.7% 3.8% 2.8% 4.3%

MD/NJ/OH per Capita Growth $232 $236 1.6% $246 4.4% $253 2.9% $263 4.1% $262 (0.5%) $276 5.3% $278 0.7% $284 2.2% $288 1.6% 1.9% 1.8%

Source: Pennsylvania Lottery, Maryland Lottery, New Jersey Lottery, Ohio Lottery. Note: red line indicates pre-/post-casino activities.

As illustrated, during its first four years coexisting with in-state casinos, on a per-capita basis, the Pennsylvania lottery had negative sales growth (-0.4 percent through 2010), while collectively the three neighboring states depicted experienced average annual sales growth of 1.9 percent. Although Pennsylvania lottery sales rebounded in 2011, the average annual growth in per-capita lottery sales since casinos still lags the neighboring states (0.5 percent vs. 1.8 percent). Findings from the Pennsylvania Legislative Budget and Finance Committee corroborate our findings, as explained in this report111 from Executive Director Philip R. Durgin: ... Prior to last year, none of these reports found compelling evidence that the operation of slots facilities had a substantial negative impact on Lottery sales on a statewide basis. Our 2011 report, however, concluded that, based on a comparison of Lottery sales in host counties, counties adjacent to host counties, and non-adjacent counties, the casinos do appear to have suppressed Lottery sales, at least in those counties that host a casino. ... While the rate of sales growth has slowed significantly since the introduction of casino gaming, we attribute the slowdown primarily to unprecedented growth in sales in the
110 111

The Pennsylvania Lottery reported sales revenue of $3.48 billion in FY2012.

The Impact of Slots on the Pennsylvania State Lottery, report presentation by Philip Durgin at May 23, 2012 meeting, http://lbfc.legis.state.pa.us/reports/2012/52prs.PDF.

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four-year period between FY 2002-03 and FY 2005-06. Various factors, including a substantial expansion of the Lottery retailer network and Pennsylvanias entry into the multistate Powerball jackpot game, led to the rapid growth in Lottery sales during these years.

3.

Rhode Island

The following table shows total sales results for Rhode Island Lottery over the last 25 fiscal years ended June 30. There were no VLTs prior to FY1994 (shown by the red line). Figure 26: Rhode Island lottery sales (total and per-capita), 1998-2012
Lottery Sales / Fiscal Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 1989-93 1995-99 Total Sales ($M) Traditional (non-VLT) $61.3 $61.0 $65.8 $65.7 $64.5 $105.1 $138.5 $119.2 $133.6 $136.4 $170.0 $195.7 $193.3 $207.0 $235.7 $239.0 $249.4 $241.9 $261.1 $244.8 $241.2 $238.5 $234.6 $230.6 $249.5 $362.1 $754.9 Video (VLTs) $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $27.6 $57.0 $86.6 $112.3 $131.5 $155.3 $194.7 $229.1 $281.0 $314.7 $358.9 $399.2 $416.5 $416.7 $477.8 $460.9 $467.8 $492.6 $527.3 $0.0 $542.8 Total RI Lottery $61.3 $61.0 $65.8 $65.7 $64.5 $105.1 $166.1 $176.2 $220.2 $248.7 $301.5 $351.0 $388.0 $436.1 $516.7 $553.7 $608.3 $641.1 $677.6 $661.6 $719.0 $699.4 $702.4 $723.2 $776.8 $362.1 $1,297.7 Traditional (non-VLT) $62 $61 $66 $65 $64 $103 $136 $116 $130 $132 $164 $187 $184 $197 $225 $228 $238 $230 $248 $233 $229 $227 $223 $219 $238 $72 $146 Per-capita Sales Video (VLTs) $0 $0 $0 $0 $0 $0 $27 $56 $84 $109 $127 $149 $186 $218 $268 $300 $342 $380 $396 $396 $454 $438 $444 $469 $502 $0 $105 Total RI Lottery $62 $61 $66 $65 $64 $103 $163 $172 $214 $240 $290 $336 $370 $416 $492 $528 $579 $610 $645 $629 $684 $665 $667 $688 $740 $72 $251

Source: La Fleurs World Lottery Almanac 2012, Rhode Island Lottery

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In the five full fiscal years before VLTs, per-capita lottery sales were $72 vs. $251 in total lottery sales in the five years after VLTs. Excluding VLT revenue, traditional lottery sales per capita more than doubled following VLTs from $72 to $146. We note that two Indian casinos opened in Connecticut in the 1990s, which may help to explain soft per-capita sales results in Rhode Island between FY1993 and FY1996.

4.

Conclusion

We believe the examples from these three states render the direct impact of casinos on lottery sales as minimal or inconclusive. This macro-based analysis cannot adequately capture every aspect of impact on lottery sales occurring via externalities, especially the introduction and/or expansion of online gambling in the same jurisdiction. Some externalities may be variations in marketing and/or advertising initiatives, distribution channels, games offered, demographics, macro-economic conditions, competition in neighboring jurisdictions, etc. Additionally, the lottery does not operate in a vacuum so there may be similar externalities impacting other organizations (either complementary and/or competing) that rely upon discretionary income (as does the lottery).

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M. Lottery Sales: Online Sales Impact

This section of report illustrates the impact if lottery online sales to traditional lottery sales in two other jurisdictions, British Columbia and Austria. These two examples were chosen because they were both early entrants into the Internet lottery sales market, because they both provide relatively transparent online revenue data, and also to provide geographic variety in taking examples from both Europe and North America.

1. British Columbia
The British Columbia Lottery Corporation (BCLC) is tasked with conducting, managing, and operating all forms of gambling in British Columbia. BCLC began lottery operations in FY1985 and assumed responsibility for all online gambling in FY1998-99. In FY2004, BCLC introduced PlayNow.com for online play and the purchase of select lottery products. In FY2010, BCLC became the first North American operator of legal, regulated online casino games on PlayNow.com. The following table shows annual BCLC sales results over its most recent five-year period (FY2008 through FY2012, with each fiscal year ended March 31). Sales data are shown in four distinct categories: Retail Network convenience stores, gas stations, etc. selling lottery products. Hospitality Network lottery products offered via lottery terminals in social settings, such as bars, pubs, restaurants. eGaming lottery transactions through PlayNow.com, which includes both online lottery sales and sports betting (all years presented), as well as online casinos games that commenced in FY2010. Casinos and Community Gaming Centers as of FY 2012 this includes 17 casinos (slots, table games and poker), 17 community gaming centers (slots only), as well as 10 bingo centers.

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Figure 27: British Columbia Lottery total and per-capita sales/revenue, 2008-2012
British Columbia Lottery Corporation eGaming (includes sports betting) $18.7 $23.5 $33.6 $42.9 $65.6
36.9%

FY 2008 2009 2010 2011 2012

Annual Growth

Retail Network $709.7 $710.7 $691.7 $807.5 $789.2

2.7%

Hospitality Network $248.5 $220.0 $212.6 $212.0 $206.6

(4.5%)

Casinos & Community Gaming centers $1,582.3 $1,596.0 $1,579.4 $1,616.3 $1,640.0
0.9%

Total BCLC* $2,559.2 $2,550.2 $2,517.3 $2,678.7 $2,701.4

1.4%

Lottery Sales ($M)

Lottery Sales as % of Total

$ per Capita

2008 2009 2010 2011 2012 2008 2009 2010 2011 2012

27.7% 27.9% 27.5% 30.1%

29.2%

9.7% 8.6% 8.4% 7.9%

7.6%

0.7% 0.9% 1.3% 1.6%

2.4%

61.8% 62.6% 62.7% 60.3%

60.7%

100.0% 100.0% 100.0% 100.0%

100.0%

$312 $306 $291 $336 $324

$109 $95 $90 $88 $85

(6.2%)

$8 $10 $14 $18 $27

34.5%

$696 $688 $665 $672 $673

(0.8%)

$1,126 $1,099 $1,060 $1,114 $1,109

(0.4%)

Annual Growth 0.9% Source: British Columbia Lottery Corporation, BCStats

As illustrated, despite the proliferation of online gambling offerings since FY2010, percapita lottery sales at retail locations were greater in the two full years with online gambling present (2011-2012) than they were in the two full years immediately prior at $330 vs. $309 per-capita. However, per-capita sales/revenue within the hospitality network and at casinos and community gaming centers decline when comparing 2011-2012 to 2008-2009.

2. Austria
Casinos Austria and Austrian Lotteries operate online gambling in Austria through a joint subsidiary.112 Through their online gambling portal www.win2day.at, the range of games includes traditional lottery games and casino-type games, including roulette, black-jack, slots, poker, and bingo. Online gambling began in February 2003. According to a study prepared by Media & Entertainment Consulting Network, through 2010 Internet sales per-capita in Austria were highest of 19 lotteries having comparable/similar Internet sales channels (based on select data from international lottery operators, primarily European, where both 2010 and 2009 data were publicly available for benchmarking purposes).113

112 113

Casinos Austria, 2010 Annual Report.

Media & Entertainment Consulting Network, Lottery Benchmarking and Success Factors: Benchmarks, Success Factors, and Best Practices 3rd edition. London/Munich, September 2011.

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The following table shows annual sales results for the Austrian Lottery over its most recent five-year period (2006-2010). Sales data are net of VLTs (which are operated through the Austrian Lottery). Figure 28: Austrian Lottery total and per-capita sales/revenue, 2006-2010
Austrian Lotteries & Casinos Austria Lottery Sales as Lottery Sales ($M) % of Total Remainder of Lottery, net VLTs $1,383.3 $1,419.9 $1,652.7 $1,668.6 $1,541.8
2.7%

CY 2006 2007 2008 2009 2010

Annual Growth

Total Sales, net VLTs $2,353.0 $2,527.3 $3,051.3 $3,168.5 $2,977.4

6.1%

Win2Day (Internet) $969.7 $1,107.4 $1,398.6 $1,499.9 $1,435.6

10.3%

2006 2007 2008 2009 2010 2006 2007 2008 2009 2010

100.0% 100.0% 100.0% 100.0% 100.0% $285 $304 $366 $379 $355

41.2% 43.8% 45.8% 47.3% 48.2% $117 $133 $168 $179 $171

58.8% 56.2% 54.2% 52.7% 51.8% $167 $171 $198 $200 $184

Annual Growth 5.7% 9.9% 2.4% Source: Austrian Lottery, Casinos Austria, Statistics Austria. Euros have been converted to US dollars.

As illustrated, lottery sales (including online casino gambling) grew by 4.6 percent on an average annual basis over the five-year period; however, sales through the Internet channel grew by 8.8 percent over this period. On a per-capita basis, despite the surge in Internet sales, traditional lottery sales (i.e., remainder of lottery sales, net VLTs) have grown from 2006 to 2010, albeit at an average rate of only 1 percent per annum. On a per-capita basis (based on Austrias total population of 8.27 million in 2006 to 8.39 million in 2010) and adjusted to US dollars, Austrias total lottery sales net of VLTs grew from $285 in 2006 to $355 in 2010. This growth has been driven through the Internet channel, as percapita Internet sales grew from $117 in 2006 to $171 in 2010, which is average annualized growth of 9.9 percent. Of Austrias Internet lottery sales, through 2010 over 90 percent were attributed to casino games rather than traditional lottery games. 114

114

Media & Entertainment Consulting Network, Lottery Benchmarking and Success Factors: Benchmarks, Success Factors, and Best Practices 3rd edition, September 2011.

$ per Capita

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N.

Substitution and Cannibalization Issues

There is no more hotly debated and more relevant question surrounding lottery Internet sales than whether the new channel might lead to cannibalization of existing products. All suppliers interviewed by the Task Forces Working Group have stated a common, blanket belief that there has been no cannibalization of traditional physical lottery sales in any European jurisdiction that has moved to offer an Internet lottery sales channel. This conclusion has been shared by several US lottery leaders in various testimony or dialogue with legislators and groups representing existing lottery retailers. Intuitively, the expectation that instant tickets rather than lotto games may bear a disproportional substitution-like impact from the introduction of Internet scratch tickets stands to reason. Consider the product attributes of a big-jackpot lotto game. These unique attributes cannot be substituted for by a new electronic version of the same offering. Thus, as far as the impact on lotto games is concerned, the launch of a new Internet sales channel would offer only additional sales opportunities. There would be no category cannibalization because the Internet offers no substitution. However, the product attributes of the traditional instant scratch ticket (low-tier prizes, high payout percentage, and entertaining play styles) can easily be replicated via an electronic version and, in fact, these product attributes can be substantially improved upon in electronic form. What is the relevance of this possible substitution effect? Consider that over the last 15 years, US lotteries have experienced a merchandising revolution that fundamentally changed and vastly enlarged the lottery business. This revolution has been characterized by the flip in product predominance from online, terminal-based games to instant-scratch games. Where once lottery in the United States usually meant lotto-type terminal games, today a US lottery is far more likely to be defined by instant scratch tickets. Twenty years ago most states earned far more from lotto than from instants. Ten years ago that ratio became reversed and today sales of instant tickets exceed sales of lotto games in every state. Massachusetts was at the forefront of this instant ticket revolution. The focus on the instant ticket and all of the merchandising, retailing and playerrelationship differences which flow from it is the single-biggest differentiator between the American and European lottery experiences over the last decade. By and large, European and Australian lotteries have been slower to adapt to the instant ticket merchandising revolution. Many European jurisdictions remain largely immune to the trend. The contrasts between the American and European markets are startling. In Massachusetts, sales of instant scratch tickets accounted for 69 percent of overall sales in the first quarter of 2012.115 Yet in Finland, a European country with a population similar to Massachusetts at 5.4 million, sales of instant

115

Massachusetts State Lottery sales data

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scratch tickets account for only 11 percent of overall sales. The same percentage holds for Danske Spil in Denmark, another European country with population similar to Massachusetts at 5.6 million, and SCML in Portugal, a larger country with a population of 10.6 million, earns only 4 percent of its lottery sales from the instant-scratch product. To assert with any reasonable confidence that a new product or initiative will perform in Jurisdiction A based on the performance and experience of Jurisdiction B, one must first have a clear and firm understanding of how market and lottery operational conditions in those jurisdictions differ. If, in fact, there is a substitution effect from the launch of Internet scratch tickets such that the sale of the physical scratch product would not be what they otherwise would be without the substitution, such a situation would have negligible effects on most European lottery operations. The lottery would see a dollar-for-dollar (or, more precisely, a Euro-for-Euro) substitute transaction and would benefit from facilitating the transaction via a more efficient, less expensive channel. On one hand, the European lottery retailer would be negatively impacted from the substituted sale of the instant product, but that product line only accounted for roughly 10 percent to 15 percent of its overall lottery sales to begin with. Further, the retailer could be placated as its lottery finally deploys elements of the instant ticket merchandising revolution that were earlier deployed with such sales success in the United States. Such an approach would enable the retailer to see overall growth in the instant category even after the effect of Internet substitution was applied. Although this growth from improved merchandising at bricks-andmortar retailers would likely be less it otherwise would have been without the Internet substitution, all parties are likely to be satisfied for some period. Because if draw games were not offered online substitution would likely only impact instant scratch games, which are, for European lottery operators, a minor product category and because other as yet unused merchandising strategies remained available to mitigate even these small impacts, a European operator would rationally conclude that the opportunities available to the lottery via a direct Internet sales channel should be fully and completely exploited. However, the impact of a possible substitution effect for most US lotteries would be considerably more significant given that the product line most likely to feel the effects of substitution accounts for such a larger percentage of the lotterys focus and revenue. From a strict revenue perspective, the state would not be impacted and the supplier would actually benefit. Like the European lottery, the state would realize a dollar-for-dollar substitution on the transactions and would derive financial benefit from the more efficient channel. The supplier would benefit to the extent that a portion of the 5 percent sales commission now going to the physical retailer would be redirected to the supplier as a fee for facilitating the Internet based transaction. The big impact of possible substitution in a jurisdiction which features high proportional sales of instant-scratch tickets would likely be felt operationally as customers substitute the newer, more convenient, more engaging form of a product for the older paper
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version. Accepting and preparing for the political and operational consequences of such a possible transition would no doubt be one of the largest challenges facing US lottery managers.

1. Substitution Effect in Massachusetts

In November 2011, Governor Patrick signed the Expanded Gaming Act to legalize casinos. Just a month later, the US Department of Justice issued an opinion that effectively gives the right to states to individually regulate online gambling.116 Several states have already begun drafting legislation to begin offering online gambling. 117 Illinois became the first state to introduce online lottery sales following the catalytic Department of Justice opinion, on March 25, 2012.118 Although online gambling is by no means new, this new regulatory environment is likely to be a catalyst for a significant increase online gambling availability. Just as Massachusetts begins the process of determining the sites of the future casinos, it must now also consider how to deal with the new opportunity to offer gambling online. Online gambling has many parallels to the casino debate. Both are cases in which the state government determines whether the industry can exist legally. Both industries have potential costs and benefits, many of which are not fully understood by policymakers and voters. Because the state has the responsibility to act in the best interest of its citizens, and because there are many unknowns, particularly surrounding the impacts of online gambling, a careful examination of the different issues is critical. In this chapter we consider some of the likely impacts if online gambling is introduced in Massachusetts. The major focus is on the substitution effect likely to occur with the introduction of online gambling.

a. Previous Literature
Online gambling is a relatively new phenomenon. Its popularity rose dramatically during the past decade, partially due to the popularity of the poker game no-limit Texas Holdem. Poker tournaments became popular TV material in the 2000s, and as computer technology has advanced, it has facilitated more online gambling opportunities. As with many other issues related to cutting-edge technology, the academic literature lags far behind real-world developments.

116

This exempts sports gambling, as the opinion specifies that the Wire Act applies to sports betting. See Virginia A. Seitz (2011), Whether proposals by Illinois and New York to use the Internet and out-of-state transaction processors to sell lottery tickets to in-state adults violate the Wire Act, Memorandum Opinion for the Assistant Attorney General, Criminal Division, US Department of Justice (issued 12-23-11; dated 9-20-11)
117

For a brief discussion of likely changes, see Sue Schneider (2012), Department of Justice deals a new hand in relation to online betting, Gaming Law Review and Economics 16(3): 79-80
118

Judy Keen, Illinois to become the first state to allow online lottery sales, USA Today, March 22, 2012.

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Although there are no reliable revenue data for online gambling at this early date, a previous Spectrum study prepared for the National Indian Gaming Association reported that there were almost 2,700 online gambling sites operating worldwide in 2010.119 The study reports a sharp increase in online gambling sites from 2001 through 2006. There were roughly 2,900 online gambling websites at the time the UIGEA was passed in 2006. There was then a modest decline for several years, but the trend again turned positive in 2008. There have been few published studies on the economic impacts of Internet gambling on other industries. However, we review the few studies that have been published or that are in a working stage. As a basis for this discussion, it is useful to review what is known about the interindustry relationships among more established gambling industries. This can give some insight into the likely impacts of online gambling in Massachusetts.

b. Inter-Industry Relationships
Numerous studies have examined the impacts of one gambling industry on another, but most of these studies are limited in terms of their scope and time period covered. A summary of some of the more relevant studies appears in the table below. The findings are mixed, and they suggest that the impacts on other related industries or state tax receipts depend on the industry and specific market in question. One message that is clear from the studies summarized in the table below is that the substitution effect concern is real. The introduction of a gambling industry in a state can have a negative effect on other industries and even on tax revenues. Two studies that should be of particular interest to Massachusetts are those by Borg, Mason, and Shapiro (1993) and Kearney (2005). The Borg, et al. study shows that, while lotteries may reduce revenues in other industries, the overall tax revenues to states tend to increase with the introduction of lotteries. This makes sense because states typically keep around 50 percent of all lottery ticket sales. The study by Kearney shows that lotteries do not reduce revenues in other gambling industries.

119

See p. 14, Spectrum Gaming (2010). Internet Gambling Developments in International Jurisdictions: Insights for Indian Nations. White paper produced for the National Indian Gaming Association

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Figure 29: Studies on the relationships among gambling industries

Paper Years States/Counties Findings

Anders, Siegel, and Yacoub (1998) Borg, Mason, and Shapiro (1993) Elliot and Navin (2002) Fink, Marco, and Rork (2004) Kearney (2005) Popp and Stehwien (2002) Siegel and Anders (1999) Siegel and Anders (2001) Anders, Siegel, and Yacoub (1998)

1990-96 1953-87 1989-95 1967-99 1982-98 1990-97 1994-96 1993-98 1990-96

1 county (AZ) 10 states All states All states All states 33 counties (NM) 1 state (MO) 1 state (AZ) 1 county (AZ)

Indian casinos cause a reduction in tax rev. Lotteries cause a decline in some other tax rev., but total tax rev. increases Casinos and pari-mutuels harm lotteries Net increase in lottery rev. causes a decrease in state aggregate tax rev. Lotteries do not harm other forms of gambling Indian casinos reduce county tax rev. A 10% increase in gambling tax rev. leads to a 4% decline in other tax rev. Slots harm lottery; horse and dog racing do not affect lottery Indian casinos cause a reduction in tax rev.

Source: Douglas M. Walker and John D. Jackson (2008), Do US gambling industries cannibalize each other? Public Finance Review 36(3): 308-333

A more recent study (Walker and Jackson, 2008) examined the inter-industry relationships for all states for these industries: casinos, lottery, horse racing and greyhound racing. The findings are summarized in the following table. This study was an improvement on the studies listed above because it was more comprehensive, using data on all industries in all states. But the data used are from 1985-2000. With the expansion of online gambling and the recent wave of commercial casinos in the late 2000s, these relationships could now be different. A final caveat is that, since the model incorporates data from all states during the 1985-2000 period, the specific relationships may not apply to a particular state at a particular time. The following table indicates that the industry listed in the rows affect industries in the columns in a positive way [+] or negative way [-]. Parentheses () indicate that the results were not statistically significant. For example, the lottery has a negative impact on casinos, and a positive impact on dog and horse racing. Figure 30: Summary of intrastate industry relationships
Model & Variables Casino Dog racing Horse racing Lottery Indian casino sq. ft. Source: Walker and Jackson (2008) Casino () + + Dog racing + (+) Horse racing + + + Lottery + +

Of particular interest, the results above suggest that casinos and lotteries are likely to be substitutes for each other. However, the study by Walker and Jackson (2008) does not provide any information on the degree to which the industries affect each other. These results, in combination with those indicated in the first table above, suggest that the lottery in Massachusetts may be modestly harmed by the introduction of casinos. (Again, the academic

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studies are not conclusive on this issue.) However, if there is a substitution effect, the introduction of online gambling may offset the decline in lottery revenues due to the introduction of casinos. Overall, the academic literature is not in agreement on how different gambling industries affect each other. The literature is not very informative on how online gambling affects other industries. Next we review the few studies that offer some insight on this issue.

2. Online Gambling
The American Gaming Association commissioned a white paper on online gambling in 2011. The paper discusses the legal developments that affect the availability of online gambling and it gives a general overview of the size of the industry. It does little, however, to address any substitution effects that may be relevant to the forthcoming expansion of online gambling in the United States
120

The paper by Philander (2011) is one of the few published papers that specifically examines the impact of online gambling on another gambling industry (i.e., on the casino industry).121 The paper is limited to the pre-UIGEA period (pre-2006). The study finds that each dollar increase in online gambling leads to a $0.30 reduction in commercial casino revenues. However, the results also suggest that the introduction of online gambling in a state increases the overall revenues for the state, when considering the effects of the two forms of gambling only. 122 The study does not address the impact of online gambling on other types of spending. Philander and Fiedler (2012) examine US and Canadian data on online and offline gambling, from 2009-10.123 Their data indicate that online poker and offline (casino) gambling are complementary, rather than substitutes. The data for this study are more recent and the results are, therefore, perhaps more reliable than Philanders study (2011) which uses pre-2006 data. A key concern for state lottery officials and lottery retailers is the extent to which the introduction of online gambling would affect traditional lottery ticket sales at retail outlets. This concern is justified because there is little empirical evidence on the impacts of state-sponsored online gambling. As noted earlier, Illinois became the first state to introduce online lottery sales following the revision of the Justice Departments stance on the 1961 Wire Act, in March 2012.

120

David Stewart (2011), Online gambling five years after UIGEA. Washington, DC: American Gaming Association. americangaming.org
121

Kahlil Philander, The effect of online gaming revenue on commercial casino revenue, UNLV Gaming Research & Review Journal 15(2): 23-34
122

Specifically, if a $1 increase in online gambling leads to a 30 decrease in casino revenues, then overall gambling revenues increase by 70.
123

Kahlil Philander and Ingo Fiedler (2012), Online poker in North America: Empirical evidence on its complementary effect on the offline gambling market. UNLV working paper

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It is still too soon to determine the impact the online offerings have had on traditional lottery sales.124

a. Anecdotal Evidence
It is worth examining what anecdotal evidence is available for Massachusetts. Online gambling has been available to US citizens throughout the past decade. The 2006 UIGEA did affect how online gamblers paid and got paid, and the law did force many online gambling websites to move offshore. Nevertheless, citizens in Massachusetts and elsewhere could still gamble online if they wished to. However, the sale of lottery tickets has not generally been available online throughout the country. One piece of anecdotal evidence to consider is how the Massachusetts State Lottery has performed as the popularity of online gambling has increased over the past decade. The following chart shows lottery revenues in Massachusetts and two other states for comparison.125 Figure 31: State lottery revenues, selected states, 2001-2011
$5,000 $4,000 Revenues (millions ) $3,000 MA $2,000 $1,000 $0 2001
Source: La Fleurs

GA AZ

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Although Massachusetts has one of the largest lotteries in the US, the figure indicates that revenue has been relatively flat since 2005. Over the entire 2001-11 term, lottery revenues have clearly leveled off. This trend may be due to any number of factors, including the increased availability of casino gambling and other gambling opportunities, other consumption expenditures. The increasing availability of online gambling may also be a factor, but there is no

124

The concern for lottery retailers was highlighted in a recent article. See Alexandra Berzon (2012), State up the online ante, Wall Street Journal (April 25)
125

Data source: La Fleurs Magazine annual fiscal reports, various years

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indication that the existing availability of online gambling has had a major impact on Massachusetts lottery sales. The following charts illustrate the same states lottery revenues in per-capita terms. Different states exhibit different trends, but like the US overall, per capita lottery sales in Massachusetts have been somewhat flat over the last decade. Since good online gambling data do not exist, it is difficult to ascertain exactly how online gambling may affect traditional lottery sales. Figure 32: Per-capita lottery sales, selected states, 2001-2011
$800

$700
Per capita lottery sales $600 $500 $400 $300 $200 $100 MA AZ GA US

$0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Source: La Fleurs

To the extent that online gambling and traditional lotteries are substitutes, we might have expected to see a blip in the data in 2006-07, immediately following the passage of the UIGEA, which presumably had a negative impact on online gambling, at least in the short term. Yet, no clear effect of this sort is noticeable in the data, particularly in Massachusetts. This raises doubt about the extent to which online gambling (in general) and lottery tickets are substitutes. Since there is not much empirical work on which to base ones expectations about the likely impact of online gambling in Massachusetts on casinos and other businesses there, it is worth dissecting different facets of the economic and social impacts that are possible. Prior to moving on to this discussion, several assumptions are necessary. First, it is assumed that all online gambling that occurs within the state will originate in the state. That is, online gambling will only be allowed from within the state. We also assume that the minimum-age laws will apply and can be enforced. Both of these assumptions can be met with the latest Internet technology.126
126

Dean Takahashi (2012), Spoof-proof location authentication to help legitimize mobile gambling, Venturebeat.com

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3. Experiences in Europe
As noted, evidence from existing Internet lottery jurisdictions suggests that any adverse impact upon conventional sales agents and retailers will be minimal. In the EU market, the introduction of online lottery play actually increased lottery sales in retail locations.127 This was particularly true in Finland, Italy and the UK, when overall sales and commissions increased after launching an Internet channel. Internet lottery suppliers and many national and provincial lotteries that now offer online products claim that the demographics of Internet purchasers are significantly different from traditional lottery purchasers and that introducing an Internet channel grows the total market much more than any cannibalization effect on existing sales. While it is obviously in the selfinterest of Internet lottery operators and suppliers to make this claim, the wide distribution and consistency of the research strongly indicates that the Internet lottery player is a different person than the traditional lottery player. If this is true for the majority, then online sales will add more new lottery players than they convert from traditional sales channels and Internet sales will be incremental rather than cannibalistic. GTECH cites several European examples for increased retail sales during and after the introduction of Internet sales. The most convincing example may be Finland, which first introduced online sales in 1997 and has seen retail sales grow by 1 billion since then, with 67 percent coming from traditional retail channels.128 In Britain, which introduced online sales in 2003, overall lottery sales increased by almost 2 billion and retail commissions increased by more than 8 percent. In a more recent example, Belgium introduced Internet sales in 2010 and since then overall lottery sales have increased 16 percent with 73 percent of the increase coming from retail channels.129 Scientific Games claims that retail sales grow faster for EU lotteries that have an Internet presence and argues that the online channel engages more players overall, drives many of them back to retail.130 Paddy Power notes that its retail betting shops continue to flourish even though all of the products they offer can now also be found online. 131 Betware was the only vendor to advocate a strategy for immediately moving all current instant and draw games online, citing extensive previous experience in Europe, beginning in 1996, that confirms no negative impact upon traditional retail sales of the most popular scratch off and draw products.132

127 128 129 130 131 132

MECN Lottery Benchmarking Report; Sciplay Analysis GTECH presentation before the Treasurers Online Products Task Force Working Group, April 10, 2012. Ibid. Scientific Games, Massachusetts Connected presentation, 2011. Paddy Power, MSLC Presentation, April 19, 2012. Betware, Response to Topics on Internet Gaming, April 19, 2012.

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The key factors in avoiding cannibalization of traditional retail sales appear to be a measured introduction of online products, differentiation between online and offline instant games, and the attraction of a new and younger demographic to lottery play. Another factor is the addition of an entirely new advertising channel to support retail sales. Here again insight is provided from the European experience. Marcus Geiss, Executive Board Director of Tipp24 SE, a German online lottery broker, and a speaker at GiGse 2012, maintains that online advertising works to increase retail sales: We have much advertising on our sites but only 1 percent click on the banner [advertisement]. A larger proportion, up to 20 percent of those who saw the ads, now go to the convenience store to buy lottery. Demographic studies of European lottery players demonstrate that Internet players are younger than traditional lottery players and are much more likely to use mobile devices for Internet gambling. These findings are entirely consistent with the body of research comparing Internet gamblers with land-based gamblers in Europe. They are also consistent with research conducted in the United States that profiles players under 34 years old as much more likely to download and play games to their mobile devices.133 Data supplied to Spectrum Gaming Group by two of the major European online operators support the contention that Internet sales do not necessarily cannibalize traditional bricks and mortar retail sales of the same products. The first example was supplied by Paddy Power, whose 2011 financials show that 79 percent of operating profit was generated by the fast growing online segment.134 Eamonn Toland, President of Paddy Power North America, provided data concerning the sports betting operation during the years when Internet sales were being implemented across a number of markets but principally in the UK and Ireland. Robust growth was driven by expansion into new markets. During this six-year period turnover, or volume of sales, for the sports betting group as a whole increased at a compound annual growth rate (CAGR) of 14.9 percent while gross gaming revenue (GGR) increased at a CAGR of 15.5 percent. Online volume and sales increased most rapidly, growing at 25 percent and 28 percent, respectively, but retail volume and sales also increased, although at a lower rate, with 12 percent and 13 percent CAGR, respectively. Even traditional telephone volume and sales grew prior to the Great Recession, increasing at a compound annual rate of 9 percent and 8 percent, respectively, at the same time that Internet transactions became available. Sports betting is well suited to Internet sales, as well as mobile transactions, which makes the sustained growth in retail sales and volume remarkable. The following charts illustrate the growth in sales volume and GGR for 2003-08.

133 134

Parks Associates, Trends in Digital Gaming White Paper Paddy Power, LLC, 2011 Annual Report

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Figure 33: Paddy Power sportsbook turnover (volume) 2003-2008

2,500 2,101.0 2,000 1,500 2003 2008

Millions

1,109.0
1,000 500 185.1 0 Group Online Retail Phones 177.4 913.6 694.9 551.1 297.1

Source: Paddy Power LLC

Figure 34: Paddy Power sports book gross gaming revenue (GGR) 2003-2008
800 700 600 Millions 500 400 300 200 100 0 Group
Source: Paddy Power LLC

694.9

2003 2008 297.1 224.1 144.4 94.6 13.5 Online Retail Phones 67.9 177.4

The second example, provided by Alex Kovach, Managing Director of Camelot Global Services, examines Internet lottery sales for the UK National Lottery. These data show a dip in total sales through the recessionary years 2006-09 but growth in the years thereafter. These data strongly suggest that the recession had more of an impact on retail lottery sales than did the implementation of Internet lottery sales. Internet sales have grown from nothing in fiscal 200405 to almost 4 percent of total sales in fiscal 2011-12. This chart illustrates that the strongest growth in UK National Lotterys online product sales have occurred in concert with comparable growth in retail sales.

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Figure 35: UK National Lottery retail and interactive sales growth 2003/4-2011/12 (M)
6,000

Retail

Direct

% of total
5,487.7

18% 16%

5,000 4,591.7 4,674.4 4,759.8 14% 12% 10% 8% $1,039.2 6% 4% 2% 0% 2003/4

Source: Camelot

4,567.8

4,526.5

4,000

Millions

3,000

2,000 $253.0 $343.6 $439.8 $22.9 $577.8 $690.0 $823.1

1,000

2004/5 2005/6 2006/7 2007/8 2008/9 2009/10 2010/11 2011/12

4. Substitution Effect: Understanding the Concerns

One of the major concerns about legalizing gambling, whether it is casinos or, now, online gambling, is that any additional economic activity resulting from legalized gambling comes at the expense of other industries. According to this argument, the introduction of online gambling would simply shuffle spending among industries, so that any positive employment or state revenue effects from gambling are offset by losses in existing industries, which see lower sales volumes and decreased employment. This is the substitution effect or industry cannibalization argument. Theoretically, of course, this effect is no different than standard market competition that occurs when any new business opens in a market. New firms or industries promote economic efficiency, more variety, and lower prices all of which are beneficial to consumers. Certainly it is true that casinos and online gambling may lead to reduced consumer spending on other goods and services. At the same time, however, there may be complementary industries that thrive with the introduction of casinos and online gambling. For example, the introduction of online gambling would create a new opportunity for entrepreneurs to create new software and applications for consumers. Next we consider possible scenarios for how online gambling might affect retailers and casinos in Massachusetts. We limit the consideration of impacts to existing lottery retailers and casinos because these are the firms which are most likely to see a substitution effect because the

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$91.7

4,571.3

4,761.8

4,999.3

141

products offered online would be potentially competing with the new casinos in the state and lottery tickets purchased at retail stores. Presumably, the introduction of online gambling in Massachusetts would not attract any tourists. Nor would we expect that currently Massachusetts citizens are going out of state to engage in Internet gambling. So unlike the impacts of casinos, the potential impacts of online gambling are limited to the behavior or the existing people in the state.

a. Concern: Online Gambling Expenditures Divert Expenditures Away from Other (Non-Gambling) Industries
Suppose that online gambling expenditures represent spending that would have otherwise been spent on other entertainment, such as movies or bowling, or on other goods, but not at casinos or for purchasing lottery tickets. In this case, there is no substitution effect for other gambling industries. Then, assuming the tax rate applied to online gambling is greater than the general sales tax applied to other goods and services purchased in the state, the introduction of online gambling would represent a net increase in tax revenues for the state. The amount would be the difference in tax rates multiplied by the amount of spending. The above analysis applies in the unlikely case that 100 percent of online gambling revenues represent diverted expenditures. It is very likely, however, that a substantial portion of the online gambling would represent new expenditures. The larger the proportion of new expenditures, the larger the increase in state lottery revenues or tax receipts will be. Even to the extent that the availability of online gambling diverts expenditures away from other industries, this is to be expected with the introduction of any new product or service, and does not, in itself, warrant much concern beyond that which would be shown if a new restaurant chain was to open with locations across the state. Generally, more options for consumers lead to greater overall economic well-being.

b. Concern: Online Gambling Expenditures Come at Expense of Massachusetts New Casinos

If Massachusetts introduces state-regulated online gambling, as many other states are likely to, there is obviously a concern that such an offering would harm the new casino industry in the state. Of course, the state also controls what types of gambling are allowed online and it could minimize any cannibalization of the casinos by not allowing casino games online. Still in this case, realistically, people can access online gambling, legal or not, regulated in the United States or not. One argument, then, is that if people will have access to it anyway, the state could benefit by regulating and taxing it itself. This way the state could ensure that the games are run fairly, meet other regulatory requirements, and pay taxes due. Since casinos are new, if online gambling were introduced at about the time casinos open in the state, it would be difficult to discern whether or not the online gambling is affecting the

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casinos. One recent paper on the issue (discussed earlier in this chapter) indicates that $1 of online gambling reduces casino gambling by 30 cents. If the states concern is that casino revenues are decreased, then the state could levy a tax against online gambling operators (or a fee on consumers) and use this revenue to subsidize casino owners so that the casino owners were not harmed. However, if the concern is primarily with the states tax receipts, then, as discussed earlier, online gambling taxes plus casino taxes would be greater than casino taxes alone. Finally, it is likely that online gambling would be complementary to land-based casinos. Indeed, the paper by Philander and Fiedler (2012) indicates that online and offline gambling (i.e., casinos) are complementary. This suggests that the introduction of online gambling will generate revenues but will also increase interest in casinos. Perhaps some individuals who have never been to a casino try gambling online and decide that a casino visit may be fun. Although there is not much empirical evidence on the issue, what evidence does exists indicates that online gambling probably acts as a complement to casinos. Casino customers are fairly representative of the US population.135 Roughly 60 percent of casino visitors are over the age of 50. Presumably the average age of online gamblers is significantly younger. Although 25 percent of the US population claims to have participated in casino gambling in the past year, only 1 percent have participated in online gambling. 136 If online gambling and casino gambling appeal to different demographic groups, then certainly the two industries could benefit each other. Younger people who may get their first experiences gambling online may subsequently decide to try a casino. Conversely, individuals who enjoy casino gambling may decide to try their luck at online gambling too. The limited empirical evidence suggests that the two activities tend to be complementary.

c. Concern: Online Gambling Expenditures Come at Expense of Retail Lottery Ticket Sales
State-regulated online gambling is perhaps most likely to initially offer lottery ticket sales. Since retail outlets which sell lottery tickets receive a commission on their ticket sales, these retail locations may face a loss of commissions if a large proportion of existing lottery ticket sales were to move online. There is little research to guide us in analyzing this issue. Perhaps the starting point for addressing this possibility is to acknowledge the likely demographic differences between online gamblers and people who buy lottery tickets at retail locations. As noted above, online gamblers are more likely to be young. They are also perhaps more likely to be going to the lottery website specifically to be buying lottery tickets. Whereas, a sizable proportion of retail lottery ticket sales may be spontaneous. In any case, as with casinos,
135 136

American Gaming Associations State of the States 2011, pp. 27-37 State of the States 2011, p. 25

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online gamblers may largely be a different demographic group that retail ticket purchases. This fact suggests that there will not be a significant substitution effect between online and retail lottery tickets. From the perspective of lottery revenues, the introduction of online gambling will almost certainly increase the total lottery ticket sales because the introduction of online gambling provides a new opportunity that did not exist before. So the states total revenues from the Lottery will almost surely increase with the introduction of online lotto. As with the previous analysis of casinos, one could argue that some people may try lotto online for the first time, and subsequently decide to occasionally buy lottery tickets at retail outlets. In this situation, retailers benefit from the introduction of online gambling. Perhaps equally as likely, however, is the possibility that instead of going to the local gas station, lotto players decide to order their tickets online. This would reduce retail lotto sales and therefore the commissions received by the retailers. There is no good way of estimating the likely degree of substitution between the two options for purchasing lottery tickets. If there is a great concern that the introduction of online lottery tickets would significantly reduce retail sales of tickets, the state could implement any variety of policies that could offset any losses to retailers. Several possibilities include: Increase the commission rate paid to lottery retailers at a rate that meets or exceeds the expected or calculated degree of substitution. This could be done by examining the trend in sales at retail locations to estimate how online sales are affecting retail sales. Charge a fee to consumers for online purchases and use the fee receipts to subsidize lottery retailers. This policy would have the additional effect of increasing the relative price of online tickets, which may steer some consumers to purchase from retailers instead of online. However, if the Internet is a convenience compared to going to a retail location, consumers should be willing to pay a small fee for the convenience. If the online lottery ticket customers location can be determined, the lottery could pay a commission to the nearest retail lottery ticket seller (or nearest group of retail sellers) for each online ticket purchase. This policy would presumably eliminate any commission losses borne by retailers.137 Allow consumers to designate a preferred retailer who receives commissions going forward on all online product purchases. For consumers who do not to designate a preferred retailer, use standard commission to create a pool for reimbursing all retailers on a pro-rated basis based on sales of specific products. (Loto-Quebec model)

137

Russell Sobel, Visiting Scholar, Adjunct Professor, College of Charleston.

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Utilize a pre-paid card available for sale only at Lottery retail locations to fund all online product purchases. (Delaware and Georgia model)

The introduction of any new good or service would, theoretically, lead to an increase in consumer spending. Since lottery tickets and casino games are already offered in the state (or will be soon, in the case of casinos), it is unclear the extent to which the introduction of online gambling will increase overall consumers spending. It is likely to be a positive impact, of course, but it is difficult to estimate the net impact in advance of actual experience.

5. Substitution, Cannibalization: Summary

We have considered some of the positive economic impacts that are typically linked to the introduction of casinos. These impacts are less likely to follow the introduction of online gambling. This suggests that increased tax revenues (or, for the Lottery, profits for local aid) for the state are the likely primary benefit from the introduction of online gambling. Since other states and jurisdictions are likely to begin offering online gambling, and since such opportunities already exist offshore, the issue is this: Massachusetts can capture tax dollars that would otherwise be going outside the state through the introduction of online gambling. This policy change would be unlikely to have any significant negative impacts on other industries, and would not likely significantly increase the overall amount of gambling in the state. The introduction of online gambling is going to affect casinos and the traditional lottery. From the states perspective, the goal should be to optimize tax revenues from the combination of legalized gambling offered in the state. As new technologies are introduced and as markets develop, some firms or industries may see losses, but this is how markets work. Each firm and industry must try to remain competitive to fight for consumers business. Online gambling in the United States is still relatively new and presents challenges for existing gambling industries. But the introduction of new goods and services, and newer technologies almost always increases standards of living. So policymakers should not seek to prevent such changes, but rather determine the optimal way to guide them toward the benefit of the citizens. Given the recent academic literature which relies on the most recent data, we can summarize as follows: Different forms of gambling may act as substitutes or complements, depending on the industries and jurisdictions. Online gambling has the potential to be complementary to offline gambling. In the worst case, the introduction of online gambling acts as a modest substitute, but leads to a net increase in total gambling revenues.

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O.

Projecting Massachusetts Lottery Sales

Through FY2012 (fiscal year ended June 30) the Massachusetts State Lottery had annual sales of $4.74 billion, or per-capita sales of approximately $717. Over the last 10 years (20032012) average per-capital sales were $689, while over the last five years average per-capita sales were $694. The following table shows total/average annual sales data for the Lottery, along with state population estimates and derived per-capita sales figures over the last 10 years. Figure 36: Massachusetts State Lottery total and per-capita sales, 2003-2012
FY 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2003-2012 2008-2012 Lottery Sales ($M) $4,204.6 $4,381.8 $4,482.9 $4,524.1 $4,460.8 $4,709.3 $4,442.9 $4,423.7 $4,428.0 $4,741.4 $4,480.0 $4,549.1 Population (M) 6.408 6.428 6.447 6.467 6.487 6.507 6.527 6.547 6.578 6.608 6.500 6.554 Per-Capita Sales $656 $682 $695 $700 $688 $724 $681 $676 $673 $717 $689 $694

Source: Massachusetts State Lottery

Next, we show Lottery sales projections annually through FY2017 under three distinct scenarios, along with three cases for each scenario (i.e., low-case, expected, and high-case). The following are the scenarios and a brief description of each: Status-quo assumes no lottery Internet sales through 2017. Essentially, total lottery sales are projected for future years based on assumptions related to per-capita sales projections, coupled with inflationary growth. Phased Engagement Strategy assumes phased Internet sales initiatives in sixmonth increments effective FY2014. This includes five phases: Phase 1, New Casual & Social Games effective July 1, 2013 (FY2014) Phase 2, Lotto & keno effective January 1, 2014 (FY2014) Phase 3, Draw-based Games effective July 1, 2014 (FY2015) Phase 4, Instant & Scratch Games effective January 1, 2015 (FY2015) Phase 5, Red & Casino Style Games effective July 1, 2015 (FY2016) All Internet Initiatives effective July 1, 2013 assumes launch of the five phases simultaneously, effective FY2014.

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Assumptions We assume the FY2012 sales per-capita value is the benchmark to apply in our forwardlooking sales projections (under each of the three scenarios presented). The US Congressional Budget Office forecasts growth in the Consumer Price Index by calendar year, while we utilize this measure as our inflation-adjustment mechanism in projections (i.e., applicable to the FY2012 sales per-capita result). In June 2012 the following projections were issued: Figure 37: Forecasted CPI growth, through 2017
CY 2012 2013 2014 2015 2016 2017 2012-17 Growth in CPI (Percent) 1.7% 1.4% 1.4% 1.7% 2.0% 2.2% 1.7%

Source: US Congressional Budget Office, The 2012 Long-Term Budget Outlook, June 5, 2012.

We rely on population projections from our demographic software package (Demographicsnow.com) that has projections through 2016, along with US Census population estimates as of 2000 and 2010, while we apply relative growth rates (between 2010 and 2016 figures) to estimate population totals in Massachusetts for 2011-2015 and 2017. We assume Internet sales initiatives are impacted by a ramp-up period. We assume that the first full year of each Internet sales initiative achieves 70 percent of its potential sales (i.e., discounted), second full year of respective Internet sales are at 85 percent of potential sales, while the third year (and beyond) of respective Internet sales are at full potential. For all three scenarios, our expected-case projections are primarily based on a fixed set of per-capita sales projections (for both traditional and Internet sales) from running our model through 10,000 iterations for each of three scenarios.138 As such, each input-variable in the respective model is assigned a random value (within our pre-determined range of acceptability) in each iteration of our model; therefore, we yield a dynamic result set. The following table illustrates values we utilized for 11 input-variables within our model. Importantly, the distribution of each value is uniform, so all values between the lowcase and high-case have an equal chance of occurring in each iteration of model.

138

To yield dynamic revenue projections, Spectrum applied what if analysis to 11 input-variables (assumptions), which allows for application of a variety of low and high boundaries/ranges to the variable set, the inputs, that we deemed acceptable and then run the model based on 10,000 iterations of our model for each scenario. As such, each input-variable in the respective model is assigned a random value (within our pre-determined range of acceptability) in each iteration of our model. This provides for a comprehensive output range, as well as the most likely outcome (or expected result), along with low-case and high-case results defined by the standard deviation (below and above our expected case, respectively).

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Figure 38: Per-capita sales and cannibalization assumptions

Scenario/ Phase All Scenarios Phase 1 Phase 2 Phase 3 Phase 4 Phase 5 Description Traditional Sales (Sales per capita) New & Social Games (Sales per capita) New & Social Games (Cannibalization of traditional sales) Lotto & keno (Sales per capita) Lotto & keno (Cannibalization of traditional sales) Draw Games (Sales per capita) Draw Games (Cannibalization of traditional sales) Instant & Scratch Games (Sales per capita) Instant & Scratch Games (Cannibalization of traditional sales) Red & Casino Style Games (Sales per capita) Red & Casino Style Games (Cannibalization of traditional sales) Low case $681.58 $9.00 0.00% $22.50 22.50% $22.50 22.50% $45.00 30.00% $67.50 22.05% Expected case $717.49 $10.00 0.00% $25.00 25.00% $25.00 25.00% $50.00 33.40% $75.00 25.00% High case $753.33 $11.00 0.00% $27.50 27.50% $27.50 27.50% $55.00 36.70% $82.50 27.50%

Source: Spectrum Gaming Group

Cannibalization of traditional sales assumes that the indicated percentage of Internet sales may be cannibalization of traditional lottery sales (e.g., in Phase 5 at expected-case we assume that of the $75 in Internet sales per capita, 25 percent of this amount would come from traditional sales, and thereby reduced traditional sales per capita by such amount). To our knowledge, there is no empirical data, studies, and/or results available that are applicable to this study and our modeling (re: cannibalization effects to traditional lottery sales from introduction of various forms of Internet sales); therefore, the cannibalization rates we apply in our modeling are based on the collective thoughts of the Spectrum Gaming Group team assigned to this project.

1. Lottery Sales Projections Status-quo

Under the status-quo scenario, the following table shows our Lottery sales projections from FY2013 through FY2017 (along with FY2012 preliminary, actual results), at our low, expected and high cases, along with the compound annual growth rate (CAGR).

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Figure 39: Massachusetts State Lottery sales projections at status-quo

Scenario: (Total Sales $M) Period FY12 FY13 FY14 FY15 FY16 FY17 CAGR (2012-17) Traditional Sales $4,741.4 $4,717.6 $4,805.9 $4,910.4 $5,031.9 $5,166.5 1.7% LOW Internet Sales $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 n/a Internet Sales $0 $0 $0 $0 $0 $0 n/a Total Lottery Sales $4,741.4 $4,717.6 $4,805.9 $4,910.4 $5,031.9 $5,166.5 1.7% Total Lottery Sales $717 $711 $721 $733 $747 $764 1.3% Traditional Sales $4,741.4 $4,859.1 $4,950.1 $5,057.6 $5,182.8 $5,321.4 2.3% Traditional Sales $717 $732 $742 $755 $770 $787 1.9% EXPECTED Internet Sales $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 n/a Internet Sales $0 $0 $0 $0 $0 $0 n/a Total Lottery Sales $4,741.4 $4,859.1 $4,950.1 $5,057.6 $5,182.8 $5,321.4 2.3% Total Lottery Sales $717 $732 $742 $755 $770 $787 1.9% Traditional Sales $4,741.4 $4,997.7 $5,091.3 $5,201.9 $5,330.6 $5,473.2 2.9% Traditional Sales $717 $753 $763 $776 $792 $809 2.4% HIGH Internet Sales $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 n/a Internet Sales $0 $0 $0 $0 $0 $0 n/a Total Lottery Sales $4,741.4 $4,997.7 $5,091.3 $5,201.9 $5,330.6 $5,473.2 2.9% Total Lottery Sales $717 $753 $763 $776 $792 $809 2.4%

(Per-capita $) Traditional Period Sales FY12 $717 FY13 $711 FY14 $721 FY15 $733 FY16 $747 FY17 $764 CAGR (2012-17) 1.3% Source: Spectrum Gaming Group

As illustrated, under our expected-case scenario we project Lottery sales could grow to $5.32 billion in FY2017, or at a CAGR of 2.3 percent from the FY2012 level, while respective sales per capita could grow to $787 in FY2017, or a CAGR of 1.9 percent. In summary, we believe it is reasonable to assume that Massachusetts State Lottery sales could grow to approximately between $5.17 billion and $5.47 billion in 2017 (from $4.74 billion in FY2012). This is primarily based on the application of projected population and inflationrelated growth to actual FY2012 per-capita sales results (where low-case and high-case is predicated on the standard deviation resulting from 10,000 iterations of our model).

2.

Lottery Sales Projections Phased Engagement Strategy

Under the phased engagement strategy scenario, the following table shows our Lottery sales projections from FY2013 through FY2017 (along with FY2012 preliminary, actual results), at our low, expected and high cases.

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Figure 40: Massachusetts State Lottery sales projections under phased Internet engagement strategy
Scenario: (Total Sales $M) Period FY12 FY13 FY14 FY15 FY16 FY17 CAGR (2012-17) Traditional Sales $4,741.4 $4,717.6 $4,797.7 $4,820.1 $4,795.9 $4,879.7 0.6% LOW Internet Sales $0.0 $0.0 $103.6 $427.5 $1,015.6 $1,216.7 n/a Internet Sales $0 $0 $16 $64 $151 $180 n/a Total Lottery Sales $4,741.4 $4,717.6 $4,901.4 $5,247.6 $5,811.5 $6,096.4 5.2% Total Lottery Sales $717 $711 $735 $783 $863 $901 4.7% Traditional Sales $4,741.4 $4,859.1 $4,935.1 $4,952.2 $4,916.1 $4,998.1 1.1% Traditional Sales $717 $732 $740 $739 $730 $739 0.6% EXPECTED Internet Sales $0.0 $0.0 $108.0 $440.6 $1,045.6 $1,253.3 n/a Internet Sales $0 $0 $16 $66 $155 $185 n/a Total Lottery Sales $4,741.4 $4,859.1 $5,043.1 $5,392.7 $5,961.8 $6,251.4 5.7% Total Lottery Sales $717 $732 $756 $805 $886 $924 5.2% Traditional Sales $4,741.4 $4,997.7 $5,074.0 $5,085.8 $5,037.9 $5,118.1 1.5% Traditional Sales $717 $753 $761 $759 $748 $757 1.1% HIGH Internet Sales $0.0 $0.0 $112.5 $453.6 $1,075.8 $1,290.1 n/a Internet Sales $0 $0 $17 $68 $160 $191 n/a Total Lottery Sales $4,741.4 $4,997.7 $5,186.4 $5,539.4 $6,113.7 $6,408.2 6.2% Total Lottery Sales $717 $753 $778 $827 $908 $947 5.7%

(Per-capita $) Traditional Period Sales FY12 $717 FY13 $711 FY14 $719 FY15 $719 FY16 $712 FY17 $721 CAGR (2012-17) 0.1% Source: Spectrum Gaming Group

As illustrated, under our expected-case we project Lottery sales could grow to $6.25 billion in FY2017, or CAGR of 5.7 percent from the FY2012 level, while respective sales per capita could grow to $924 in FY2017, or CAGR of 5.2 percent. In this scenario the vast majority of sales growth (total and per-capita) is driven by Internet sales, as we project traditional lottery sales would have CAGR of 1.1 percent through 2017, with CAGR for per-capita sales growing by less than 1 percent. In summary, we believe it is reasonable to assume that Lottery sales could grow to approximately $6.1 billion to $6.4 billion in 2017 (from $4.74 billion in FY2012). In FY2017 we project traditional lottery sales would range from $4.88 billion to $5.12 billion, while Internet sales initiatives would yield from $1.22 billion to $1.29 billion. The following table shows our projected sales results by fiscal year with sales detail for each phase, under our expected case.

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Figure 41: Massachusetts State Lottery sales projections, by type, under phased Internet engagement strategy
New & Social Games $0.0 $0.0 $48.0 $59.6 $71.8 $73.7 n/a New & Social Games $0 $0 $7 $9 $11 $11 n/a Instant & "Scratch" Games $0.0 $0.0 $0.0 $122.6 $278.2 $341.0 n/a Instant & "Scratch" Games $0 $0 $0 $18 $41 $50 n/a "Red" & Casino Style Games $0.0 $0.0 $0.0 $0.0 $377.0 $470.0 n/a "Red" & Casino Style Games $0 $0 $0 $0 $56 $69 n/a Total Lottery Sales $4,741.4 $4,859.1 $5,043.1 $5,392.7 $5,961.8 $6,251.4 5.7% Total Lottery Sales $717 $732 $756 $805 $886 $924 5.2%

(Total Sales $M) Period FY12 FY13 FY14 FY15 FY16 FY17 CAGR (2012-17)

Traditional Sales $4,741.4 $4,859.1 $4,935.1 $4,952.2 $4,916.1 $4,998.1 1.1%

Lotto & Keno $0.0 $0.0 $60.0 $135.8 $166.0 $184.3 n/a

Draw Games $0.0 $0.0 $0.0 $122.6 $152.6 $184.3 n/a

Internet Only $0.0 $0.0 $108.0 $440.6 $1,045.6 $1,253.3 n/a

(Per-capita $) Traditional Period Sales FY12 $717 FY13 $732 FY14 $740 FY15 $739 FY16 $730 FY17 $739 CAGR (2012-17) 0.6% Source: Spectrum Gaming Group

Lotto & Keno $0 $0 $9 $20 $25 $27 n/a

Draw Games $0 $0 $0 $18 $23 $27 n/a

Internet Only $0 $0 $16 $66 $155 $185 n/a

3. Lottery Sales Projections All Internet Initiatives Effective July 1, 2013

Under the scenario in which all Internet phases are effective July 1, 2013, the following table shows our Lottery sales projections from FY2013 through FY2017 (along with FY2012 preliminary, actual results), at our low, expected and high cases.

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Figure 42: Massachusetts State Lottery sales projections, all Internet phases effective July 1, 2013
Scenario: (Total Sales $M) Period FY12 FY13 FY14 FY15 FY16 FY17 CAGR (2012-17) Traditional Sales $4,741.4 $4,717.6 $4,601.4 $4,658.9 $4,728.6 $4,855.4 0.5% LOW Internet Sales $0.0 $0.0 $861.4 $1,058.0 $1,273.8 $1,306.6 n/a Internet Sales $0 $0 $129 $158 $189 $193 n/a Total Lottery Sales $4,741.4 $4,717.6 $5,462.8 $5,716.9 $6,002.3 $6,162.0 5.4% Total Lottery Sales $717 $711 $819 $853 $892 $911 4.9% Traditional Sales $4,741.4 $4,859.1 $4,720.0 $4,775.3 $4,842.9 $4,972.8 1.0% Traditional Sales $717 $732 $708 $713 $719 $735 0.5% EXPECTED Internet Sales $0.0 $0.0 $888.1 $1,090.8 $1,313.2 $1,347.1 n/a Internet Sales $0 $0 $133 $163 $195 $199 n/a Total Lottery Sales $4,741.4 $4,859.1 $5,608.2 $5,866.0 $6,156.1 $6,319.9 5.9% Total Lottery Sales $717 $732 $841 $875 $914 $934 5.4% Traditional Sales $4,741.4 $4,997.7 $4,838.5 $4,891.5 $4,957.0 $5,090.0 1.4% Traditional Sales $717 $753 $725 $730 $736 $753 1.0% HIGH Internet Sales $0.0 $0.0 $915.1 $1,123.9 $1,353.1 $1,388.0 n/a Internet Sales $0 $0 $137 $168 $201 $205 n/a Total Lottery Sales $4,741.4 $4,997.7 $5,753.6 $6,015.4 $6,310.1 $6,478.0 6.4% Total Lottery Sales $717 $753 $863 $898 $937 $958 5.9%

(Per-capita $) Traditional Period Sales FY12 $717 FY13 $711 FY14 $690 FY15 $695 FY16 $702 FY17 $718 CAGR (2012-17) 0.0% Source: Spectrum Gaming Group

As illustrated, under our expected-case scenario we project Lottery sales could grow to $6.32 billion in FY2017, or CAGR of 5.9 percent from the FY2012 level, while respective sales per-capita could grow to $934 in FY2017, or CAGR of 5.4 percent. In this scenario the vast majority of sales growth (total and per-capita) is driven by Internet sales, as we project traditional lottery sales would have CAGR of one percent through 2017, with CAGR for percapita sales growing 0.5 percent. Our modeling indicates that total lottery sales between FY2014 and FY2017 would be $1.29 billion to $1.31 billion greater under this scenario (all Internet initiatives effective FY2014) when compared to our projections under the phased engagement strategy. In summary, we believe it is reasonable to assume that Lottery sales could grow to approximately $6.2 billion to $6.5 billion in 2017 (from $4.74 billion in FY2012). In FY2017 we project traditional lottery sales would range from $4.86 billion to $5.09 billion, while Internet sales would yield from between $1.31 billion and $1.39 billion. The following table shows our projected sales results by fiscal year with sales detail for each phase, under our expected-case scenario.

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Figure 43: Massachusetts State Lottery sales projections, all Internet phases effective July 1, 2013, by type
New & Social Games $0.0 $0.0 $48.0 $59.6 $71.8 $73.7 n/a New & Social Games $0 $0 $7 $9 $11 $11 n/a Instant & "Scratch" Games $0.0 $0.0 $240.0 $294.6 $354.7 $363.8 n/a Instant & "Scratch" Games $0 $0 $36 $44 $53 $54 n/a "Red" & Casino Style Games $0.0 $0.0 $360.0 $441.9 $532.0 $545.7 n/a "Red" & Casino Style Games $0 $0 $54 $66 $79 $81 n/a Total Lottery Sales $4,741.4 $4,859.1 $5,608.2 $5,866.0 $6,156.1 $6,319.9 5.9% Total Lottery Sales $717 $732 $841 $875 $914 $934 5.4%

(Total Sales $M) Period FY12 FY13 FY14 FY15 FY16 FY17 CAGR (2012-17)

Traditional Sales $4,741.4 $4,859.1 $4,720.0 $4,775.3 $4,842.9 $4,972.8 1.0%

Lotto & Keno $0.0 $0.0 $120.0 $147.3 $177.3 $181.9 n/a

Draw Games $0.0 $0.0 $120.0 $147.3 $177.3 $181.9 n/a

Internet Only $0.0 $0.0 $888.1 $1,090.8 $1,313.2 $1,347.1 n/a

(Per-capita $) Traditional Period Sales FY12 $717 FY13 $732 FY14 $708 FY15 $713 FY16 $719 FY17 $735 CAGR (2012-17) 0.5% Source: Spectrum Gaming Group

Lotto & Keno $0 $0 $18 $22 $26 $27 n/a

Draw Games $0 $0 $18 $22 $26 $27 n/a

Internet Only $0 $0 $133 $163 $195 $199 n/a

We believe the examples from these three states render the direct impact of casinos on lottery sales as very minimal, or even inconclusive. This macro-based analysis cannot adequately capture every aspect of impact on lottery sales occurring via externalities, especially the introduction and/or expansion of online gambling in the same jurisdiction. Some externalities may be variations in marketing and/or advertising initiatives, distribution channels, games offered, demographics, macro-economic conditions, competition in neighboring jurisdictions, etc. Additionally, the lottery does not operate in a vacuum so there may be similar externalities impacting other organizations (either complementary and/or competing) that rely upon discretionary income (as does the lottery).

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P.

Online Lottery Products

The key to successfully enter the Internet market will be the attractiveness and quality of online products. This holds true from both revenue and a popularity (or site visitation) viewpoints. Currently, the Massachusetts State Lottery website is popular for checking winning numbers. Lottery sites are among the most frequently visited on the Internet but they also reflect some of the shortest visitation. For example, the Illinois Lottery site ranked second among the top 100 gambling-related sites worldwide for 2012, largely on the basis of high visitation during the run up to the largest Mega Millions jackpot in history. 139 However, due to the implementation of Internet sales for these lotto products, traffic on the Illinois Lottery, although declining precipitously after the record setting $650 million Mega Millions jackpot hit, traffic rankings have continued to increase every month thereafter since implementing online sales. Figure 44: Monthly traffic rankings for Illinoislottery.com, October 2011 through August 2012
10/11 11/11 12/11 01/12 02/12 03/12 04/12 05/12 06/12 07/12 08/12 0 2,000 4,000 Traffic Ranking 6,000 8,000 10,000 12,000 14,000 13,736 12,861 12,369 11,937 2,479 2,227 2,176 2,149 1,359 1,511

16,000
Source: www.ranking.com

14,421

1. Social Games
Social gaming is a broad category with varying definitions. At the Global iGaming Summit and Expo (GiGse) held in San Francisco in April 2012, one of the questions most frequently asked of panelists in this field was Can you define social? Few experts in the field could satisfactorily answer that question. Social games are generally played against others via a social network or on a social media platform. By nature they are multi-player games, and some
139

iGaming Business North America, data provided by Casino City Press

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even massively multi-player online (MMO) games. Many social games incorporate peer-topeer competition on contests that could be considered games of skill, but many others clearly constitute games of chance that would be potentially permissible under the Massachusetts State Lotterys charter. To provide some scope to the size of this market, on October 4, 2012 Facebook said that it had had surpassed 1 billion users140 and half of them are estimated to play some type of social game.141 Social media platforms are also actively embracing casino games and poker, although in the United States these games are restricted to free or subscription play. A 2011 study by Information Solutions Group showed that in the United States and the UK alone there are an estimated 118.5 million social gamers spending more than 15 minutes per week playing social games, and two-thirds (81 million) play social games daily. 142 Those figures break out into 98 million active players in the United States and 20 million in the UK.143 Today, the top five casino games played on Facebook are Double Down, Bingo Blitz, Best Casino, Slotomania, and Texas Holdem. These five casino-style games on a single platform attract a total of 11,240,000 daily active users.144 Social casino sites throughout the United States attracted a total of 35.4 million monthly players in 2012.145 Due to this huge number of players, commercial casino operators and equipment manufacturers have become interested in real-money social gaming, as witnessed by IGTs $500 million acquisition of Double Down Casino in January 2012. 146 Monetized social games are reliably estimated to be a $1.6 billion dollar industry worldwide in 2012.147 North America represents the largest single market for monetized social gaming, generating 41 percent of the total, or $660 million in revenue, followed by Europe with 28 percent, or $446 million, and Asia with 19 percent, or $311 million.148

140

A Billion Users Raise Stakes at Facebook for Revenue, Somini Sengupta and Nick Bilton, The New York Times, October 4, 2012
141 142 143 144 145 146

Social Media Platforms for Gaming and Gambling, Online Casino Reports, October 13, 2012 2011 PopCap Games Social Gaming Research, Information Solutions Group Ibid. Social Media Platforms for Gaming and Gambling, Online Casino Reports, October 13, 2012 SuperData, Social Casino Metrics: Industry Trends & Analyses, August, 2012

Benefits touted to IGT acquisition of Double Down Interactive, Howard Stutz, Las Vegas Review-Journal, January 14, 2012
147 148

SuperData, Social Casino Metrics: Industry Trends & Analyses, August, 2012 Ibid.

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Figure 45: Social casino global revenues

Source: SuperData

Recent data document robust growth in social gaming behavior, clearly related to the rise in popularity of online social media. According to a 2011 study, 42 percent of Internet users played a social media game in the last three months, up from 28 percent a year earlier.149 Some 26 percent of the social game players purchased virtual currency with real money.150 In 2011, Facebook earned $470 million in revenue from the sale of Facebook Credits, its exclusive virtual currency.151 This rapid growth in social networks and social gaming is expected to continue as smartphone adoption among US consumers continues to increase. Beyond its communication and expression benefits, social media have become an important resource for casual entertainment, offering games that range from virtual farming to zombie eradication and include board games, poker and casino games including tables and slots.152 Within this emerging field, many intellectual property holders and other entities have sought to create their own social games. Poker is fundamentally a social game since it is played at a table among friends or competitors, or both. Social casinos such as Zynga and Double Down see some of their strongest participation statistics with Texas Holdem and other varieties of poker.153 Social gaming is also
149 150 151

2011 PopCap Games Social Gaming Research, Information Solutions Group Ibid.

Getting to 'Game On' for Social Media Developers, Richard Raysman and Peter Brown, NY Law Journal, July, 2012
152 153

Ibid. SuperData Social Casino Metrics: Industry Trends & Analyses, August, 2012.

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one of the fastest growing mobile gaming applications, second only to sports betting in terms of mobile penetration. Social gaming also appeals most strongly to the younger and more mobile demographic. A PopCap study documented an increase in social gaming participation for among the 18-29 age group, resulting in a reduction of the average age for a social game player from 43 to 39 years between 2010 and 2011.154 Two predominant models have developed in social gaming, both usually associated with a freemium site in which multiple free-play games are offered but players can choose to spend real money on the games if they so desire. These sites are also referred to as free play, or F2P, sites. Play is monetized either through subscriptions, as with Caesars popular Slotomania site on Facebook, or through the purchase of premium amenities, advanced features, or enhanced functionality designed to convey an advantage in game play, as well as associated premium services.155 Although playing slot machines for money on Facebook should run afoul of the Unlawful Internet Gambling Enforcement Act of 2006 (UIGEA), when a subscription model is utilized the transaction is entirely legal. The user is deemed to be purchasing time on device and does not receive real money for hitting winning outcomes on a wager. According to a 2012 study by the Casual Games Association, F2P revenue is growing at a faster rate than subscription play and F2P revenue exceeded subscription for the first time in 2011 as daily and monthly active users (DAU/MAU) were incentivized to convert to real-money play. While participation numbers for social gaming are astronomical, earnings are currently miniscule on a per-player basis. The standard industry metrics of average revenue per user (ARPU) and average annual revenue per paying user (AARPU) are almost always below $10 and often below $5, and the conversion rate for freemium sites to for money play ranges between 2 percent and 4 percent and is often below 2 percent depending on the popularity of the site.156 Thus social casino estimated global revenues of $1.6 billion pales in comparison to Internet gambling sites, which posted more than $32 billion in 2012 worldwide. However, social casinos are in many ways a training ground, or a farm system, for Internet gambling sites and land-based casinos as well as Internet lotteries. Social games are important to Internet lottery for a number of reasons: They offer the opportunity to vastly increase the popularity of a lottery website. They increase the length of time that visitors spend there, changing the lottery website from a place where customers go briefly to find the daily numbers to a destination where customers can also spend time playing more experiential games in a social setting.

154 155 156

2011 PopCap Games Social Gaming Research, Information Solutions Group. Freemium Gaming Metrics 2012, Casual Games Sector Report, Casual Games Association. SuperData, Social Casino Metrics: Industry Trends & Analyses, August, 2012.

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Free-play versions of online lottery products allow trial play and adoption for new online products. Conversion from free play to real-money play adds a new revenue stream for the Lottery. Social gaming is one of the fastest growing mobile gambling applications and can readily be transferred to mobile devices. Social gaming is most popular among 18-25 year olds, the demographic category least represented among regular Massachusetts State Lottery players.157 The highly experiential nature of social games affords the Lottery one of the best vehicles by which to evolve from solely transactional products to a combination of transactional and experiential online products. The attributes that make social games so much fun to play can be assimilated by game developers into new draw-based games which will remain games of chance while offering a more fulfilling experience, and more time on the game, than traditional draw and scratch products.

157

Annual Tracking Survey & Brand Assessment, SocialSphere, May 8, 2012

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Q.

Gaming vs. Gaming: Two Industries Converge

For several decades, two distinct industries have operated in parallel universes, both referring to themselves as the gaming industry. In one universe, for example, there is the American Gaming Association, a trade organization founded in 1995, which represents the interests of the commercial casino industry. In that same universe are government agencies such as the New Jersey Division of Gaming Enforcement, founded in 1977, which regulates the casino industry in Atlantic City. At the same time, another gaming industry sometimes referred to as the games industry has operated as a provider of everything from video and arcade games to online social games. The prospect and promise of online wagering, however, has put these two industries on the path of convergence. Technologies and the changing political and legal landscape have been quickly removing the distinctions between these hitherto separate industries. The clearest example of this convergence can be found in the evolving offerings of Zynga, the leader in the social gaming sphere, which is aggressively developing casino-style games for its non-casino customer base, which is huge by any reasonable standard. Texas Holdem Poker, a Zynga game on Facebook, has 35.2 million monthly active users. 158 A recent Zynga press release noted: As Zyngas second mobile casino game, Zynga Slots brings the thrill of Las Vegas slot machines to the palm of players hands while introducing social elements for players to share the excitement with their friends, said Justin Cinicolo, vice president, Zynga Mobile.159 At the same time that Zynga is moving into casino-style games, casino operators have begun moving in the opposite direction. Caesars Entertainment and Electronic Arts Inc. have developed a mobile gaming application called the World Series of Poker by EA, leveraging Caesars World Series of Poker. The Las Vegas Sun wrote: The WSOP app is the latest to join a virtual strip of Las Vegas gaming companies jumping into the social gaming business. Some companies, including the owners behind Station Casinos, are hoping their brands will move into real money games as online gambling laws allow.160 While social gaming is demonstrating growth in the number of users, it has not demonstrated a serious challenge to online wagering in terms of dollar value. The following chart, developed by blogger and author Tyler York, who focuses on online games, illustrates this disparity.

158 159

AppData.com.

Zynga Takes Players for a Spin With New Mobile Game for iPhone, iPad and iPod Touch: Zynga Slots, June 15, 2012.
160

New WSOP app continues social gaming trend, Ron Sylvester, Las Vegas Sun, July 11, 2012.

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Figure 46: Monetized social gaming and online gambling growth ($ in billions)
$40 $35 $30 $25 $20 $15 $10 $5 $0.2 $0 2007 2008 2009 2010 2011E 2012E $0.7 $1.8 $18.3 Social gaming Online gambling $25.8 $22.9 $30.3 $33.6 $34.8

$3.7

$4.9

$6.2

Source: Inside Social Games, H2 Gambling Capital, Casual Games Association

York has identified a serious weakness in the business model of social gaming: It leaves the user with very little incentive to ever pay, and even today, on average only 2.5 percent of users pay in a casual social game. This is a big part of why social game companies suffer from poor monetization that hamstrings their development and user acquisition budgets.161 According to York, the disparity reveals a serious weakness in the business model of development and user acquisition budgets. Moving to mobile hasnt helped developers fortunes. Less than 30 percent of mobile users ever pay for an in-app purchase. This has contributed to a staggering 60 percent of developers that never break even on the iOS app store (referring to Apples mobile application store). That disparity between users and revenue is one reason why companies such as Zynga can be expected to move into legal online gambling within the next several months. Indeed, Zynga has stated it plans to enter this arena, pending regulatory approval, in 2013. The convergence of gambling and gaming (gaming meets gaming) presents challenges for suppliers on both sides of this divide. For traditional gambling suppliers, it means new, powerful competition. For the non-traditional, game-oriented providers such as Zynga, it means they must pay attention to such issues as licensability. For the Massachusetts State Lottery, however, it means:
161

Social Gaming + Gambling: An Intersection of Opportunity. http://gamasutra.com/blogs/TylerYork/20120711/173932/Social_Gaming__Gambling_An_Intersection_of_Opport unity.php (accessed November 4, 2012)

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Greater competition among suppliers to produce the more creative, attractive games. An enhanced opportunity to attract broader, younger demographics.

1. Demographics of Gaming
The growing convergence between gambling and social gaming means a likely convergence in the demographics as well, and that is generally good news for the Massachusetts State Lottery, since it increases the likelihood of expanding the demographic reach of lottery products. Inside Network Research released a survey in June of 385 respondents who were qualified to participate on the basis of: If they own or have access to an iPhone, iPod Touch, iPad, Android phone or Android tablet. If they play games on any of these devices at least once a week. If they are 18 or older.162

Here is a breakdown of the age of the respondents (who were 50-50 on a male-female breakdown): Figure 47: Age breakdown of social gamers % of respondents

19-24, 11% 54 and up, 21% 25-30, 15% 49-53, 11% 31-36, 18%

43-48, 12%
37-42, 13%

162

Inside Virtual Goods: Spending and Usage Habits of the Mobile Gaming Audience US, by Bonnie Ho, June 30, 2012, Inside Network, Inc.

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Source: Inside Network Research

Notably, the breakdown shows a wide range of demographics, with the largest slice being 54 and older. The next chart examines the types of social games played, which helps put that in perspective: Figure 48: Types of mobile games played (at least once per month)

60% 50% 50% 40% 30% 20% 10% 0% Word games Puzzle games Card games Arcade games Action games Board games Casino games Hidden object MMO and RPG* 27% 26% 20% 17% 13% 7% 44% 41%

* Common terms for "massively multiplayer online" and "role-playing game"

Source: Inside Network Research

Clearly, not all the forms of mobile gaming would lend themselves equally to an online form of wagering. And some forms such as word games or puzzle games are likely not appropriate at all, simply because they fail to meet the basic test of randomness that is essential to any form of legal, regulated gambling. We caution against games of skill being part of the online mix with the possible exception of poker, which is clearly a skill game when in the hands of experienced, serious poker players, but there remains a significant random element to it. The following chart shows the most popular games being played on mobile devices by this sample. The list is notable in that nearly all of the games are quite new, with little resemblance to classic casino games. This list reinforces one of Spectrums basic tenets when it comes to online gambling: The most popular games that will be played in the future, to a great extent, have not yet been invented. While we do not profess familiarity with this mix of games, we believe that such games as well as games to be developed in the future can be customized to the needs of the Massachusetts State Lottery (as well as other legal entities offering online wagering) to incorporate the essential elements of fairness and randomness.

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Figure 49: Mobile games played previous 30 days

50% 40% 30% 20% 10% 0%

45% 38% 28%

17% 13% 9% 6% 5% 5%

Angry Birds

Words with Friends

Bejeweled

Draw Fruit Ninja Something

Cut the Rope

Where's Where's my Water? Waldo?

Zynga Poker

Source: Inside Network Research

The following chart shows that most mobile gamers despite the mobility offered by their devices play at home, but the point that 35 percent play at work and 9 percent play at school should not be lost on policymakers at the Massachusetts State Lottery. The very nature of the Internet particularly as access to an online site becomes increasingly portable lends itself to what is arguably inappropriate activity when it comes to wagering money. The downside of such potential play at work or school (which itself implies some potential underage play) must remain an area of concern and can be discouraged as an essential element within any publicservice messaging put forth by the Lottery, but it cannot be eliminated. Figure 50: Mobile game play location
100% 80% 60% 40% 20% 0% 35% 22% 9% 24% 34% 29% 14% 5% 86%

Source: Inside Network Research

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The following tables summarize many of the demographic characteristics of these social gamers: Figure 51: Social game player demographics
Plays with? Connect to Social Networks Game Discovery Download Free or Premium? Male Plays by themselves, but plays slightly more with friends Neutral Emphasis on recommendations from friends (Neutral) 60% download only free games; 40% download premium and/or free Free is the most important consideration when deciding on a game to download; recommendations from friends is also a consideration 21% have made ingame purchases Female Plays by themselves, but plays slightly more with family Neutral Emphasis on recommendations from friends (Neutral) 66% download only free games; 34% download premium and/or free Free is the most important Consideration when deciding on a game to download 14% have made in-game purchases

Download Decision

In-Game Purchase

Plays with?

18 to 30 Plays by themselves, But more social with friends in mobile gaming More apt to connect to social networks to play games Emphasis on recommendations from friends

31 to 48 Plays by themselves, But will play with family too

49 and up Plays by themselves

Connect to Social Networks Game Discovery

Neutral

Less apt to connect to social networks to play games Emphasis on recommendations from friends

Emphasis on both Top Apps in Google Play and recommendations from friends 65% download only free games; 35% download premium and/or free Free is the most important consideration when deciding on a game to download, friend recommendation is also a consideration

Download Free or Premium? Download Decision

53% download only free games; 47% download premium and/or free Free is the most important consideration when deciding on a game to download; recommendations from friends and good ratings are also considerations 24% have made in-game purchases

68% download only free games; 32% download premium and/or free Free is the most Important consideration when deciding on a game to download

In--Game Purchase

16% have made in-game purchases

15% have made in-game purchases

Source: Inside Network Research

By any measure, the demographics of social gaming are broad and represent an opportunity for the Massachusetts State Lottery to capture a new demographic. However, we must issue one additional cautionary note: Any marketing to an online gamer must pay careful attention to avoid even the appearance of targeting an underage demographic. We further caution
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that marketing must be considered in its broadest sense. Even the very name of a game particularly if it is associated with a non-wagering game that attracts an underage demographic has to be a consideration. This cautionary note is not dissimilar to warnings that were issued to cigarette manufacturers who were cautioned about using symbols such as Joe Camel in marketing campaigns. We recognize and the Lottery has emphasized that prevention of inappropriate wagering is a priority, and the marketing of games should be coordinated with the pursuit of that priority.

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R.

Mobile Gaming

In a 2010 conference at Google headquarters, Mary Meeker, head of Morgan Stanleys global technology research team and the woman once dubbed the Queen of the Net, presented her latest State of the Internet report, which highlighted two trends expected to dominate in the next decade: mobile and social networking. While the ascension of these trends is by no means surprising to the technologically informed, the extensive supporting data illustrate the magnitude and rapid rate of change embodied in these two trends. The main point of Meekers extensively detailed report was that mobile Internet access will surpass fixed Internet access by 2014. She believes that we are currently in the midst of the next great technology cycle of the past 50 years, the mobile era, which follows the mainframe era of the 1950s and 60s, the mini-computer era of the 70s and the desktop Internet era of the 80s.163 In the mobile era, More users will connect to the Internet over mobile devices than desktop PCs, and the ramp-up to smartphones and tablets will occur more rapidly than the onset of any of the previous technology eras. 164 Subsequent State of the Internet reports by Meeker have supported this trend with additional data on the growth of mobile traffic as a component of Internet traffic, reaching 10 percent in May 2012 and explored the challenges of mobile monetization.165 Indeed, Meekers 2010 prediction is coming true more rapidly than expected. By the beginning of 2011, mobile broadband subscriptions surpassed fixed broadband subscriptions for the first time, and by 2016, mobile is expected to make up 80 percent of all broadband subscriptions worldwide.166 Mobile adoption is particularly evident in developing economies, many of which may skip the wired telecommunications phase entirely. Smartphone sales have surpassed PC sales in 2011 and approximately 4 billion smartphones are expected to be sold between 2011 and 2015.167 This smartphone sales growth illustrates a similar trend where mobile computing will overtake fixed means as the leading platform for computing globally in 2012. 168 Given ample evidence of this migration trend from fixed to mobile Internet access, major technology companies have developed mobile strategies. Mobile migration builds expectations for substantial growth in e-commerce generated by features such as location-based services, time-based promotional offers, mobile coupons and push notifications. For the gaming (i.e., nongambling) industry, the move to mobile is even more strongly pronounced and is occurring more

163 164 165 166 167

Mary Meeker: Mobile Internet Will Soon Overtake Fixed Internet, Matthew Ingram, GiGaOM, April 12, 2010 Ibid Internet Trends 2012, Mary Meeker, Kleiner, Perkins, Caufield The Global Information Technology Report, 2012 World Economic Forum.

This figure is the average of data on worldwide mobile devices from Gartner, Strategy Analytics, and IDC, The Global Information Technology Report, 2012 World Economic Forum.
168

The Global Information Technology Report, 2012 World Economic Forum.

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rapidly. Currently there are more than 128,000 active gaming apps available on iTunes 169 and the launch of new and more portable gaming platforms like the iPad Mini with rich graphical interfaces will speed the adoption of mobile gambling applications. Mobile advertising is also more effective than desktop advertising. The effective cost per mille (eCPM), or the amount spent per thousand impressions for desktop ads, is $3.50 while the eCPM for mobile is $0.75 on average.170 The other trend highlighted in Meekers report is the social networking phenomenon, where usage has surpassed generic email in terms of both aggregate numbers of users and time spent in the past decade; this growth continues to increase rapidly. Mobile gaming is now the fastest-growing segment of the gaming (i.e., non-gambling) sector. Console and PC-based video gaming, not long ago the largest non-cash gaming segment, has been steadily declining over the past three years as more people play social and other types of new games on their mobile devices. According to industry tracker NPD Group, the number of Americans playing video games dropped 5 percent last year, from 222.5 million in 2010 to an estimated 211.5 million in 2011.171 The majority of these people migrating from PCs to mobile devices are found in the category of light PC gamers in the NPD study. In addition, the study showed that 23 percent of 5,923 app gamers surveyed say that they played games exclusively on mobile devices and nearly 50 percent say they played more mobile games this year compared to 2011.172 The NPD Group attributes the rapid increase in app gamers to two major factors: free games and convenience.173 Monetized mobile gaming (i.e. gambling and subscription or freemium business models) is also growing rapidly. From a global perspective, the mobile casual gaming market is estimated to be worth $2.7 billion in 2011 and is expected to triple to $7.5 billion in sales by 2015. 174 Asia is currently the largest market for mobile casual gaming with revenues estimated to reach $3.2 billion by 2015. 175 However, Europe shows the fastest growth in mobile gambling revenue and is projected to overtake Asia by the end of 2013 and exceed $4.0 billion by 2015. 176 The strong growth in mobile wagering in Europe is primarily driven by sports betting. For

169 170 171 172 173 174 175 176

App store metrics, http://148apps.biz/app-store-metrics/. Internet Trends 2012, Mary Meeker, Kleiner, Perkins, Caufield Business Week, October 8 October 14, 2012 Mobile Gaming 2012, NPD Group, October, 2012 Ibid. Mobile Gaming 2012, Casual Games Sector Report, SuperData. Mobile Gaming 2012, Casual Games Sector Report, SuperData. Global revenue summary, H2 Gambling Capital.

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instance, in the UK, 76 percent of all mobile wagers are sports bets. 177 Globally, mobile gaming in all its forms, including sports betting and lottery sales, is estimated to be approximately $20 billion in 2011 and is expected to exceed $100 billion by 2017. 178 In the absence of legislation legalizing Internet gambling in the US, North America and the rest of the world are expected to display very slow mobile growth over the next three years,179 although mobile casual games continues to grow rapidly. Figure 52: Global mobile gambling revenues 2003 2015E (in Euros)
3,500 3,000 2,500 2,000 1,500 1,000 500 0 2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E 2013E 2014E 2015E Asia Europe N America RoW

Source: H2 Gambling Capital. (RoW = rest of world)

The majority of mobile casual gaming revenue is produced by the freemium model in which players can play for free or decide to purchase premium amenities and features. By way of explanation, LinkedIn offers a familiar example of a freemium model in a business setting. A more appropriate example is the Angry Birds application for Android phones, in which players can turn off the annoying advertisements by paying the Bad Piggy Bank. According to SuperDatas mobile study, freemium sales account for 55 percent of all mobile game revenues, compared to the 6 percent or revenue generated by advertising. 180 Conversion rates for freemium models are relatively low. For mobile casual games between 3.5 percent and 10 percent of users on free play sites convert to paying customers, and the majority spends between $8 and $15 per month.181 Freemium mobile models allow players to purchase
177 178 179 180 181

Ofcom Communications Market Report 2012. Mobile Gambling Markets: Casinos, Lotteries, & Betting 2011-2015, Juniper Research H2 Gambling Capital Mobile Gaming 2012, Casual Games Sector Report, SuperData. Ibid.

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within an application in very small amounts, or micro-transactions, which can add up over time. The 2012 SuperData study found that female gamers ages 25-34 spent an average of $12.92 per month on micro-transactions while males in the same age group spent an average of $5.12. 182 Such in-app purchases are steadily increasing in proportion to advertising revenue, the traditional money maker for mobile products as a whole. The demographics of mobile gamers unsurprisingly mirror smartphone user profiles. A 2012 survey conducted for PopCap games among 1,004 US (602) and UK (402) Internet users owning a mobile device found that 46 percent of respondents use a smartphone, 18 percent own a tablet, and 15 percent own more than one mobile device.183 Other findings include: Internet users in the US who played a mobile game in the past month increased 45 percent compared to 2011. Across both US and UK, males and females played mobile games in equal numbers. Males are more likely to play on both a smart phone and a tablet. Average age of a mobile gamer is 39.5 years compared to 39.3 in 2011. 66 percent of mobile gamers are less than 45 years old. 16 percent of mobile gamers are 55 or older. The average age of those who only play mobile games on a tablet is 44.7. Half of a players total game play time is devoted to mobile devices. Mobile phones (33 percent) and desktop/laptop computers (32 percent) are used most often for playing games. Tablets represent 13 percent of total game play. Mobile gamer smartphone usage stands at 71 percent, a 16 percent year over year increase.

Another study by NewZoo Research released in April 2012 estimated the number of people in the US playing mobile games at 101 million, more than one-third of the adult population of the country (234,564 over 18 years of age 184) and an increase of 34 percent over the previous year.185 More importantly, over one-third of those playing mobile games in the US, 37 million,186 have paid for the privilege, an increase of 35 percent over 2011.187 The most
182

Worldwide mobile gaming revenue could reach $7.5 billion by 2015, Jasmine Maleficent Rea, Venturebeat.com, March 29, 2012.
183 184 185 186 187

PopCap Games Mobile Gaming Research - Confidential - Prepared by Information Solutions Group 2012. 2010 Census, US Census Bureau NewZoo 2012 Research and Analysis, April, 2012. NewZoo 2012 Research and Analysis, April, 2012. Ibid.

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common mobile gaming device is a smartphone, favored by more than two-thirds of mobile gamers, followed by tablet, regular phones, and iPod Touch in the US, although regular phones remain popular mobile gaming devices in many European countries. Figure 53: Preferred devices for mobile gaming US and European Countries, 2012
68%

69%

80%
70% 60%
Regular Phone

75%

50% 40% 30% 20% 10% 0%

Smart Phone Tablet

21% 18%

iPod Touch

26%

34%

62%

18%

19%

20%

68% 14% 18% 9% Netherlands 170 7%

17% 14%

U.S.
Source: NewZoo Research

U.K.

Germany

15% 11%

France

The NewZoo study also demonstrated the importance of creating a destination gaming portal, or in Apples case a gaming ecosystem, as the iOS operating system, while holding only a minority share of smartphone operating systems, owns a majority share of US mobile gaming revenues. Android applications generated only 16 percent of the revenue among the top grossing 200 games in iPhone, iPad, and Android app stores while Apple products generated 84 percent.188 This Apple share breaks out as 54 percent iPhone/iPod and 30 percent iPad. According to the survey, both iOS and Android operating systems make 91 percent of their mobile revenue from in-game expenditures. Another study by MocoSpace, the largest mobile gaming community in North America, found that age directly correlates to spending on virtual goods within mobile social games. Younger players spend by far the most time playing but older players spend exponentially more on virtual goods and premium amenities.189 Over a three-month period between August and November 2011, this study surveyed almost 500,000 gamers drawn from MocoSpaces base of 22 million users. Gamers over 35 years of age, who made up 18 percent of respondents,

188 189

NewZoo 2012 Research and Analysis, April, 2012.

New Report Details Demographics of Mobile Gamers Buying Virtual Goods, John Gaudiosi, Forbes, December 20, 2011.

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represented 43 percent of all virtual goods spending, compared to 18 to 35 year olds who made up 43 percent of the survey base but represented only 18 percent of virtual goods purchases. 190 This data, while unsurprising given that younger people generally have more time to spend on mobile games while older people as a rule have more money to spend on micro-transactions, does support the conclusion that ad-based revenue models may be more successful with younger customers while freemium model may be more profitable among older players. Figure 54: Percentage of mobile gamers within age group purchasing virtual goods 2011

45+

70%

Age group

35-45

50%

25-35

22%

18-25

10% 0% 10% 20% 30% 40% 50% 60% 70% 80%

Source: MocoSpace

Over the past four years, the number of Americans playing games on the Internet for at least one hour per month has increased 241 percent, from 56 million in 2008 to 135 million in 2011.191 Free-to-play and social games are converting an increasing number of online gamers to the freemium model due in part to the absence of barriers such as retail cost and subscription fees. In addition, an increasing number of people who do not consider themselves as video game players are playing social or mobile games and spending real money purchasing virtual items and upgrades through micro-transactions. Game developers have already taken notice and are finding that the traditional retail model video game is not as remunerative long-term as freemium based applications. If the Massachusetts State Lottery chooses to offer online products in the future, it will be essential to develop and implement an articulated mobile strategy offering mobile applications linked to the Lottery website and featuring a suite of online products optimized for mobile platforms.

190 191

Ibid Trends in Digital Gaming: Free-to-Play, Social, and Mobile Games, Parks Associates, 2012.

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S.

Implementation Costs

While the revenue opportunity presented by online products is attractive in the long term, there is a significant cost to market entry, especially during initial implementation. Any lottery seeking to enter the online market will need to invest in technology, infrastructure, product development, personnel and, most importantly, marketing and advertising. This investment would be even more costly for Massachusetts, which has traditionally operated the back end systems of its lottery and utilized multiple vendors. There are multiple paths to implementing online lottery products. The least costly road to market entry was followed by Illinois, which privatized its lottery and subcontracted Internet sales to Northstar, a consortium formed by GTECH and Scientific Games for the specific purpose of running lottery operations in Illinois. Other US lotteries, including Delaware, intend to partner with a single vendor to supply the Internet operating platform to be used by licensed private gaming companies, in this case the three racinos operating in the state, to offer lottery and casino games online. If the Massachusetts State Lottery Commission follows its current model, it will need to acquire hardware and software equipment, hire and train new personnel, and undertake extensive new product development. Once launched, Internet products will require advertising and promotion to create awareness and attract new customers. By looking at the cost expenditures of other lotteries that have moved to online product sales we can identify general costs of market entry for Massachusetts. It is difficult to determine the precise costs of implementing online lottery products, as the available public financial records do not break out spending with sufficient granularity to identify specific spending for equipment, personnel, marketing, product development, etc. as it relates to Internet operations. However, we can illustrate in general terms the magnitude of investment in capital and infrastructure required to begin utilizing the Internet as a sales channel for interactive lottery products. As a general example, when the United Kingdom National Lottery entered the Internet market in 2002 it engaged Camelot as the primary platform provider and initiated a rebranding and overhaul of the traditional lottery as well as initial implementation of online products such as lotto and keno. Parliament allocated a total of $141 million for this effort in 2002, including $72 million for operations and technology, $45 million for advertising, and $25 million for rebranding retail locations.192 While this example is not directly applicable to Massachusetts given the greater size of the UK market with 62 million in population and a much larger number of retail locations, it does provide some sobering figures for implementation cost. The move to online products has been highly successful for the UK National Lottery, resulting in interactive

192

Camelot, UK Daily Mail

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products producing $30 in per capita sales and contributing 15.6 percent of total lottery sales. 193 However, operational costs remain high and in 2011 the UK National Lottery spent $76 million on operating expenses. Other more recent examples of spending for Internet lottery products in European countries with populations of similar size to Massachusetts, which has an estimated population of 6.6 million in 2011, include the following: Veikkaus Oy (Finland population 5.4 million in 2012) spent $9.3 million on product development and 21.1 million on advertising during 2011.194 Norsk Tipping (Norway population 4.9 million in 2012) spent $31.6 million on advertising during an Internet site revamping during 2011.195 Danske Spil (Denmark population 5.6 million in 2012) spent $6.1 million on marketing for new game development in 2011.196

Closer to home in North America the British Columbia Lottery Corporation once again provides a useful example for estimating relative expenditures during implementation of online products. The BCLC staged its implementation in phases, one online product or class of products at a time over a six-year period. We believe that this is the optimum policy for leading lotteries to follow as it spreads the internal investment cost and external retailer impact of new online products over time, provides opportunities to assess progress and react based upon actual results and it allows time to develop the internal skills and knowledge base to assure success in operating, developing, and marketing online products. The British Columbia Lottery Corp. also utilizes multiple vendors to operate its wide variety of online products while controlling the back end systems behind the main platform. For example, the PlayNow.com website uses PaddyPower the Irish bookmaker and one of Europe's largest sports betting companies, for oddsmaking while OPenBet provides the sportsbook platform software. British Columbia began planning for Internet sales in 2002 and signed a contract with GTECH in 2003 to provide the main operating platform for online product sales. The phased implementation began in 2004 and initially started with lotto, keno and sports betting offered by the end of 2006. Beginning in 2008 the BCLC started pushing strongly into interactive products with online versions of scratch games being offered. These instant games were analogous to traditional products but not exact copies that would compete directly with the products offered in retail locations. In 2009 the BCLC implemented peer-to-peer multiplayer eBingo as an online product, followed closely by ePacific Holdem poker. 197 In 2010 major
193 194 195 196 197

National Lottery Commission Annual Report and Accounts, 2010/11. Veikkaus CSR Report and 2011 Annual Report 2011. Norsk Tipping Annual Report 2011. Danske Spil Profits Soar in a Liberalised market, G3 Newswire, September 7, 2012. BCLC The New Age of Gaming, presentation by Kevin Gass, VP Corporate Affairs at AGRI Conference, 2011

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enhancements were made to online products as the BCLC instituted the PlayNow.com site featuring a full array of social, casino, and poker games, adding more than a dozen new products to their online offerings.198 This new site integrated all of the online product offerings through a single portal with a single player account management engine provided by OpenBet. Despite a serious security breach in July of 2010 that led to 134 player accounts being compromised, the PlayNow.com installation has been highly successful. In fiscal 2011/12 PlayNow.com revenue rose 34.6 percent over the previous period.199 BCLC officials in public remarks at lottery conferences repeatedly state that the online player is for the most part a completely different customer than the traditional lottery ticket purchaser. The majority of newly registered PlayNow.com customers are younger (under 34 years of age) and reflect higher education and income levels compared to traditional lottery customers. While the BCLCs implementation of online products has undoubtedly proven successful it has also been costly to acquire the technological capabilities. Capital expenditures equaled 10 percent of total lottery revenues at the peak investment periods. Looking at capital expenditures as a proportion of total lottery sales, we can see that the BCLC ramped up spending during the most important phases of its implementation strategy: the initial acquisition of an Internet products platform in 2004, and the conversion of the eGaming operation to PlayNow.com in 2010.

198 199

BCLC The New Age of Gaming, presentation by Kevin Gass, VP Corporate Affairs at AGRI Conference, 2011 2011/2012 BCLC Annual Service Plan Report

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Figure 55: BCLC capital expenditures as a percentage of lottery revenues, 2001-02 2011-12
$1,200 Lottery Revenues 10.0% $1,000 $997.4 $962.7 $968.6 $960.4 $976.9 $938.0 $954.2 Capital Expenditures CapEx % Lottery Revenues 10.2% $1,062.4 $1,061.4 9.9% $937.9 12%

10%

$800 In Canadian $

8.6% $967.4

8% 7.7% 7.0% 6%

$600 5.1% 3.1% $93.5 2.1% $49.0 $20.2 $29.6

6.2% $400 4.4% $97.4 $82.9 $92.5 $81.3 $74.4 $43.9 4%

$0

$60.5

$200

2%

0%

01/02 02/03 03/04 04/05 05/06 06/07 07/08 08/09 09/10 10/11 11/12

Source: BCLC

A more granular view of the cost of implementing online products can be obtained by charting British Columbias spending on technology and infrastructure compared to the revenue generated from eGaming, which BCLC began breaking out as a separate line item in fiscal 200607. As the following chart illustrates, spending on technology and infrastructure exceeded the revenue generated by online products through the first two years of operation. It was not until revenues approached $20 million that online products could be considered to reach breakeven, a metric common to ecommerce implementations in other industries according to Forrester Research.

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Figure 56: BCLC lottery and eGaming expenditures and eGaming revenues 2005-06 2011-12
$70 Lottery spending $60 eGaming spending
In Canadian $ millions

$65.6

$50 $40 $30 $20 $10 $05/06 $5.2

eGaming Revenue $33.6 $21.9 $15.0 $14.3 $23.5 $18.7

$42.9

$11.4
$7.1 $6.6 $2.9 08/09 $8.0 09/10

$9.4

$9.1 $8.0

$7.8 06/07

$1.9 07/08

$4.5 10/11

11/12

Source: BCLC

Lotteries entering the online products field should think and spend as if they were an ecommerce startup company, at least in the initial implementation period. Beyond startup costs, continuing expenditures will be required to maintain these new capabilities. In fiscal 2010-11 the BCLC spent Cdn $4.4 million Canadian with its primary online products vendor, OpenBet, and increased these expenditures to $5.4 million in fiscal 2011-12.200 In fiscal 2011-12 the BCLC spent a total of Cdn $11.0 million on the PlayNow.com specifically and another $5.1 million on the Gaming Management System (GMS), also provided by OpenBet, maintaining customer accounts on the operating platform, or a combined total of $16.1 million to maintain a full-blown eGaming system offering a wide array of online products.201 The GMS system is in the early phases of implementation and the BCLC has budgeted $44.2 million for the next fiscal year, or a total of $52.4 million on PlayNow.com as a whole in fiscal 2012-13. These costs do not include personnel expenditures, which are difficult to separate by operational area when looking at financial statements. It will be essential for the Massachusetts State Lottery to employ a minimum number of key personnel experienced in online operations, gaming and marketing. Fully developed Internet lottery operations that we have examined in other jurisdictions generally include staff positions for an executive-level head of the online products division; director-level positions for business development, marketing, project management and operations; and manager-level positions for marketing, e-gaming operations,

200 201

British Columbia Lottery Corporation, Financial Information Act, Fiscal Year Ended March 31, 2012 2011-12 BCLC Annual Service Plan Report

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business development, player relations and data analytics. As a general benchmark for a North American lottery operating a full online product platform, in fiscal 2012 the BCLC spent Cdn. $82.1 million on employee costs, an increase of 7.2 percent over the previous fiscal year. 202

202

British Columbia Lottery Corporation, Financial Information Act, Fiscal Year Ended March 31, 2012

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T.

Legal, Regulatory Issues

Comprehensive oversight and regulation of gambling already in place in many states and nations can help ensure that Internet gambling is operated by those who have demonstrated the requisite level of good character, honesty and integrity. And we note that technologies exist to help ensure that it can be regulated in more than name only. Take, for example, the following excerpt from a December 2009 paper, Can Internet Gambling Be Effectively Regulated? Managing the Risks, authored by Malcolm K. Sparrow of the John F. Kennedy School of Government at Harvard University: Notwithstanding the current prohibitionist legal and regulatory approach, millions of US residents gamble online through offshore gambling sites. As a result, the United States finds itself in the unfortunate position of incurring all the social costs of online gambling while having no control over the gaming sites that serve US residents. The United States cannot disqualify industry participants from competing effectively for US-based customers or offer its residents any consumer protections. Nearly all states permit some form of commercial gambling, and the industry is large and well-established. Clearly, policymakers have extensive precedent from which to draw strategies to mitigate the potential social harms of gambling. Although some controls used in bricks-and-mortar casinos may not translate well to online gambling, several of the risks we examined become more amenable to control online. New technologies can be effective, even for those risks that are more difficult to address online. For example, geolocation and age verification technologies can help turn potentially significant risks into manageable ones.203 There are a number of legal issues which must be addressed by the Lottery prior to entry into the online space. First and foremost, the Massachusetts General Court must pass enabling legislation that specifically allows the Lottery to offer products over the Internet. Greenberg Traurig LLP was contracted by the Lottery to study the December 23, 2011, Department of Justice opinion regarding Internet lottery sales and answer three questions: 204 Is the MSLC currently authorized to sell products over the Internet or other electronic communications? If so, what products may it sell or not sell? Does the DOJ opinion limit its scope to intrastate sales to adults?

203

http://www.house.gov/apps/list/hearing/financialsvcs_dem/sparrow.pdf and http://www.scribd.com/doc/23677373/Can-Internet-Gambling-Be-Effectively-Regulated-Managing-the-RisksWired-Safety-12-02-09

204

Overview of Federal and Massachusetts Law Concerning Internet Lottery Games, Greenberg Traurig, 2012.

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Is an individual/entity that is not the MSLC currently authorized to sell gambling products over the Internet or other electronic communications in the Commonwealth?

Greenberg Traurigs response to the first question above is negative. The Lottery is not authorized under current legislation to sell products over the Internet. The DOJ opinion opens the door for future Internet sales but specific state-level enabling legislation must first be passed by the Commonwealth in order to establish legal authorization. The answer to the second question is affirmative. The DOJ opinion limits sales of Internet lottery products to adults residing within the state. The answer to the third question is negative. The DOJ opinion does not favor authorizing any entity other than the Lottery to sell gambling products over the Internet, with the exception of certain rights granted to horse and dog racing operators. These responses provide legal assurance that the Lottery can in future offer lottery products over the Internet without violating federal law, provided that such sales become clearly legal under state law. While the DOJ opinion removes the longstanding threat of federal challenges to Internet lottery sales under the 1961 Wire Act, new legislation would be required in order to do so and such legislation would have to specifically authorize Internet lottery games, address issues such as the use of credit cards, and establish age and location verification safeguards to ensure that only in-state adults are allowed to participate. The Legislature can authorize the Lottery, as well as commercial operators to offer Internet poker and casino games but it cannot authorize non-Lottery commercial entities to offer Lottery games. Beyond enabling legislation, the Lottery must also consider a variety of additional issues. These include the following: Freedom of Information Act (FOIA) issues Privacy protection Credit cards Aggregating play for tax purposes Security Minority (age) issues Geolocation Registration process Play-per-day cap safeguards Data protection/security Mobile and hand held devices Licensing issues

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Freedom of Information Act issues are a particular concern for lotteries due to the desire for privacy among players and especially large jackpot winners. In addition, because players will register for online games and all electronic gambling activity is tracked in real time by customer, Internet lottery games operations would provide perfect data regarding individual and aggregate play. This information, were it to be made public, could be utilized to compile loss records for individual players or reverse engineered to determine payout percentages for individual products. Privacy protection is essential both as a player obligation and from a public policy standpoint. Players are unlikely to register for online play if there is any uncertainty regarding the security of their personal information.

1. Licensing issues
As online gambling, lotteries, casino gambling and social gaming converge, one issue that is evolving is the question of who should issue licenses, and by what standards? Spectrum has performed several licensing investigations for domestic lotteries, and has assisted lotteries and gambling regulatory agencies in the establishment of regulations and staffing related to the control of this process. We note from our experience that traditional lotteries are not set up to investigate entities, nor to issue licenses based on probity standards that are common in online gambling, such as the establishment of an applicants good character, honesty and integrity. At the same time, it is clear that European licensing agencies based in such locales as Malta, Gibraltar, Guernsey, and the Isle of Man have standards for licensure that might be considered inadequate by US standards. We base that conclusion on the simple fact that the European operators caught up in Black Friday when the DOJ handed down indictments against multiple operators who had taken bets in the United States were all licensed in Europe. Notably, at least some of these locales have focused on becoming regulatory centers, in part, because that entails its own economic benefits for these regions. Consider the following summary from the Financial Times of London: Online gambling has become a rapid growth sector on Guernsey and the Bailiwick has capitalised on the reputation of the regulatory regime established more than a decade ago on its tiny neighbour island Alderney. According to a report from accountants KPMG, the online gambling industry contributed 50m ($80m) to Guernseys economy in 2009, up from 7m in 2007. Moreover, KPMG predicts further growth of 40 per cent in the next couple of years. While still a small sector compared with financial services, online gambling is seen as a welcome diversification that puts Guernsey alongside other offshore jurisdictions such as Gibraltar, Malta and the Isle of Man, which have lured gaming companies and bookmakers away from the UK mainland.

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Sportingbet is the largest employer in the sector, with 100 staff on Guernsey and nine on Alderney, while Virgin Games has also established a presence. The Alderney Gambling Control Commission has issued about 45 licences to companies including Rank, Gala Coral and Blue Square, with most operating through Guernsey. Regulation is probably the key, says Bob Dutnall, Sportingbet managing director. You need stability and robust regulation and Alderney is at the forefront of that across the world. Andr Wilsenach, chief executive of the Alderney Gambling Control Commission, the sectors regulator which oversees companies on both islands, says: We are one of the longest established online gambling authorities. Alderney is leading the online gambling world in terms of regulation. That regulatory position didnt just happen, he adds. Alderney sought to capitalise on the growth of telephone betting in the late 1990s but quickly realised the future was online.205 Contrast that with the evolution of gambling regulation in the United States, when agencies such as the New Jersey Casino Control Commission, the Nevada Gaming Control Board and others including the Massachusetts Gaming Commission were established for reasons that range from the need to prevent organized crime infiltration into gambling to the need to maintain public confidence in the integrity of the process. We expect such contrasts to become more evident as casinos, lotteries and foreign operators converge in the United States. One question remains open: Will lotteries and other government agencies including tribal establish and/or maintain high licensing standards, or will there be pressure to adopt the lowest common denominator? Notably, different groups can be expected to press for differing standards, depending on which position fortifies their present competitive stance. For example, some European operators and, possibly, with the support of their US clients or partners would be more likely to seek standards that allow them entry into the US market. Such standards could be set based on specific criteria, such as whether or not they accepted or facilitated wagers in the United States before or after April 2006 (when the Unlawful Internet Gambling Enforcement Act was adopted). By contrast, other groups such as existing vendors that supply the domestic gambling and lottery markets which have already been licensed by US standards would be expected to push for higher standards, effectively using those standards as barriers to entry to develop or maintain competitive advantages.

205

Online Gambling: Islands Bet on High-Tech Industry for Jobs and Growth, Bob Sherwood, Financial Times of London, November 17, 2010.

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One notable characteristic of the present European online gambling market is the rise of affiliates which can be thought of as either online junket operators, or online lottery agents. Such affiliates effectively provide links to online gambling sites in exchange for some remuneration based on the level of play received. By most US standards, affiliates would likely face a requirement to meet high licensing standards since they do participate in the sharing of gambling revenue. That is largely an unfamiliar concept in Europe, where affiliates effectively fly under the licensing radar. We cannot accurately assess at this early stage how US regulators may address the issue of licensure for affiliates, but one indicator is how Nevada is approaching the issue. According to Mark Lipparelli, chair of the Nevada Gaming Control Board, regulators there are leaning toward a call forward system in which affiliates can operate without the expense and risk of licensure. However, if regulators receive intelligence or other actionable information that an affiliate may not meet the states standards for good character, honesty and integrity, investigators can call that affiliate forward to require they apply for, and receive, a license from the state. 206

2.

Internet/Sweepstakes Cafes

One of the more recent developments that bridges both land-based and online gambling operations is the rise of Internet/sweepstakes cafes, often known as cyber cafes, across the United States. Bloomberg Businessweek estimates that there are between 3,000 and 5,000 of these facilities operating nationwide and, while none of them report public earnings, current revenue estimates approach $6 billion annually. 207 Up to $1 billion alone is thought to be generated in Florida by a total of up to 1,500 Internet caf sites.208 These storefront operations are often located in strip malls and suburban areas close to residential neighborhoods. They operate on the subscription model, with customers paying for blocks of Internet time during which they can play games that look like electronic slot machines for points and prizes such as additional Internet time or pre-paid telephone cards. Because no money is wagered at the machines and no cash is transferred on winning, the subscription model is not characterized as gambling but rather a form of sweepstakes promotion. According to Businessweek, this is a high-cash-flow, high-margin business in which a single terminal at a successful cafe can generate $1,000 to $5,000 per month in gross revenue. This implies that a moderate facility with 100 machines could produce approximately $250,000 a month in handle, or roughly $3 million a year. Businessweek suggests that in less than 10

206 207 208

Interview with Mark Lipparelli, January 2012 The Casino Next Door, Bloomberg Businessweek, April 25, 2011 Marc W. Dunbar, Esq, speaking on April 19, 2012

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years of operation, Internet/sweepstakes cafes in the United States have grown into a collective $10 billion to $15 billion industry. 209 Most of these Internet/sweepstakes establishments operate in gray area in local, state and federal law. Legal challenges are ongoing at the various level of the legal system as current statutes are contested in dozens of states across the nation. Spectrum carefully examined whether the legalization of Internet-based state lotteries could lead to the establishment of Internet cafes. Our research indicates that the integration of Internet-based state lotteries and Internet cafes is a remote possibility, based on the legal implications and public policy issues surrounding the controversial Internet caf industry. In June 2011, Massachusetts Attorney General Martha Coakley issued a new permanent regulation banning gambling at these sweepstakes casinos, citing evidence that illegal gambling was going on at Internet cafs throughout the state. The regulation bans the operation of establishments where a gambling purpose predominates over the bona fide sale of bona fide goods or services in this case, cyber cafs and phone card video game terminals. The attorney general contends that many establishments that offer these services are actually fronts for illegal online gambling, including unlawful lotteries, online slot-machine games, sweepstakes, and other forms of gambling. In Florida, as part of their marketing research, many savvy Internet caf operators have filed freedom of information requests with the state lottery seeking to obtain lottery data regarding the highest-grossing lottery retailers in a particular area. The Internet caf operators then try to locate an Internet caf site within a close proximity of the lottery retailers. The Internet caf operators marketing research indicates that the lottery scratch-off player is also a typical Internet caf patron. This interaction between the these two forms of gambling has given rise to the view that that state-sanctioned lottery games, including legalized online gambling, and Internet cafes could lead to a merger of the two in some jurisdictions. Historically, as a legal matter, enabling legislation for the operation of state lotteries has not specifically been extended to Internet cafes. There are no examples in the history of lottery gambling in which a state lottery has incorporated Internet cafes as part of its business model. State lottery statutes would have to be amended to permit a state-operated lottery to extend its existing lottery agent network to provide a lottery retailer license to an Internet caf operator. The authorization of Internet gambling as an addition to a state lotterys gambling options would have to specifically grant Internet cafes the capacity to become a legal lottery retailer. The very legality of Internet cafes and the challenging public policy issues surrounding this controversial form of gambling make the possibility of the integration of Internet cafes and online lottery remote. The state-sanctioned combination of Internet cafes and online lottery play would be subject to complaints from existing lottery retailers, many of whom have voiced

209

The Casino Next Door, Bloomberg Businessweek , April 25, 2011

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objections to online gambling in general. The direct threat to existing physical lottery retailers presented by the integration of Internet cafes into existing lottery operations is a matter that lottery retailers would very strongly oppose. The political efforts of Internet cafe operators to be included in any move to authorize Internet lottery could prove to be a difficult undertaking given the legal gray area that most of these establishments operate within. Absent any specific mandate to the lottery that it must include Internet cafes as part of authorizing online gambling, the merger of the two forms of gambling is improbable. One example of how the dynamics of this issue may be argued is the establishment of the New York Lottery in 1977. The popular numbers runners in many urban New York neighborhoods were not incorporated by the new state-sanctioned lottery business model and were virtually replaced by legal lottery retailers. In 1995, when the New York Lottery authorized Quick Draw keno, the gray area joker poker machines in New York City were not made part of the legal lottery retail network. The issue of Internet cafes has been a concern in multiple states, as noted in a veto last year by New Jersey Gov. Chris Christie of legislation that would authorize Atlantic City casinos to offer Internet wagering. The New York Times reported in January 2011: Mr. Christie vetoed the bill in part over concerns that it would undermine his administrations efforts to prop up Atlantic City, whose gambling revenues have suffered as neighboring states have opened casinos. In his veto message, Mr. Christie noted that nothing contained in the legislation would prohibit commercial establishments outside Atlantic City such as nightclubs, bars, restaurants, cafes and amusement parks from offering Internet gambling opportunities. But this month (January) Mr. Christie said that given the Justice Departments goahead, the state should move forward with its plans. I think New Jersey should be in that business, I think we should be an epicenter for that business, but I want to do it right he said.210 The revised legislation addresses the issue of Internet cafes by prohibiting such facilities from advertising.211 As of this writing, the revised legislation has not been voted on by either the full Assembly or the Senate in New Jersey.

210

As States Weigh Online Gambling, Profits May be Small, by Michael Cooper, New York Times, January 17, 2012 http://www.nytimes.com/2012/01/18/us/more-states-look-to-legalize-online-gambling.html (accessed May 5, 2012)
211

Email from William J. Pascrell, Princeton Public Affairs Group. May 7, 2012

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U.

Technology Issues

Most lotteries and gambling regulatory agencies were established in an era when policies were simpler, as was the gambling technology. The testing of video lottery terminals and controls involved with instant lottery games have never needed to confront such issues as age verification, geolocation, online collusion and other issues that are central to online gambling. Moreover, online gambling is emerging in the United States at a time when technology testing is increasingly being outsourced to a handful of qualified firms. While, for example, regulatory agencies in Nevada, New Jersey and Pennsylvania could find it cost effective to establish their own in-house testing laboratories for slot machines, that is increasingly less practical in an online world. Spectrum interviewed several technology firms for this report. One such firm, which oversees financial transactions, is Prelytics, based in Las Vegas. CEO Dan Ives noted the following: This (trend toward outsourcing testing) is compounded dramatically by the fact that the gaming ecosystem has evolved from closed, proprietary hardware and firmware based systems to open, standardized technology based systems in which substantial understanding of the technology capabilities, security and communications methods are as in important as, if not more important than, the elements of the game itself.212 Because of the unique nature and heightened requirements governing online gambling, however, the importance of testing has not been diminished. An important role for regulators, then, is to recognize the need for outsourcing to qualified firms while establishing the parameters for testing that meet their jurisdictions specific policy needs. Ives noted: By the very nature of online gaming, the scope of the policy considerations will inherently increase. As an example, when moving from a terminal based system into which one applies cash or cash equivalent payments, online systems by definition will likely require other forms of funding. By definition this implies a provision for personal payment information which now expands the scope into payment processing regulations and potential privacy considerations as both personal information and potentially personal geolocation information may be required to enable gaming sessions to occur.
The Online Gaming Ecosystem

In the traditional gaming and lottery environment of the 1990s and 2000s, the ecosystem has typically been a closed system or private network-based environment in which cash equivalents are used for payment and games are generally provided in non-modifiable form on proprietary platforms and in controlled physical environments. The very essence

212

May 4, 2012 email from Dan Ives to Spectrum

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of online systems of any type dictates that these fundamental facts be reversed. Hence, policy considerations pertaining to such a deliverable take on a far greater scope. The very reason the Internet has been able to so dramatically impacted world economies is because the core technologies have been standardized to such a great degree that nearly anyone can development, deploy, manage or exploit these systems. And so, the gaming ecosystem now takes on all of the characteristics and inherent exposures of any other public-facing, online-based financial system. But the core policies and requirements pertaining to gaming dont change. Age and location, regulation of the game itself and control of the transaction remain critical to the policies and outcome.
The Games Not Just a Program Anymore

By definition, the scope of the gaming environment is evolving to include not only the games themselves but the elements of communications, security and identification within the eco-system. This evolution was initiated with the advent of networked games and then server based gaming. But, in the online world, this now implies that millions of sophisticated users and developers are highly familiar with the very underpinnings of the core technology and methods under which the games are created and operate. By definition, the standards that have enabled this distributed, highly accessible world are the same factors that must be considered in testing, securing and operating these games. Ultimately, testing and systems assurance become far more complex and mandate greater knowledge and scrutiny of the technology and the entire eco-system not only on issuance or deployment but on an ongoing, real-time basis.
Emerging Critical Technologies

Affordable technologies are fast emerging that can assist in the application of policies and assurance of online gaming systems. Low-cost, integrated bio-metrics, geo-positional products, multi-faceted authentication methods and new security technologies all are impacting how activities can be transacted online in simple and more secure ways. These technologies ultimately provide regulators more options for assuring the application of their policies, but the costs can be greater and the scope of policy potentially increased. As an example, the use of biometrics continuously during an online gaming session might assure that the participant continues to be a person of the appropriate age, but regulators might now have to consider how that biometric information is stored, by whom, where it is maintained and what elements of privacy might apply in its use, storage and security. Regulators need to ask certain questions that technology providers and independent testing laboratories must answer. Such questions include: How reliable is the technology? Where is it working?

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What are the anomalies and problems that have occurred thus far and how are they being addressed? How is the ecosystem now secured? Are systems self-aware and self-auditing? How can regulators maintain real-time awareness of system compliance? Can regulators settle for less than 100 percent accuracy in testing?

The latter question is particularly important, for example, in issues related to player identification and geolocation. If a player is making online wagers at or near a physical border which divides the line between acceptable and unacceptable betting what is the likelihood of an error? Furthermore, what is the likelihood of fraud or spoofing such that the geolocation is intentionally altered? Policymakers will have to make determinations as to acceptable levels of errors in such areas, recognizing that they must strike a balance between rejecting a certain level of legitimate play vs. accepting a certain level of illegitimate play. The Massachusetts State Lottery is asking the essential question: Should its technology be upgraded or replaced? That question is being addressed through the issuance of an RFR. We respectfully suggest that the attendant policy questions posed here are no less important. As stated above, one of the distinguishing characteristics of the Lottery is that it maintains its own database and information technology infrastructure. While this is an advantage in fostering the independence and innovativeness of the Lottery, it also comes with a cost in terms of supporting and regularly updating those in-house systems. Internet lottery sales and potentially new online product lines will likely exceed Lottery capabilities, given current hardware and software systems. Similarly integrating systems with Internet gambling vendors/suppliers will tax current systems and likely require substantial equipment upgrades. Internet gambling will undoubtedly increase system utilization loads and add a variety of security issues. The Lottery is currently out for bid for a consultant to assist it in preparing an RFR for the development of a new system to support all future technology needs, including Internet capacity, should the Lottery be directed to pursue that course of action.

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V.

Public Policy Issues

Based on our global observations of the state of online gambling, we suggest that many views of the future tend to be rather myopic, and do not account for one fundamental characteristic of the Internet: Its ability to change rapidly. Consider that, in five years, todays 13-year-olds will be legally allowed to play the Lottery. Will they be satisfied with current games, or will they gravitate to new offerings designed with them in mind? Clearly, the latter scenario is more likely. That means, in part, that many of the games that adults will be playing online in five years have not, as of this writing, been invented yet. The Massachusetts State Lottery thus has an opportunity to develop new offerings and enhance its independence by developing a system that encourages new game developers to adhere to certain requirements: Games must meet all standard requirements for lottery offerings, including requirements related to fairness, chance, pay tables and other requirements. At the same, time, however, developers should be required to demonstrate that a new offering holds a reasonable chance of reaching new, younger demographics.

The latter goal could be achieved, in part, by testing games out in other settings, such as play-for-fun sites, through focus groups or other means. Such issues will be explored as this research and analysis continues. By developing such criteria, and opening opportunities to a variety of potential developers, it would encourage individuals, small businesses and other firms to become lottery suppliers. This assumption is based on the observation that the development of a new game has low financial barriers to entry. Cost is secondary to creativity. With respect to the relationship between future land-based casinos and the Lottery, the following factors need to be considered: Cross-marketing efforts should be considered that would allow casinos and the Lottery to develop more attractive offerings. For example, by allowing casinos to offer complimentary items ranging from meals to show tickets to room nights to lottery players would make the Lottery offering more attractive while also allowing casinos a low-cost means of identifying and cultivating loyal, profitable customers. The online policies and programs of the Lottery and the casinos should be effectively coordinated to eliminate, or reduce, potential problems that could result from both entities offering similar online games. Casinos will be required to be Lottery agents under the Expanded Gaming Act of 2011, but we suggest that they be encouraged to be enthusiastic, effective Lottery agents, taking advantage of their position as attractions to out-of-state gamblers.

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We recognize that some existing retailers might prefer that casinos not offer Lottery products, but that is neither realistic nor justified. In states such as New Jersey, casinos are traditionally among the best-performing lottery agents without having any discernible impact on other retailers.213

213

Comprehensive Analysis: Projecting and Preparing for Impact of Expanded Gaming on Commonwealth of Massachusetts, Spectrum Gaming Group, August 1, 2008, p. 137-138

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W. Problem Gambling
Warning: Gambling involves risk. By gambling on this website, you run the risk that you may lose money or suffer psychological injuries. Notice on sportingbet.com, a London-based Internet gambling website

1. Background
Various studies and organizations put the prevalence of pathological gambling at up to 1 percent of the US adult population, or up to roughly 2 million people, in a given year. The National Council on Problem Gambling (NCPG) estimates that another 2 percent to 3 percent, or between 4 million and 6 million, have problem gambling, meaning they meet one of more of the criteria and are experiencing problems due to their gambling behavior.214 The Massachusetts Council on Compulsive Gambling (Massachusetts Council) estimates that between 85,000 and 185,000 of Massachusetts adults have experienced disordered gambling (see definition below) in their lifetimes. There are various professional and general terms used in assessing gambling problems, and they are often used interchangeably. The following definitions are provided by Massachusetts Council:215 Pathological gambling: The American Psychiatric Association classifies pathological gambling as an impulse control disorder and defines it as the persistent and recurrent maladaptive gambling behavior that disrupts personal, family or vocational pursuits Compulsive gambling is the original lay term for pathological gambling. Sub-clinical pathological gambling (i.e., problem gambling): Gambling behavior that does not necessarily meet the criteria for pathological gambling but results in harmful effects to a gambler, his or her family, significant others, friends, co-workers, and others. Disordered gambling: Used to describe the combination of pathological and subclinical pathological gambling.

For purposes of this report, we use the popular term problem gambling216 throughout as an umbrella term that includes pathological, compulsive and disordered gambling activity. The NCPG defines problem gambling as follows:
214 215

NCPG, http://www.ncpgambling.org/i4a/pages/Index.cfm?pageID=3315; accessed October 18, 2012

http://www.masscompulsivegambling.org/stuff/contentmgr/files/47ef8aeda7ca662202dd1196f5dcb77c/downloa d/mass_council_fact_sheet_general_2011_v1.pdf

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Problem gambling is gambling behavior which causes disruptions in any major area of life: psychological, physical, social or vocational. The term Problem Gambling includes, but is not limited to, the condition known as Pathological, or Compulsive Gambling, a progressive addiction characterized by increasing preoccupation with gambling, a need to bet more money more frequently, restlessness or irritability when attempting to stop, chasing losses, and loss of control manifested by continuation of the gambling behavior in spite of mounting, serious, negative consequences. The personal consequences of problem gambling can include bankruptcy, criminal action, suicide, divorce, family fighting, job loss, medical problems and emotional issues. The societal consequences include increased need for social services, law enforcement and judicial services. The standard clinical tool used to determine pathological gambling uses criteria established in the American Psychiatric Associations Diagnostic and Statistical Manual of Mental Disorders, Fourth Edition (commonly known as DSM-IV). The criteria are as follows: Persistent and recurrent maladaptive gambling behavior as indicated by five (or more) of the following: 1. Is preoccupied with gambling (e.g. preoccupied with reliving past gambling experiences, handicapping or planning the next venture, or thinking of ways to get money with which to gamble) 2. Needs to gamble with increasing amounts of money in order to achieve the desired excitement 3. Has repeated unsuccessful efforts to control, cut back, or stop gambling 4. Is restless or irritable when attempting to cut down or stop gambling 5. Gambles as a way of escaping from problems or of relieving a dysphoric mood (e.g. feelings of helplessness, guilt, anxiety, depression) 6. After losing money gambling, often returns another day to get even (chasing ones losses) 7. Lies to family members, therapist, or others to conceal the extent of involvement with gambling 8. Has committed illegal acts such as forgery, fraud, theft, or embezzlement to finance gambling 9. Has jeopardized or lost a significant relationship, job, or educational or career opportunity because of gambling 10. Relies on others to provide money to relieve a desperate financial situation caused by gambling The gambling behavior is not better accounted for by a Manic Episode.

216

The term also commonly used in the Massachusetts Expanded Gaming Act of 2011.

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Gamblers exhibiting three or four of the above criteria are deemed to be problem gamblers (as opposed to pathological). The NCPG advises gamblers who answer yes to even one of 10 similar questions that it poses to seek professional help. Kathleen Scanlan of the Massachusetts Council provided the Working Group with a another measure of the prevalence of problem gambling, showing four levels of gambling behavior along a wagering continuum: Figure 57: Gambling-behavior continuum
Gambling Behavior Level Zero Level One Level Two Level Three Description Never gamble Healthy gambling Unhealthy/Problem Compulsive/Pathological Population % 20% 77% 0.9 2.3% 0.4 0.6%

Source: Massachusetts Council on Compulsive Gambling

The figures cited for dangerously compulsive gambling by the Massachusetts Council appear to be relatively consistent across international borders, types of betting games, and distribution channels for gambling products. The 2010 British Gambling Prevalence Study used two different methods to assess the rate of problem gambling among adults in the UK. The first method estimated suggested it is 0.7 percent and the second 0.9 percent. In the 2007 survey, both methods indicated a rate of roughly 0.6 percent.217 Problem gamblers often have other disorders as well, or what clinicians call comorbidity. A 2005 study by Department of Psychiatry at the University of Connecticut Health Center found that almost three quarters (73.2%) of pathological gamblers had an alcohol use disorder, 38.1% had a drug use disorder, 60.4% had nicotine dependence, 49.6% had a mood disorder, 41.3% had an anxiety disorder, and 60.8% had a personality disorder.218 Researchers therefore say it is difficult to isolate gambling as the primary source of an individuals addiction; it could also be the result of another addiction.

2.

Problem Gambling and the Internet

Any discussion on the introduction of Internet gambling to a new jurisdiction raises the specter of increased problem gambling issues and poses new questions regarding gambling and social responsibility. Because the appeal of the Internet is based fundamentally on the greater convenience of being able to do things from the comfort and privacy of ones own home, it is often assumed that greater convenience and 24/7 access will concomitantly bring with it greater additive gambling behavior.

217 218

British Gambling Prevalence Study, 2010

National Center for Biotechnology Information, US National Library of Medicine; http://www.ncbi.nlm.nih.gov/pubmed/15889941

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Researchers have found that existing studies of Internet gambling are of limited value in determining whether the availability of Internet gambling increases either severity or likelihood of problem gambling. Authors Debi LaPlante, et al.219 in 2012 cited several studies from 2001-09 that reported a higher prevalence of problem gambling among Internet players, adding an important caveat: Unfortunately, most of the early research focusing on the prevalence of Internet gambling and disordered Internet gambling is not necessarily representative of the population at-large or the subgroups of the general population to which they should generalize. Furthermore, the empirical data collected were self-reported: the guiding methodological approach for this period is the use of recalled data. Though relatively valid for basic prevalence estimates, self-report data are vulnerable to a variety of biases that limit their usefulness for inferring causality or temporal sequence, including faulty memory, self-deception, other deception (e.g., impression management), and simple reporting errors. Nonetheless, these studies ushered in the current period of normal science for Internet gambling research. The guiding conceptual view for this period includes the assumption that Internet gambling is an especially dangerous form of gambling predominantly characterized by excess. They added: ... These studies champion a clarion call to researchers and policy makers for more research that uses actual Internet gambling data. Rachel Volberg, president of Northampton-based Gemini Research Ltd. and a widely respected problem-gambling epidemiologist, believes the self-reported data can be of great value, noting that Some ways of asking about such behavior are better than others.220 Perhaps the most useful study of actual Internet gambling behavior is The bwin.party DOA research collaborative. The bwin.party DOA collaborate involves a major international Internet gambling operator bwin.party digital entertainment PLC of Gibraltar and the Division on Addiction (DOA) at Cambridge Health Alliance, a Harvard Medical School teaching affiliate. The collaborative began in 2005 and has generated a series of studies that have established benchmarks not only for problem gambling but also for normative, or healthy, gambling behavior. Through the course of the study, bwin.party has provided anonymous data on over 100,000 customers,221 and the initial case study was conducted on 49,000 online players covering

219

Debi A. LaPlante, Sarah E. Nelson, Richard A. LaBrie and Howard J. Shaffer, The bwin.party division on addiction research collaborative: Challenges for the normal science of Internet gambling, In R. J. Williams, R. T. Wood, & J. Parke (Eds.), Routledge International Handbook of Internet Gambling, pp. 161-179; 2012.
220

Interviewed October 30, 2012.

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a more than three years of activity, making it the largest longitudinal study of its kind ever conducted. The DOA publishes its research in scientific journals after a peer-review process. In addition, the data upon which the results were based are made available online as part of the Transparency Project, allowing other independent experts to verify the findings and to complete their own scientific research. On March 22, 2012, the Task Force met with Kathleen Scanlan and Jim Wuelfing of the Massachusetts Council, where findings of from the bwin.party DOA collaborative were presented. Among the findings from the bwin.party DOA collaborative:222 Problem gambling rates on the Internet are not significantly different from problem gambling rates observed with other forms of land-based gambling. Problem gambling indicators are less associated with magnitude of betting or volume of transaction but more with indiscriminate betting across multiple and diverse products. Self-imposed limits are a stronger identifier of problem gambling than site-imposed limits. Tracking software and data analytics can be used to identify potential problem gamblers early on for remedial action.

More specifically, in a 2008 report using bwin.party data, authors Richard A. LaBrie, et al, provided revealing, data-driven findings The sample included 4,222 gamblers who played casino games. Results: The median betting behaviour was to play casino games once every 2 weeks during a period of 9 months. Subscribers placed a median of 49 bets of 4 each playing day. Subscribers lost a median of 5.5% of total monies wagered. We determined a group of heavily involved bettors whose activity exceeded that of 95% of the sample; these players bet every fifth day during 17.5 months. On each playing day, these most involved bettors placed a median of 188 bets of 25. Their median percent of wagers lost, 2.5%, was smaller than that lost by the total sample. Conclusion: Our findings suggest that Internet casino betting behaviour results in modest costs for most players, while some, roughly 5%, have larger losses. The findings also show the need to consider time spent as a marker of disordered gambling. These

221

National Center for Responsible Gaming, NCRG Conference: Responsible Gaming on the Internet The Bwin.party Case Study
222

Massachusetts Council on Compulsive Gambling, Treasurer Grossmans On-Line Products Task Force presentation, March 22, 2012

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findings provide the evidence to steer public health debates away from speculation and toward the creation of empirically-based strategies to protect the public health.223 In their 2012 report, LaPlante, et al. examined three forms of online gambling sports betting, poker and casino games but not lottery. In fact, the word lottery does not appear in their 2012 report, perhaps underscoring the lack of lottery online-play research available. This certainly would be true among US players, where the only operating online lotteries are in Illinois and Minnesota, which are relatively new and have limited online products. With little or no relevant research available, it is uncertain what effect if any the availability of online Lottery games would have on problem gambling in Massachusetts. Based on our interviews and review of research, we believe the impact will be negligible in the early phase(s) of our recommended introduction of online Lottery games. Gemini Researchs Volberg said the likelihood is relatively low that merely having tickets for sale online will exacerbate problem gambling. 224 Keith Whyte, the NCPG Executive Director, said he believes that Internet gambling in general may not increase the prevalence, but may exacerbate some existing problems.225 Marlene Warner, Executive Director of the Massachusetts Council, noted that lottery play is the No. 1 reason gamblers call her organization for help scratch tickets, with casinos not far behind.226 The observations of Warner and others underscore our belief that the incidents and/or exacerbation of problem gambling online is more likely to increase (but not necessarily) when (or if) Lottery online play becomes faster-paced with such games as instant scratch-offs, video lottery terminals, etc. Indeed, a 2010 report from the bwin.party collaborative concluded that gamblers characterized by high intensity and frequency of gambling and by high variability of wager sizes during their first month of gambling were at higher risk than other gamblers to report gamblingrelated problems upon closing their accounts. 227 LaPlante, et al. note in their bwin.party report that the form of gambling does not drive an addiction: [I]t is important to note that the isolation of a single type of gambling as inherently addictive is inconsistent with contemporary models of addiction (Shaffer, LaPlante et al., 2004;
223

Richard A. LaBrie, Sara A. Kaplan, Debi A. LaPlante, Sarah E. Nelson and Howard J. Shaffer, Inside the virtual casino: a prospective longitudinal study of actual Internet casino gambling, European Journal of Public Health, April 23, 2008, p. 410.
224 225 226 227

Interviewed July 30, 2012 Interviewed August 1, 2012 Interviewed August 6, 2012

Julian Braverman, Howard Shaffer, How do gamblers start gambling: identifying behavioural markers for highrisk internet gambling, The European Journal of Public Health Advance Access, January 27, 2010

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Shaffer, LaPlante, and Nelson, in press). Such models indicate that the object of addiction does not drive the development of addiction. Instead, addiction emerges because of a complicated interaction between individuals, their environment, and the objects with which they interact. Consequently, what might eventually emerge as a primary object of obsession and/or addiction for one person might be completely uninteresting to another. Empirical studies of gambling-related involvement support the proposition that specific objects play a minor role in the development of addictive behaviour (LaPlante, Nelson et al., 2009). If objects themselves were inherently addictive, such inter-individual variance would not occur. Its just not that simple.

3.

Massachusetts Policy

The issue of problem gambling takes on newfound importance for the Lottery with both the implementation of online play and with the legalization of casinos in Massachusetts. First, as noted earlier, online play would transform the Lottery from a distributor of tickets into a gambling operator. The extent to which the Lottery will be a gambling operator will be determined by the number and types of games it will offer online. That is, will the Lotterys online play be more transactional (i.e., merely buying a draw ticket online) or will it be more experiential (actually playing and gambling online)? In Spectrums opinion, the more experiential Lottery play becomes, the more responsibility it carries to address problemgambling issues. Second, the Commonwealth has established through the passage of the Massachusetts Expanded Gaming Act of 2011 (the Gaming Act, which authorizes four casinos) a comprehensive and progressive responsible-gaming policy. Although the Gaming Act applies only to the fledgling casino industry, the Lottery or perhaps the Commonwealth itself must decide to what extent the Lotterys online play should follow the spirit of the responsible-gaming measures required of the states licensed casino operators. Among other things, the Gaming Act requires the following of the Massachusetts Gaming Commission or casino licensees with respect to responsible gaming: Applicants for gaming licenses and gaming licensees shall demonstrate their commitment to efforts to combat compulsive gambling and a dedication to community mitigation, and shall recognize that the privilege of licensure bears a responsibility to identify, address and minimize any potential negative consequences of their business operations; ... An agreement that the applicant shall mitigate the potential negative public health consequences associated with gambling and the operation of a gaming establishment, including: ... (ii) providing complimentary on-site space for an independent substance abuse and mental health counseling service to be selected by the commission; (iii)

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prominently displaying information on the signs of problem gambling and how to access assistance; ... Taking additional measures to address problem gambling including, but not limited to, training of gaming employees to identify patrons exhibiting problems with gambling and prevention programs targeted toward vulnerable populations; Keep conspicuously posted in the gaming area a notice containing the name and a telephone number for problem gambling assistance; provided, however, that the commission may require the gaming licensee to provide this information in more than 1 language; Provide a process for individuals to exclude their names and contact information from the gaming licensees database or any other list held by the gaming licensee for use in marketing or promotional communications; A gaming establishment offering a cashless wagering system shall allow individuals to monitor and impose betting limits on their cashless wagering. The gaming establishment shall allow individuals to set betting limits on their cashless wagering including, but not limited to, per bet limits, hourly limits, daily limits, weekly limits and monthly limits. An individual may lower limits and increase limits; provided, however, that the individual shall not increase betting limits more than once in a 24hour period. The gaming establishment shall issue to each patron who has been issued a rewards card or who participates in a cashless wagering system by the gaming establishment a monthly statement, mailed to the patron at the patrons physical mailing address, which shall include the patrons total bets, wins and losses; provided, however, that a patron shall be given the opportunity to decline receiving a monthly statement at the time the rewards card is issued or during initial participation in a cashless wagering system; provided further, that a patron may later opt out of receiving monthly statements by providing a written request to cease monthly statements to the gaming establishment. The Massachusetts Gaming Commission shall undertake a baseline study of the existing occurrence of problem gambling in the commonwealth; provided, however, that the study shall examine and describe the existing levels of problem gambling and the existing programs available that prevent and address the harmful consequences of problem gambling; provided further, that the commission shall contract with scientists and physicians to examine the current research as to the causes for problem gambling and the health effects of problem gambling and the treatment methods currently available in the commonwealth; provided further, that the commission shall report on the findings of the baseline study and provide recommendations to the house and senate committees on ways and means, the joint committee on economic development and emerging technologies, the joint committee on mental health and

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substance abuse and the joint committee on public health relative to methods to supplement or improve problem gambling prevention and treatment services. The NCPGs Whyte said of the Expanded Gaming Act, I think the Massachusetts problem-gambling and responsible-gaming regs are the best effort yet, taking promising practices from across the United States and around the world. It remains to be seen in the long run if the arbitrary level of funding is adequate to build a comprehensive problem gambling services system, and ultimately whether that system can mitigate the impact of expanded gaming and eventually reduce the severity and/or prevalence of gambling problems.228 In light of the responsible-gaming policy established by the Commonwealth for casino operators, Spectrum believes the Lottery could face an erosion of public trust and/or goodwill if it does not take similar steps in the areas of problem gambling. As noted above, we believe such steps should be taken at that point Lottery players are gambling online, as opposed to merely purchasing a draw ticket online.

4.

Standards for Online Play

At this point, there is no independent, widely accepted responsible-gaming standard for Internet gambling. We note that neither the North American Association of State and Provincial Lotteries nor the World Lottery Association has such online-play standards. The Responsible Gaming Council in Ontario has developed Responsible Gambling Standards for Internet Gambling, an extensive code that remains in draft form. Spectrum recommends that the Lottery follow the NCPGs Internet Responsible Gambling Standards, adopted in April 2012. The NCPG developed the Standards based not only the experience of its staff and state affiliates, but also in consultation with responsible-gaming codes and research from 17 international organizations with experience in Internet play. The NCPG in particular noted the work of the Responsible Gaming Council, an independent, progressive and highly regarded organization. It is noteworthy that the NCPG Standards, while addressing Internet play, do complement the responsible-gaming requirements in the Massachusetts casino law. The NCPG Standards are divided into eight categories:
228

Operator Policy Staff Training Informed Decision Making Assisting Players Self-Exclusion

Interviewed October 23, 2012

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Advertising and Promotion Game and Site Features Research

Spectrum believes that the NCPG Standards are comprehensive, reasonable and, importantly, flexible from the standpoints of both the operator and the player. (See Appendix for the NCPG Standards.) As one example, in the Policies section of Assisting Players the NCPG advises: Clear policies are in place for assessing and handling situations where a player indicates they are in distress or experiencing problems. There is a procedure in place to address third party (e.g., spouse, relative) concerns about players gambling behavior.
Note that the NCPG does not suggest what the policies should be, just that they should be established. In yet another example, this one directed toward player controls, the NCPG encourages players to set either online or through a customer-service representative weekly or monthly limits on their time or amounts wagered, with the following options. Note that the NCPG does not suggest what the settings should be, but only that they should be in place:

Players have the option of setting daily, weekly or monthly limits on the size of deposits. Players have the option of setting a system-wide loss or time limit. Players have the option of setting individual loss or time limits of for each type of game offered by the site. Players may lower a limit at any time from their account or with a customer service agent. This will take effect immediately. Players may request increases in or removal of their limits. After a delay of 24 hours, the player must reconfirm their request for the limit to be changed.

When the Lottery establishes its responsible-gaming standards for online play, they should be communicated prominently to players including a continuously displayed link while playing so they are aware of the tools and help available. We further recommend that the help feature include a live-chat button that instantly connects to Massachusetts Council problem-gambling counselors (assuming cooperation from the Massachusetts Council, of course). Warner said that such a live-chat feature may help problem gamblers before they reach a crisis stage.

5.

Opportunity for Research, Tools and Treatment

Both the NCPG Standards and the Gaming Act call for extensive problem-gambling research and for tools both by the regulators and players. We note that the Gaming Act requires
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the Massachusetts Gaming Commission to develop an annual research agenda in order to understand the social and economic effects of expanding gaming in the commonwealth and to obtain scientific information relative to the neuroscience, psychology, sociology, epidemiology and etiology of gambling. The research agenda, which is ambitious and comprehensive, concerns the field of problem gambling generally; i.e., it does not restrict the research to casino gambling. Therefore, it would be in the best interests (financially and professionally) of both the Lottery and the Massachusetts Gaming Commission for the two gambling-related agencies to cooperate on such research, with the Lottery contributing detailed, aggregate wagering data and funding. The Gaming Act further requires casino licensees to collectively pay at least $5 million annually to into the Public Health Fund 229 for the costs of service and public health programs dedicated to addressing problems associated with compulsive gambling or other addiction services. The $5 million assessment can be used to help fund the research agenda noted above. We believe the Lottery should also contribute to the Public Health Fund, in an amount commensurate with the volume of its online play; the amount can be better determined after the Public Health Fund programs are established. We note that that unlike traditional lottery play, and even a significant amount of casino play (i.e., that which is not captured through player-loyalty cards), all personal gambling activity conducted via the Internet is digitally captured. As such, gambling via the Internet will give operators, regulators, clinicians, treatment professionals and researchers as well as gamblers themselves an unprecedented amount of quantifiable, verifiable and timely data about players gambling expenditures and behaviors. In Massachusetts, the combination of tracked casino play (among patrons who do not opt out) and Lottery online-play data has the potential to provide problem-gaming professionals with perhaps the most detailed and comprehensive gamblingactivity data set ever collected in this country. Such data can be used not only for research, but also for patrons and operators to track and regulate patrons play either by the patrons, by the operators or by the regulators. LaPlante, et al. underscores this point in their 2012 report of the existing research on Internet gambling with a caution: Because of the amount of individualized gambling-related information collected, webbased gambling companies can intervene in ways not possible for land-based gambling. Specifically, using advanced algorithms, companies can operate automated risk-detection systems that provide early warning messaging to site subscribers who are at risk for the development of gambling-related problems. However, if such algorithms rest on faulty assumptions, their potential for false positives and false negatives is great.

229

A Commonwealth fund created in the Gaming Act, overseen by the Executive Office of Health and Human Services.

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Gemini Researchs Volberg noted that one such promising tool is Playscan,230 which analyzes a players behavior and, when combined with questions the player has answered, can issue warnings that might indicate a gambling problem. Playscan AB, based in Sweden, said the Swedish lottery Kombispel will be the first lottery in the world where players can use Playscan from day one; previously, the program had needed six months of data before providing results to players. As per both the NCPG Standards and the Gaming Act, players should be able set time and dollar limits on their wagering. A key decision for the Lottery especially if one day it chooses to engage in instant/fast-paced games only would involve the initial settings. That is, will players be required to set limits in the first place perhaps even starting with a default setting, or will players merely have the option of establishing them in the first place (as is now required of casino licensees)? Another tool is self-exclusion, which is common in the land-based casino industry. Selfidentified problem gamblers can put themselves on an exclusion list that denies them the ability to enter casinos, or receive promotional material. While such lists could be extended to online offerings, the program needs to be developed to address multiple sites. In the land-based world, in most markets, exclusion lists can be easily extended to multiple properties, but in online gambling, if different sites are regulated by different agencies or if some are not regulated at all, what value would an exclusion list offer? At the same time, problem-gambling experts seek to ensure adequate funding for treatment and other programs, while they are exploring any possible advantages to be offered by the nature of online gambling, which unlike in land-based casinos or traditional lotteries player patterns and activities can be readily identified. The treatment of problem gambling is, in practice, a state-level public policy issue typically handled by a health or social services agency. In Massachusetts, it is the Department of Public Health, Bureau of Substance Abuse Services, which oversees problem-gambling treatment through one of 13 centers throughout the state. The Department of Public Health also contributes a substantial portion of funding to the Massachusetts Council, which also receives funding from the Lottery. The Council further provides counseling through its 24-hour helpline, referrals to state outpatient treatment centers, referrals to organizations such as Gamblers Anonymous, and resources on its website. Gambling funding and treatment varies by state. The NCPGs Whyte said more than half of the states have no public funding of treatment and that 80 percent of private insurers refuse coverage for pathological gambling. Problem-gambling experts say some clinicians are sometimes able to work around the insurance issue by instead diagnosing patients with a covered

230

More information at http://www.playscan.com/pages/product#.UIaAzIbF0UU

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disorder; as noted earlier, problem gamblers typically have another disorder or mental-health issue.

6.

Conclusion

Our research and interviews with experts in the problem-gambling field yielded two overarching themes: Problem gambling needs to be addressed through a combination of proactive programs and adequate funding. Internet gambling is so new and unproven in its impacts that public officials and problem-gambling experts need to be fully flexible in identifying and implementing policies designed to address this issue.

Problem gambling is a complex and deep subject, itself worthy of a far more comprehensive examination than we can present within the confines of this report on the overarching subject of online Lottery play. Fortunately, Massachusetts has three outstanding problem-gambling resources that may be of service to the Task Force: Division on Addiction at the Cambridge Health Alliance. Contact: Howard J. Shaffer, Ph.D., Director; (781) 306-8600 Gemini Research Ltd. in Northampton. Contact: Rachel Volberg, Ph.D., President; 413-584-4667 Massachusetts Council on Compulsive Gambling. Contact: Marlene Warner, MA, Executive Director; (617) 426-4554

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X.

Economic Development
1. Massachusetts as Games-Development Hub

In addition to the primary benefits to the Lottery of expanding onto online play, there are potential economic-development synergies particularly in regard to the opportunity for Massachusetts to license Internet Lottery games to other jurisdictions and to increase statewide high-technology employment by becoming a hub of Internet gambling development. As noted earlier, Internet lottery is now in its infancy. Therefore, this entire industry appears to be a classic blue ocean market space. The term blue ocean was first highlighted in the 2005 business book Blue Ocean Strategy by W. Chan Kim and Renee Mauborgne and was used to describe how enterprises can generate high growth and profits by creating new demand in an uncontested market space.231 Enterprises that are able to create demand in blue ocean territory enjoy significant benefits associated with being first to market. Deborah Ettington of Penn State Universitys Smeal College of Business astutely compared first-mover advantage to the familiar phrase of the early bird getting the worm. Essentially, entities that are the first to market or early leaders in providing a new product or service are often rewarded with market dominance, technology leadership and control of resources.232 Massachusetts could profit by leading the nation in the introduction of online Lottery play. We note that the Lottery already has distinguished itself in creating innovative games. Unleashing this creativity in the realm of online lottery products, particularly new types of monetized social games, can create new employment opportunities for game development firms in Massachusetts. As new jurisdictions seeking to introduce their own Internet Lottery offerings find the technical, staffing and other hurdles to building these capabilities internally to be daunting, they would be encouraged to instead license finished games software or the underlying platform code from Massachusetts offering the Lottery an incremental revenue opportunity. Perhaps most importantly, the technology leadership aspect that would be provided through the early adoption of Internet Lottery technologies could provide incremental software programming jobs for current state residents as well as encourage external programmers to gravitate to Massachusetts to be closer to the epicenter of this growth.

231

W. Chan Kim and Rene Mauborgne (2005). Blue Ocean Strategy: How to Create Uncontested Market Space and Make the Competition Irrelevant. Boston, MA: Harvard Business Review Press.
232

Deborah R. Ettington, First Mover Advantage, http://www.referenceforbusiness.com/management/ExGov/First-Mover-Advantage.html

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There are Massachusetts companies at work today in the Internet gambling space, although in the absence of legalized Internet gaming in the United States it is difficult for them to survive. For example, one local tech firm, Cambridge Interactive Development Corporation (CIDC), recently voiced support for the Internet poker legislation proposed by State Rep. Daniel Winslow, R-Norfolk and a member of the Treasurers Online Products Task Force. CIDC is a Massachusetts-based software developer for online poker currently doing business overseas in legalized European and Asian markets supplying operators such as Everest Poker and BetClic Poker. CIDC was founded 15 years ago in Cambridge, and has employed more than 200 people worldwide, 150 of whom were, until recently, located in Massachusetts.233 Tim Parilla, Internal Counsel for the firm, also spoke at the first of the Treasurers Public Forum meetings, describing the economic benefits that Internet game development could bring to the Commonwealth. Unfortunately, in a development reminiscent of the collapse of Kurt Schillings 38 Studios video gaming venture in June of this year, CIDC officials on July 12, 2012 informed the Massachusetts Division of Career Services that it was closing its office at 150 Cambridge Park Drive and laying off 120 employees.234 Massachusetts is already a thriving hub for video game software development. When comparing video game software development and lottery or casino game software development, Monty Sharma, Managing Director of the Massachusetts Digital Games Institute (MassDiGI), noted that the skill sets are extremely similar. MassDiGI has identified an existing cluster of game development in Massachusetts (particularly around the Boston area), allowing it to ideally support an extension of services into lottery or casino game development. The existence of business clusters were first described by Harvard Business School Professor and popular business author Michael Porter. In his book The Competitive Advantage of Nations, published in 1990, Porter described clusters as geographic concentrations of interconnected companies, specialized suppliers, service providers, firms in related industries, and associated institutions (e.g., universities, standards agencies, trade associations) in a particular field that compete but also cooperate.235 A classic example of a geographic cluster like that described by MassDiGI is Californias Silicon Valley, the renowned epicenter of information technology. Far from being a mere phenomenon, Porter highlighted that clusters offer significant benefits in that they enhance not only productivity, but that they are also key drivers of job growth, wage growth, new business formation, and innovation.236
233

CIDC press release, Massachusetts Gaming Software Developer Supports Internet Poker Amendment, April 25, 2012
234

July 12, 2012 letter from CIDC to Division of Career Services. http://www.scribd.com/doc/109109337/NewCIDC-Delaware-Corp-7-13-12-Cambridge (accessed November 4, 2012)
235

Michael Porter, Location, Competition, and Economic Development: Local Clusters in a Global Economy. Economic Development Quarterly, Feb2000, Vol. 14 Issue 1
236

Michael Porter, Clusters and Economic Policy: Aligning Public Policy with the New Economics of Competition. Harvard Business School, ISC White Paper, November 2007

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The scale of this existing gaming development cluster in Massachusetts was quantified by MassDiGI on September 17, 2012, when it released the results of its MA Digital & Video Game Industry Cluster Census & Econometric Survey, in which 124 entities responded. These survey participants included game development and publishing companies of all sizes, from publicly traded game companies to small independent game development studios, interactive media companies, colleges and universities, middleware/tools developers, professional services, investors, freelancers/independent contractors, retailers, event organizers and other game community organizations.237 MassDiGI reported that the 124 participants in the survey currently employ 2,041 people. Considering that the Entertainment Software Association (ESA) reports that the average salary for video game developers is $89,781, the industry would represent total statewide compensation of over $234 million. MassDiGI further estimates that the salaries and benefits helped to support an additional 5,307 indirect jobs.238 In addition, while overall nationwide economic growth is stagnant, with the Bureau of Economic Analysis reporting gross domestic product growth from June 2011 through June 2012 of just 2.1 percent, it is notable that the MassDiGI survey also concluded that over the span of just three years, the states digital and video game cluster has expanded at 78 percent in terms of direct employment and that 39 percent of survey participants were planning on hiring in the upcoming 12 months. So while a gaming software development cluster clearly exists in the state and video game development is growing throughout the region, Albert Reed, CEO of Demiurge Studios Inc. in Cambridge, nonetheless noted a worrisome employment trend: Theres a constant drain from the East Coast to the West Coast. Thats partly because cities like Los Angeles, San Francisco and Seattle are home to some of the worlds largest video game publishers like Activision Blizzard, Inc., Microsoft Corp., Nintendo of America, and Electronic Arts Inc. He added, We do not have a very large anchor developer or publisher here right now. As a result, when local companies try to recruit talent, were swimming upstream a little bit. 239 While the lack of an anchor company in Massachusetts may be a factor in this migration, it may also be the simple irony that the supply of new programmers being produced in the state is actually significantly outpacing the currently strong growth of the industry. According to Sharma of MassDiGI, there are currently 1,000 game-development students in the state. Even if the recent industry job growth continues at the annual 26 percent rate that has been realized over the past three years, that would leave over 450 gaming software programming graduates who will be

237 238

http://www.massdigi.org/wp-content/uploads/2012/09/massdigisurveysummary91712.pdf

Massachusetts Digital Games Institute, MA Game Industry Experiences 78% Growth in 3 Years, September 17, 2012; via http://www.massdigi.org/wp-content/uploads/2012/09/massdigifinalreleasesurvey91712.pdf
239

Hiawatha Bray, Video game industry a bright spot in Mass, The Boston Globe, September 17, 2012.

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forced to leave the state each year (a phenomenon that is not unique to gaming software development, as Sharma noted that in terms of overall IT students, approximately 10,000 to 12,000 have to leave the state annually following graduation to find employment). In economic terms, those 450 migrating jobs represent over $42,000,000 in taxable income that would be lost to other states such as California, Texas, Washington and New York the four states that lead Massachusetts in video game software developer employment, according to the ESA. Expanding the Lottery with new, Internet-based digital games can be reasonably projected to further enhance this existing cluster because of the similarities and potential similarities between video game software development and casino/lottery game development. This would increase high-technology and high-wage employment opportunities and reduce the current brain drain of knowledge workers who need to leave the commonwealth to pursue their careers. While the Lottery moving into online play would be beneficial in numerous ways, it will not in and of itself be a panacea for economic development in the regional software development space. Additional actions would need to be undertaken to fully cultivate this growing industry. The Commonwealth has already taken some steps to promote this industry most notably the aforementioned Massachusetts Digital Games Institute, which was designated by the Commonwealth, for academic cooperation, economic development, and job creation across the Massachusetts digital and video games ecosystem240 Other states, however, are doing much more. In fact, Stephen Riden, a Boston lawyer, noted in a recent article that at least 20 states have enacted legislation to provide tax incentives to interactive media companies. Typically, the tax incentives take the form of credits, grants, and exemptions.241 According to Mr. Riden, these incentives include: Alabama A qualified production company shall be entitled to a 25% rebate of all state certified expenditures and 35% of all payroll paid to residents of Alabama for the state certified production. Production expenditures for a project must equal or exceed at least $500,000 but must not exceed $20,000,000.242 Arkansas Rebates of fifteen percent (15%) of qualified costs in connection with the production of a state-certified film project; and an additional ten percent (10%) of the payroll of below-the-line employees who are full-time residents of Arkansas.243 Colorado The new Colorado Film Incentive program offers a 20% cash rebate for production costs taking place in the state. The incentive program covers feature films,

240 241 242 243

http://www.massdigi.org/about-us/ Stephen D. Riden, Tax Incentives for Video Game Companies, October 2010 / Updated June 2011 http://www.alabamafilm.org/2010/filmmakersincentives2.shtml http://www.arkansasproduction.com/arincentives_state.php

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television pilots, television series (broadcast and cable), television commercials, music videos, industrials, documentaries, video game design and creation, and other forms of content creation.244 Connecticut In 2006, the Connecticut General Assembly established a tax credit program to encourage the production of digital media and motion pictures in the State of Connecticut. The legislation makes it possible for eligible production companies to receive a tax credit on a sliding scale of up to 30% on qualified digital media and motion picture production, pre-production and post-production expenses incurred in the state.245 Florida Florida provides a 20% tax credit, plus an additional 5% for Family Friendly content as well as an additional 5% Digital Media Facility Bonus.246 Georgia - The Georgia Industry Investment Act of 2008 provides Georgia companies developing games and digital media with a 30% tax credit on qualified Georgia expenditures.247 Hawaii Hawaii provides a tax credit of 15% per cent of the qualified production costs incurred by a qualified production in any county of the State with a population of over seven hundred thousand; or 20% per cent of the qualified production costs incurred by a qualified production in any county of the State with a population of seven hundred thousand or less.248 Kentucky Kentucky provides qualified productions the option of taking advantage of either a sales tax refund incentive or an income tax credit of up to 20% of approved expenditures.249 Louisiana The Digital Interactive Media and Software Development Incentive provides a tax credit of 25% of qualified production expenditures for state-certified digital interactive productions in Louisiana and 35% tax credit for payroll expenditures for Louisiana residents.250

244 245 246 247 248 249 250

http://www.coloradofilm.org/incentives/index.html http://ct.gov/ecd/cwp/view.asp?a=3880&q=454834 http://www.filminflorida.com/ifi/incentives.asp http://www.georgia.org/industries/entertainment-industry/digital-entertainment/Pages/default.aspx http://www.capitol.hawaii.gov/hrscurrent/Vol04_Ch0201-0257/HRS0235/HRS_0235-0017.htm http://filmoffice.ky.gov/incentives/

http://www.louisianaeconomicdevelopment.com/incentives--programs/digital-interactive-media-and-softwaredevelopment-incentive.aspx

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Maine Companies may receive tax rebates equal to 12% of qualified wages paid to Maine residents working on a certified production and 10% of nonresident wages. They may also receive tax credits equal to 5% of the non-wage production expenses.251 Michigan Michigan provides funding of 27% of direct Michigan expenditures an extra 3% for expenditures at a qualified facility or post production facility, 32% for Michigan Personnel and 25% for Non-Michigan Personnel.252 New Jersey New Jersey offers a tax credit in an amount equal to 20% of qualified production expenses, available to production companies meeting certain criteria, chiefly: (1) At least 60% of the total expenses of a project, exclusive of postproduction costs, will be incurred for services performed and goods used or consumed in New Jersey.253 New Mexico - New Mexico offers a 25% Film Production Tax Credit as well as a 25% Refundable Tax Credit for post-production services rendered in New Mexico.254 North Carolina North Carolina provides a 15 percent tax credit for employers developing interactive digital media.255 Ohio The Ohio Motion Picture Tax Credit provides a refundable tax credit that equals 25 % of in-state spend and non-resident wages and 35% in Ohio resident wages on eligible productions.256 Rhode Island Rhode Island provides a tax credit of 25% of state certified production costs incurred directly attributable to activity within the state.257 Texas The Texas Moving Image Industry Incentive Program offers qualifying productions the opportunity to receive a payment of 5% to 17.5% of eligible Texas spending or 8% to 29.25% of eligible wages paid to Texas residents, depending on budget levels and types of productions, upon completion of a review of their Texas expenditures. Texas also offers up-front Sales Tax Exemptions on most items rented or purchased for direct use in production; refunds of the 6% State Occupancy Tax on

251 252

http://www.filminmaine.com/files/mafi_explained.pdf

http://www.legislature.mi.gov/(S(uzfpcovijqxy2our1rl2awen))/mileg.aspx?page=getobject&objectname=mcl125-2029h&query=on
253 254 255 256 257

http://www.njfilm.org/Incentives.htm http://www.nmfilm.com/Incentives.aspx http://www.newsobserver.com/2010/07/23/593855/video-games-get-tax-break.html http://www.ohiofilmoffice.com/Incentives.html http://www.film.ri.gov/taxinfo.html

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hotel rooms occupied for more than 30 consecutive days and refunds on Fuel Tax paid on fuel used off-road.258 Virginia - Tax credits in Virginia begin at 15 % of all qualifying expenses, including wages. If the production is shot in an economically distressed area of the state as designated by the Virginia Economic Development Partnership, the base amount increases to 20%. An additional 10-20% can be added for the payroll of workers from Virginia, and each first time film industry employee is eligible for an additional credit of 10%.259 Wisconsin Wisconsin offers a 25% Production Services Tax Credit for accredited productions.260

Due to these extensive incentives available elsewhere, Sharma estimates that it costs as much as 30 percent more to develop a video game in Massachusetts than it does in other jurisdictions. Due to the unique nature of the video game business, these added costs are an even greater barrier to investment than they would be for other industries. For example, with motion pictures, even movies that are unsuccessful at the box office have the potential to recoup their investment through DVD sales and other commercial opportunities. For video games, however, the risks are dramatically higher as a game that does not become a hit in its initial release will most likely be a financial failure for the production company. As a result, venture capitalists and other traditional funding sources are generally not available to video game production companies as these types of firms will invest in technology, but not in content or content development. So with a major means of traditional startup and ongoing funding not available to game-production companies, governmental incentives become much more important to their business model and a much greater influencing factor on where to locate and to invest. While these above-listed states extend many, if not all, of the same economic incentives available to the film industry to video game developers, this is not the case in Massachusetts. While the Commonwealth offers a 25 percent production credit, a 25 percent payroll credit, and a sales tax exemption261for filmmakers, legislation filed in the Massachusetts House of Representatives to extend these incentives to video game developers has not been passed and is currently not available. Aside from tax credits, according to Sharma, when game development studios are considering a location, the biggest other consideration is talent. Massachusetts already possesses solid infrastructure in this regard. Mass has a great educational system, so we have

258 259 260 261

http://governor.state.tx.us/film/incentives/overview http://www.film.virginia.org/incentives/tax-emptions/ http://www.filmwisconsin.net/incentives/overview-of-state-incentives/ http://www.mafilm.org/production-tax-incentives/

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the raw material needed to staff a large sector, he said. Numerous Massachusetts colleges in the feature video game design programs and, in fact, two of The Princeton Reviews top 10 undergraduate schools to study video game design for 2012 are in Massachusetts: Massachusetts Institute of Technology and Becker College, as well as two additional colleges that received Honorable Mention status: Northeastern University and Worcester Polytechnic Institute.262 Should the Lottery seek to expand into online play, it should prove to be a major lift to game developers throughout the state and generate not only direct economic benefits, but significant ancillary benefits as well. However, to maximize these benefits, the Commonwealth may want to consider additional actions to further stimulate growth, such as the extension of tax credits to game developers and perhaps the extension of MassDiGIs services to include more traditional business-incubation services.

2.

Tourism

One argument for casinos is that they can draw in tourists and tax revenues from out-ofstate. A casino near Boston, for example, may attract tourists who might not otherwise visit Boston. The casino adds an additional entertainment option for tourists. Of course, casinos within the state also benefit the citizens of the state who would like the option of visiting a casino close to home. In the case of Massachusetts, it is likely that the main economic benefit of casinos will come not from drawing tourists, but rather, from keeping its people at home. The introduction of online gambling is not likely to have a large tourism impact. It is difficult to imagine people driving or flying to the state in order to buy Lottery tickets or play casino games online. Such options are generally widely available, and so the conservative expectation is that online gambling will do nothing to increase tourism in the state. It is possible, of course, that, while in Massachusetts, some tourists may decide to gamble online. But it would be surprising if this effect was very large. Another benefit from the introduction of casinos is that the building of casino resorts creates jobs that might not otherwise exist. Casino operations are labor-intensive, and this means that casinos provide a long-term employment opportunity. During a recession or recovery, this prospect is especially attractive to voters and politicians. The introduction of online gambling, unlike the opening of a casino, is not likely to create a large number of direct jobs. Yes, there may be some jobs at state regulatory agencies and the private or public organizations that offer online gambling. But for the most part, there is no new infrastructure that must be developed to offer online gambling. So whether online gambling comes to Massachusetts or not, we would not expect a significant impact on employment and wages in the state.

262

http://www.princetonreview.com/game-design-press-release.aspx

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Y.

Internet Gambling: Background

1. Early Development

The Internet became a viable option for gamblers in the mid 1990s as the new medium became more reliable, realistic, and graphically attractive and as robust transaction processing was established. However, due to the inability of US legislators to decide whether wagering over the Internet was legal, an industry developed in the United States and used by US players grew rapidly and prospered outside of US borders. A watershed in the early development of Internet gambling occurred in 1994, when the tiny nation of Antigua and Barbuda passed the Free Trade & Processing Zone Act. This effectively created a free-trade zone allowing US bookmakers to base in Antigua and take bets by phone for horse racing and sports events protected from US anti-gambling laws.263 Antiguas new law authorizing legal bookmaking offered potential application to Internet gambling and soon licenses were being granted to operate online casinos.264 However, while this law established a licensing authority, no meaningful regulation or enforcement was concurrently enacted. Two key software innovations set the stage for the rapid growth of Internet wagering. 265 The first was the development of fully integrated Internet gambling software in 1994 by Microgaming, which provided the initial means for playing casino games over the Internet. The second was the development of encrypted communication protocols in 1995 by Cryptologic, which for the first time established a robust foundation for secure online monetary transactions.266 Other early Internet gambling software developers soon followed, including the Canadian company Starnet Communications and the Swedish software developer Boss Media, which was acquired in 2008 by GTECH, now a division of Lottomatica Group. 267 US-based software developers, while clearly interested in new Internet applications, could not participate in this incipient industry because at that time Internet gambling was considered illegal under the 1961 Wire Act. This law was originally passed as an element of US Attorney General Robert Kennedys efforts to defeat organized crime and was designed to cut the wire connecting bookies to sports events.

263 264 265

Robert T. Wood, Robert J. Williams, Internet Gambling: Past, Present and Future, 2007 Antigua & Barbuda Investment Authority, www.investantiguabarbuda.org

Robert J. Williams and Robert T. Wood, Internet Gambling: A Comprehensive Review and Synthesis of the Literature, University of Lethbridge, Alberta, Canada, August 2007
266 267

The History of Internet gambling, 777.com, Online Entertainment, Ltd. onlinecasinoarchives.com, November 15, 2008

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2. Proliferation Offshore
Soon after the first legal jurisdictions were established, the first operational online casinos began play-for-fun operations and by the close of 1995 web-based casino games were available for the first time, although money wagering was not. These casinos were soon followed by Internet sports betting operations, including Interops, Sports Book and Ladbrokes. Early sports betting websites were only marginally interactive, listing odds and providing toll-free telephone numbers for placing bets. The first instance of real money being wagered over the Internet by a member of the general public, according to Williams and Woods review of the literature, was actually a lottery transaction, the online purchase of tickets in a manual drawing by the International Lottery in Lichtenstein Foundation that occurred on October 7, 1995. 268 (We discuss the history of Internet lottery operations later in this chapter.) Multiple operators contend for the distinction of being the first online casino, including The Gaming Club and Intercasino, but the first money wager on casino games is generally attributed to Antigua-based Intercasino in January 1996.269 Intercasino was a Cryptologic venture that originally offered 18 online games and access to the National Indian Lottery. Once the first Internet wagers were taken, a period of rapid expansion began and online casinos proliferated. As competition grew among offshore operators, technology continued to evolve and both game inventories and user interfaces steadily improved. Between 1996 and 1997 other Caribbean islands (Netherlands Antilles, Turks & Caicos, Dominican Republic, Grenada, and St. Kitts & Nevis) and several Central American countries (Belize, Costa Rica, Panama) began hosting online wagering sites. Early Internet gambling operators preferred to base operations in such small countries in order to enjoy the legal protective legislation brought about by their positive influence on such small economies. The prosecution of software provider Starnet Systems in 1999 by Canada, a developed country that clearly prohibited Internet gambling, accelerated this trend.270 In 1997 Starnet had initiated the business model of licensing its software to casino operators in return for a percentage of earnings, using those funds to establish its own betting site, WorldGaming.net. The Internet gambling industry continued to expand online content as Microgaming released the first progressive online slot machine, Cash Splash. 271 The first Internet bingo site offering cash prizes online was established in 1998. 272 The first Internet poker room

268 269 270 271

Robert T. Wood, Robert J. Williams, Internet Gambling: Past, Present and Future, 2007 David G. Schwartz, Roll The Bones, 2006 Robert T. Wood, Robert J. Williams, Internet Gambling: Past, Present and Future, 2007 History, Online casino Project. http://onlinecasinoproject.com/Internet-gambling-

Internet Gambling history.html

272

Williams and Wood

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also went online in 1998 at planetpoker.com. Farther abroad, Eurobet in the United Kingdom began offering online sports and race betting in 1996.273 Centerbet, in the Northern Territory of Australia, began offering online sports betting in 1996 and three more sports books were in operation by the end of 1997.274 First Nations tribes in Canada entered the online gambling industry in 1996 when the Kahnawake Gaming Commission was established as a licensing and regulatory entity based in the Mohawk Territory of Kahnawake, located on the south shore of the St. Lawrence River near Montreal.275 By 2001, the estimated number of patrons who had gambled online neared 8 million and Internet gambling became a global phenomenon.276 Licensing jurisdictions and offshore operations sprang up in Argentina, the Caribbean, Central America, the Isle of Man, Alderney, Malta, and Gibraltar. In Africa, Sun International Hotels used Boss Media software to build an online version of its casino, licensed and operated out of the Isle of Man. Successful European online casino operators quickly recognized the potential for expansion in Asia and began actively marketing to the region. Cassava Enterprises, operating the popular Casino-on-Net site from Antigua since 1997, incorporated in Gibraltar and set up a new subsidiary in 2003 titled 888.com after the luckiest number in Chinese culture.277 This company soon became the worlds highestspending advertiser among online casino operators. Internet gambling experienced explosive growth beginning in 1997, increasing from an estimated 15 sites in 1996 to more than 200 by 1997, to more than 700 by 1998, 1,800 by 2002, and eventually reaching a high point of 2,926 online casinos by 2006.278 Internet gambling revenue grew apace, with more and more sites processing real-money wagers in several currencies and producing annual revenues estimated between $835 million and $1 billion, with US players contributing an estimated two-thirds of the total revenue. By the end of the millennium, the total revenue figure had grown to an estimated $2.2 billion, although the contribution from US players declined as online gambling proliferated offshore.279 By 2001 revenue estimates had tripled to more than $3 billion globally, more than doubled by 2004 to $8.2 billion, and by 2006 had reached an estimated total of $10.9 billion worldwide. By June 30, 2010, this industry has grown to an estimated 42.8 million unique, real-money Internet-gambling

273 274

Eurobet, 2007

Netbets: A review of Internet gambling in Australia, Report for the Select Committee on Information Technologies. Senate Information Technologies Committee, March 2000
275 276 277 278 279

Kahnawake, Murray Marshall Internet Gambling Report, Fifth Edition. PRNewswire, March 22, 2001 888Holdingsplc.com David G. Schwartz, Roll The Bones, 2006 R.D. Hammer, Does Internet gambling strengthen the US economy? Dont bet on it, 2001

Federal Communications Law Journal, 54(1), 103.

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accounts worldwide and 2,679 Internet gambling sites in operation.280 Global Internet gambling revenue for non-US companies was estimated to be $5.9 billion in 2008 from players in the United States and $21.0 billion from players worldwide.281 Due to the quasi-criminal status of online gambling in the United States, the lack of any large established land-based casinos in the small countries where it first proliferated, and the potential threat to licenses of those small casinos that did exist, the Internet gambling industry developed as an online-only play and has largely remained that way up to now. All of the initial Internet casinos were exactly that online storefronts with no ties to land-based operations. As a result, credibility was a major issue; reputation became one of the most important attraction attributes for Internet gambling websites, as many early players never collected their winnings. As the industry matured, the more reputable sites gained traction through attentive customer service, registration with multiple jurisdictions, and certification by large accounting houses such as PricewaterhouseCoopers. Land-based casinos were relatively late to enter the Internet gambling market. The first was in 1999, when an Australian casino operator, Lasseters in Alice Springs, Northern Territory, began offering games over the Internet. UK operators William Hill and Ladbrokes took their sports betting online shortly afterward in late 1999 and early 2000, respectively. 282 Certain other land-based operators have made attempts to enter the online gambling space over the years but for these companies, which include MGM Mirage, Aspinalls, and Kerzner International, the risk of potentially compromising their land-based licenses usually outweighed the rewards posed by the prospect of online operations.

3. Legalization in the United Kingdom

The path to European legalization of Internet gambling was paved in the United Kingdom, where opposition to online betting was not as strident as in the United States. In 2001 the British Channel Island of Alderney legalized Internet betting and established itself as a licensing jurisdiction. The Isle of Man followed and these two tiny Crown dependencies became popular as legitimate gambling jurisdictions for the licensing and participation of US land-based gambling companies, while providing much needed economic stimulus for the small Channel Islands. The Isle of Man went a step further than the Caribbean and Central American jurisdictions by introducing not simply licensing but also seeking to protect customers through Internet gambling regulation, testing and enforcement. This approach attracted MGM Mirage to become the first US land-based casino company to launch an Internet gambling business. The
280 281 282

H2 Gambling Capital Internet Gambling Fact Sheet, American Gaming Association, 2010. Robert T. Wood, Robert J. Williams, Internet Gambling: Past, Present and Future, 2007

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MGM Mirage site focused exclusively on legal markets in Europe and abroad with support from the Nevada Gaming Control Board. Although MGM Mirage eventually withdrew from the Internet gambling market, along with its US software supplier, the venture proved that US companies could also participate in the rapidly expanding market while also complying with US land-based regulators. Alderneys Gambling Control Commission, established in May 2000 and led by Andr Wilsenach, a former South African land-based regulator, modeled its regulatory and licensing infrastructure after the Nevada and South Africa land-based regulatory models. MGM Mirages software provider, WagerWorks, a US-based systems developer now owned by International Game Technology, was Alderneys first licensee. Other publicly traded companies quickly followed, including BSkyB, World Poker Tour, Virgin, Rank Group and Paddy Power, as licensees operating online casinos. Alderney firmly established itself as an attractive European gambling jurisdiction by creating a credible regulatory infrastructure, player-protection policies and favorable tax structure which lured many of the largest Internet operators to license there. In 2011, however Alderney was widely criticized in the press and by land-based operators for failing to identify a $300 million fraud issue with Full Tilt Poker, although it remains one of the top Internet gambling jurisdictions from a regulatory standpoint. Britain continued down the path to normalization of Internet gambling, releasing the Gambling Review Report in 2001. This carefully constructed assessment supported legalization of all types of Internet gambling in the United Kingdom. This eventually led to the UK Gambling Bill, a comprehensive measure legalizing Internet gambling while allowing more landbased casinos and betting operations. Culture Secretary Tessa Jowell played a major role in revising the bill and imposing strict regulations and high standards for all UK gambling operations. The culmination of this legalization process was approval in April 2005 of the UK Gambling Act,283 which established Internet gambling as a legitimate industry within the European Union and highlighted the United Kingdom as a model for other jurisdictions contemplating Internet gambling. The Gambling Act of 2005 has three principal objectives: Preventing gambling from being a source of crime or disorder, being associated with crime or disorder or being used to support crime. Ensuring that gambling is conducted in a fair and open way, and Protecting children and other vulnerable persons from being harmed or exploited by gambling.284

283 284

UK Gambling Act, Office of Public Sector Information, National Archives Gambling Act 2005, Part I, Section I

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The Act created the UK Gambling Commission to oversee all regulation enforcement in the areas of licensing online casinos, preventing underage gambling and problem gambling, keeping out organized crime, and ensuring gaming fairness through software testing and accreditation, and the publication of game odds and monthly payout percentage reports. In addition to issuing and monitoring operating licenses, the UK Commission issues codes of practice, investigates and prosecutes illegal offenses, and advises the Secretary of State for Culture, Media and Sport. Under the UK Gambling Act, both Alderney and the Isle of Man were white listed as it applied to remote gambling, enabling their licensees (many of whom are UK-licensed online sports books and land-based operators) to continue to operate from those jurisdictions and market their services to the UK. Unlike the situation in the United States, legalization enabled existing gambling operators with operations in the online sector, including such firms as Eurobet, William Hill and Ladbrokes, to bring their online operations onshore into the United Kingdom, Alderney, or the Isle of Man.

4. Prohibition in the United States

Although the technology that enabled Internet gambling was first developed in the United States and the great majority of early players were Americans, the issue of its legality was never debated openly in Congress. As a result, the legal status of Internet gambling in the United States has remained in limbo for more than 15 years. This unresolved legal situation has prevented the development of any major US-based operators and prevented domestic land-based commercial casino companies from entering the market. As a result, a vibrant and innovative industry has arisen internationally, centered in Europe, while potential operators and suppliers in the United States have remained at a technical, product and operational disadvantage relative to international operators. US authorities had long maintained that Internet gambling is illegal under the 1961 Interstate Wire Act,285 originally passed as one of Attorney General Robert Kennedys antiracketeering efforts. The Wire Act made it illegal to place wagers on live events across phone lines, and for more than a decade lawyers have argued whether it could also be applied to Internet wagering. The majority of legal opinions held that it could not and the US Court of Appeals for the Fifth Circuit ruled in November 2002 that the federal Wire Act prohibits electronic transmission of information for sports betting across telecommunications lines but affirmed a lower-court ruling that the Wire Act in plain language does not prohibit Internet gambling on a game of chance. The Department of Justice (DOJ) relied on its interpretation of the Wire Act to establish its position that all Internet gambling is illegal despite the Fifth Circuit ruling up until the passage of UIGEA in 2006, although it never tested that position

285

US Code, Chapter 50 - Gambling, Legal Information Institute, Cornell Law School

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with a case in open court. Reinterpretation of this position by the DOJ in a December 23, 2011, opinion has reversed this stand. (This matter is discussed in depth later in this report.) Opposition to Internet gambling grew stronger after 2000, partly in response to the explosive growth of this new phenomenon, and Congress pressured US-based search engines to stop advertising for Internet gambling companies. The online industry responded in a suit by Casino City Inc. claiming its First Amendment rights to free speech were violated, but the case was thrown out after multiple appeals.286 Internet advertising for casino sites currently appears in a wide variety of online and traditional media and also at land-based casino events such as the World Series of Poker. These ads, however, are carefully couched not to promote the dot.com real-money sites but rather the dot.net sites that are free-play mirror sites. The Nevada Gaming Commission explored regulating Internet gambling on an intrastate basis beginning in 2001, working with the Nevada Gaming Control Board to adopt regulations governing licensing and operation of Internet gambling within state boundaries. The law required Nevada regulators to study Internet gambling systems and determine if whether current security technologies were sufficient to prevent access by minors and other abuses. While the Nevada Gaming Commission found that Internet gambling could be adequately controlled, it also was required to determine if it could be operated in compliance with federal law. In 2002, the US Department of Justice advised Nevada of its longstanding view that federal law prohibits gambling over the Internet, including casino-style gambling. As a result, Nevada put its regulatory efforts on hold. Nonetheless Nevada gaming and regulatory authorities have remained focused on legalized Internet gambling and in December, 2011 approved the first official US regulations for the authorized operation of intrastate poker.287 While Nevada explored potential regulation, other states without commercial casino operations strengthened anti-Internet gambling measures, with Illinois, Indiana, Louisiana, Massachusetts, Oregon, South Dakota and Utah passing laws banning Internet gambling within their borders. Additionally, attorneys general in Florida, Kansas, Minnesota, Oklahoma and Texas issued opinions that Internet gambling is illegal within state borders.288

a. Unlawful Internet Gambling Enforcement Act

The Unlawful Internet Gambling Enforcement Act289 (UIGEA) became law in October 2006. It was passed as a rider to the Safe Port Act, an essential piece of homeland security legislation which was presented in the final minutes of the session and never debated on the floor of Congress. UIGEA did not make Internet gambling illegal but it was effective in reducing the
286 287 288 289

Internet Gambling History, Online casino Project, 2007 The Wall Street Journal, Nevada Sets Framework For Internet Poker, Alexandra Berzon, December 22, 2011 American Gaming Association website, Industry Information Fact Sheets: Internet Gambling, 2010 H.R. 4411:Internet Gambling and Enforcement Act, Govworks.com

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volume of financial transactions to fund the practice. UIGEA also has dampened the prospects for eventual federal-level (interstate) legalization in favor of state-by-state (intrastate) legalization efforts. This law was designed to suppress Internet gambling by targeting the payment mechanisms used to make deposits, place bets and withdraw funds on all the thousands of offshore wagering sites. UIGEA did not address the legality of online gambling, restrict the operation of offshore sites, or render illegal any form of wagering that had previously been legal. Its intent was to establish a means for enforcing existing federal law under the Wire Act by making it illegal for banks, credit card companies and similar institutions to process financial transactions for Internet gambling sites. UIGEA effectively prevented credit card companies and banks from processing fund transfers for Internet gambling transactions. Importantly, there are specific issues related to Internet gambling that UIGEA does not address. It does not update the federal Wire Act to specifically apply to any forms of Internet gambling; it does not resolve the dispute between the US Justice Department and the Fifth Circuit Court on whether the Wire Act applies to all forms of Internet gambling; it does not resolve whether the US horse racing industry is entitled to a legal exemption from the ban on Internet gambling; and it does not resolve whether Native American nations and tribes retain the right to operate Internet gambling sites regardless of federal regulations. UIGEA maintained the ambiguity of federal law regarding Internet gambling by not clearly defining the legality of online wagering and leaving the question open as a states-rights issue.290 After UIGEA passed, publicly traded Internet gambling operators voluntarily withdrew from the US market and excluded US residents from real-money wagering on their sites through the use of geographic-location software. The immediate loss of US player revenues adversely impacted the financial results of these publicly held companies, primarily 888.com and Party Gaming. However, it did not succeed in forcing all US players out of the market, as many simply migrated to less-scrupulous offshore providers still willing to take bets from US players. PokerStars and Full Tilt Poker are two examples of companies that chose to stay in the US market, and as a result became for a time the two most dominant poker networks in the world. While the law remained ambiguous on the question of legality for Internet casino and poker, the DOJ intensified an ongoing crackdown on sports betting operators and alternativepayment providers and imposed sanctions on offshore gaming companies participating in these activities which were now interpreted as clearly illegal. This prompted Antigua and Barbuda to take their case to the World Trade Organization (WTO), which ruled in its favor, denying US appeals and judging the US government to be in noncompliance with WTO trade policy because the legislation retains carve-outs for Internet gambling, including lotteries, horseracing and fantasy sports betting.291
290 291

American Gaming Association, Industry Information Fact Sheets: Internet Gambling, 2010 Interactive Gaming Council, World Online Gambling Law Report

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UIGEA went into effect in mid-2007, following a 270-day grace period to allow financial institutions to develop enforcement policies and procedures. Major sports organizations including the National Football League supported this legislation because it did not specifically target fantasy sports, but was opposed by the banking industry, which was obligated to provide the prevention mechanisms and undertake the financial burden of enforcement. Sports organizations had previously championed their own legislation, passed in 1992, the Professional and Amateur Sports Protection Act, which made sports betting illegal. Reaction to UIGEA abroad was generally negative and many European authorities and industry experts viewed the act as a form of trade restriction. The European Parliament 292 observed that the Act has a remarkable genesis in that it was (a) never debated by the Senate before being passed into law, and (b) was constructed as a late addendum (Title VIII) to a completely unrelated piece of legislation, namely the Safe Port Act. Professors Robert Williams and Robert Wood of Lethbridge University, Alberta, Canada, noted that in practice, the UIGEA targets providers rather than consumers,293 and that Internet gambling continues because only 50 percent of all Internet gambling sites refused to take wagers from players located in the United States after full enforcement of the law in 2007. Regardless of international reactions, UIGEA has been successful in suppressing demand for Internet gambling in the United States, and recent enforcement actions in 2011 and 2012 have had a large financial impact on Internet poker. UIGEA enforcement efforts by the Justice Department gathered momentum in 2011, culminating in the April 15 crackdown on the leading online poker operators popularly known as Black Friday, when indictments were unsealed in the Southern District of New York against the owners of the three most popular offshore poker sites: Full Tilt, Absolute Poker, and Poker Stars. The DOJ seized domain names in the United States, and froze player accounts to prevent the withdrawal of deposits. The Justice Departments aggressive enforcement actions under UIGEA have continued into 2012, including the February indictment from Baltimore against Bodog.com founder Calvin Ayre. 294

5. Evolution of the Online Lottery

The National Lottery of Finland claims the distinction of being the first lottery to fully leverage the Internet, although this claim is contested by the Icelandic lottery vendor Betware. Finlands lottery was granted a license to operate online in 1996295 and the Coeur dAlene Tribe in Idaho opened an online lottery in 1997. Scandinavian countries led the original movement of

292

Robert Young and Jonathan Todd, Internet gambling, Focusing On Integrity And A Code Of Conduct For Gambling, European Parliament, Policy Department, Economic and Scientific Policy, November 2008
293 294 295

Williams and Wood www.calvinayre.com R. van der Gaast, Finland: Internet gambling Update, September, 2001

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state lotteries online and continue to lead the industry in many categories. Swedish operator Svenska Spel opened an e-commerce website in May 1999, and progressively expanded its online product inventory by introducing a series of state-run lottery firsts: Oddset sports betting, lotto and keno in 2000; online instant ticket sales in 2003; probability games in 2004; and Internet poker in 2006.296 By fiscal 2010, Internet sales represented 16 percent of Svenska Spels total lottery revenue of SEK3.1 billion.297 Danish operator Danske Spil followed Sweden online in 2002, now selling almost all traditional lottery products online and also offering Internet gambling using Betwares platform. In 2010 Danske Spils online sales grew 13 percent, generating DKK1.8 billion, or 21.1 percent of total lottery sales. 298 The leading Internet lottery operator in Norway is Norsk Tipping, where more than 10 percent of its total sales are generated via mobile devices. The Scandinavian lotteries have traditionally been the leading innovators for Internet sales in Europe; the average proportion of Internet sales to total sales in Europe is 10 percent. 299 Finland, the first to offer Internet sales, generated 30 percent of its total revenues from the Internet in 2011.300 Denmark is close behind with 17 percent, while other long-term online lotteries such as Sweden and Norway hover around the European average. In the UK, Internet gambling boasts a 20 percent penetration rate, the majority of which is sports betting, while the Internet lottery penetration rate is somewhat lower at 16 percent of the adult population. Southern European countries generate a much smaller proportion of their lottery sales through the Internet, usually less than 5 percent, but this is due in large part to the lower Internet and broadband penetration rates in Southern European countries. Northern European countries, particularly Scandinavian countries, universally reflect Internet penetration rates higher than the 79 percent US average while Southern European states generally display lower rates of Internet availability. 301

296 297 298 299 300 301

La Fleurs Magazine, March/April 2011 Ibid. Ibid. GTECH Veikkaus Oy 2011 Annual Report Internet World Stats

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Z.

Current State of Online Play: International

1. Global

Internet gambling is a thriving offshore industry that developed overseas in the absence of any regulated market in the United States. Globally, Internet gambling currently represents about 8.6 percent of the gross revenue from all forms of gambling, a total estimated to be almost 300 billion ($410.7 billion) by the end of 2012. The proportion of Internet gambling to overall gambling has grown from 1.7 percent in 1998 to 7 percent in 2009, and it is conservatively estimated to reach almost 10 percent of 332 billion ($420 billion) in gross gaming revenue (GGR) by 2015.302 These figures translate into an estimated global Internet gambling revenue total of 32.5 billion ($42.7 billion), by 2015. Figure 58: Internet (or interactive) gambling as a proportion of global GGR
350

12% Global Total

300

% Interactive 9.1% 8.6% 7.7% 7.0% 6.9% 9.0% 9.2% 9.5% 9.8%

10%
As percent of global gaming revenue

250

8.6%

8%

200
Millions

6%

150

6.1% 5.0% 4%

100

4.1% 2% 183.4 202.3 215.2 231.6 248.7 251.1 254.1 261.6 284.7 299.8 312.1 322.5 331.8 0%
2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E 2013E 2014E 2015E

50

Source: H2 Gambling Capital

As shown in the following chart, sports betting is by far, the largest revenue segment of Internet gambling. These 2011 estimates display markedly lower relative contribution from Internet poker than in 2010 due in large part by the US DOJ enforcement actions against
302

H2 Gambling Capital

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international companies operating offshore, US-facing sites. H2 Gambling Capital estimated that poker revenues in 2010 comprised 14.4 percent of global Internet GGR; the 2011 estimates contribute only 12.6 percent to global online revenues. That said, sports betting revenues continue to grow globally and constitute one of the fastest growing elements of mobile gambling. Figure 59: Global Internet gross gambling revenue breakdown by product type, 2011
Skill/ Other Gaming/ Commerical Lotteries, 5.3% Bingo, 5.9%

State Lotteries, 9.2%

Betting, 43.3% Poker, 12.6%

Casino, 23.7%

Source: H2 Gambling Capital

Examining the trend, it is evident that sports betting revenue has shown the fastest growth, followed by equally strong growth casino revenue, while poker has grown more slowly and displayed slow growth globally since 2006.303 As the above chart illustrates, sports betting is the largest single component of Internet gambling revenue on a global basis, and it is by far the most active element in gambling conducted from mobile devices.304 However, as the DOJs legal opinion of December 23, 2011, states, sports betting remains the one form of gambling specifically prohibited by the 1961 Wire Act and barring new Federal legislation, sports betting will not be a component of any potential US Internet gambling initiatives.

303 304

H2 Gambling Capital, 2011 data set H2 Gambling Capital

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Figure 60: Global Internet gross gambling revenue trends, by product type

35,000 State Lotteries Skill/Other Gaming/Commerical Lotteries 30,000 Bingo Poker Casino 25,000 Betting
21,836 24,609 23,795 26,967 28,687 30,684 32,363

20,000
Millions 17,131 16,179

19,452

15,000
13,040

10,057

10,000
7,519

5,000

2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E 2013E 2014E 2015E
Source: H2 Gambling Capital

An analysis of global Internet gambling by region shows that the strongest growth over the past decade has been in Europe, now the worlds largest Internet gambling market, followed by Asia and the Middle East. North American GGR declined after UIGEA passage, which curtailed US Internet gambling, and revenues currently remain below their highest level observed in 2006. This finding indicates a substantial degree of suppressed demand in the US market due to the semi-prohibition of play since UIGEA.

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Figure 61: Global Internet gross gambling revenue, by region

35,000 Europe Asia/Middle East 30,000 North America Oceania 25,000 Latin America/Caribbean Africa 20,000
Millions

15,000

10,000

5,000

2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E 2013E 2014E 2015E
Sources: H2 Gambling Capital

By region, Europe experienced the greatest magnitude of growth in the latter portion of the past decade (although Africa and the Caribbean posted higher growth rates, they constitute only a small portion of the total worldwide revenue). North America, in contrast, grew less than 2 percent due chiefly to UIGEA enforcement. Similarly, the fastest growing Internet product category was skill games, bingo, and state lotteries. Sports betting, the largest single revenue component grew 10 percent, and casino games grew 11 percent, while Internet poker grew 12.7 percent over the same period.305 Importantly, this growth was driven primarily by new European jurisdictions coming online, particularly Italy and France, while the US market declined postUIGEA.

305

H2 Gambling Capital

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Figure 62: Global Internet gross gambling revenue growth 2005-10, by region
25 Latin America/Caribbean, 0.49

Africa, 0.18 Oceania, 1.25 North America, 4.43

20

15
Billions

Latin America/Caribbean, 0.12 Oceania, 0.66

Africa, 0.06 Asia/Middle East, 6.24

10

North America, 4.05

Asia/Middle East, 3.82

Europe, 2.98

Europe, 8.82

0 2005 Sources: H2 Gambling Capital 2010

Figure 63: Global Internet gross gambling revenue growth 2005-10, by product type
25

20

State Lotteries, 1.61 Skill games, 0.99 Bingo, 1.26

15
Billions Skill games, 0.23

Poker, 3.55

10

State Lotteries, 0.51 Bingo, 0.39

Casino, 5.01

Poker, 1.95 Casino, 3.03

Betting, 8.99 Betting, 5.59

2005
Source: H2 Gambling Capital

2010

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2. Europe
In Europe, where the majority of states actively or passively permit Internet gambling, the five largest countries contribute almost three-quarters of total revenue, and the most recently legalized national markets also exhibit the highest growth. Figure 64: European Internet gambling revenue contribution by country

All other EU (14 states) 24% Greece 3% France 11% Germany 12%

Italy 24%

United Kingdom 14% Spain 12%

Source: H2 Gambling Capital

The European market contains a mix of national markets including relatively mature markets such as the United Kingdom and newer markets such as Italy and France. In the UK, growth rates for all online products have been steep historically but are now leveling off. Internet gambling penetration has leveled off at slightly more than 20 percent of the adult population, and the average loss per adult was 210 annually in 2010 ($330) and forecast to remain stable. 306 In Italy, by comparison, Internet gambling penetration is substantially lower but growing more rapidly, as are revenues for all product types, and the per-person loss is higher at 333 annually in 2010 ($437) and forecast to continue increasing.307

306 307

H2 Gambling Capital Ibid

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Figure 65: UK Internet gambling expenditures per capita ()

250

150

100

50

0 2003 2004 2005 2006 2007 2008 2009 2010 2011e 2012e 2013e 2014e 2015e

Source: H2 Gambling Capital

Figure 66: Italy Internet gambling expenditures per capita ()

500

416

410

411

140

100

0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011e 2012e 2013e 2014e 2015e Source: H2 Gambling Capital

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Italy also shows the rapid growth of Internet poker, which saw a dramatic increase after legalization in 2008 relative to other online gambling products and which is expected to continue this increase through 2015.308 Figure 67: Italy Internet gambling product trends
700
Betting

600 500
Millions

Casino Poker Bingo Lottery

400 300

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100 0
2003 2004 2005 2006 2007 2008 2009 2010 2011e 2012e 2013e 2014e 2015e Source: H2 Gambling Capital

In the UK, by comparison, poker revenue growth has not been as dramatic as in Italy but it has been sustained and it has been paralleled by all other Internet gambling products including Internet lottery. Figure 68: UK Internet gambling product trends
800 700 600 500 Millions 400 300 200 100 0 2003 2004 2005 2006 2007 2008 2009 2010 2011e 2012e 2013e 2014e 2015e
Source: H2 Gambling Capital Bingo Betting

Poker
Casinos State Lotteries

308

H2 Gambling Capital

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The UK represents one of the largest and most developed Internet gambling markets in Europe. As such it appears to have reached a plateau in terms of Internet gambling penetration, stabilizing at roughly 20 percent of all interactive gambling in the UK. 309 Figure 69: UK Internet gambling revenue vs. penetration rate
12
Gross gambling revenue in billions 25%

10 8

20%

15%

6
10%

4 2 0
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0%

2003 2004 2005 2006 2007 2008 2009 2010 2011e 2012e 2013e 2014e 2015e
Source: H2 Gambling Capital

While some of this stabilization may be due to the effects of the global economic recession, the recently stable UK penetration ratio is highly consistent with the 19.5 percent observed for Finlands online lottery penetration and may serve as a current benchmark for Internet gambling penetration in the most developed local markets. Mobile-device penetration of Internet gambling participation is also growing in Europe. According to data compiled by the UK Gambling Commission, mobile gaming penetration grew from 10 percent in 2007 to almost 14 percent by the end of 2010, and continues to increase rapidly. 310 Market barriers to Internet gambling in Europe continue to erode and the number of countries permitting the practice in Europe continues to grow. Over the past three years more European Union members have begun to open their markets to Internet gambling and to license operators at the national level. In 2012 Denmark and Spain opened their markets to Internet gambling and Cyprus, Greece, Ireland and Portugal are all in the process of changing their current regulatory models, as is the German state of Schleswig-Holstein.311 The following map illustrates changes in European regulatory frameworks over the past four years.

309 310 311

H2 Gambling Capital UK Gambling Commission, June, 2011; iSuppli Market Barriers A European Online Gambling Study 2012, Gambling Compliance

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Penetratin rate

Figure 70: European online gambling regulatory changes 2009-2012

Source: Gambling Compliance

b. International Lottery
Until recently, European lottery operators have been the most innovative and trendsetting regarding Internet wagering. Scandinavian and Icelandic lotteries led the industry in moving online more than ten years ago. The Scandinavian lotteries have also been the leaders in innovation, deploying new types on online products and utilizing multiple interactive channels to reach customers. Several northern European operators now derive one-fifth or more of their total revenue from online sales. Successful European online lottery providers include Lottomatica, Intralot, NeoGames, SciPlay and Betware. The Scandinavian lotteries have led the world in deploying Internet lottery capabilities. The northernmost European countries were the first to field interactive lottery channels and have traditionally been leaders in innovation regarding interactive sales and online products. The most successful Internet lottery is the Finnish operator, Veikkaus Oy, which recently released figures showing that 30 percent of total sales were generated through interactive channels.

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Across the globe, lottery organizations have come to embrace the Internet as a new and effective channel of communications and sales. Today virtually every lottery in the world uses the Internet to communicate with its retailers and players and use of the Internet to sell lottery products is now a significant and growing focus of several of the worlds leading lotteries. In some continental markets Europe and Australia in particular Internet lottery sales have been a reality for more than a decade. 312 In other regions, development of Internet sales channels has lagged for several reasons. Jurisdictions that do not have high levels of overall Internet penetration have not seen widespread adoption of Internet lottery sales programs. Other technological and political factors which have limited lotteries in some areas (such as Africa and Central America) from keeping pace with traditional, state-of-the-art lottery distribution and sales systems have also inhibited development of widespread Internet lottery sales solutions. An examination of global lotteries can identify the ways in which the European experience may be relevant and helpful to US policymakers and can illuminate differences which may call for an Internet lottery solution more precisely tailored to the unique Massachusetts market.

c. European Internet Lottery Adoption

Europe is a leader in the adaption of new Internet sales technology and in the revenue which has been derived from lottery Internet sales. The National Lottery of Lichtenstein claims to have been the first lottery in the world to sell a manual lottery ticket via the Internet, in October 1995. This was followed by a succession of Internet sales initiatives undertaken by several European operators including Veikkaus Oy in Finland (1996), the Austrian Lottery (1998), Lotto Bayern of Germany (2001) and Norsk Tipping of Norway (2001). Scandinavian lotteries have also expanded to include multi-country networks with the establishment of Viking Lotto, a partnership of five Northern Europe lotteries founded in 2000. This network includes Denmark (Dansk Tipstjeneste), Finland (Veikkaus Oy), Iceland (Islensk Getsp), Norway (Norsk Tipping), and Sweden (AB Tipstjanst). Since founding, Viking Lotto has grown to include smaller Northern European countries such as Estonia (Eesti Loto). After the turn of the century, larger operators such as Camelot (United Kingdom) and La Francaise des Jeux (France) also moved to establish Internet sales channels. Today most of the European lotteries recognized by the World Lottery Association offer some form of Internet and/or mobile sales channel for the sale of lottery products. A variety of Internet sales approaches are utilized by different lotteries throughout Europe. Some lotteries use the Internet only as an additional sales channel for the lotto-type jackpot games which dominate the European market while others utilize the Internet to offer
312

The European Lotteries, A Brief History of Lottery in Europe, www.europeanlotteries.org/communication/games_brief_history.php

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electronic versions of virtually all the products offered at bricks-and-mortar stores, including electronic versions of instant scratch tickets. Some lotteries offer a suite of games and play styles which can only be found on the Internet. Generally, European lotteries have chosen a direct B2C (business to consumer) sales interface which bypasses the physical bricks-and-mortar lottery retailers. There appears to have been very little controversy over this choice, a fact that might surprise some American lottery analysts but which reflects significant operational, market and political differences in Europe, which are discussed in greater detail below. At least one major European lottery utilizes an affiliate system in which Internet traffic from other websites and operators who are proficient in aggregating would-be customers is redirected to the lottery sales site. A variation on this affiliate model is found in several Australian provinces. There, the customer interface and Internet transaction is managed and processed by the affiliate and the transaction information is then securely relayed to the Lotterys gaming system. Different lotteries use different supplier structures and relationships to support their Internet sales offerings. Sales and revenue results from the various operational models deployed throughout the continent vary, with the French lottery, La Franaise des Jeux, utilizing perhaps the most complex Internet sales program. One particularly salient point jumps out: lottery operators in Europe have readily adopted Internet lottery sales channels while their counterparts in North America have taken a more cautious approach. What has been enthusiastically embraced there has been met here in the US with ambivalence, resistance and, in some cases, deliberately constructed legal roadblocks. European lotteries have been tremendously successful with traditional retail and Internet sales channels and offerings. Gross gaming revenue from all state-licensed and controlled lotteries in the European Union totaled 34.6 billion in 2011, a 4.3 percent increase over the previous year.313 The majority of this revenue comes from draw games (Lotto, Euromillions, Joker) 67 percent, and the second largest proportion is generated by instant games, representing 18 percent of total GGR. 314 According to the European Lotteries trade association, Internet lottery sales grew at an average of 11 percent during 2010. According to La Fleurs, growth has been even stronger in 2011, with leading European lotteries growing Internet sales by 15 to 30 percent.315

313 314 315

European Lotteries report on Lotteries in the EU and in Europe in 2011, Lausanne, Switzerland, May 2012. Ibid La Fleurs 2012 World Lottery Almanac

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Figure 71: European average interactive sales per capita, 2007-2010

30 25 20 15 10 5 0 2007
Source: MECN

26.00 23.40 20.30 16.90

2008

2009

2010

Per capita lottery spending in the European Union ranges from a low of 3 in Latvia (US$3.84), or 6 in Lithuania (US$7.69), to more than 100 (US$128) in Cyprus, Greece, Italy, Spain and the Nordic countries as measured by the European Lotteries in 2012.316 The average per capita spending on lottery products across the European Union was 69 (US$88.42) in 2011.317 For the 78 reporting lotteries, private and state-owned/operated, across the entire continent the corresponding figure for per capita spend was 44 (US$56.39).318 This figure includes the Russian Interlot, Orglot and Ural Loto lotteries serving a population of almost 143 million and spending at 0.5 (US$0.64) per capita. European Union lottery sales, as measured by four categories of draw based games, instant games, sports games with pari-mutuel, and fixed odds, were 76.9 billion (US$98.5 billion) in 2011, representing a 4.2 percent increase over the previous year. 319 The 52 reporting lotteries in the European Union gave back to worthy causes a total of 23.4 billion (US$30 billion), a 5.1 percent increase compared with 2010. On average, a state licensed lottery in the EU gives back to society 68 percent of every Euro earned.320

316 317 318 319 320

European Lotteries report on Lotteries in the EU and in Europe in 2011, Lausanne, Switzerland, May 2012. Ibid Ibid European Lotteries report on Lotteries in the EU and in Europe in 2011, Lausanne, Switzerland, May 2012. European Lotteries report on Lotteries in the EU and in Europe in 2011, Lausanne, Switzerland, May 2012.

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The game mix for European lotteries is markedly different from US lotteries in general and the Massachusetts State Lottery in particular. European state-owned or operated lotteries depend primarily on draw-based numbers games for generating the majority (67 percent in 2010) of their revenues while US lotteries321, and especially Massachusetts, rely on instant games for more than two-thirds of the revenue produced in FY2013 through September, 2012. Figure 72: European state-owned lottery average game mix 2010
Sports games fixed odds*, 4% Sports games parimutual, 2% Slots/VLTs/EILs outside casinos, 8% All other games and non gaming activities, 1%

Instant games, 18% Draw based games, 67%

Source: European Lotteries

By way of comparison, The Massachusetts State Lottery relies on instant games for the bulk of its revenue. Through September, 2012, FY 2013 sales revenue breaks out primarily by instant games (69 percent), followed by Keno (17 percent). The relative proportions for instant games in Massachusetts and draw-based games in Europe are almost identical, as shown in the chart below (a duplicate of Figure 5).

321

European Lotteries report on Lotteries in the EU and in Europe in 2011, Lausanne, Switzerland, May 2012.

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Figure 73: FY 2012 Massachusetts State Lottery sales by product (through September)
Mass Cash 1% MegaMillions 1% Powerball 2% MegaBucks 1% Daily Race 1% Cash Winfall 0% Lucky For Life 0%

Numbers Game 7%

Keno 17%

Instant Games 69%

Source: Massachusetts State Lottery

Interestingly, this fundamental difference between European and American lotterys game mix may be starting to change as the more innovative European lotteries begin experimenting with their game mix and more strongly promote instant and social games. For example,the Finnish lottery, Veikkaus Oy, is a trendsetter for online products and one of the most successful intereactive lotteries in the world today. In 2011 Veikkaus Internet product sales exceeded the half billion Euro mark ($690.9 million) and surpassed 30 percent of total sales (30.1 percent) for the first time. Veikkaus has traditionally relied on draw games for the bulk of their online product revenue but 2011 represented the first full year of interactive bingo, launched in September, 2010, which generated $70.4 million, and saw the revenue from instant games increase to $46.4 million, a gain of 4.8 percent year over year. 322 The most popular online products offered on Veikkaus.fi in 2011 were Lotto, Keno, and fixed odds betting which is divided into two categories: sports betting and sports pools. Revenue from these four categories totaled 541 million ($690.8 million), with almost half coming from draw based games, one-quarter from sports betting, and one-fifth from arcade games, a new category that posted 78 percent growth over the previous year. 323 Keno also saw

322 323

Veikkaus CSR Report and Annual Report 2011. Ibid.

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strong growth in Finland for 2011 and surpassed sales of fixed odds betting in the month of April, 2011 due to the introduction of televised daytime drawings. 324 This contributed to a growth rate for draw based games of 17 percent compared to the previous year.325 Figure 74: Revenue share by product type, Finland lottery FY 2011

Sports Pools games 7.6% Draw games (incl. Lotto, Jokers and Keno) 47.7%

Sports Betting 26.1%

Arcade games 18.7%

Source: Veikkaus Oy

The Finnish lotterys leverage of television as a sales channel via the Veikkaus TV network has also succeeded in increasing sales, particularly for real-time Live Betting, which grew from $0.64 million to $7.28 million during 2011 thanks to the introduction of elite sports broadcasting.326 Veikkaus has also made significant progress in identifying and rewarding customers through the use of a loyalty card, a practice that began in 1997 as a requirement for registering online players but has expanded beyond online products to include traditional ticket sales since 2006. In 2011 there were 1,368,000 Veikkaus Card holders in Finland, an increase of 11.9 percent over 2010.327 Of these cards, 30 percent register online players and 17 percent register retail players, which means that only 52 percent of lottery play in Finland is unregistered while Veikkaus has registered nearly half of all lottery players and can now collect information about their play habits and offer targeted marketing communications and promotions.
324 325 326 327

Veikkaus CSR Report and Annual Report 2011. Ibid. Ibid. Ibid.

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3.

Europe, North America: Noting the Differences

a. Different Culture/Organizational Models

US policymakers are now being asked to consider adapting European models to the American lottery market. In Europe, lotteries and lottery products have long been understood to be in the normal channel of consumer commerce. Some lotteries, such as SNS in the Netherlands and the Austrian lotteries have been operating continuously for well over 200 years. Over time, optimal organizational structures have been created or reworked so that today the predominant European operational model is a privately managed lottery operating under license from the government. Thus it can be generally said that in Europe lotteries are run as private businesses within an overall economy in which a large role for government is otherwise familiar and expected. This is in direct contrast to the American experience. Here, lottery activities are run directly by government within an economy in which government plays a comparatively lesser role and in which direct government operation of a consumer-facing business is largely unheard of. These differences reflect different deeper cultural assumptions about the underlying activity. The traditional, predominate American attitude toward lotteries is that they constitute an activity which by its inherently compelling nature can and should only be offered via strict and direct governmental direction and control. This presumption is not widely shared by European consumers, operators or policymakers. In general, it can thus be said that in Europe businesses run lotteries for the benefit of themselves and the governments, whereas in the North America governments run lotteries for the benefit of themselves and businesses, notably the retail agents. The cultural differences with regard to lottery operation manifests itself most clearly in different lottery structures (government run vs. privately run) but it also reflected in different approaches to general sales opportunities which these structures might exploit, including Internet sales. In Europe, where the presumption is that lottery products warrant no differential treatment than most other consumer products, the question of whether to partake in new merchandising and sales opportunities such as a new Internet channel is, by and large a question of business priorities and logistics. Once the numbers were there to justify the effort and expense the lottery operator would and could move to create a new Internet sales channel. For instance, in most European countries, using a credit card to purchase lottery products is, and has always been, a non-issue. European operators and regulators saw little or no reason to treat a lottery transaction any differently than any other retail transaction.

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In contrast, in the United States where the presumption is that lottery products require differential and more controlled treatment the question of offering lottery via the Internet becomes predominately a question of public policy and law. The various questions which tend to dominate the discussion of the issue amongst American lottery managers Is it legal? Is it appropriate? How will it impact various political stakeholders? are not and were not as relatively important for European lottery operators.

b. Different Competitive Threats Driving Lotteries to Internet Sales

In Europe, licensed lottery operators are forced to contend with close physical proximity between sovereign operators and, until 2009, a murky, common market legal landscape which was more conducive to unwelcome, Internet-based, cross-border gaming sales from private operators. Increasingly, lottery operators in a particular jurisdiction were seeing ever-larger numbers of their in-market customers responding to Internet-based entreaties from other lottery and private gaming operators. Highlighting the problem as it existed circa 2000: a government report in one early-moving jurisdiction noted it is possible [for residents] to take part in a large number of lotteries and games of foreign origin on the Internet in addition to our authorized lotteries. 328 A year later in advocating for the ability for its lottery to offer Internet sales channels, the Norwegian Ministry of Cultural Affairs reported: International money games will increasingly become a threat to the national money game [i.e., Lotto] unless the national games are awarded competitive conditions.329 Clearly, the perceived need to respond to competitive intrusions was an initial driving factor which led the pioneering Scandinavian lotteries to begin to offer their own Internet-based sales channels. Until a 2009 decision of the European Court of Justice effectively clamped down on cross-border poaching by private Internet gambling operators, virtually every authorized lottery operator in Europe felt the impact of cross-border Internet intrusion and sought to protect their commercial interests by offering a robust Internet sales channel of their own. A similar situation was encountered and still exists today in Canada, where gray-market private gaming operators pose a considerable commercial threat to provincial lotteries. In British Columbia, the need to respond and to offer a competitive alternative via a lottery Internet sales channel is recognized as the driving force which lead the lottery to move to create and regulators to approve a new lottery Internet sales channel. In the United States, the situation was and is quite different. Here, federal laws, including the Wire Act of 1961 and the Unlawful Internet Gambling Enforcement Act of 2006, served to effectively bar private operators from using the Internet to create a competitive intrusion on each State lottery. Other laws, as well as effective interstate cooperation amongst the 44 state-run
328

http://www.gamingandlotteryfiles.com/novamediafile.php?file=Viking%20Lotto.htm (accessed November 4, 2012)

329

http://www.gamingandlotteryfiles.com/novamediafile.php?file=Norway.htm (accessed May 5, 2012)

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monopoly lotteries, have further served to effectively eliminate the threat of electronic crossborder poaching of customers. High-profile, effective prosecutions by the DOJ of illegal Internet operators are generally acknowledged to have significantly diminished the prevalence of illegal Internet gambling across the nation. As a result the poaching conditions in Europe, which drove first-moving lotteries to offer their own Internet sales channels, are not today a major, driving concern for US lottery managers and decision makers.

c. Different Treatment of Laws with Regard to Internet Lottery

Laws are a reflection of societal preferences, so it should not be surprising that the uniquely American perspective with regard to controlling lotteries should be reflected in unique legal frameworks governing the activity. In Europe, most law is silent with regard to whether a lottery may sell via the Internet. Some government regulations speak to specific aspects of Internet-based sales (sales to minors, etc.) but by and large, European statutes and lawmakers were and are relatively indifferent to whether Lotteries should or could sell lottery products via the Internet. The environment in the United States is strikingly different. As is characteristic of our federal system, different cultural values and priorities among the population of the several states are reflected in different statutory and regulatory treatment of lottery sales, including sales via the Internet. On one end of the continuum some states such as Utah, Mississippi and Hawaii outlaw all lottery activities. Others such as Michigan and Wisconsin provide for a lottery but only if run directly by the state and under a series of relatively restrictive operational mandates. On the other end of the continuum, several states including New York, West Virginia and Delaware apply an expansive, proactive treatment to their lottery directing it to maximize market growth across a host of different, non-traditional lottery gaming operations such as keno or video lottery (i.e., slots) operations. At least one state (Illinois) has seen fit to outsource the day-to-day operation of its lottery to a private operator under an operational framework that is closer in practice to the European operations model. This diversity of operational preferences is also reflected in different statutory treatments relating to Internet sales. The statutes of several states specifically prohibit their state lotteries from selling lottery products via the Internet. In other states, a web of indirect state statutes, regulations and administrative rules work to essentially bar the same activity. Over most of the period in which Internet sales have been technologically possible, the generally perceived position of the federal government had been that use of Internet technology to facilitate a lottery transaction was contrary to federal law. This added yet another significant layer of legal obstacles which, taken with a host of other factors, served effectively to check the development of Internet sales initiatives by US lotteries. However, as courts interpreted the federal statutes relating to the issue, it was becoming increasingly clear to astute observers that the ambiguity surrounding the position of the federal

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Government was about to be clarified. In 2010, New York and Illinois, whose lotteries operate on the more expansive side of the lottery operations continuum, asked the DOJ to opine on the legality of plans to offer lottery products for sale via the Internet. Laws in both states allowed for their lotteries to sell via the Internet (in Illinois case, state law actually required that the lottery do so). In late December 2011, the DOJ affirmed this view in a letter ruling, opining the federal governments position that the prohibitions of the 1961 Wire Act pertained only to betting on sporting events. As far as the federal government was concerned, states were free to offer Internet-based gaming within their jurisdictions. In light of what had been a decade or more of uncertainty about federal treatment of Internet lottery sales it is not surprising that by the time the DOJ offered this clarification only one state Illinois was in a practical position to become an early mover into the Internet sales space and actually begin offering sales via the Internet sales channel. Despite this, some commentators predicted that the DOJ opinion would set off a frenzy of movement toward lottery Internet sales. However, as noted in most jurisdictions, with the notable exception of previous early entrant Minnesota, state-level statutes and regulations continued to bar lottery Internet sales. A more detailed discussion of current Internet lottery developments in the various states is found in section herein.

d. Differences in Organizational Structure of Operators

The cultural differences between how Europeans and Americans view lottery are further reflected in the different types of business structures utilized to operate lottery organizations. These different organizational differences influence how respective lottery organizations approach the issue of whether and how to adapt lottery Internet sales solutions. In the United States, day-to-day operations of 43 of the 44 authorized lotteries are run by governmental entities, with Illinois being the lone exception. Some America lotteries such as Georgia, Connecticut and Tennessee, carry the identifier corporation following their name but this does not mean that they are private, for-profit organizations. Rather these are governmentowned, government-managed public-benefit corporations which, while having somewhat more flexibility than most state agencies and departments, are nevertheless very much governmental entities. In contrast, most lotteries outside the United States are operated by private, for-profit companies under a license issued by a governmental authority. In Europe a handful of government-run lotteries survive but by and large most lottery organizations are run by private, for-profit operators. Almost all of the lotteries created in the modern lottery era (i.e., 1980present) were set up and operated as private, for-profit businesses and several formerly state-run operators have been converted to private companies, including Stichting National in the Netherlands, the Austrian Lottery and FDJ in France. The venerable Irish National Lottery, traditionally run by that nations semiprivate Post Office, is now being put up for bids to be taken private.

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Private lottery operators in Europe have become highly successful and very big business concerns. Two private companies dominate the Italian market and one of them, Lottomatica, is so successful that it purchased and now controls the dominant American-based lottery industry technology company, GTECH of West Greenwich, RI. In the United Kingdom, the National Lottery is run by Camelot Ltd., a privately held company now owned by the Ontario Teachers Pension Plan. It stands to reason that the management orientation, perspective and decision-making processes of the government employees and political appointees who manage American lotteries differ from that of their European colleagues. These different perspectives color a variety of operational issues and choices, including specifically the understanding of the differing risks and rewards associated with Internet sales initiatives.

e. Profit Motive, Shareholder Expectations

Most private lottery operators understand themselves to be in keen competition with other privately run, for-profit gaming operators as well as with other private marketers of fast-moving consumer goods. In this context, Internet sales represent a new, more effective and efficient sales channel. Energy and resources can, thanks to an Internet sales channel, now be focused on a more efficient, direct and powerful channel. The relationship with the end consumer, which was formerly subject to a large, sometimes unwieldy and hard-to-manage network of physical retailers, can be directly managed via the Internet. Lottery managers who operate in a private management context are beholden primarily to their corporate board and shareholders who, of course, are primarily interested in a profitable return on their investment. It is true that these managers are also responsible to government regulators, pursuant to the terms of their license, but in practice this reporting relationship tends to be less direct than the responsibility which the manager feels toward his or her corporate decision makers. In addition, the lottery managers compensation is likely to be related to corporate performance which is, first and foremost, a financial metric. Such motivations and operational realities are highly relevant to a private lottery companys decision as to whether and how best to pursue new opportunities, including Internet sales solutions. From the perspective of shareholder expectations, a failure to position ones private company to take advantage of the operational efficiencies and opportunities for overall revenue growth that a lottery Internet affords would be akin to management malfeasance. In contrast, the expectations and demands on US lottery managers are quite different. As direct or semi-direct political actors, the primary mandate for a US lottery manager is to balance a diverse menu of ever-shifting variables, one of which (but only one) is sales and revenue growth. Financial performance metrics are important but not dispositive. Rarely is financial performance a relevant determinant to the managers personal compensation or job security. Ironically, despite being paid significantly less, on average than their private European

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counterparts, the American lottery manager is significantly less insulated from risk. The European manager operates in an environment where lottery and gaming are less controversial issues. Even in this regard, the European manager is separated from direct political retribution by several layers of corporate and licensing authorities. In contrast, his American counterpart is more often than not directly on the front line, directly responsive to political decision makers and thus and exposed to the displeasure of a governor or legislators who may be aggrieved by the managers choices. This results in at least two recognized management consequences which, in turn, relate to whether and how US lotteries embrace major operational changes such as adopting Internet lottery sales channels. The first turnover among top decision makers within the US lottery industry is significantly higher than in Europe. It is common in various states for lottery directors to enter and depart with a new political administration and even within the life of one political administration (e.g., four to eight years). This level of turnover potentially impacts the type of research and development, preparation and managerial confidence that is required to support a major, potentially transformative new initiative. In Europe, it is not at all unusual to see the same management team serving the same private operator for years and sometimes decades at a time. The second management consequence flowing from the differences in European and American management structures is that decision making within most US lotteries is characterized by extreme caution, deliberateness and a significant reliance on the private gaming systems vendors to provide both operational innovation and, often, the internal and external political support needed to support major innovation. If a particular initiative or market opportunity is not one which the vendors see as being in their interests, it is extremely difficult for a lottery manager in the United States to move the initiative forward. Since they serve private companies, European lottery leaders can, and do leverage their security, longer tenure and access to resources to create their own credible, successful management and sales solutions. Indeed, in moving forward with an Internet sales solution all of the first moving European lotteries and most of the follow-ups have developed their own, in house proprietary technology and sales solutions for their Internet channels. These include Svenska Spel (Sweden), Norsk Tipping (Norway) Veikkaus (Finland), France, Austria, Slovakia and others. A far smaller number, including Iceland, Spain and Denmark, have used an outside vendor (Betware) that focuses exclusively on lottery Internet solutions. The traditional lottery vendors (GTECH, Scientific Games and Intralot), which between them service every lottery in the United States, have developed Internet sales solutions, but the number of European lotteries utilizing them is fractional.330 The management structures found in most European lotteries have enabled those lotteries to move forward boldly and aggressively in pursuing the various opportunities that the Internet

330

Presentation by Lottery industry vendors, (April 2012).

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affords. Shareholder pressure, individual performance incentives, management confidence, inhouse research and development capabilities and a permissive regulatory environment have all played a role in shaping and driving the European experience with Internet lottery. Equally apparent is the fact that few, if any, of those same driving variables are found in the American lottery environment. Thus, it should be less surprising that the European Internet model has not found widespread success in the American lottery market.

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AA. Current State of Online Play: North America

From the perspective of an American player, Internet gambling became much less reputable and much more difficult to pursue post-UIGEA. After the legislation was signed into law, all publicly traded Internet gambling operators withdrew from the US market and for US players Internet gambling migrated to the only available outlets: privately held offshore firms. Attendance at the Main Event in the World Series of Poker peaked in 2006 and has not returned to similar levels recently.331 For the 2012 World Series of Poker Bluff Magazine reported that in the 22 events of 2012 that are directly comparable to 2011 events attendance was down 8.9% compared to the previous year, and the WSOP 2012 prize to date was only $44.9 million, down almost 15 percent from 2011.332 This transition to privately held operators also worked to suppress enthusiasm among US players as the industrys reputation suffered from revelations of cheating scandals and later prosecution efforts by the US Department of Justice (DOJ) culminating in the April 15, 2011, Black Friday indictments against Full Tilt, Absolute Poker, and Poker Stars. After US domain names were seized and player accounts were frozen, play habits changed in the United States with players making smaller deposits and not allowing funds to reside in player accounts overnight. Another great shock to US Internet poker players was administered by the DOJ when on September 20, 2011, that agency filed suit against Full Tilt Poker on charges of fraud. Full Tilt was one of the largest poker sites on the Internet at the time and one of the most heavily advertised. The Justice Departments suit claimed that the site was operated as a Ponzi scheme, in which funds deposited in player accounts were used to pay executive salaries, operating and marketing costs, and the contracts and expenses of celebrity poker stars including Howard Lederer, Chris Ferguson and Rafael Furst.333 This had a tremendous impact on the thousands of US citizens playing on the site but the wider effect was to create distrust of many offshore operators and dampen enthusiasm for Internet poker in the United States. The DOJs aggressive enforcement actions under UIGEA since 2011 have had an evident negative effect upon online gambling behavior in the United States, particularly in regard to Internet poker. In 2006 poker made up 20.5 percent of all Internet gambling revenues. By 2009 this figure had fallen to 18.3 percent, by 2010 poker it had fallen to 14.4 percent and in 2011 had

331 332 333

www.pokerblackfriday.com. WSOP by the Numbers, Year-Over-Year Attendance, Ryan Lucchese, Bluff Magazine, June 16, 2012. US Alleges Poker Site Stacked Deck, Alexandra Berzon, The Wall Street Journal, September 22, 2011.

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declined to 12.6 percent334 Contrarily, Internet casino revenues made up 21.6 percent of Internet gambling revenues but climbed to 23.7 percent by the close of 2011.335

1. Commercial Gaming
Legalized Internet gambling was initially opposed by commercial gaming operators as a threat to the carefully cultivated expansion of land-based casino gambling that has occurred over the past 35 years. This long-term expansion from a Las Vegas-centered industry in the 1970s to the present situation where 42 states offer casino-style gambling in some form and two have legalized online gambling but yet to commence operations. Today the land-based casino industry, with a few notable exceptions that include Las Vegas Sands, has reversed its previous position and now support federal legislation of Internet poker and casino games. Not surprisingly. The land-based casino industry has lobbied for specific legislation that would benefit commercial casinos through varying degrees of exclusivity at the expense of state lotteries and Indian tribes. Most leading US commercial casino companies in the United States have in some way positioned themselves to take advantage of Internet gambling. Caesars Entertainment (formerly Harrahs) has invested significant resources in establishing an online presence with the creation of Caesars Interactive Entertainment, which is currently a Europe-facing site but can easily be offered to US players should federal level legalization occur. Other US commercial casino operators and slot manufacturers have added free online games to their customer offerings in preparation for potential legalization. Boyd Gaming opened its loyalty program to free social gaming on its B Connected website in April 2012; its rewards program members can now compete against each other for points and badges and see their scores tallied on a leader board.

2.

Indian Gaming

Indian gaming generates almost as much land-based casino gambling revenue (29 percent) as commercial casinos (31 percent) do, and together with land-based state lotteries (23 percent when measured by net proceeds to the states) they make up more than three-quarters (83 percent) of all gambling expenditures in the United States. Legal US gambling of all types (excluding Internet) generated total revenues of $90.43 billion in 2009, the most current year for which data are available in all segments including tribal gaming. Broken down by segment: commercial casinos $34.3 billion, Indian gaming $26.39 billion, lotteries $20.87 billion, parimutuel wagering $2.83 billion, charitable gaming $2.07 billion, card rooms $1.21 billion, other

334 335

H2 Gambling Capital. Ibid.

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gaming (including cruise ships, convenience gambling and non-racino video lottery terminals) $2.75 billion.336 Figure 75: US legal gambling industry market share by segment, 2009
Pari-Mutuel wagering, 3.1% Charitable gaming, 2.3% Racinos, 7.1% Commercial Casinos, 30.9% Lotteries, 23.1% Card Rooms, 1.3% All other gaming, 3.0%

Indian Gaming, 29.2%

Sources: Casino Citys Indian Gaming Industry Report 2011, Christian Capital Advisors

Five states produced 61 percent of the total Indian gaming revenue: California, $6.78 billion, or 25.4 percent; Oklahoma, $3.23 billion, 12.1 percent: Connecticut, $2.14 billion, eight percent; Florida, $2.06 billion, 7.7 percent and Washington, $2.03 billion, 7.6 percent.337 Indian gaming revenue on the whole rose 1.3 percent in 2010, although in California revenues fell 2.5 percent compared to the previous year due to the struggling economy, and over the past three years have fallen from a high of $7.34 billion in 2008 to $6.78 billion in 2010 a 9 percent decline. Therefore it is no surprise that in California Indian gaming is taking the lead in legislation to legalize Internet gambling, specifically Internet poker. As of 2010 there were 448 Indian gaming facilities nationwide, and Indian casinos were found in 28 states, operated by 239 338 of the 562 federally recognized tribes.339 A total of 24 states operate some form of Class III gaming and four states offer only Class II games.340

336 337 338 339 340

Casino Citys Indian Gaming Industry Report, 2011 Edition Ibid. Ibid. 500 Nations.com Casino Citys Indian Gaming Industry Report, 2012 Edition

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One of the fundamental divisions in Indian country is whether to support Internet gambling legislation at the federal or state level. Tribes from states where tribal gaming is the primary segment of casino gambling are poised to enter the Internet space. Successful tribal gaming operators from states with large population bases, such as California, often favor the intrastate model because it offers the quickest and most direct path to dominating the in-state Internet poker market. Smaller tribes often favor the interstate model, believing that the federal government will do a better job of respecting tribal sovereignty and offer more opportunity for smaller operators due to existing treaty obligations and the ability to market across the country rather than within the boundaries of a single state. Due to this internal division, leadership in the National Indian Gaming Association (NIGA) leadership has been cautious in establishing an official position in favor of legalization, while simultaneously recognizing the importance of the Internet channel to Indian gaming. Twin fears are driving this cautious stance on backing the interstate model. First, there is apprehension that legalization at the national level would unduly favor commercial casinos and possibly lead to marginalization of Indian gambling operations. This apprehension is amplified by the fact that previously crafted legislation for interstate gambling (both the Reid and Barden bills) has clearly favored commercial casino interests. Second, there is also apprehension that legalization at the national level would negatively impact sovereignty and lead to increased taxation of tribal gaming by the federal government. The intrastate model also generates apprehension that Indian gaming operations might be marginalized by state lotteries entering the Internet gambling space by offering casino games and poker directly to consumers via online channels. Even worse for Indian gaming is contemplating the prospect that individual states could dispense with existing gaming compacts and seek to monopolize all potential gambling revenues under state auspices. A NIGA resolution on legalization of Internet gambling was agreed to at the Mid-Year meeting at Shakopee, MN, in October 2010 and remains in force today. The six points of that resolution, listed below, emphasize equal opportunity for tribal gaming, respect for sovereignty, tax-free status, and the inviolability of the federal Indian Gaming Regulatory Act (IGRA) and existing tribal-state compacts.341 No position is staked out on the preferred model for Internet gambling. Indian tribes are sovereign governments with a right to operate, regulate, tax, and license Internet gambling, and those rights must not be subordinated to any nonfederal authority. Internet gambling authorized by Indian tribes must be available to customers in any locale where Internet gambling is not criminally prohibited

341

National Indian Gaming Association, NIGA MY-001

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Consistent with long-held federal law and policy, tribal revenues must not be subject to tax Existing tribal government rights under Tribal-State Compacts and IGRA must be respected The legislation must not open up the Indian Gaming Regulatory Act for amendments Federal legalization of Internet gambling must provide positive economic benefits

Notably, tribal leaders throughout the United States are largely unsure as to how they might ultimately participate in Internet gambling, and what opportunities or challenges they will face. In October 2011, Spectrum Gaming Group Managing Director Michael Pollock testified before the US Senate Indian Affairs Committee. His comments included the following: I have spent significant time in recent months meeting with tribal leaders both in Washington and throughout the United States. The common question I hear is: What will Internet gaming mean for our tribe, our casinos, our future? I suggest that, with the politics of this issue in such a state of flux, such a question is impossible to answer with any degree of certainty. A more relevant question then is: What should Internet gaming mean for our tribe, our casinos, our future? That question is more easily addressed because we know the business model that most Indian and commercial casinos follow, and we know the potential of Internet gaming. Internet gaming represents a significant revenue stream for government. What is less readily apparent is that Internet gaming also represents a significant marketing opportunity for Indian casinos. Internet gaming offers the ability to reach customers easily at low cost, to identify customers potential, to cultivate customers and reward them through the ability to earn visits at their brick-and-mortar casinos. If Internet gaming is allowed to develop as simply a revenue stream, then I suggest the United States has squandered a once-in-a-century opportunity. In Europe, for example, Internet gaming has developed largely as an independent revenue stream. The European model, however, has limited applicability in the United States, largely because Europe does not have anything close to the brick-and-mortar infrastructure that has developed throughout the United States. Hundreds of billions of dollars have already been invested in casinos across the country, in part because authorizing governments sought to create more than tax revenues. They sought to create jobs, to invigorate downtowns, to spur tourism and to assist many Indian nations develop sustainable business models to create career opportunities for their members and their communities.

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Those goals assume that gaming and non-gaming adults alike will generate real, not virtual, visits to casinos. That is how you generate employment, and how you generate sufficient returns on all that invested capital.342 For many tribes, that crystallizes the concern: Will online gambling benefit their landbased operations or compete against them? For state lotteries, Indian gaming could be considered a potential competitor since tribal authorities are sovereign entities under US law. Whatever gambling delivery systems or products may eventually become legal through state legislation, recognized indigenous Indian tribes will be free to compete unless limited by a compact with the state. For the Massachusetts State Lottery it should also be noted that, while commercial casinos have been bound by legislation to be licensed by the Lottery and sell MSL products, Indian tribes as sovereign nations are under no such obligation.

3.

Lottery

The US Department of Justices December 23, 2011, landmark opinion was rendered in response to specific inquiries from the New York and Illinois lotteries regarding the possibility of conducting Internet sales in future. The most recent development is the Illinois Lottery offering online ticket sales for lotto games as of March 25, 2012 providentially in time for the largest Mega Millions jackpot drawing ever. While new, technology-based sales solutions are being embraced in other countries, it has been a slow, uneven embrace of these solutions in North America which, arguably, is the worlds most advanced and sophisticated lottery market and which features high Internet penetration rates and overall technological capabilities. 343 The reasons for this are multiple, varied and complex. Some observers have focused on legal uncertainty as the primary, root cause explaining North Americas slowness in adopting Internet lottery sales. They conclude that the removal of much of this legal uncertainty by recent clarifying opinions from the Department of Justice will now lead to a frenzy of activity and rapid and widespread adoption of Internet sales channels by North American lottery operators.344

342

Testimony of Michael J. Pollock, US Senate Indian Affairs Committee, October 6, 2011 http://www.indian.senate.gov/hearings/hearing.cfm?hearingID=0bd5589287f5bbb3d229c1850f6ff999 (accessed May 1, 2012)
343

Internet penetration in North America is estimated to be 87%, compared with 77% in Europe. IWS, Internet Users in North America, (March 2011), http://www.Internetworldstats.com/stats14.htm
344

Paul Lauzon, Internet Gambling goes wireless in US: Meeting with Perception , Lottery Insights, (April 2012), p.

25

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Such a simplistic, single issue perspective ignores the salient fact that Canadian lotteries which were never subject to DOJ restrictions or uncertainty have, like their US counterparts, been far slower than European lotteries to embrace Internet sales channels. Those who believe that ambiguity over a single federal statute has been the impediment to widespread and quick adoption of Internet lottery are missing the deeper point. Such a perspective is mistakenly based on the presumption that legal frameworks are an organic cause of public policy, when in reality they are better understood as a constructed reflection of underlying preferences and values. No single factor can control how a particular lottery jurisdiction relates to Internet opportunities; a multitude of factors explain why and when a lottery may or may not embrace these opportunities. Disparate adoption indicates that there are particular and unique factors at play in the North American lottery environment which differ from those lottery markets in Europe and Australia, which have more readily embraced lottery Internet solutions. [See Legalization Efforts in preceding chapter for listing of online lottery status by state.]

4.

Poker: Emerging as Point of Entry

Internet poker lagged several years behind Internet casino applications due to the greater complexity involved in creating an effective real-time, peer-to-peer game, and large poker networks, known as massively multiplayer games, have taken even longer to develop. The first Internet poker room, planetpoker.com, opened in 1998, but it took until 2003 for online poker to experience the kind of tremendous growth which had previously been observed with online casino games. Poker rapidly became a craze in the United States, when live poker tournaments were televised and poker celebrities were created by winning televised tournaments. The parallel craze took place online and because the social aspects of poker suited it well to the Internet. In many ways poker is the ideal application due to its social aspect, in which players are content playing against one another rather than playing against the house. This social dimension has also shaped the way in which the game has developed online, in that greater volumes of players on a site generate critical mass, allowing for larger tournaments and prizes and assuring that a handful of top ranking sites dominate the industry. PartyPoker pioneered online poker tournaments in 2001, generating highly successful events that have been emulated by competitors ever since. Due to this early success in attracting players, PartyPoker quickly established a position as the dominant site in the Internet poker market prior to UIGEA.345 In late 2001, ESPN televised the World Series of Poker (WSOP) nationwide346 and in 2002 the World Poker Tour (WPT) made its debut on the Travel Channel. 347 Televising these
345 346

www.partypoker.com wsop.com

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events generated widespread interest in tournament poker by creating broad consumer awareness and online buzz. This popular appeal gave the offshore poker sites an advertising platform enabling them to reach tens of millions of people. As a result, those sites offering the biggest money tournaments began to experience exponential increases in player participation. The poker wave began to crest when Chris Moneymaker, until then an unknown poker player who learned to play on and qualified via the Internet, won the $2.5 million main event in the 2003 WSOP.348 This event, broadcast nationwide by ESPN and promoted by PartyPoker through heavy advertising, began a three-year efflorescence of poker popularity which supported the growth of the game online as more people played over the Internet for business and pleasure. The WSOP, WPT and ESPN legitimatized poker as a sporting competition and, together with massive advertising spend by the top Internet poker sites, powered tremendous improvement in the public image of the game. That phenomenon coincided with the expanse rise of broadband access, and was further fueled by the concomitant rise in availability of live poker in commercial and Indian gaming states. Gambling Compliance, for example, noted that the percentage of adults with broadband access rose from 3 percent in 2003 to 25 percent in 2006,349 which is clearly no coincidence as it was contemporaneous with the rise of pokers popularity. Poker has been a quintessentially American game, and the original Internet poker sites were strongly focused on US players. The poker wave soon washed over European and international shores as the games popularity expanded beyond US borders. As European players discovered the poker craze, a multitude of international poker sites sprang up primarily focused on Europe, beginning with Ladbrokes in 2002350 and including an increasing number of betting companies. Most of these new poker sites operated under the network model, in which the network provider aggregates play from multiple sites under a central umbrella software platform, thereby generating the greatest number of active players possible through a single portal while simultaneously offering this large player base open seats immediately at the widest variety of games and price points, tournaments and prizes the essence of liquidity. The race to maximize liquidity sparked new entries into the market sharply focused on Internet poker and spending heavily on advertising and promotions. One of the most successful of these was Full Tilt Poker, launched in 2004, and promoted by some of the best-known names in poker, including Chris Ferguson and Howard Lederer, who were also consulted in developing the software.351 Full Tilt successfully pursued this strategy of involving professional celebrity

347 348 349 350 351

worldpokertour.com Poker News Daily Chris Krafcik, speaking at GiGse, April 25, 2012 pokerplayer.co.uk www.gamblingsites.com

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players with televised endorsements and soon rose to the top rank of online poker sites. By 2005, a handful of dominant poker sites and networks had emerged that accounted for the great majority of global Internet poker revenue prior to UIGEA passage. The question of the legality of Internet poker was hotly debated in the United States, with legal proponents staking the position that poker is a game of skill played against other players rather than the house. Opponents, however, included the US Department of Justice (DOJ), which continued to maintain that the game was illegal when played over the Internet and prosecuted many of the leading poker sites as offenders. For example, PartyGaming reached a non-prosecution settlement with the DOJ in 2009, in which the company agreed to pay a $105 million fine to escape prosecution for having taken bets from US players prior to UIGEA; 352 other firms including payment processer Neteller reached similar undisclosed agreements to escape prosecution. UIGEA passage in 2006 forced the exit of PartyPoker, 888.com, Paradise Poker, Cryptologic and others from the US market and left a vacuum, which privately held companies still willing to assume the risk of taking bets from US players were quick to fill to their advantage. PokerStars and Full Tilt Poker, privately held firms financially backed by US residents, soon emerged as the dominant providers for US poker players. In spite of UIGEA, at least 2.5 million Americans continued to play on offshore sites, betting an estimated $30 billion annually in the years immediately following UIGEA passage.353 This situation began to change after 2010 as the DOJ stepped up enforcement actions under UIGEA. Widely publicized prosecutions dampened enthusiasm for Internet gambling among US players. Additionally, the transition to privately held operators worked to suppress enthusiasm among US players as the industrys reputation suffered from revelations of cheating scandals and later prosecution efforts by the DOJ. The most important single UIGEA enforcement event was the April 15, 2011, Black Friday, in which indictments were unsealed in the Southern District of New York against the owners of the three most popular offshore poker sites: Full Tilt, Absolute Poker, and Poker Stars. Domain names were seized in the United States, and player accounts were frozen. The Justice Departments aggressive enforcement actions under UIGEA have continued into 2012, including the February indictment from Baltimore against Bodog.com founder and former Forbes magazine billionaire cover man Calvin Ayre.354 As a result of the DOJ enforcement actions, today many US players are discouraged from playing online and those who still do so generally make smaller deposits and do not allow their funds to remain uncollected on the site. Data compiled by the American Gaming Association suggest that UIGEA may have dampened participation in all poker play, whether face to face or

352 353 354

The Economist, April 23, 2011 American Gaming Association white paper, Online Gambling Five Years After UIGEA, David O. Stewart, 2011 www.calvinayre.com

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online. The AGAs 2010 State of the States survey found that poker participation, whether landbased or online, reached a peak of 18 percent of the sample in 2004 and 2005 and then fell for the next three years to a low of 11 percent in 2008 and rebounded to 15 percent in 2009. A key question which may only be answered by eventual legalization is how much of the decline in US Internet poker since 2005 has been due to falling popularity of the game and what proportion is due to UIGEA enforcement and its results. Figure 76: United States poker participation rates, 2003-2009
20% 18% 15% 14% 10% 12% 15% 13% 11% 18%

5%

0% 2003 2004 2005 2006 2007 2008 2009

Source: American Gaming Association, 2010 State of the States

These developments have had the effect of reducing financial projections for global Internet poker revenues and consequently suppressing the magnitude of future projections for the US Internet poker market. While the Full Tilt-DOJ settlement has restored some confidence in offshore Internet poker, the current global situation reflects a declining market. Our belief is that, once legalized, Internet poker will once again achieve the popularity experienced prior to UIGEA passage but we do not expect this to occur overnight and it may take several years for the domestic market to fully recover. John Connelly, VP Business Development for gaming equipment maker, and Internet gambling provider Bally Technologies, summed up the difficulty making a profit from Internet poker in a recent interview for Casino Journal: Now that theyve slowed down and thought about this and done the analysis that you would normally do when you have the time, quite frankly poker is not where the majority of the money is being made by these international operators. Five years ago the rake was 15 percent and the cost to keep a player loyal to you was 100. Fast forward to today and the rake is around 5 percent and it can cost 3,000 to retain a

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player. The bottom line profitability is not attractive for a lot of companies. The majority of profit is coming from the casino side which is slot play and table games. 355 Figure 77: North American Internet poker revenues, 2003-2015E
$2,000 $1,778 $1,559 $1,502 In millions $1,000 $978

$1,500

$1,534

$1,387

$1,188

$500 $270 $0 2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E 2013E 2014E 2015E $512 $385 $350 $327 $315

Source: H2 Gambling Capital

According to H2 Gambling Capital, the US poker market accounts for only 8 percent of the total revenue generated by Internet poker players worldwide. 356 That is a far cry from the majority (more than 50 percent) of global Internet poker revenue that once came from US players in the early days on Internet gambling and a testimonial to the effectiveness of UIGEA enforcement actions as well as the reduced credibility of offshore poker sites. However, legalized Internet poker may once again return to its former US dominance. H2 estimates that if the 12 largest states enter into legalized Internet poker, the US share of global Internet poker revenue will increase to 28 percent over a five-year period and could eventually exceed European online poker revenue in a best-case scenario.357

a. Poker Considerations
The concept of online poker has important characteristics driving its consideration by policymakers. Indeed, we note that gaming legislation that has been introduced at the federal level and in states such as California often focus on poker. It is either viewed as a profit center in and of itself, or as an entry point that would ultimately lead to other forms of online gambling. We have observed indications that initial projections within states regarding poker participation
355 356 357

Mapping the Future, Casino Journal, October, 2012. H2 Gambling Capital, US Interactive Gambling Report, April, 2012. H2 Gambling Capital, US Interactive Gambling Report, April, 2012.

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are being revised downward. Witness, for example, a report from the Iowa Racing and Gaming Commission that revised annual revenue projections from online poker downward from $35 million to between $3 million and $13 million.358 We suggest, based on numerous interviews with leading political and online professionals, that one driving force is that poker is seen as politically expedient, i.e., that elected officials view it as a safe means of moving to online wagering that would not encounter significant political opposition. While we cannot vouchsafe the veracity of that view we suggest that no one truly knows, beyond political intuition, whether poker is more politically palatable than other forms of online wagering we can point to two observations that are supportable: Poker, as a legal form of online wagering, is being touted and pushed by European operators and others who have a vested interest in it. Such vested interests range from existing brands to significant databases of active players to working models and operating systems. Spectrum cautions that the presence of such vested interests could distort their arguments. Poker, whether in its online or land-based form, does not promise to be a major profit center, based on margins, in contrast to other casino offerings.

Revenues are generated in the form of a rake, which is the house take from each pot, and there is significant market pressure from players to keep the rake small in order to make the pots more competitive with other games and more attractive to players. Atlantic City casinos, for example, limit the size of the rake to 10 percent, up to a maximum of $4. The Press of Atlantic City noted that, Despite the growing popularity of poker, fueled by nationally televised tournaments and celebrity players, the game generates relatively little revenue for casinos through the rake, the fee or small percentage of the pot collected by the house. Poker is seen more as a complement to the slot machines and more lucrative table games, such as blackjack. With poker rooms, in general, the money is minimal, (Golden Nugget poker room manager Keith) Richman said. Poker, for us, is a complementary accommodation.359 The same would hold true for online poker, as the same pressures and cost structures would be present. Still, poker as an online offering must be considered, since it has strong political and industry adherents, and because it offers some insight into the potential size of the online market in the United States.
358

Iowa Report Doubts Intrastate Pokers Revenue Potential, gamblingcompliance.com http://www.uni.edu/csbr/sites/default/files/Iowa_Report_Doubts_Intrastate_Poker___s_Revenue_Potential.pdf (accessed May 6, 2012)
359

Tournaments, casino promotions highlight opening of Golden Nugget Atlantic City's upscale poker room, Press of Atlantic City, February 18, 2012. (http://www.pressofatlanticcity.com/communities/atlanticcity_pleasantville_brigantine/tournaments-casino-promotions-highlight-opening-of-golden-nugget-atlanticcity/article_f1833a9c-59ef-11e1-abe7-0019bb2963f4.html (accessed May 6, 2012 )

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A succinct summary of poker in the United States was offered by GamblingCompliance at the 2012 Global i-Gaming Summit & Expo in San Francisco: In the annals of American Internet poker, the six-year period between November 2006 and April 2011 is remembered as belonging to the tandem of PokerStars and Full Tilt. The two businesses aggressively pursued market share in the United States via televised advertising campaigns, tournament sponsorships, player-sponsorship deals and free-toplay, or dot-net, Internet poker sites. They are thought to have amassed several billion in Internet poker revenues during that time. At the height of PokerStars and Full Tilts commercial and political power in 2011, both businesses were lobbying aggressively for legislation that would expressly permit them to operate on an intrastate or interstate basis in the United States Moreover, that year, PokerStars and Full Tilt had entered into agreements with Nevada-based gaming companies to, among other things, lobby for Internet gambling legalization on Capitol Hill. On April 15, 2011, federal prosecutors in New York indicted the founders of PokerStars and Full Tilt Poker, along with nine other individuals, on charges including bank fraud and money laundering. Shortly thereafter, PokerStars and Full Tilt stopped accepting money deposits from customers in the United States360 The following chart shows the amount spent by some poker lobbies before and after that April 15 date. Figure 78: Poker-lobbying expenses in the US
$500 $405 $420 $400 $ in thousands $300 $210 $200 $100 $170 $150 $290 $230 $150 $390 Poker Players Alliance Interactive Gaming Council Pokerstars $300 $230 $315

$Q1 2011
Source: GamblingCompliance.com

Q2 2011

Q3 2011

Q4 2011

360

Andrew Gellatly, Editorial Director, Gambling Compliance, speaking at GiGse, April 24, 2012

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Gambling Compliance developed projections as to the size of the US market, based in part on the data provided by these operators: Figure 79: US poker revenue reported by four major providers, 2005-6
$800 $700 $600 $ in millions $500 $400 $300 $200 $100 $PartyGaming Sportingbet Bwin (with OnGame) 888 Holdings $87 $160 $52 $150 $230 $719 2005 2006

$559

$7

Source: Gamblingcompliance.com

The chart above shows that these four operators generated at least $920 million in annual business from the United States, excluding smaller, non-reporting operators. Clearly, we support estimates that the total was $1.5 billion to $2 billion in that period prior to the establishment and enforcement of the UIGEA. This analysis also demonstrates the growth of poker in Europe, and European operators ability to penetrate the US market. Notably, while poker is a major online game in Europe, there is no discernible poker culture in Europe, unlike the United States, where poker has long been a popular gambling pastime. This would indicate that online poker could generate more play in the United States than it does in Europe. European operators expect that, unlike in Europe, online wagering in the United States will have a limited number of licenses, which translates into much lower marketing costs. Marketing will be much easier, with an audience that operators believe is desperate for the product. Marketing costs for European operators tend to be around 25 percent of revenue, while startups seeking to develop a brand will be closer to 50 percent. 361 One reason for such high marketing costs is the proliferation of wagering sites, and the difficulty that such sites face in reaching potential viewers through search-engine optimization and other marketing tools. Additionally, the proliferation of sites makes it easy for players to switch sites. In the United Kingdom, online poker churn (a term that defines the movement of players in and out

361

Anton Bell, Gaming Edge Associates, speaking at GIGSE, April 26, 2012

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of sites) averages between 10 percent and 13 percent per month, meaning that customers stay on the site for about seven months.362 Still, the political realities in the United States during that period exemplified by the 2006 UIGEA passage created opportunities for foreign operators to tap the US market. Indeed, it must be noted that the European online gambling market evolved differently than it would have in the United States, in part because of the presence of a large, land-based casino industry in the United States that first viewed online gambling as a threat, coupled with licensing standards in the United States that are far different, and arguably more stringent, than they are in Europe or elsewhere.

b. Players Other Games

US Gaming Survey.com (USGS) conducted an online survey of poker players during the last three weeks of December 2011. Respondents invited to take the survey were members of the Poker Players Alliance and more than 8,000 completed the survey. Results showed that 72 percent of all respondents play for stakes under $100 per week.363 For players who are actively wagering over the Internet today, presumably on US-facing offshore sites, a great majority (89 percent) would readily move to a US licensed and regulated website if one were available. 364 This survey also collected information regarding lottery play by Internet poker players, 53 percent of whom also play land-based lottery games. Among this sub-group, 54 percent or more than one-quarter of the total survey population appear to be casual lottery players spending less than $5 per week on lottery tickets and 81 percent spends $10 or less on the lottery.365 These findings indicate that Internet poker players are not likely to be core frequent lottery players.

362 363 364 365

Malcolm Graham, PKR, speaking at GiGse, April 26, 2012 US Gaming Survey, US Online Poker Survey 2012 US Gaming Survey, US Online Poker Survey 2012 USGS Online Poker Survey 2012

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Figure 80: Internet poker player weekly lottery spend

60% 50% 40% 30% 20% 10% 0% $1 - $5 $5 - $10 $10 - $25 > $25 Do not play state lotteries 27% 13% 5% 1%

54%

Source: US Gaming Survey.com Online Poker Survey 2012

Internet poker players who also play the lottery were further asked in the USGS survey whether, if legal online poker and lottery were both available in conjunction with one another, they expected their weekly lottery purchase to be affected. Some 49 percent said they would expect online lottery availability to have no effect on their current weekly purchase behavior while 14 percent would expect online availability to increase their weekly lottery purchase. Only 1 percent expected their weekly lottery purchase to decrease.366 Figure 81: Expected effect of Internet poker availability on lottery purchases
Decrease it 1% Increase it 14%

Have no effect 49% Do not play lottery 36%

Source: US Gaming Survey.com Online Poker Survey 2012

366

USGS Online Poker Survey 2012

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Similarly, an earlier USGS survey of Internet casino players found that an even stronger majority 55 percent of males under age 50 and 52 percent of men over age 50 expected online casino games to have no effect on their visitation of land-based casino properties. A substantial proportion of online players, 20 percent of males under age 50 and 16 percent of men over age 50 expected their land-based casino visitation to actually increase.367 Poker, as an online offering, depends highly on the potential pool of players available for games at all hours of the day, referred to as the liquidity of the market. With an adult population of 5.2 million, the prospect of sufficient liquidity is an open question. At this writing, federal legislation is being considered that would allow interstate online poker, but that is an unknown. A similar unknown at this point is whether different states across different time zones would be able to pool their poker resources, as is being done among certain provinces in Canada.

5.

Legalization Efforts

Numerous efforts were made in Congress to delay or defeat UIGEA prior to passage and to repeal the legislation after passage none have met with any success. House Financial Services Committee Chairman Barney Frank spearheaded efforts to delay or defeat UIGEA after passage, drafting the Internet Gambling Regulation and Enforcement Act (IGREA) in April 2007, as well as a series of similar bills culminating in HR 2267 the Internet Gambling Regulation, Consumer Protection, and Enforcement Act designed to license and regulate Internet gambling and allow states and tribal governments to assume jurisdiction. A companion bill, the Internet Gambling Regulation and Tax Enforcement Act of 2009, was introduced by Representative Jim McDermott; this bill required any licensee under IGREA to pay a 2 percent fee (i.e., federal tax) on all deposits, as well as increasing protections against tax cheating. Despite the promise these legislative efforts offered for legalizing Internet gambling and the potential for a regulated industry producing $42 billion in tax revenue over 10 years, by 2010 Congress had effectively killed both bills. These pro-Internet gambling measures did succeed in making some state and federal legislators rethink their positions regarding Internet gambling. Additionally, these legislative efforts generated support from US commercial and tribal gaming interests and assisted reversing the land-based industrys general opposition to Internet gambling. The American Gaming Association, a trade group for the US commercial casino industry, has evolved its stance with regards to Internet gambling from one of opposition to one of outright support. This sea change in the position of the domestic casino industry has been brought on by the evident success of the Internet gambling industry internationally, the establishment of robust player protection, age verification, and geolocation systems to assure social responsibility and security, as well as the industrys own efforts to position their

367

USGS, National Online Wagering Survey 2011

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companies to defend the Internet space against foreign competition and prepare for what they see as eventual but inevitable legalization. The most recent efforts to pass a Federal legislation have focused on the legalization of Internet poker. On July 26, 2012, Eugene Johnson, a Spectrum Gaming Group executive, testified before the US Senate Committee on Indian Affairs, in an oversight Meeting on the subject of the Regulation of Tribal Gaming: From Brick & Mortar to the Internet chaired by Senator Akaka, Democrat from Hawaii. At that time there were two bills circulating in the US Senate with the potential to become law, Senator Akakas bill, which was considered friendlier to tribal gaming, and Senator Reid and Senator Kyls bill, which is considered more advantageous to the commercial casino industry. The plan had been to attach one of these bills, undoubtedly the Reid/Kyl version, to a must-pass piece of legislation, in this case the Cyber Security Bill. In the event that must-pass legislation never made it to the Senate floor and the prospect of federal interstate legalization of online gambling has evaporated for the remainder this Congressional session and most probably for the next twelve months. Most political commentators on this issue believe that the chances for federal legalization will be better under a Democratic administration in the White House than they may be under a Republican administration. Federal legislation, depending upon the details of any particular bill that may be passed, could prohibit state lotteries from participating in Internet gambling or restrict them to offering only traditional lottery games online. The latest released summary of the Reid/Kyl bill, tentatively titled Internet Gambling Prohibition, Poker Consumer Protection, and Strengthening UIGEA Act of 2012 legalizes Internet poker but explicitly prohibits other forms of Internet gambling, including by state lotteries. Under this draft Internet poker bill, state and tribal lotteries could offer online lottery ticket sales but could not offer Internet games that are similar to slot machines or casino games. As such, this bill constitutes a legislative threat to unrestricted state lottery online products. As drafted, this bill would invalidate Delawares passed legislation authorizing Internet gambling through the state lottery. It also prohibits tribal casinos from offering Internet gambling if their states choose not to opt into the federal scheme, although a second online poker bill titled Tribal Online Gaming Act of 2012 released by the Senate Indian Affairs Committee would be much friendlier to tribal gaming. Both of the current draft bills would place regulatory oversight of Internet gambling with the Department of Commerce. In the absence of effective interstate legislation, several states have moved aggressively to fill the vacuum. A summary of recent legalization activity notes the following states could implement Internet wagering as early as the end of 2012: Nevada has already legalized intrastate Internet poker and awarded the first two Internet gambling licenses awarded in the US on June 21, 2012. Regulation 5A governing the licensing of Internet poker operators and service providers was adopted in December 2011. Operator licenses can only be granted to companies that already hold non-restricted Nevada gaming licenses but service provider licenses are less

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restricted. On September 20, 2012 the Nevada Gaming Commission approved Regulation 5.240 which established three new service provider licensing subcategories for geolocation, patron identification, and payment processing. Delaware became the first state to legalize lottery Internet gambling when on June 28, 2012 Governor Jack Markell signed into law HB 333, sponsored by Representative John Viola, Chair of the House Gaming & Pari-mutuels Committee. This measure allows the states three existing racetrack casinos to offer online lottery games through co-branded websites using a central platform operated and promoted by the Delaware Lottery. The law also expands the number of outlets that can host keno and sell sports lottery (parlay betting) tickets. Revenue from Internet lottery sales will be rolled into current benefits distribution except that the first $3.75 million will be retained by the Delaware Lottery to ensure that the initiative is revenue neutral to the state. The Lottery Director will have discretion over which games will be permitted but it is expected that lottery tickets, video lottery, and casino style table games will all be offered online. Only persons physically present in the state will be allowed to participate. Pre-paid debit cards will be used to fund electronic Internet gaming accounts and these cards must be purchased at current lottery retail locations. New Jersey has passed several bills in the Assembly approving Internet gambling, mobile wagering, and sports betting. At the federal level New Jersey Representative Frank LoBiondo has sponsored a bill in the US House of Representatives, HR 3797, which would legalize sports betting in the 46 states which are not grandfathered under PASPA. At the state level, New Jersey has passed legislation legalizing Internet gambling, mobile betting, and sports betting. At the state level two bills, one in the Senate, S1565 sponsored by Senators Ray Lesniak and Jim Whelan, and one in the Assembly, A2578 sponsored by Assemblymen John Burzichelli, Vincent Prieto, Ruben Ramos, and Lou Greenwald have both passed in committee. These two bills would grant Internet gambling licenses to casinos currently operating in Atlantic City. License fees are estimated to be at least $200,000 with a $100,000 renewal fee plus 20 percent tax on annual gross revenues and an annual fee of $150,000 per license to fund compulsive gambling programs. All hardware supporting Internet gambling must be located within Atlantic City. In addition mobile betting at casinos has already been signed into law on August 8, 2012 with the regulations becoming effective on October 8, 2012. Bills S2236, sponsored by Senator Robert Gordon in the upper house and A2160 which passed in the Assembly on May 24, 2012 will allow mobile betting at racetracks in New Jersey. Finally, a bill permitting sports betting, P.L.2011, Chapter 231 was signed into law on January 17, 2012. This bill has been opposed by the NFL, NBA, MLB, NHL, and NCAA sports associations who have cooperatively filed suit to block it under the Professional and Amateur Sports Protection Act (PASPA). The state has moved forward with the Division of Gaming Enforcement

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publishing final regulations on October 15 and set to begin awarding licenses on January 9, 2012. California has had several bills attempting to legalize in-state Internet poker in the legislature over the past two years but none has made it to the floor due to opposition from tribal gaming interests on the basis of potential licensees and tribal sovereignty issues. The current bill, SB 1463, sponsored by Senate President Pro Tem Darrell Steinberg and Senator Rod Wright, would grant 10-year, $30 million Internet poker licenses to in-state gambling enterprises which have been under state regulation for at least three years, including California Indian tribes, card rooms, horseracing associations, and advance deposit wagering (ADW) operators. Licensed Internet poker operators would pay a 10 percent tax on monthly gross revenues which could be deducted from the license fee for the first three years. A second bill legalizing sports betting, SB1390 sponsored by state Senators Rod Wright and Joel Anderson, would authorize the same licensed entities to offer wagering on professional and collegiate sports excepting those that take place in California or in which any California college team participates. This bill also appears dead at least for the remainder of this year. Illinois proposed an Internet gambling bill, HB 4148 sponsored by Senate President John Cullerton, which would permit the state lottery to sell $5 million affiliate licenses to private operators including casinos, race tracks, and advanced deposit wagering enterprises utilizing the state lotterys website but the measure died on the floor of the state senate. Iowa had an Internet poker bill, SF 2275 sponsored by Senator Jeff Danielson passed by the state Senate on March 13, 2012, but the session ended before the measure came up for consideration in House. This bill authorized online poker only and required service providers to partner with existing land based riverboat and racetrack casinos currently licensed by the state. The District of Columbia City Council, after exploring and then rejecting Internet gambling last year, introduced legislation on September 19, 2012, to form a study committee to explore potentially legalizing all forms of gambling including online gambling. Hawaii saw two bills introduced in the legislature to authorize casino gaming, a state lottery, and Internet gambling but neither bill advanced during the 2012 session. Massachusetts saw an amendment to the state budget authorizing Internet gambling introduced and then withdrawn early in the 2012 session.

A number of other states are now considering some form of legalized Internet gambling, including Florida, Georgia, Mississippi, Pennsylvania, and Rhode Island, subject to passage of

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enabling legislation and resolution of potential legal challenges. Once one state legalizes Internet gambling, it is likely that other states will quickly follow, creating additional momentum for state by state legalization while applying additional pressure for the movement of federal legislation.

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BB. Internet Player Demographics

1. Demographics the North American Internet Gambler
The 2011 Active Gambler Profile, produced by MMGY Global for the casino equipment manufacturer WMS, surveyed more than 3,800 gamblers in the United States, Mexico, and Canada and found that 13 percent of US respondents have visited an online gambling site, compared to 22 percent of Canadians and 41 percent of Mexican respondents. These penetration rates strongly support the intuitive conclusion that legalized and regulated Internet gambling generates higher penetration rates than illegal gambling. Poker is the most popular online game in every North American country, followed by slots, table games, and bingo. 368 The majority of online gamblers spend less than one hour per visit per site, but many do visit more than one site during a gambling session. Earlier research conducted by London-based e-Commerce and Online Gaming Regulation and Assurance (eCOGRA) in 2006 with some 10,800 Internet gamblers benchmarked typical Internet gambling sessions at 1-2 hours and play frequency two to three times per week on average. 369 The primary motivation for playing online is convenience, expressed as the ability to multitask and control the place and time that gambling takes place, and secondary reasons include privacy, comfort, relaxation, and the influence of marketing incentives.370 The American Gaming Association (AGA), as reported in its 2006 State of the States, undertook a special survey in which it provided some comparisons of Internet gamblers and traditional casino gamblers. The 2006 AGA study found that Internet gamblers are more strongly male than traditional casino gamblers: 68 percent vs. 53 percent, respectively. More importantly, this survey found that Internet gamblers are significantly younger than traditional casino gamblers, as shown in the following chart:

368 369 370

YPartnership, 2011 Active Gambler Profile eCOGRA 2006 Global Online Gambler Report YPartnership, 2011 Active Gambler Profile

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Figure 82: By age group, Internet gamblers vs. traditional casino gamblers
50%

43%
40%

Casino

Internet

37%

30%

26% 18% 14% 14% 9% 2% 20% 15%

20%

10%

0% 21-29 30-39 40-49 50-59 60+

Source: American Gaming Association State of the States 2006

Internet gamblers are also generally better educated than traditional casino gamblers, with Internet players significantly more likely to have a four-year college degree or higher level of education. Figure 83: By education level, Internet gamblers vs. traditional casino gamblers
40%

33%
30%

35% 28% 25% Casino Internet

21%
20%

15% 12%
10%

17%

9% 2% 2%

0% Some high school Completed high Vocational school school or some college 4-year college graduate Some postgraduate education Post-graduate degree

Source: American Gaming Association State of the States 2006. Note that the survey for traditional casino gamblers did not include an option for some post-graduate education.

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Internet gamblers in North America play more frequently than traditional casino gamblers but they play for smaller stakes per session. YPartnership (predecessor to MMGY Global) found in its 2010 Active Gambler study that the median (excluding zero) amount spent on gambling per day-trip North American active gambler to a casino was $200 per trip. The same study found that the mean (i.e., average) amount bet per online session by North American Internet active gamblers was $90.10. In North America, 35 percent of active gamblers visited an Internet gambling site during the previous 12 months.371 Figure 84: Types of online games played among North American Internet gamblers

None of the above, 17% Table games, 17% Bingo, 22%

Poker, 52%

Slots, 47%

Source: YPartnership, 2010 Active Gambler Profile

Internet gamblers preferences for poker are further illustrated in the next chart, which shows the most frequently visited Internet gambling sites by all active gamblers, prior to the Black Friday indictments, segmented by poker and casino/slots/bingo games. This chart demonstrates that a small number of the most popular Internet poker sites those with the greatest liquidity, or active users playing on the site, (i.e., PokerStars and Full Tilt Poker) dominate the online industry. For the Internet casino sites, market share is much more evenly distributed, with Slots.com having the greatest individual share.

371

YPartnership, 2010 Active Gambler Profile

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Figure 85: Most frequently visited Internet gambling sites by all active gamblers
40% 31% 50% 40% 30% 20% 10% 0% VegasRed Foxy 888 888 Intercasino.com FulltiltPoker.com

20%

18%

29% 18%

16%

15%

14%

14%

12%

12%

11%

11%

11%

10%

11%

10%

10% William Hill

Jackpot Joy

Skybet

Coral

Casino-on-Net

PokerStars.com

PartyPoker.com

Ladbrokes

Slots.com

Gala

POKER Source: 2010 Active Gambler Profile

PartyCasino.com

Casino Classic

Bodog.com

CASINO/SLOTS/BINGO

Massachusetts appears well positioned for the introduction of Internet-based lottery sales, ranking as the fifth-most wired state in the nation, ranking behind only New Hampshire, New Jersey, Utah and Connecticut. The state enjoys a higher proportion of Internet users than the nation at large, boasting an Internet penetration rate of 86.2 percent as of June 2010, compared to 77.3 percent for the United States as a whole.372 Most importantly, more than 70 percent of Internet users nationwide also make online purchases.373 Figure 86: US Internet penetration rates by state June 2010
100 80 Percent 60

40
20 0

Source: Internet World Stats, International Telecommunication Union

372 373

InternetWorldStats.com

Ernst and Young, Is There A Future for Lottery in Retail?, presentation at La Fleurs 2012 Lottery Symposium, April, 2012

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Bet 365

10%

NH NJ UT CT MA OR WA AL WI ME HI MD ID MN VT NY RI DE NE NV CO CA WY KS FL IL AZ MI VA PA IA US Avg OH GA DC ND MT IN TN SD MO NC WV KY TX NM OK LA SC AR MS

Regular and frequent Internet users are demonstrably younger than the population as a whole. National surveys on the frequency of Internet usage find consistently that people in the younger demographic ranges are the most frequent users. For example, a 2008 Gallup Poll found that, on a nationwide basis, respondents below the age of 30 spent the most time online (62 percent spending more than one hour per day), followed by the next-youngest segment surveyed, people 30 or older but under the age of 50 (54 percent spending more than one hour per day). 374 Moreover, the frequent Internet user is more likely to be better educated, higher income, and fully employed than other population segments. In short, the Internet demographic represents many of the potential customers who currently do not participate regularly in lottery games. Engaging this demographic is not only a means for increasing sales by involving a wider pool of players, it is also a strategy for assuring the supply of customers for the future. Figure 87: Internet usage frequency by demographic group - 2008
% Saying they use the Internet "more than an hour a day"
Post-graduates $75,000 or more Ages 18-29 Ages 20-49 Men Employed Some college College graduates $30,000 - $75,000 (National Adults) Unmarried Married Ages 50-64 Women Non-working High school or less Less than $30,000 34 32 23 0 10 20 30 40 Percent 50 60 70 80 42 41 45 48 49 54 53 53 52 51 63 62 68

48
47

Ages 65+

Source: The Gallup Poll, December, 2008

374

Gallup Poll, 2008

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2.

Lottery Demographics

For most lotteries, there are two primary types of players: frequent (core) and infrequent (non-core) players. As is also observed in the commercial casino industry, the great majority of revenue is provided by frequent, or core, players. In addition, infrequent players are often younger and more female than frequent players. Encouraging infrequent players to purchase lottery products more often is the clearest avenue to growing revenue as well as solidifying the future player base. The Chicago research firm Independent Gaming Research (IGR), formerly Independent Lottery Research (ILR), conducts a tracking study polling about 450 consumers each month that illustrates this issue and terms these two segments Joe (core) and Jack (noncore). Joe, who plays the lottery five times more than Jack, is 37, married, with an annual income of $52,000. Jack, the occasional (non-core) lottery player, is 38, married with one child, and slightly beats Joe in the income category: $53,000. Jack is the target audience for lotteries as he comprises 51 percent of the adult population, vs. Joes relatively paltry 14 percent. 375 According to IGR, both segments spend relatively the same amount per purchase, but core players play five times more frequently than non-core players.376 Most importantly, noncore players outnumber core players by 78 percent to 22 percent. While both segments report that their spending has been adversely impacted by the economic recession, Joes generally display a more favorable impression of the lottery than Jacks. On average, Joes are more likely (on a scale of 1-9) than Jacks to say they like the lottery (7.3 Joes, 5.5 Jacks), that lottery games are fun to play (7.0 Joes, 5.8 Jacks) and that money spent on the lottery is put to good use in the states that have them (6.1 Joes, 5.2 Jacks).

375 376

International Lottery Research, Changing Wheels of Fortune Building A New Player Base International Lottery Research, Changing Wheels of Fortune Building A New Player Base

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Figure 88: Proportion of Core (Joe) lottery players to Non-Core (Jack) players
100%

17%
80%

17%

19%

23%

21%

60%

Joe Jack 82% 83%

40%

81%

77%

79%

20%

0% 2007 2008 2009 2010 2011

Source: Independent Lottery Research. See definitions of Joe and Jack in preceding paragraph.

Nationally, 33 percent of the eligible population (over 18 years of age) never plays the lottery, 50 percent play infrequently, while 14 percent are frequent players. 377 Figure 89: Lottery play currently vs. one year ago among those who play lottery

Playing Less, 31%

Playing Same, 61%

Playing More, 8%

Source: Independent Lottery Research

377

International Lottery Research, Changing Wheels of Fortune Building A New Player Base

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A 2006 survey of 2,250 adults across the nation including 1,473 who had gambled within the previous year illustrates the demographic differences among participants in different forms of gambling: Figure 90: Profile of gamblers in the United States, 2006
Any type of gambling All adults 67% Bought lottery ticket 52% Gender 56% 48% Race/Ethnicity 53% 45% 47% Age 48% 56% 55% 43% Education 48% 55% 52% Family income 57% 60% 54% 44% Region 63% 52% 48% 47% Religion 48% 62% 52% White Protestants 40% 58% Visited casino 29% Bet on sports** 23% Played cards for money 17%

Men Women

72% 62%

31% 27%

32% 15%

25% 10%

White Black Hispanic*

68% 62% 62%

30% 24% 22%

23% 24% 16%

18% 14% 12%

18-29 30-49 50-64 65+

71% 69% 68% 58%

30% 30% 31% 22%

30% 25% 22% 13%

32% 17% 11% 10%

College graduates Some college H.S. grad or less

65% 71% 66%

31% 32% 27%

25% 23% 22%

15% 21% 17%

$100,000+ $50K-$99k $30K-$49k Less than $30k

79% 74% 67% 59%

40% 37% 27% 21%

39% 27% 22% 16%

24% 22% 21% 11%

Northeast Midwest South West

77% 64% 62% 68%

31% 26% 24% 38%

26% 23% 21% 23%

20% 18% 15% 17%

Protestant Catholic Secular

61% 77% 72%

24% 39% 29%

19% 30% 24%

13% 23% 23%

Evangelical Mainline

50% 73%

19% 29%

14% 24%

11% 17%

*Hispanics are of any race ** Betting on sports includes professional sports, college sports or an office pool

Source: Pew Research Center

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3.

Massachusetts State Lottery Player Demographics

Frequency of play for Massachusetts State Lottery players as shown by the SocialSphere tracking study reflects the national averages for core players with 20 percent of all players purchasing lottery products at least once per week. Massachusetts State Lottery players as a whole are primarily female (58 percent), age 35-54 (39 percent), Catholic (37 percent), and evenly split between those making more and less than $50,000 annually (46 percent each category).378 More than half of Lottery players (56 percent) are Facebook regulars. The key age demographic for the Lottery is the 35-54 bracket, which posts the highest representation among weekly and monthly players. The least engaged segment is the youngest age demographic, 18-34, who are most strongly represented in the once a year and never response categories.379 Figure 91: Massachusetts State Lottery frequency of play by age group
20% 22% 20% 15% Once a Month 19% 17% 17% 25% 27% 27% 21% 21% 55+ 31% 35-54 18-34 All Players

Once a Week

12%

Once a Year

Not in last Year

18% 18%
11%

19% 18% 22% 25% 30% 35%

Never

0%

5%

10%

15%

20%

Source: Massachusetts State Lottery Annual Tracking Survey & Brand Assessment, May 2011

For analysis purposes, the Lottery segments its customers primarily by play frequency and status, and the SocialSphere Tracking Study develops a demographic profile for each segment based on age, gender, income and education, and spending statistics, as well as several
378 379

Massachusetts Lottery Annual Tracking Survey & Brand Assessment presentation by SocialSphere, May 18, 2011 Ibid.

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other behavioral characteristics. Full demographic profiles are available in the SocialSphere presentations, but for the purposes of this report, we provide an overview. Weekly players are the most active and highest value segment. Some 83 percent of weekly players play instant games, spending an average of $92 monthly and $1,107 annually, 41 percent of which is spent on instant games. Weekly players are also more likely to be older, Catholic, and readers of the Boston Herald. Monthly players are worth much less: $24 per month on average and $290 per year and play all lottery products with less intensity than weekly players, although instant games are a strong interest with 73 percent playing every month. Infrequent yearly players are the least valuable segment, spending an average of $52 per year, the majority of which (70 percent) is spent on instant tickets. Positive perceptions of the Lottery are important to player spending behavior. Respondents surveyed in the annual tracking study who rate the Massachusetts State Lottery at the top end of the factor perceptions scale spend significantly more on lottery products than others.380 Regular Lottery players have increased their frequency of play in recent years but spending has remained relatively constant, indicating that the core customer base is fully engaged and it appears that further revenue increases will be sparked by an improving economy short term and/or converting more of the non-core, less-frequent players into Lottery customers.

380

MSL Annual Tracking Survey & Brand Assessment presentation by SocialSphere, May 18, 2011

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CC. US Lottery Outlook and Adoption of Internet Sales

The history of US lotteries has been a story of boom and bust. Lotteries have played an important role in the history of this nation, helping to finance the establishment of original English colonies and funding public works efforts during our formative years.381 At the time of the American Revolution multiple lotteries were operating in all 13 colonies. The religious reawakening beginning in the 1830s along with an outrageous scandal in the Louisiana lottery in the 1870s led to the prohibition of lotteries at the state level. The federal government outlawed interstate mail for lottery purposes in 1890 in 1895 invoked the Commerce Clause to forbid shipments of lottery materials across state lines, effectively ending all lotteries in the US382 No commercial lotteries existed in the US for thereafter until 1964, when New Hampshire successfully re-established the intrastate lottery. Inspired by this success other states began re-introducing lotteries as a means for generating additional revenue for worthy causes. New York followed suit in 1966; New Jersey in 1970, and 10 other states by 1975. Currently 43 states in the continental US have state lotteries, as does the District of Columbia. Figure 92: Map of US lottery states

Source: Minnesota State Lottery 2011 Overview. Note: Alaska and Hawaii (not shown) do not have lotteries.

Another lottery resurgence is dawning, with the advent of Internet gaming, online products, and Internet ticket sales.

381 382

National Gambling Impact Study Commission Ibid.

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Spectrum Gaming Group executives conducted in-depth interviews and obtained conference presentations and information from directors from approximately 20 North American lotteries over a 60-day period. This base comprises almost half of all the US state lotteries, and our research provided consistent feedback in terms of expectations regarding the adoption of the Internet sales channel. There is a universal belief that the Internet as a lottery distribution channel is inevitable, but that the timing will be dictated by the political environment. In terms of drivers, all cited the adoption of web-based product and service delivery by all business sectors, the high and growing penetration of Internet usage across demographic groups, and the desire to keep pace with consumer expectations. In addition, most lottery directors initially expect moderate sales impact and no negative impact on the bricks-and-mortar retailers, based on the existing European data, initial reports from Illinois and vendor insight.

1. Current Plans/Offerings
For the most part, states have limited current usage of the Internet to offering a website, having some form of second chance drawing and/or a players club, and offering subscription lotto game sales. The states are all hopeful that they will have Internet-based play in the future, although many do not foresee immediate plans; they believe timing could be accelerated if there were good experiences in other states. Several states reported that the primary issue is the existing political climate in their state, which was frequently described as conservative and not inclined to be first to market. Most anticipated a soft-launch strategy, to test the channel and then build as appropriate. Plans were generally described as an initial launch with the lotto products only and then expanding to the scratch products, with the hope to eventually introduce true Internet play. It was expected that the introductions would be a quiet, low impact roll-out of Lotto games to test the channel; several also noted that subscription sales have been available online as a niche offering with no negative impact to retailers or public relations. Virtually all expected that when they launched online, the Lottery would provide the platform working directly with one of its vendors; few were entertaining the option of licensing online retailers or franchising the online channel to a third party. There was a strong and consistent belief that lotteries are trusted, credible organizations with strong brands; the risk was too great of damaging this equity by outsourcing a third party to be a lottery channel and losing control over the brand/brand experience. Lottery directors consistently expressed a desire to have an open platform that would allow developers to build games for this channel; there was a widespread acknowledgement that it is not clear what types of products will ultimately be most relevant in this channel and the platform should be able to adapt to opportunities that they equated with the Angry Birds lottery game. A few projected a full rollout of all lottery products as soon as allowed. The challenges of creating the platform were not considered to be

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significant, particularly as some vendors have done significant work in this area; the RFP process however was anticipated to be a significant time issue for some. Most expected that all current products would be the first phase, followed by other more interactive scratch products; a long-term vision of the role of updated current scratch products vs. new products was not clear.

2.

Barriers to Launch of Internet Channel

Several states reported that the primary issue is the existing political climate in each state, which was frequently described as conservative. Many had the expectation that the concern level would dissipate if other states had positive experiences and/or there were competitive pressures to enter. Interestingly, legal readiness in terms or whether regulatory relief was required to offer Internet game sales did not appear to be the driving factor in terms of launch timing; all said they would obtain some level of legislative/executive branch approval prior to launch, even if it was not required. Some indicated that the lotteries are charged with maintaining the lottery vs. achieving growth; there is no pressure or desire to aggressively pursue growth options, particularly if they could be met with public or political resistance. In addition, there was a strong impression that there is little to no tolerance for lotteries to make a mistake, so having the benefit of waiting and learning from other states is significant. Many cited the fact that legislators are concerned about key security-related issues that reflect on public policy: age verification, geographic/location verification, social issues/problem gambling, etc. Lottery directors believe these issues are easily addressed based on vendor feedback. Concerns about the retail channel were mixed, primarily driven by the response of the channel to date. All lottery directors acknowledged the value of the retailers to the success of the lottery and the strong relationships that exist; lottery licenses have a high value to retailers and the availability of online games is not expected to damage that value. States were mixed, however, in terms of the retailer response to the concept of online lottery games: Several had not received any pressure from the retailers despite exposure to national lobbying in their state, while others received strong negative feedback from the retail community. The states that are not experiencing retailer resistance believe that proactive reporting and dialog about industry data demonstrating the lack of negative impact/opportunity for positive impact has been valuable; in addition, some retailers were seen as less concerned because they know it is not an imminent issue in the state. Some lotteries cited that the introduction of online play was designed to respect the retail channel while establishing a presence online: Lotto games are not seen as likely to impact retailers where they tend to be spontaneous purchases stimulated by jackpot signage in store. In addition, a few states stated that they were likely to hold off on the planned purchase games like pick 3/pick 4.

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There was limited concern about player data/lack of anonymity and Freedom of Information Act issues. A few lotteries believed they would need legislation to ensure privacy of the date while several currently have protections in place that they believe would apply to this type of database.

3.

Role of Casinos in Internet Adoption

Interestingly, there were strong differences among state lottery interviewees regarding the perceived impact of in-state online gambling on lottery products overall and the specific impact of online games on casinos. The states that have casinos reported no concern about the impact of casino sales on lottery sales; their experience has been that lottery sales do not suffer as a result of casino presence and believe that the player is seeking a different, more social experience than the lottery game experience. These states reported a positive and cooperative relationship with the casinos in their market; these states have experienced a natural and positive coexistence, which they acknowledge is likely driven by both product mix and regulatory structure. They have not met any resistance from in-state casinos to the concept of online lottery product sales; they did acknowledge that casinos may have a strong interest in peer-to-peer/casino style games if they were to be permitted online. For the most part, this class of Internet-based game is not seen as imminent in terms of governmental approvals or launches; some of the lotteries expected that these types of games would more naturally be branded by the casinos. Among states that are just implementing casinos or do not have casinos, there is a belief that lotteries and casinos compete for limited entertainment or gaming dollars and there is a need to proactively launch Internet games. This belief is strengthened by potential legislation in the Congress that would award exclusivity for Internet gambling to commercial casino interests. A current US Senate bill sponsored by Senate Majority Leader Harry Reid and Senator Jon Kyl would legalize Internet poker but outlaw many other forms of online gambling, including lottery ticket sales, which have been underway in Minnesota on a subscription basis since 2010, and in Illinois via ecommerce since March 25, 2012.383 iPoker lobbyist Jon Porter was quoted in the article commenting, Now the states are moving rapidly and the federal government is saying, time out.384 The Internet was consistently seen by state lottery executives as a new distribution channel as opposed to a new product, offering convenience and access for players. The revenue impact was projected to be very limited in the near term and revenue was not being viewed as a significant benefit of the channel for lottery. Many of the lotteries believe the Internet is important for the maintaining the health of the lottery. There is an apparent belief among them that the online sales are an important and expected part of staying relevant, although it is not

383 384

Alexandra Berzon , The Wall Street Journal , April 25, 2012 Ibid.

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necessarily expected to be a significant source of sales until key products are introduced: mobiledevise play, true gambling products, and faster-action games such as keno. Specific issues cited included: opportunity to grow the player base among the younger players where lotteries have traditionally struggled, need to be available in the channels where people expect to see you, ability to offer more entertaining/interactive experiences, opportunity for players to learn the games. Several lottery directors see the online channel as allowing a more approachable, less intimidating environment to learn how to play the games/ they cited player feedback in research that the primary barrier to play is intimidation and lack of knowledge about how to play. The online channel is seen as offering the opportunity for these consumers to learn the games and then building confidence to play in the retailer location also. Many lotteries cited vendor data that online sales have a halo effect on the bricks-and-mortar sales. There are several hypotheses about the profile of the players that will use the online channel but no states were aware of specific consumer research in the United States about potential adoption levels. Hypotheses included younger players (especially if mobile is available), as well as older players; many cited behaviors such as Facebook, online banking, etc. as evidence that the older generations are more computer savvy than the stereotypical expectations. Having more channels will increase the social acceptability of lottery play which will improve spending on the games Although the online channel was seen as offering convenience, it was not expected to replace current sales. The lack of anonymity in gaming online was seen as an advantage in terms of responsible gaming controls for both the lottery and the player.

4.

US Lotteries and the Internet in 2012

Since the Department of Justice issued its opinion on December 23, 2011, reversing its long held position that the 1961 Wire Act barred state lotteries from participating in online gambling, Delaware and Nevada have legalized (but not yet implemented) Internet gambling. Nevada has authorized Internet poker and begun awarding licenses to vendors and operators. Delaware has passed legislation permitting online ticket sales and online casinos. In addition, at least seven states California, Delaware, Hawaii, Iowa, Illinois, Mississippi, and New Jersey have introduced legislation authorizing some form of legal Internet gaming in their states. Conversely, Utah has passed legislation specifically prohibiting any form of Internet gambling, while Michigan and Colorado have specifically banned Internet lottery sales. Maine has altered its gaming statute in response to the DOJ ruling, and Pennsylvania has introduced legislation to increase awareness of the risks of internet gaming. Vermont has authorized a study on the potential impact of Internet lottery ticket sales.385

385

2012 Legislation Regarding Internet Gambling or Lotteries, National Conference of State Legislatures.

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Currently, lotteries in New York, Minnesota, New Hampshire, North Dakota, and Virginia offer some form of online subscription sales for lotto tickets. Illinois is the only US lottery at this time to offer same day sales of lotto tickets over the Internet. Several US lotteries allow third party sites to sell their tickets via the internet similar to mail order purchases where physical tickets are purchased via the Internet and held in reserve for the player. These lotteries include California, Florida, Indiana, and New York. This is not strictly considered Internet gambling because it is not an instantaneous transaction with an electronic product being delivered to the customer.386 Other US state lotteries offer e-games which are downloadable products which can be played on computers. One example is the New Jersey Lottery, which introduced Cyber Slingo in February 2004 and Tetris in November 2004.387 These games should be considered computer games and not truly Internet games. In the New Jersey example, the two games have since been retired and are no longer available on the lottery website.

a. Illinois Lottery
The Illinois Lottery initiated Internet same day sales of lotto tickets on March 25, 2012. Proving the maxim that timing is everything, this launch coincided with the largest Mega Millions jackpot in history and initial sales were robust. Michael Jones, Superintendent of the Lottery, speaking at the GiGse conference one month after implementing Internet sales, recounted the Illinois Lotterys efforts to move online: We basically had a Legislature that passed a specific law that directed the Department of the Lottery to begin a test. That was four years ago when this began. All of this technology was still kind of in the ether, of a test of very specific products, our broadest base products, the ones that have very large prizes and potentially could attract the largest number of people to play: Lotto and Mega Millions, and the test was very specific. It said it could take place in a 36- to 48-month period. You have to have controls in place both the geo-control and age control. Following that statutory authorization, various legal opinions within Illinois including opinions from the lotterys chief legal counsel, and the governors legal counsel gave assurances, according to Jones, that It was legal on its face. The Illinois Lottery sent a letter to the DOJ, informing it of the Lotterys intent and of the legal opinions, seeking comment from that federal agency. For two years, we really heard nothing from the Department of Justice, other than having a couple of very amicable meetings with them. But again our point of view was clear, that this was legal and we were going to do it, Jones said.

386 387

WinTrillions.com. New Jersey Lottery, http://www.state.nj.us/lottery/about/6-0_about.htm.

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That request from the Illinois Lottery led in large measure to the highly publicized December 23, 2011, DOJ opinion. Following that opinion, the Illinois Lottery began moving toward implementation, according to Jones, who was recently appointed to a second, nonconsecutive term as superintendent. Jones view is: Lets get this thing started. It is a fantastic way to broaden the lotterys base, to become relevant to the people of the state of Illinois who support the lottery but dont participate in it. And (it is) a great way to make money for our capital development projects. Working with the lotterys private manager, Northstar, Jones began creating an interface. He noted one issue early, based on his experience in the lottery and working in a state that offers both lottery and casino games. The casino industry and the lottery industry dont know very much about each other. Especially, the casino industry cant really get a feeling for what makes someone participate in the lottery, or what lotteries do, he said. According to Jones, A well-run lottery is one in which a lot of people play a little bit to the same people playing a lot. We try to attract the broadest group of people to participate in what is a monopoly. We dont have competition, other than normal competition of what people do with their disposable dollars. Our goals are pretty simple. As a monopoly, as the only entity that is selling Mega Millions, Lotto and hopefully Powerball tickets in the state of Illinois to the 9 million adults in the state of Illinois over the Internet, we try to urge a design of the most intuitive, easy interface possible. One that would have these controls for age and geography in place, and to make it as simple as possible and so the jury is still out. Jones said the Lottery resisted urges to move to poker, and focused instead on lottery products. In large measure, that focus was driven by internal surveys that showed, among other things, that 80 percent of adults in Illinois are in favor of the lottery, while only 9 percent to 12 percent of our adults play, he said. According to Jones, the surveys indicated that online players would be mostly young adults, and a much higher percentage of women than currently play the lottery. He said that for a prize of $100 million or more, research indicates that between 600,000 and 1 million people would come to our website and participate, by buying a Mega Millions ticket and hopefully a Powerball ticket. Jones also addressed the issue of the potential opposition and intransigence of lottery retailers: We did an extensive amount of research on this (and determined that) the key thing that is happening to the lottery industry over the last 25 years is, basically, profit stagnation. There have been sales increases, (and) these are almost all fueled by instant ticket prize percentage payouts. But the total number of people playing the lottery is getting older. Its almost following the same paradigm as horse racing after World War II. The young adults very rarely play the lottery. If they do, they play it when the prize is big and then they go away. He coupled that observation with research that showed almost 100 percent of all the adults in every lottery state walk through a lottery retailer every week. It is probably the most

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varied, fantastic retail network of any product sold in the United States. But only a small percentage of them actually play any lottery game. Qualitative research conducted in Illinois utilizing an ethnographic technique known as street talk was cited by Jones, who said he observed a remarkable phenomenon: Literally, we have videotapes of people standing with a lottery retailer logo behind their shoulder and, when asked Did they buy a lottery ticket? They would say: They dont sell lottery tickets there. We are irrelevant to them. We are invisible to them. So, the goal in part was to convert some of these same people into lottery customers. What you are basically doing is using the retail channel that everybody uses these days, he said, referring to the Internet. Jones, noting his own experience in stints working for the Illinois Lottery, said It was shocking to come back and run a lottery in 2011 and find the exact same products sold in exactly the same way as they were sold in 1985, with very little differentiation. But the world has changed since then. Again, noting that non-lottery players, who indicated they would play online with prizes exceeding $100 million or more, were asked if they would then purchase lottery tickets from retailers. Jones said that 71 percent of people said, You know, all of sudden, I would understand. I wouldnt be intimidated by the jargon. I wouldnt be intimidated by the huge number of games that are available. Yet, despite such opportunities, the notion of selling lottery games online generated immediate pushback by the retail merchants of various stripes. I couldnt understand why. Much of that was based on misunderstanding, with a false assumption that jackpot games would only be available online, and that retailers would not be participating. Once that was cleared up they (retailers) supported our effort to pass a bill to allow us to sell Powerball. ... They finally understood that, if we were going to generate 600,000 or 1 million new players, that would have an effect on them. They finally understood that it was mostly their task to convert these people who were walking through these retailers and were not playing into people who did play. As Jones summarized the issue: The brick-and-mortar vs. Internet discussion, at least in Illinois, was solved by information and by research and by pointing out the obvious. He added, You certainly can make a public policy case and a good business case for having lotteries move to the Internet with their existing products. You get into a little bit of a fuzzy area if you take all the products from brick-and-mortar onto the Internet without any plans to involve brick-and-mortars. In looking at other North American lotteries and their approach to the Internet, Illinois is unique in being the first and only US state lottery managed by a private company and thus is probably not an appropriate model for Massachusetts. Illinois hopes to realize increased revenue streams through the semi-privatization with Northstar Lottery, a management consortium formed
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by lottery technology vendors GTECH and Scientific Games. Illinois signed a 10-yearagreement with Northstar in which the state retains full ownership of lottery assets and control over all aspects of the operation, including approval of annual business plans, while Northstar is responsible for sales, marketing, game development, technology and support services acquisition.388 Northstar earns yearly management fees to cover overhead and supplier costs and receives an annual compensation incentive of up to 5 percent of net income but must pay penalties of up to 5 percent for failing to meet revenue targets. From an overall perspective it appears that Illinois early entry into online products is succeeding, although it is currently falling short of planned revenue goals. On July 24, 2012, the Illinois Lottery reported that sales for the fiscal year ending June 30 have increased dramatically, rising to $2.67 billion, with more than $708 million going to public school education and other worthy causes in the state.389 These unaudited results represent an increase from fiscal year 2011 of 17.9 percent with most of the growth coming from a 27 percent rise in instant ticket sales to a total of $1.62 billion.390 Jones attributed the increased sales to a change in the lottery's image as well as placing added emphasis on specialty games such as Veterans Cash and Ticket for the Cure and increased marketing for the re-launch of Little Lotto as the Lucky Day Lotto. 391 While these three month top-line results are impressive, they still fall $100 million short of the projections for net revenue made by Northstar. According to a Chicago Tribune analysis, Northstar brought in $726 million in net revenue instead of the predicted $825 million.392 At this juncture it is difficult to determine how much of that increase is attributable to the introduction of Internet sales in Illinois, how much is due to the fortuitous timing of the Internet sales introduction, and how much is due to the marketing and product changes introduced by Northstar. It is equally difficult to determine with any granularity whether there have been any adverse effects upon traditional retail sales caused by sales generated through the online channel and the degree to which they may be affected. Jones has stated repeatedly in public appearances at industry conferences that there have been no signs of cannibalization of retail sales following Illinois move online but no public data have yet been provided to support these claims and because the lotterys engagement strategy included no systemic protections for retail agents it remains to be seen what the actual impact will be on traditional lottery sales. Online product sales through the Illinois Lottery require registering and setting up a customer account, which can then be funded through credit cards or linked to a checking
388 389 390 391 392

The Semi-Private Lottery, Stateline, Pew Center on the States The Semi-Private Lottery, Stateline, Pew Center on the States The Semi-Private Lottery, Stateline, Pew Center on the States Associated Press, July 24, 2012 Lottery manager misses revenue goal by about $100M, Matthew Walberg, Chicago Tribune, July 31, 2012

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account. Accounts can be funded in amounts between $1 and $2,500 and winnings in amounts less than $600 are automatically deposited in the players account.393 Winnings in excess of $600 must still be processed by the Illinois Lottery Claims Department but online purchasers receive an email notifying them to initiate the process. Illinois will also provide players with an Illinois Lottery Visa Debit Card which functions as a storage vehicle for credited winnings from the players account and can be used for general non-lottery purchases just like a conventional debit card.

b. Delaware Lottery
The Delaware Lottery is the first US lottery to introduce online gambling beyond the sale of lotto tickets or pull-tabs over the Internet. The Delaware Gaming Competitiveness Act of 2012 authorizes the Lottery to offer traditional lottery games over the Internet. The Act further authorizes Internet gambling on casino style games through the control and operation of the Delaware Lottery.394 The states three racetrack casinos currently operating video lottery terminals and casino table games through the lottery will be permitted to take those products online through co-branded websites using a central platform operated by the Delaware Lottery. The Delaware model is unique compared to European models representing new type of online gambling in which the state lottery controls the platform and allows commercial racetrack casinos to operate within that ecosystem. This legislation opens the door for the state lottery to offer its complete inventory of lottery products over the Internet as well as a full suite of casino through the lotterys racino partners including table games such as blackjack, roulette, and craps, slot machines in the guise of video lottery terminals, and poker. In addition, the state lottery will maintain the exclusive right to provide interactive gambling products within the state, permitting the addition of new types of games developed in future. Most importantly, the legislation also allows the state to explore compacts with other states to allow interstate wagering, a major consideration for a small state with a population of less than 1 million (897,934 according to the 2010 census) ranked 45th in population among the 50 states.395 The Delaware Lotterys rapid move into online gambling was motivated largely by increased competition from new casinos in Pennsylvania and Maryland, which is negatively impacting the gambling revenue at its three racetrack casinos, which shed 15.9 percent of their employees last year, the largest loss of casino jobs in the nation.396 Delaware estimates that

393 394 395 396

Illinois Lottery website FAQs, https://www.myillinoislottery.com/en-us/footer/help.html#subscriptionCard. 2012 Legislation Regarding Internet Gambling or Lotteries, National Conference of State Legislatures. 2010 Census, United States Census Bureau, Department of Commerce. Michael Cooper, States Up the Ante in Bid to Lure Other States Bettors, New York Times, August 2, 2012.

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competition from neighboring states will drive gambling revenues downward from $248.8 million in the 2011 fiscal year to $206.4 million in the fiscal year beginning in July 2012. 397 The law requires the lottery to employ geolocation and age verification technology to ensure that only adults residing within the state borders are allowed to gamble over the Internet. Proceeds from the Internet operations will be used to allow these racinos to reduce their collective licensing fees by $7.75 while remaining revenue neutral to the state. Internet gambling will be supplemented by an expansion of existing keno and parlay sports betting into more locations and Delaware expects these measures to produce $3.75 million over six months after implementation, currently scheduled for January 2013. 398

c. District of Columbia Lottery

The District of Columbia had ambitions to become the first Internet lottery jurisdiction in the nation, planning to implement online products five months prior to the DOJ reversing its position on the legality of Internet lottery sales. Antar Johnson, former assistant general counsel for the DC Lottery, noted at the GiGse conference that his agency took a decidedly different strategy from Illinois: At the DC Lottery, we actually took a different approach. We have a base for our lottery games and we also have a lot of agents that depend on revenue from those lottery games. I could tell you that, initially, we were already comfortable with where we stood on the legal basis. DC, being a small jurisdiction, we decided to go very aggressive. We changed our enabling statute which was a very old one, a 30-year-old lottery. Simply what I did was change it from games of chance to chance and/or skill. Johnson said that change allowed us to offer non-traditional lottery games. So, while Illinois was endeavoring to expand its traditional lottery games online, the District of Columbia focused on new offerings such as poker and random-number-generated games, which are akin to online slot machines. We didnt want to take money away from our agents, and we didnt want to cannibalize our games, Johnson said. We were actually ready to go in July 2011, and we came real close to pulling the trigger, but there are a lot of lessons that people can learn from the DC lottery, he said, with the chief lesson being that the anti-gaming establishment, which fought the effort, proved to be formidable. Consequently, the enabling legislation that set the stage for the district to be a pioneer in the industry was repealed in February 2012. DC faced what could undoubtedly be described as the most difficult situation in the world for geolocation technology. Due to the small size and urban nature of the Districts environs and

397 398

Ibid. Alexandra Berzon, Delaware Lawmakers Clear Online Gambling, The Wall Street Journal, June 27, 2012.

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its position astride the borders of Maryland and Virginia, implementing Internet sales within the boundaries of the District of Columbia presented huge challenges for precisely locating purchasers. The technology available at the time was insufficiently accurate in defining location within the desired 25-yard radius and new technology had to be created in order for precise geolocation to work.

d. Minnesota Lottery
The Minnesota Lottery is the stealth player in online products. It has quietly been selling lotto tickets over the Internet on a subscription basis since November 2010, when a Buy Online tabs appeared on the lottery website. At the 2010 Lottery Expo in Las Vegas, the lotterys executive director at the time, Clint Harris, explained that this soft launch was conducted without any promotion or advertising to customers in order to avoid the appearance of competing with retailers.399 Acting Director Jenny Caufield, who was operations director in 2010, spoke at the same conference saying that the move was prompted by a St. Cloud State University survey documenting that ticket sales to younger players in the 18-36 age bracket had declined sharply. The survey showed that only 38 percent in 18-24 age bracket had purchased a ticket in 2009, compared with 73 percent in 1998, and that only 56 percent in the 25-38 age bracket had purchased lottery in 2009 compared with 70 percent in 1998. 400 This decline in lottery purchase among younger customers convinced management at the Minnesota Lottery that it was necessary to expand beyond traditional channels for reaching players and engage the Internet. The Minnesota Lottery is comparable to the Massachusetts State Lottery in that a similar majority of sales are generated by scratch games in both lotteries 68 percent in Minnesota in 2010 and 69 percent in Massachusetts in 2011. The Minnesota Lottery has also demonstrated similar innovation in the industry by being the first US lottery to permit mobile game play for worthy causes. On May 14, 2012, Governor Mark Dayton signed a bill that enabled charitable pull-tab style scratch products to be played on mobile devices. Instead of pulling off a paper pull tab, players can now touch a button on iPads supplied by bars and restaurants that conduct charitable gaming.401 This groundbreaking step was predicated by the need to finance a new $975 million stadium to house the Minnesota Vikings football team. Proceeds from the mobile and video pull tabs will fund bonds to finance stadium construction. Initial revenue figures have exceeded expectations at $40 to $45 per day per device but the rollout is still in progress and the novelty

399 400

Minnesota Lottery Looks to Goose Online Sales, Steve Karnowski, Yahoo Finance, November 22, 2011

Gambling in Minnesota, Minnesota State Lottery and St. Cloud State University, Minnesota State Lottery Overview, 2011.
401

Tony Batt, iPad Gaming Arrives in Minnesota, Gambling Compliance, September 28, 2012

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may eventually wear off.402 Minnesota will receive 5.4 percent of the revenue from electronic pull tabs to help pay the approximately $350 million state pledge for stadium construction while 85 percent of the payout will go to players.403 One vendor, Acres 4.0, is currently ready to launch a mobile application that with a new range of games developed specifically for the enabling legislation.404 According to John Acres, founder and CEO of Acres 4.0, Virginia, Michigan, California and Kentucky have also expressed interest in offering electronic pull-tabs via mobile devices.405 At the same time that the legislature approved iPad gaming it also approved plans for electronic charitable sports tipboards for parlay betting. However, the Minnesota Gaming Control Board in June chose not to adopt the measure, citing the 1992 federal Professional and Amateur Sports Protection Act that restricts sports betting to four grandfathered states and prohibits the practice in the other 46 states.

e. Georgia Lottery
The Georgia Lottery is moving quickly to create an online offering, and we expect it to launch shortly. We interviewed lottery officials and found, not surprisingly, that they are grappling with many of the same issues that the Massachusetts State Lottery is confronting. Such issues include ensuring that retailers are not hurt, and that problem gambling is fully addressed. The Georgia Lottery barred by statute from accepting credit cards or checks will rely on debit cards. Retailers will be authorized to sell debit cards (although buyers are not required to purchase them from lottery retailers), which would be sold with no transaction fee for lottery purchases. Players redeeming winning tickets from the retailer would have the option to take their payouts as an increment loaded on the debit card, which would require no cash out from the retailers register and incent the agents to promote card usage. Initially, the hope is that many players who go to retailers now to cash in tickets say a Cash 3 winning ticket for $500 would be offered a non-registered card, similar to a standard gift card, which is a cash equivalent. Players would be encouraged to register that card, which would be embossed with the players name and have both a magnetic strip and a bar code, through their bank account. Registration offers the lottery an opportunity to know their customer for the first time, while offering the player the security of having their money safely in an account in case they were to lose the card.

402 403 404 405

Ibid. Ibid. Minnesota Provides Launchpad for iGaming, iGaming Business North America, October 2012 Tony Batt, iPad Gaming Arrives in Minnesota, Gambling Compliance, September 28, 2012

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From the players standpoint, such cards are a convenient, cashless means of collecting winnings and playing more. One of the most attractive features of these debit cards is that players who have opened an account can then add their favorite numbers to their profile and then simply present the card at a retail outlet and ask the agent to play my favorites. Players can also register for a card through the lotterys website. Among the incentives for players who register their in-store purchases with the website are instant access to information and auto-notification of winning numbers through text messaging or email. Such auto-notification win messaging would be received within 15 minutes of a drawing. Retailers would effectively serve as bank tellers to help players set up such accounts, although it must be emphasized that players need not go through a retailer to set up an account, which would be linked to a standard, FDIC-insured bank account. There are some drawbacks to these accounts. Due to Patriot Act regulations, customers are restricted to $1,000 maximum, onetime loading of their cards; however, they can continue to add their winnings to the debit card an unlimited number of times. The Georgia Lottery believes that one way of protecting retailers is working to ensure that the product mix is sufficiently differentiated. No daily numbers games would be offered online, ensuring that retailers retain access to their core Cash 3 and Cash 4 players, among others, who are often essential to visitor traffic at stores. The Georgia Lottery envisions a phased approach to implementing online lottery sales. In the first phase, the most popular draw games such as Mega Millions, Powerball and the instant lotto game Fantasy 5 would be sold online, while keno and online instant games would be developed in a subsequent phase. The online instant games, which the Georgia Lottery refers to as e-instants, would be a significant move, effectively opening the possibility of slot-like games, as well as other games, that would have pre-determined outcomes yet would have the ability to offer players more time on device. Introduction of online lotto and e-instants is expected to engage new and infrequent customer segments, such as middle-aged women who currently seldom enter convenience stores to purchase lottery products. The Internet presence is clearly expected to strengthen the Georgia Lottery brand both online and offline as a new channel is leveraged to offer new products designed for a new audience. The Georgia Lottery unequivocally rejects the suggestion that instant-ticket brands should be extended online. Rather, the goal is to create new brands online to capture a different, younger demographic. Instead, the Georgia Lottery hopes to develop its own brand the Georgia Lottery with a logo that would be ubiquitous online, and would be effectively coordinated with in-store marketing and signage. The goal would be to help encourage a new pool of online players to buy tickets in stores. The Georgia Lottery is also exploring the possibility of a loyalty program that would reward players, and is working with retailers to develop additional promotions. Loyalty program

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concepts include 1 percent cash back on the debit card, the iHope card from Discover, which could be converted into lottery coupons for redemption at retail outlets. Moreover, players using their debit card for purchases such as gasoline at a lottery retailer, could be sent push text message advertisements via their mobile phones reminding them that the Mega Millions top prize just reached X number of dollars. In addition, the data generated by player registration and tracking lottery purchases offers great potential for future marketing and product development initiatives. We also note that the Georgia Lottery shares our view that an online lottery should be developed carefully, with maximum flexibility to respond to new information as it arrives.

a. Maryland Lottery
The Maryland Lottery has tried and failed to have enabling legislation passed in 2011 and again in 2012, largely because the market entry strategy offered few protections for retail sales agents which fueled opposition in the legislature. The Maryland Lottery has offered subscription sales for its Mega Millions and Mega-Match games for years on a quarterly basis. The Maryland Assemblys Joint Chairmens Report for 2011 requested the State Lottery Agency (SLA) to report on the sale of traditional lottery games over the Internet. The first report, issued December 15, 2011, touted the promise of online sales by citing the growth of Internet and mobile connectivity, increasing use of the SLA website by customers, and the evolution of ecommerce nationwide.406 The report also illustrates how the Maryland Lottery depends upon an aging, predominantly white core demographic while smartphone and Internet offer the opportunity to engage Hispanic and African American customers who have traditionally been under-represented customer segments. Importantly, this report also cites the experience of the UK National Lottery as an example of how Internet sales and retail sales can grow in conjunction without cannibalization, mentioning that Internet sales grew from nothing in 2003 to 677 million in 2009, exceeded 13 percent of total sales, while retail commission grew from 229 million to 268 million, an increase of 8.2 percent over the same period.407 Despite the strong advocacy for online products displayed in this report, the State Legislature withheld funding from the budget in April, 2012 that would have allowed Internet lottery sales to commence July 1 st but did fund creation of a platform and regulatory frame work for online sales and requested a second report describing progress on those preparations.408 On September 19, 2012 the Maryland Lottery submitted a second report outlining the proposed program to the state Senate budget committee and the House of Delegates

406 407 408

Report on Plans for Online Sales of Traditional Lottery Games, Maryland Lottery, December 15, 2011. Ibid Online Lottery Sales Doubtful this year in Maryland, Danielle E. Gaines, Gazette.Net

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appropriations committee.409 This report cites the importance of interactive sales in bringing a variety of new demographic segments into the lottery, including younger persons and minorities, specifically African Americans and Hispanics who participate in the lottery at lower levels than white Marylanders. Internet purchases could be funded through using a debit card, linked to a checking account through automated clearing house (ACH) transfer payments, or via a physical voucher from an existing lottery retailer.410 The most important aspect of the Maryland Lotterys report are its plans for immediately implementing mobile sales channels and the inclusion of scratch-off, instant, and keno games in the initial phase.411 Also interesting is the Lotterys projection to realize $2.2 million in revenue from online sales within the first 12 months.412 However, because these plans offer no concrete protections for traditional retail sales, and do offer the possibility for migrating traditional instant and scratch games directly to the Internet, the Lottery faces strong opposition from retailer associations including the National Association of Convenience Stores (NACS).

409

Maryland online lottery sales plan draws fire from retailers, Jack Lambert, Baltimore Business Journal, September 27, 2012.
410 411 412

Scratch Offs on Your Smartphone?, The Baltimore Sun, September 26, 2011. NACS Online, October 1, 2012. Maryland Lottery Plans Expansion to Online Sales, The Examiner, November 20, 2012.

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Figure 93: North American Internet lottery/gaming comparison grid

State/Province Illinois Internet Status Operating online same day sales Online Products Lotto tickets (Powerball, Mega Millions) Funding Mechanism Credit Card or Bank Account

Minnesota

Nevada

Delaware

Georgia

Operating subscription sales & mobile pullLotto tickets (Powerball, tabs Mega Millions) pull-tabs Legislation passed Poker (No lottery sales) Licenses issued Lotto tickets (Powerball, Legislation passed Mega Millions) Planned for early 2013 Lottery tickets VLT's Casino games Lotto tickets (Powerball, Planned for 2013 Mega Millions, Fantasy 5)

Credit Card Credit Card

Pre-Paid Card

Pre-Paid Card Debit Card, bank account ACH, or retail voucher

Maryland

Planned for 2013

British Columbia

Operating

Quebec

Operating

Lotto tickets (Powerball, Mega Millions) Keno Instant games Scratch games Mobile games Lottery tickets Casino games Poker Sports betting Bingo Lotto tickets Lottery tickets Casino games Poker Sports betting Bingo

Credit Card

Credit Card

Atlantic Provinces Western Canada

Planned for late 2012 Planned for early 2013

Credit Card Credit Card

Source: Spectrum Gaming Group

5.

Canadian Internet Lotteries

Canadian lotteries have been offering Internet ticket sales since 2004.

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a. Atlantic Lottery Corporation

Atlantic Lottery Corporation, the for-profit lottery provider for New Brunswick, Nova Scotia, Prince Edward Island and Newfoundland, initiated Internet sales for lotto tickets on August 24, 2004. The products offered online were Lotto 6/49, Atlantic 49, Lotto Super 7, TAG, Atlantic Pay-Day, Pro-Line, and Over/Under were the same that were being sold concurrently at conventional retail locations. Residents of the four provinces had to first set up an account on the PlaySphere site and then fund it with a check, bank transfer, or voucher with an identification code purchased at the lottery retailer. Other Canadian lotteries followed quickly with Ontario, British Columbia, and Loto-Quebec all entering the market for Internet lotto sales within the next three years. The British Columbia Lottery Corporation entered the market most aggressively with a full range of gaming products introduced in phases over time. Loto-Quebec and Ontario have only introduced full scale casino style games and poker in 2012. Today the Western Canada Lottery Corporation representing Alberta, Manitoba, and Saskatchewan, with the Yukon and Northwest Territories as associate members is also planning to enter the Internet sales market with consulting guidance provided by the BCLC.

b. British Columbia Lottery Corporation

One of the best examples for the Massachusetts State Lottery of a lottery moving into the Internet space is the British Columbia Lottery Corporation (BCLC), which offers lessons for Massachusetts for several reasons: British Columbia is geographically close to the United States and shares many of the characteristics of US state lotteries. The BCLC is heavily reliant upon instant games for its lottery revenues. The BCLC coexists with online gambling operations within the province. Despite some initial missteps, the BCLC has succeeded in developing and implementing an Internet strategy that continues to grow revenues both for the provincial government as a whole as well as for the individual lottery retailers.

One additional reason to view the BCLC as a model is its receipt in 2011 of the Best Overall Responsible Gaming Program from the World Lottery Association, an international trade group with over 140 member-jurisdictions. The BCLC maintains a diverse distribution network of 2,900 retail sales agents, 1,000 hospitality locations, 15 casinos, 2 racetrack casinos, 17 community gaming centers, and 10

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commercial bingo halls. Internet gambling is conducted through PlayNow.com.413

a single portal,

One of the most important lessons from the BCLC is the advantage of a gradual, phased approach to implementation. The BCLC first began Internet sales operations in 2004, starting with a limited number of products and gradually introducing additional games over time. The first sales moved to or initiated on the Internet were keno, sports betting, and lotto games, and a two year period passed before the next games bingo and single game poker were offered online. BCLC did have the advantage of being able to offer sports betting as the initial online product in its phase implementation, introducing Internet purchasing with Sports Action games on the BCLC.com site in October 2004.414 This early entry into the online lottery market registered 30,000 users in its first year of operation.415 Financial results confirm that there has been simultaneous growth in Internet and retail sales during and after the introduction of full-blown Internet gambling. As the following chart illustrates, retail sales suffered during the recession but have recovered strongly in the two most recent most recent fiscal years. Retail sales did see a moderate decline in the most recent period after strong positive growth in the previous period, which may have more to do with a brand rejuvenation campaign and the introduction of new pricing strategies than substitution as a result of the growth of eGaming revenues. 416 This strong growth over the past two years coincided with the introduction of a full suite of casino style games on what is now branded the PlayNow.com site in British Columbia.

413 414 415 416

BCLC Service Plan 2012/13-2014/15. LaFleur s 2011 World Lottery Almanac. BCLC Service Plan 2004/5-2006/7. 2011/2012 BCLC Annual Service Plan Report.

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Figure 94: British Columbia Lottery Corp. retail sales trends 2006 - 2012
$1,200 $1,062.4 $997.4 $1,000 $976.9 $954.2 $937.9 $807.5 $800 $742.5 $709.7 $710.7 $691.7 Total sales Retail network Hospitality Network eGaming $240.6 $200 $14.3 $0 2006/7 2007/8 2008/9 2009/10 2010/11 2011/12 $18.7 $23.5 $33.6 $789.2 $1,061.4

$600

$400

$248.5

$220.0

$212.6

$211.9

$206.6 $65.6

$43.0

Source: BCLC Annual Service Plan Report 2011-12

The BCLC offers one of the most useful examples of online wagering in North America, having evolved with nearly a decade of experience, starting with the inauguration of online sports betting in 2004. It since added lottery and keno products online (2005), interactive online (effectively scratch and win tickets) and peer-to-peer e-bingo (2008) and, as of 2010, has been offering full casino and e-poker products. One of the most noteworthy aspects of the BCLC experience is: Different forms of gaming can be used to bolster and strengthen each other, and are not in competition with each other. Still, we note that it is paramount that the essential differences between British Columbia and Massachusetts be identified. Such differences include: BCLC offers sports wagering, albeit in a form (similar to the requirements imposed on sports wagering in Delaware) that requires parlay bets in which wagers can only be made on two distinct outcomes. BCLC oversees all forms of legalized gaming in the Province, thus affording it the ability to quickly and easily develop cross-marketing strategies that are designed to increase overall profitability.

While BCLC oversees the gaming operations at casinos including making all purchasing decisions regarding slot machines the actual management of such casinos is in the hands of private operators who own the facilities and manage the marketing of the casinos. Within the US, Delaware would offer somewhat of a parallel. The Delaware Lottery purchases

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and oversees the gaming machines and table games, but the actual casinos are owned and managed by private operators, who function as high-end lottery retailers.

c. Loto Quebec
The Quebec Lottery, managed by Loto-Quebec, claims to actually be the first legal Internet lottery in North America, when its subsidiary Ingenio and Oberthur Gaming Technologies launched Cyberslingo, the first downloadable lottery, in New Jersey on March 29, 2004. The ownership of that ephemeral title notwithstanding, Loto-Quebec was an early mover into Internet lottery, launching Tresors de la Tour, the worlds first multimedia lottery on CDROM beginning in 1999.417 In 2007 this was replaced with Loto-Clic for online purchase of lotto tickets.418 Loto-Quebec caught up with the BCLC and implemented a wide range of online products on August 27, 2012, by unveiling a newly updated gambling website, Espacejeux, which offers lottery tickets, poker, slots, and casino style table games, and a line of monetized casual games. Players will be able to purchase from a home computer, smartphone, or tablet device through a fully integrated mobile application. This follows Loto-Quebecs successful launch on the Miseo-Jeu sports betting site on the Internet in March 2012. One of the more innovative aspects of Loto-Quebecs entry into the Internet gambling market has been its inclusion of retailer input in its engagement strategy. The outcome is a so far unique concept where consumers can choose a designated retailer at the time of purchase and the so designated retail outlet will receive the same commission as traditional sales every time the customer purchases an online product. When customers fail to designate a preferred retailer a percentage of their purchase value is still transferred to a pool from which all retailers will be compensated annually on a pro-rated basis based upon their sales of the specific products contributing to the pool funds. 419 The company plans to offer a three-month promotional contest to encourage customers to designate a preferred retailer when they purchase online products for the first time.

417 418 419

La Fleurs 2012 World Lottery Almanac. Ibid

Loto-Quebec press release, August 9, 2012, http://lotoquebec.com/cms/corporatif/en/loto-quebec-andyou/press/press-releases?annee=2012&mois=-1&cat=0&motsCles=&idCommunique=loteries-en-ligne_2012-0809.

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About This Report

This report was prepared by Spectrum Gaming Group, an independent research and professional services firm founded in 1993 that serves private- and public-sector clients worldwide. Our principals have backgrounds in operations, economic analysis, law enforcement, regulation and journalism. Spectrum holds no beneficial interest in any casino operating companies or gaming equipment manufacturers or suppliers. We employ only senior-level executives and associates who have earned reputations for honesty, integrity and the highest standards of professional conduct. Our work is never influenced by the interests of past or potentially future clients. Each Spectrum project is customized to our clients specific requirements and developed from the ground up. Our findings, conclusions and recommendations are based solely on our research, analysis and experience. Our mandate is not to tell clients what they want to hear; we tell them what they need to know. We will not accept, and have never accepted, engagements that seek a preferred result. In Massachusetts, we are presently engaged by the Massachusetts Gaming Commission, and we have previously performed work for the Office of the Governor, for the Massachusetts Joint Committee on Bonding, Capital Expenditures, and State Assets and for the office of Speaker Robert DeLeo. Our public-sector clients have included the Atlantic City Convention and Visitors Authority, the Connecticut Division of Special Revenue, Delaware Lottery, Georgia Lottery, Maryland Lottery, Georgia Lottery, the New Jersey Casino Reinvestment Development Authority, Ohio Casino Control Commission, Ohio Lottery, West Virginia Lottery, the Puerto Rico Tourism Company, and the Singapore Ministry of Home Affairs. Private-sector clients have included Caesars Entertainment, Carnival Corp., casino Association of Indiana, casino Association of New Jersey, Hard Rock International, Genting, National Indian Gaming Association, Revel Entertainment, Seneca Gaming, and Wynn Resorts. Our principals have testified before the following government bodies: Georgia Joint Committee on Economic Development and Tourism Illinois Gaming Board Indiana Gaming Study Commission International Tribunal, The Hague Massachusetts Joint Committee on Bonding, Capital Expenditures, and State Assets New Hampshire Gaming Study Commission New Jersey Assembly Tourism and Gaming Committee
Report for the Massachusetts Treasurers Online Products Task Force 296

National Gambling Impact Study Commission New Jersey Senate Legislative Oversight Committee New Jersey Senate Wagering, Tourism & Historic Preservation Committee Ohio House Economic Development Committee Ohio Senate Oversight Committee Pennsylvania Gaming Control Board US House Congressional Gaming Caucus US Senate Indian Affairs Committee US Senate Select Committee on Indian Gaming US Senate Subcommittee on Organized Crime

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Disclaimer
Spectrum Gaming Group (Spectrum, we or our) has made every reasonable effort to ensure that the data and information contained in this study reflect the most accurate and timely information possible. The data are believed to be generally reliable. This study is based on estimates, assumptions, and other information developed by Spectrum from its independent research effort, general knowledge of the gaming industry, and consultations with the Client and its representatives. Spectrum shall not be responsible for any inaccuracies in reporting by the Client or its agents and representatives, or any other data source used in preparing or presenting this study. The data presented in this study were collected through the cover date of this report. Spectrum has not undertaken any effort to update this information since this time. Some significant factors that are unquantifiable and unpredictable including, but not limited to, economic, governmental, managerial and regulatory changes; and acts of nature are qualitative by nature, and cannot be readily used in any quantitative projections. No warranty or representation is made by Spectrum that any of the projected values or results contained in this study will actually be achieved. We shall not be responsible for any deviations in the projects actual performance from any predictions, estimates, or conclusions contained in this study. Possession of this study does not carry with it the right of publication thereof, or the right to use the name of Spectrum Gaming Group in any manner without first obtaining the prior

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written consent of Spectrum. No abstracting, excerpting, or summarizing of this study may be made without first obtaining the prior written consent of Spectrum. This study may not be used in conjunction with any public or private offering of securities or other similar purpose where it may be relied upon to any degree by any person other than the Client, without first obtaining the prior written consent of Spectrum. This study may not be used for any purpose other than that for which it is prepared or for which prior written consent has first been obtained from Spectrum. This study is qualified in its entirety by, and should be considered in light of, these limitations, conditions and considerations.

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APPENDIX
These reports appear on the following pages: 1. National Council on Problem Gambling, Internet Responsible Gambling Standards 2. Spectrumetrix US iGaming Watch, November 20, 2012 3. Senate Testimony: The Regulation of Tribal Gaming: From Brick & Mortar to the Internet

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Written Testimony of Frank J. Fahrenkopf Jr., President and CEO American Gaming Association
Submitted to the U. S. House Committee on Energy and Commerce Subcommittee on Commerce, Manufacturing, and Trade Hearing entitled: Internet Gaming: Regulating in an Online World. November 18, 2011
Thank you Chair Bono Mack, Ranking Member Butterfield and the subcommittee members for the opportunity to provide testimony on behalf of the American Gaming Association (AGA). Allow me a brief introduction of our organization. The AGA represents the commercial casino-entertainment industry by addressing federal legislative and regulatory issues affecting its members, their employees and customers.

The commercial casino industry operates in 22 states, directly employs nearly 400,000 men and women and is responsible for an additional 475,000 jobs through the additional economic activity we generate across the country. In total, our industry accounted for

about $114 billion in consumer spending last year nearly one percent of the entire $14.5 trillion U.S. Gross Domestic Product.

Clearly, our industry is squarely in the mainstream of the U.S. economy.

Today, of course, were here to talk about online poker. I know this is the second of two hearings this subcommittee has held on the topic. At the last hearing, you asked

whether licensing and regulation of online poker is a safe bet. Our industry believes it is.

The risky bet would be to leave unchanged current law that leaves consumers, minors and those with gambling problems vulnerable to unregulated offshore companies.

As you may know, the AGA has not always taken this position. For much of the time since online gaming was first introduced, AGA members were not convinced that online poker could be regulated to protect Americans against fraud, money laundering and other illegal activities, or to prevent minors from gambling online and protect problem gamblers.

New technology and new processes have changed that. We live in a digital world where people can purchase everything from groceries to automobiles online. These ecommerce companies have developed new technology and processes to help them facilitate sales, protect customers and, in some cases, prevent minors from purchasing their products. The same types of technological and process advancements are being used in countries such as Great Britain, France, and Italy and in provinces of Canada to effectively regulate and oversee Internet gambling.

Because of those changes, the AGA now supports federal legislation that will allow states to license and regulate online poker. We believe the best approach to making

that happen is to modernize and strengthen the Wire Act of 1961 with conforming amendments to the Unlawful Internet Gambling Enforcement Act (UIEGA) that would unambiguously eliminate illegal internet gambling.

We support this for online poker only because poker is a game that vast numbers of Americans have historically played and that millions of Americans still play. It is also a game of skill, unlike other forms of Internet gambling, and it is played between or among individuals, whereas in other forms of Internet gambling the customer is playing against the house.

The AGA asks only that any legislative proposal establish federal guidelines so there will be consistent regulations for online poker in all states. Without a federal overlay, there will be a patchwork quilt of rules and regulations that will prove confusing for customers and difficult for law enforcement to manage.

Additionally, the AGA has a long-standing policy of putting any gaming legislative proposal through three tests: 1) The legislation must not create competitive advantages or disadvantages between and among legal commercial casinos, Native American casinos, state lotteries and pari-mutuel wagering operations; 2) No form of gaming that currently is legal shall be made illegal; and 3) The legislation must respect fundamental states rights in an appropriate manner. Any online poker legislation must pass these three tests to gain AGA support.
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The fact is practically every adult in the country has played poker at one time or another, and today the preferred venue for millions of poker players is the Internet.

There is urgency to this issue, because each day millions of U.S. consumers are playing online at risk. Last year, in the United States, an estimated 10 million to 15 million people bet billions of dollars online, even though it is illegal for companies to offer realmoney Internet gambling in the U.S. Americans will continue to bet online as long as there are sites they can access, and we can expect that there will always be sites they can access as long as there are billions of dollars to be made.

Even the indictments of executives from several online poker companies last April did not stop Internet gambling. Offshore operators will continue to develop new techniques to circumvent the barriers we put in place. The volume may fluctuate with each closed website and set of indictments, but demand will prevail in the end.

And its likely that online gaming operators who fill this void will be even less regulated and less trustworthy than their predecessors, which will only hurt American consumers.

Put simply, the current environment puts American online players at risk. It is practically impossible to ensure that children are not gambling online and that the online gaming companies are acting responsibly towards those who cannot gamble responsibly. These companies, by illegally operating in the U.S., are flouting our laws; they are doing it
4

where law enforcement cannot reach them and where, in many cases, there is little to no regulatory oversight.

Consumers could be saved from this risk if Congress enacts federal legislation to modernize and strengthen the Wire Act of 1961 with conforming amendments to the Unlawful Internet Gambling Enforcement Act to unambiguously eliminate illegal internet gambling. Such legislation should allow states that wanted to could license and regulate online poker to do so, following federal guidelines. And it should create a level playing field so that all segments of the gaming industry have an opportunity to participate.

We know U.S.-licensed gaming companies, following time-tested gaming regulations, would provide safe, honest, responsible sites for the use of the men and women who want to play online poker. A strengthened UIGEA also would protect Americans from unscrupulous operators and would have the added advantage of bringing the jobs and revenues associated with this billion-dollar industry back to the United States.

The creation of the infrastructure to support a licensed and regulated online poker industry would create an estimated 10,000 high-tech jobs and generate $2 billion in tax revenue, primarily at the state level, every year.

To realize these benefits will require action by Congress, beginning with this committee. The AGA does not support any specific legislation, but there are certain provisions that any change should include: Each state should have the right to determine whether online poker should be legalized within their jurisdictions and who should be allowed to operate the sites. Due to the interstate nature of Internet transactions, federal guidelines should be established that states must follow to ensure a consistent regulatory and legal framework. U.S. law enforcement should be provided with the ability to go after illegal operators and successfully prosecute them.

In addition, online poker companies licensed in the U.S. should adhere to the same stringent level of regulation that governs brick-and-mortar casinos in this country. Our companies have a strong history of regulatory compliance. The regulations we follow are time-proven and if online poker companies are required to comply with them, it would ensure American consumers are playing in a fair and secure environment provided by a responsible operator.

The AGA introduced a Code of Conduct for U.S. Licensed Online Poker Companies that incorporates the key elements of the successful regulations followed by U.S. casinos. To be licensed, companies should agree to: Submit to extensive background investigations of the company and key personnel Ensure proper ID of every U.S. online poker player Submit to regular testing and auditing of online poker software Implement effective player exclusion processes Incorporate effective responsible gaming protections Implement effective anti-money-laundering procedures

Legislation that incorporates the provisions above and the elements of the Code of Conduct would effectively protect U.S. consumers and state licensing and regulating would eliminate illegal websites operated by offshore companies. Fortunately, new technology and processes can address those concerns. This can be accomplished through: A rigorous registration process; Technology-assisted fraud and collusion monitoring; Anti-money-laundering technology and processes; and, Promotion of responsible gaming by providing players the ability to manage their game play in real time.
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Lets take a look at these safeguards.

Registration processes and advanced technology very similar to those used by companies such as Major League Baseball, CBS and Apple would allow the online poker company to: determine where the player is located, determine whether the Social Security number used is valid and is actually the players own, which would prevent underage gambling, and find out if the player has any sanctions by state, federal or international governments.

Geo-location will be a key to ensuring an online poker player is abiding by the laws of the state in which he or she resides and is not playing online in a state where it is not permitted. The first step in this process is verifying the customers location during the initial player sign-up or registration. In those cases where there are discrepancies in information or it is determined the player resides in a location where online poker is illegal, the players registration would be rejected, and they would be unable to open an account.

The second step in the geo-location process takes place every time a customer logs on to an existing account. Each time he or she attempts to sign in, geo-location technology

would be applied to determine the IP address of their internet connection, thus determining exactly where the computer is located. Additional tools can ensure an Internet connection is not attempting to mask its location, and in some cases, real-time verification techniques can be employed when there is any ambiguity about the location.

The same database service providers that assist with geo-location processes also allow operators to verify the age of online players. This can be accomplished by confirming personal information, such as previous addresses or cars registered, through a series of challenge questions the player must answer correctly in order to log on. Additional age verification steps can also include a confirmation letter with a personal identification number sent to the address listed on government-issued identification. The PIN would then have to be entered on the operators site to enable the account.

Preventing cheating, whether by humans or software programs, is made easy through the use of fraud and collusion monitoring technology, coupled with reporting of suspicious play by other players.

For example, operators have tremendous technological tools with which to effectively address the use of bots, or computer programs that automatically play poker hands based on a certain algorithm that the cheater believes provides them with an advantage.

Bots typically cannot match the unique traits of human players, and monitoring their mouse and cursor movements on the screen is an operators first line of defense. Once identified as a potential bot, the player is subjected to a CAPTCHA challenge during which they must re-type a series of distorted letters and numbers on the screen in order to verify they are a human player. Further, operators can also apply subtle pixel changes to the players screen that will cause a bot program to freeze up and thereby allow the operator to identify the cheater and seize the account.

Technology coupled with strong regulation also can prevent money laundering online. Efforts to launder money are detected through a number of reports and checks used exclusively by the gaming industry, as well as other processes that are common in financial institutions. Player verification, operator monitoring, the recording of all transactions and other activities combined with strict compliance with federal antimoney laundering laws make a well-regulated online poker site highly unattractive to launderers.

Technology also allows players to manage their gambling in real time by doing things such as designating a set amount of money or time they can spend on the site, asking for a cooling off period and, if they feel they have lost control of their gambling, choosing to self-exclude.

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With these processes and the technology that supports them in place, patrons could play poker online in a safe, honest place. Law enforcement would be helped by operators ability to quickly identify possible fraud and other criminal activities. And, the public could be confident that operators are taking bets only from jurisdictions where it is legal, keeping minors from gambling and providing assistance to problem gamblers.

Eighty-five countries have legalized online gaming, and the technology and processes described above are being used in many of them, including Western Europe and Canada, where years of experience are proof positive that the risks formerly thought to be a companion to online poker can be effectively managed.

Before concluding this testimony, I would like to take the opportunity to address in more detail the question of the impact of online poker on problem gambling. It is settled science that at any given time that about 1 percent of the U.S. adult population are pathological gamblers, a figure that has not changed despite the dramatic expansion of gambling opportunities during the last 35 years. In fact, the most recent (2008) national prevalence study found a lifetime rate of pathological gambling of 0.6 percent.

Researchers also have found no evidence that online gamblers are more likely to be pathological gamblers. In fact, a major British study found no increase in the rate of pathological gambling between 1999 and 2007, even though Internet gambling became
11

widely available during that period. Similar results emerged in a study of Swedish gamblers.

More recently, in a 2010 article in Addiction Research and Theory, Dr. Howard J. Shaffer, director of the Division on Addictions and associate professor of psychiatry at Harvard Medical School, and his colleagues offered a comprehensive look at the research conducted to date, including summaries of their own investigations of the gambling patterns of customers of bwin.party, one of Europes largest Internet gambling companies.

Professor Shaffer and his colleagues have pioneered new methods for studying Internet gambling by virtue of their access to the actual wagering transactions of 40,000 online gamblers, including every keystroke of every person who subscribes to the bwin.party website. These data, which reflect actual gambling patterns, provide objective detailed information about betting behavior and the conditions under which gamblers place wagers.

The analysis of the bwin.party data has produced more than 10 peer-reviewed publications that contradict the notion that Internet gambling breeds excessive and problematic gambling. (A summary of the findings along with full copies of the studies mentioned above have been included with this submission.)

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Although the prevalence of pathological gambling is low, and even though there is no evidence that Internet gambling would change that pattern, it is still important that online poker companies should implement responsible gaming programs just as brickand-mortar casinos do.

By requiring licensed websites to include social responsibility protections, legalization of online poker would actually improve efforts to assist pathological gamblers. Today, without any U.S. regulation, there are no uniform requirements for player protection tools at gambling websites. Indeed, many foreign jurisdictions require no such tools, so gambling operators located in those jurisdictions often do not provide them. In addition, states can designate a portion of Internet gambling tax revenues and license fees to be directed to research about pathological gambling, as well as to treatment and to public education on the subject. For these reasons, the report by Shaffer et al. concluded that regulators should be able to design sufficient protections to prevent any significant growth in problem gambling that results from legalization.

In conclusion, states should be allowed to license and regulate online poker following federal guidelines. Such action would protect U.S. consumers, keep children from gambling on the Internet, and provide the tools law enforcement needs to shut down illegal online operators. It would also create new high-tech jobs and tax revenue at a time when both are sorely needed.

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Thank you for your time and consideration.

14

EXECUTIVE SUMMARY RESEARCH ON INTERNET GAMBLING BEHAVIORS The body of research on Internet gambling has grown over the past few years, due in part to Harvard professor Howard J. Shaffer, Ph.D., and colleagues (Shaffer, Peller, LaPlante, Nelson, & LaBrie, 2010). Their work pioneered new methods for studying online gambling by virtue of their access to the actual wagering transactions of 40,000 online gamblers, including every keystroke of every person that subscribes to the bwin Interacative Entertainment (bwin) website, one of the largest online gaming companies in the world. Using this data reflecting actual gambling patterns, rather than relying on self-report, provides objective detailed information about betting behavior, and the conditions under which gamblers place wagers (Shaffer, Peller, LaPlante, Nelson, & LaBrie, 2010, p. 277).

The Harvard research has produced more than 10 peer-reviewed publications that outline several key findings about Internet gambling behaviors listed below. These findings highlight an overarching result: they contradict the belief that Internet gambling breeds excessive and problematic gambling behavior.

For a baseline comparison, the most commonly accepted prevalence rate for pathological gambling is 1 percent of the adult population, which was first established by Dr. Howard J. Shaffer and his colleagues (1997, 1999), and confirmed by the National Research Council of the National Academy of Sciences (1999). These rates have remained consistent despite the expansion of gaming, as shown in the Harvard Medical School Department of Health Care Policys analysis of the National Comorbidity Survey Replication (NCS-R) in 2008 (Kessler et.al, 2008), which found a lifetime pathological gambling prevalence rate of 0.6 percent.

KEY FINDINGS INCLUDE: A Majority of Online Gamblers Exercise Responsible Gaming Practices by Moderating Their Gambling Behavior In a 2009 study conducted by Dr. Debi LaPlante and colleagues from the Division on Addictions, Cambridge Health Alliance, a division of Harvard Medical School, researchers studied the behavior 3,445 Internet poker players for a period of six months. Their results showed:

Online poker players automatically separated themselves into two types of gambling behavior patterns, similarly reflecting the science-based prevalence rates of responsible gamblers and problem gamblers for other types of gambling activities: o 95 percent of players gambled an average of 12 Euros worth of chips at each of two poker sessions per week. o 5 percent of players were more involved (or over-involved), gambling an average of 89 Euros at each of 10 sessions per week.

Both groups of poker players (the majority group and those who were over- involved), also showed the ability to moderate their gambling behavior based upon their wins and losses as the players lost more, they spent less time in their online poker session and wagered less money.

Those Who Gamble Online Have Shown that They Can Limit Their Behavior Overall, the Harvard researchers found only small subgroups of gamblers who appeared to be over-involved in gambling. In 2009, researchers Xuan and Shaffer studied 226 bwin sports bettors who reported that they experienced gambling-related problems and voluntarily closed their accounts. Even though they were more likely to make (and lose) a higher wager, those who closed their account were less likely to exhibit a clear sign of pathological gambling: chasing their losses. Instead, they were more likely to make wagers that were more conservative than other players. Dr. Sarah Nelson and her colleagues (2008) also studied 567 sports bettors on the bwin website that placed limits on the amount that they could deposit to the online gambling website. Researchers discovered that, after self-imposing deposit limits, online players reduced their gambling activity and the time spent gambling online.

Internet Gambling Participation Decreases Over Time Similar to research showing that gambling participation will decline after the initial spike in participation when a new game or casino is introduced to a population (LaPlante & Shaffer, 2007), Dr. LaPlante and her colleagues discovered the same trends among online gamblers when they studied online sports betting behaviors daily for 18 months (2008). Online gamblers rapidly subscribed and placed online bets within the first few days of the study period. Gambling activity peaked by the eighth day of the study, rapidly declined thereafter for the first 90 days and continued to fall for the remainder of the 18-month period. Researchers summarized that they did not find evidence to support concerns that Internet gambling will overwhelm populations of gamblers, causing escalating rates of participation, or even sustained rates of participation (p. 2410).

Internet Gamblers Respond to Industrys Efforts to Encourage Responsible Play Internet sports betting operator bwin also partnered with the Division on Addictions to study how harmreduction techniques can work when operators impose limits on players gambling behavior. Researcher Anja Broda and colleagues (2008) discovered that, when bwin imposed a limit of how much money an online sports better can put in their playing account, only 0.3 percent of 47,000 online players exceeded the deposit limits once. The researchers believed that one reason the deposit limits were rarely exceeded might be that sports bettors are highly responsible gamblers who bet for fun and spent relatively low amounts on betting.

College-Aged Adults Have Reported Low Participation Rates of Internet Gambling Two national surveys of gambling behaviors among college-aged students and young adults in the United States have looked at Internet gambling in this subpopulation and found very low rates of participation.

In a survey of more than 10,000 college students, researchers found that almost 2.5 percent had ever gambled on the Internet, and only 0.6 percent did so monthly or more frequently (LaBrie, Shaffer, LaPlante, & Wechsler, 2003).

In a telephone survey and interviews of 1,000 participants aged 18 to 21, approximately 1 percent of college-aged students reported that they gambled on the Internet (Barnes, Welte, Hoffman, & Tidwell, 2010).

REFERENCES Barnes, G. M., Welte, J. W., Hoffman, J. H., & Tidwell, M.-C. O. (2010). Comparisons of gambling and alcohol use among college students and noncollege young people in the United States. Journal of American College Health: J of ACH, 58(5), 443-452. doi:10.1080/07448480903540499 LaBrie, R. A., Kaplan, S. A., Laplante, D. A., Nelson, S. E., & Shaffer, H. J. (2008).Inside the virtual casino: A prospective longitudinal study of actual Internet casino gambling. European Journal of Public Health, 18(4), 410-416. Labrie, R. A., Laplante, D. A., Nelson, S. E., Schumann, A., & Shaffer, H. J. (2007). Assessing the playing field: A prospective longitudinal study of Internet sports gambling behavior. Journal of Gambling Studies, 23(3), 347-362. LaPlante, D. A., Kleschinsky, J. H., LaBrie, R. A., Nelson, S. E., & Shaffer, H. J. (2009). Sitting at the virtual poker table: A prospective epidemiological study of actual Internet poker gambling behavior. Computers in Human Behavior, 25(3), 711-717. LaPlante, D. A., Schumann, A., LaBrie, R. A., & Shaffer, H. J. (2008). Population trends in Internet sports gambling. Computers in Human Behavior, 24, 2399 2414. LaPlante, D. A., & Shaffer, H. J. (2007). Understanding the influence of gambling opportunities: Expanding exposure models to include adaptation. American Journal of Orthopsychiatry, 77, 616-623. LaBrie, R. A., Shaffer, H. J., LaPlante, D. A., & Wechsler, H. (2003). Correlates of college student gambling in the United States. Journal of American College Health, 52(2), 53-62. National Research Council (1999). Pathological Gambling: A Critical Review. Washington, D.C.: National Academy Press, p. 89. Shaffer, H. J., Hall, M. N., & Vander Bilt, J. (1997). Estimating the prevalence of disordered gambling behavior in the United States and Canada: A meta-analysis. Boston: Presidents and Fellows of Harvard College. Shaffer, H. J., Hall, M. N., & Vander Bilt, J. (1999). Estimating the prevalence of disordered gambling behavior in the United States and Canada: A research synthesis. American Journal of Public Health, 89, 1369 1376. Shaffer, H. J., Peller, A. J., LaPlante, D. A., Nelson, S. E., & LaBrie, R. A. (2010). Toward a paradigm shift in Internet gambling research: From opinion and self-report to actual behavior. Addiction Research & Theory, 18(3), 270-283. Welte, J. W., Barnes, G. M., Tidwell, M.C. O., & Hoffman, J. H. (2009). The association of form of gambling with problem gambling among American youth. Psychology of Addictive Behaviors, 23(1), 105-112. doi:10.1037/a0013536

Xuan, Z., & Shaffer, H. J. (2009). How do gamblers end gambling: Longitudinal analysis of Internet gambling behaviors prior to account closure due to gambling related problems. Journal of Gambling Studies, 25(2), 239-252.