Federal Regulatory Issues: Internet Gambling Regulations Proposed

Introduction

Almost a year after Congress passed the Unlawful Internet Gambling Enforcement Act of 2006 (UIGEA or the Act), the Department of Treasury and Federal Reserve Board (Agencies) proposed regulations to implement it. The Act called for these two agencies, in consultation with the Department of Justice, to propose these rules, which will guide banks, credit card companies and other payment systems on the requirements of the law and how to comply by blocking certain payments made in connection with unlawful gambling transactions through the Internet.

Background on UIGEA

UIGEA does not bar Internet gambling; rather it prohibits those engaged in the business of betting or wagering from knowingly accepting payments in connection with the participation of another in unlawful Internet gambling. The Act protects racing’s interstate activities by excluding from the definition of “unlawful Internet wagering” “any activity that is allowed under the Interstate Horseracing Act of 1978 (IHA), as amended.” It also includes a “Sense of the Congress” provision that states that the new law is not intended to change the relationship between the IHA and other federal statutes, thus maintaining the status quo in the ongoing dispute between the Department of Justice and the racing industry regarding racing’s interstate wagering activities under the IHA.

A specific provision was added to the bill prior to passage to direct that the regulations just proposed could not be used to simply redefine “unlawful interstate wagering” to prohibit racing’s activities. This was intended to ensure that the status quo is also maintained in the regulatory process that is going on now.

Proposed Regulations Appear to Maintain Status Quo for Racing

The rule proposal appears to be faithful to the expressed limits of the Act and the regulatory directive and also maintains the status quo for racing’s activities.

The proposed regulations implement the requirements of UIGEA by designating the payment systems that could be used in connection with Internet gambling and requiring participants in the payment systems to establish policies and procedures to identify and block transactions in connection with “unlawful Internet gambling.”

Racing’s Exclusion Recognized

The rule proposal specifically recognizes that three categories of gambling are exempt from the Act, including “interstate horseracing transactions (any activity that is allowed under the Interstate Horseracing Act of 1978).” The opening narrative specifically notes that “Congress expressly recognized the disagreement over the interplay between the IHA and the Federal criminal laws relating to gambling and determined that the Act would not take a position on this issue.” It goes on to state that “The Act also directs the Agencies to ensure that transactions in connection with any activity excluded from the Act’s definition of ‘unlawful Internet gambling,’ such as qualifying intrastate transactions, intratribal transactions, or interstate horseracing transactions, are not blocked or otherwise prevented or prohibited by the prescribed regulations.” (Emphasis added.)

Recognizing this directive, the proposed rule does not attempt to define which gambling activities are legal or illegal for horse racing, noting “the Act does not require the Agencies to do so.” Indeed, the rule proposal notes, “the Act itself defers to underlying State and Federal gambling laws in that regard and determinations under those laws may depend on the facts of specific activities or transactions (such as the location of the parties).”

In addition, the proposed rule specifically provides that “transactions in connection with any activity excluded from the Act’s definitions of unlawful Internet gambling [such as activities allowed under the IHA] are not blocked or otherwise prevented or prohibited by the regulations.”

The proposed regulation makes it clear that “nothing in this regulation requires or is intended to suggest that designated payment systems or non-exempt participants therein must block or otherwise prevent or prohibit any transaction in connection with any activity that is excluded from the definition of ‘unlawful Internet gambling’ in the Act as a transaction that is allowed under the Interstate Horseracing Act of 1978.”

At the same time, the rule proposal notes that “the Act does not provide the Agencies with the authority to require designated payment systems or participants in these systems to process any gambling transactions, including those transactions excluded from the Act’s definition of unlawful Internet gambling, if a system or participant decides for business reasons not to process such transactions.” It also makes it clear that a payment system may “for business reasons” decide to avoid processing any gambling transactions, even if lawful, because they may believe that the transactions “are not sufficiently profitable to warrant the higher risk they believe these transactions pose” because, for example they have experienced higher-than-usual losses due to assertions that gambling transactions were unauthorized.

AHC Comments

On December 12, 2007, the AHC submitted comments to the Agencies generally supporting the proposed rules. The AHC comments noted that the rule proposal appeared to adhere to the purpose of the Act and the expressed limits that the Act imposes on the Agencies in formulating the regulations.

But the AHC also pointed out that Section 5364(b)(4) of the Act provides that in prescribing regulations the Agencies “shall ensure that transactions in connection with any activity excluded from the definition of unlawful internet gambling in subparagraphs (B), (C), or (D)(i) [any activity allowed under the IHA] of Section 5362(10) are not blocked or otherwise prevented by the proscribed regulations.” (Emphasis and explanation added.)

The AHC comments suggested that this restriction is more than a limitation; it is a statutory directive expressing the Congressional concerns of “overblocking” any activities that are excluded from the definition of “unlawful Internet gambling.” Indeed the Agencies seem to have tried to broadly address this concern of overblocking in Section 5(d) of the rule, which provides that “Nothing in this regulation requires or is intended to suggest that designated payment systems or participants therein must or should block or otherwise prevent or prohibit any transaction in connection with any activity that is excluded from the definition of ‘unlawful Internet gambling’ in the Act as. . . a transaction in connection with any activity that is allowed under the Interstate Horseracing Act of 1978 (15 U.S.C. 3001 et seq.)”

The AHC supported that provision and recommended that it remain in any final rulemaking.

But the AHC also recommended that the Agencies provide further positive clarification to designated payment systems regarding possible policies and examples in connection with activities allowed under the IHA. Because financial institutions, and particularly credit card issuers, will be relying on these regulations as they continue to conduct business with our industry, the AHC comments noted that “it is critical that the regulations provide credit card companies and other financial institutions with guidance so that they will not overblock legitimate activities that are allowed under the IHA.”

The AHC suggested that in addition to the examples set forth in paragraphs (1), (2) and (3) of Section 6(c) of the rules, that section should also include a provision that provides that the policies and procedures of a card system operator, a merchant acquirer and a card issuer would be deemed to be reasonably designed to prevent or prohibit restricted transactions if such entities rely on a merchant category code that is limited to “any activity that is allowed under the Interstate Horseracing Act of 1978.” Specifically, the AHC suggested that a new subsection (4) be added to Section 6(c) as follows:

(4) With respect to any activity that is allowed under the Interstate Horseracing Act of 1978, rely upon a merchant category code (MCC) that is limited only to activities allowed under such Act.

The addition of this language to the examples now included in the proposed rules “would provide additional clarity to designated payment systems,” the AHC said, “further the Agencies’ expressed goal of satisfying the Act’s mandate that the rules ensure that activities allowed under the IHA are not blocked or otherwise prevented or proscribed by the regulations, and allow the state-regulated racing industry to continue to operate as it does now, thus maintaining the status-quo.”

Agency Action

The Agencies will review all the comments submitted before adopting any final regulations.