Internet casinos are outlaw operations in the eyes of the federal government, but they look like solid investments to many of Wall Street's...
Internet casinos are outlaw operations in the eyes of the federal government, but they look like solid investments to many of Wall Street’s largest firms.
Blue-chip investment houses such as Goldman Sachs, Merrill Lynch and Fidelity hold hundreds of millions of dollars in shares of online casinos and betting parlors, which are publicly traded on the London Stock Exchange and headquartered outside the United States in places such as Costa Rica or Gibraltar, an overseas territory of the United Kingdom.
The growing participation by U.S. investors highlights a striking gap between the federal law-enforcement position on online gambling and the realities behind what has emerged as a booming business.
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It also illustrates the difficulty of policing cross-border activity in the Internet age at the same time electronic commerce and a global economy are creating fast economic partners across national boundaries.
Legal experts are divided over whether U.S. investors and the investment houses that operate mutual funds could be seen as criminally liable for their actions by providing financial backing for these offshore casinos.
It is not uncommon for Americans to invest in overseas companies whose operations may be considered illegal or unacceptable in the United States, from manufacturers who use sweatshops to European energy producers that do business in Iran. The difference with Internet gambling is that the activity takes place on domestic shores — with Americans placing bets online using their computers — and the Justice Department has stated clearly that the operators are violating U.S. law.
Jaclyn Lesch, a Justice Department spokeswoman, said the agency considered online gambling illegal, but she declined to “comment on the liability or hypothetical liability of a company or an individual.”
Internet gambling analysts and company executives said the investments illustrate how widely the federal policy is, in essence, being ignored.
Millions of Americans use the Internet to play poker, blackjack and roulette, or wager on sporting events. Online casinos advertise in magazines and on television and fill billboards in Times Square and other places where crowds congregate. Celebrities such as Jesse Ventura, the former governor of Minnesota, hawk for them.
“It’s very bad”
Rep. Bob Goodlatte, R-Va., an opponent of gambling, said the federal government had essentially given up enforcing laws against offshore casinos. He noted that casino operators travel freely within the United States, gathering at trade conventions even though, he said, prosecutors would be within their rights to arrest and bring charges against them.
He said the involvement of investment firms could be part of a pattern of flouting laws.
“It’s very bad, and the Congress ought to investigate it,” Goodlatte said, adding that it may turn out that the investment houses are knowingly supporting and promoting illegal enterprises.
The investment houses have taken the position that they know there are legal risks involved in investing in offshore casinos but that the risks are outweighed by the benefits of owning shares in growing, highly profitable businesses. Those shares can give a lift to mutual funds and other investments sold by the investment houses, meaning bigger returns for clients.
“Our analysis shows the gain from these stocks outweighs the very small risk” of owning them, a spokesman for one major investment house said. The spokesman would not agree to be identified by name or to have his firm identified, citing regulatory policy that could restrict the company’s ability to buy and sell individual securities if he commented on them.
The ownership rolls of offshore casinos read like a Who’s Who of the nation’s top investment firms. For example, public filings show that tens of millions of shares of SportingBet, a company on the London Stock Exchange that allows people to place bets on sporting events, are owned by Fidelity, Merrill Lynch and Goldman Sachs.
Fidelity Management holds shares worth about $363 million, or 14.1 percent of the outstanding shares. Those shares are largely held in mutual funds. Merrill Lynch Asset Management has $164 million in holdings, and Goldman Sachs Group has $137 million.
Similarly, Goldman Sachs and Morgan Stanley Securities hold big positions in BetOnSports, another publicly traded firm in London that facilitates sports betting, according to public filings. Morgan Stanley has one of the biggest stakes — worth about $25.6 million — but the company said the position is held on behalf of one large investor, whose identity it withheld.
Goldman Sachs, Merrill Lynch and Fidelity all declined to comment.
George Hudson, a spokesman for SportingBet, said there had been growing interest from the investment houses, not just their European arms.
“It’s not just London, it’s New York,” Hudson said, noting that the interest represents a change from two years ago, when “the big banks wouldn’t touch the industry with a barge pole.”
According to Hudson and several other industry executives and analysts, a watershed event took place June 30, when PartyGaming began trading on the London Stock Exchange. It was not the first Internet casino to go public in Britain, but it drew attention because of its popularity. The ensuing demand for its shares put it among the exchange’s top 100 companies in its market capitalization, currently about $9.6 billion.
At the time, I. Nelson Rose, a professor at Whittier Law School in Costa Mesa, Calif., who has written extensively on gambling law, was flown to London to advise a number of large investment houses — both American and European — on the risks involved in owning shares. Rose declined to specify the companies for which he consulted but said he had told them there was at least some risk.
Today, Rose said he believed there was only a 10 percent chance that the U.S. government would take action against the investment houses under the Wire Act, which covers online gambling, or under federal laws that permit the government to charge the partners of illegal operations with aiding and abetting their activities. But he said that if prosecutors did so, they could make a decent case.
The companies are shareowners “in an illegal enterprise,” Rose said. “Therefore they are liable.” Potential penalties could range from small fines to prison terms.
But Lawrence G. Walters, a Florida lawyer who specializes in investment law and who has consulted for some prospective U.S. investors, said the government would have difficulty pressing a case, given that the investors do not control the offshore casinos or direct their activities. They are “passive investors,” Walters said.
“Nobody takes them seriously when they say this is a serious crime,” he said of the government and anti-gambling laws. “But there is stuff still on the books, and somebody could go down heavily if government decides to turn its attention to them.”
Profit is just too good
The bottom line, according to casino-industry executives and some financial analysts, is that the opportunity for profit may be too good for the investment houses to pass up. Overall, Internet gambling is projected to reach almost $12 billion in business this year, up from $8.3 billion in 2004, said Sebastian Sinclair, a gambling-industry analyst with Christiansen Capital Advisors.
Companies are enjoying strong growth and big profit margins. Morgan Stanley on Dec. 1 published an analysis of SportingBet that noted the company had acquired 700,000 new customers in a recent quarter, almost equal to the number it signed up all of last year. The Morgan Stanley report said the company was taking in $530,000 a day just from poker.
“There is no other leisure business in the world with the same potential for growth and shareholder returns as online gaming,” said David Carruthers, the chief executive of BetOnSports, noting that the major casinos project 20 percent annual sales growth. “We’re in our embryonic stages.”
Carruthers said the investments from U.S. financial institutions have provided the stability and legitimacy needed to help the casinos grow. “It says we’re running a business legitimately and responsibly, and we’re seen as a worldwide leisure product — similar to KFC, Ford, Coca-Cola, IBM or any other global brand,” he said.