Written by: Dean Micknal
Researched by: Eric Wasik
Edited by: Darci G. Van Duzer
Managing Editor: Lauren E. Trent

A great American philosopher once advised, “You gotta know when to hold ‘em, know when to fold ‘em.” The deck certainly looks stacked against the online gambling industry. Last Wednesday the Treasury Department and Federal Reserve issued new rules that give the Unlawful Internet Gambling Enforcement Act of 2006 (“UIGEA”) a pretty sharp set of teeth. The new regulations hit the online gambling industry where it hurts-the wallet.  Financial institutions will be required to identify and block payments related to unlawful Internet gambling starting December 1, 2009.

Criticism has been sharp, with opponents lambasting the law as a sneaky bit of midnight legislating and warning that it could damage everything from the still-reeling banking industry, to individual constitutional rights, to international trade relations. Of particular concern to opponents of the law is the fact that the UIGEA doesn’t even try to define what “unlawful internet gambling” means. The Act expressly avoids “spell[ing] out which acts are legal and which are illegal, but rather relies on underlying substantive federal and state laws.” This puts the onus on financial institutions to interpret and enforce a widely divergent and ambiguous set of laws, using payment systems that officials acknowledge are generally not designed to comply with the new law.

Of course none of this might matter if Kentucky Governor Steve Beshear gets his way. You see, Kentucky owns the internet. Well, at least parts of it.

What happens in Kentucky stays in Kentucky

Kentucky residents spend some $170 million each year at online casinos, a fact that concerns Governor Beshear both morally and materially. “The owners and operators of these illegal sites prey on Kentucky citizens, including our youth, and deprive the Commonwealth of millions of dollars in revenue. It’s an underworld wrought with scams and schemes,” the Governor said.

Shutting down online gambling in Kentucky would encourage would-be gamblers to try their luck at the state’s regulated operations such as the lottery, bingo, and the world famous horse tracks. This would not only allow the state to keep a watchful eye on who’s gambling, it would also increase the likelihood that some of that $170 million will find its way into Kentucky’s coffers. What power can a midsized, southern commonwealth wield over a $12 billion dollar industry to ensure that internationally operated sites like UltimateBet.com and Luckypyramidcasino.com don’t find their way into old Kentucky homes?

Beshear’s answer is to treat the offensive websites like any other illicit gambling devices and seize them. On September 18^th, a Franklin County Circuit Court heard evidence that resulted in a court order for the seizure of 141 internet domains that were being used in connection with illegal gambling.

Seizing the web

Just how does one go about “seizing” a website? It turns out that a catchy website name is really just a façade for a string of numbers (called an IP address) that identify the host computer to the internet. Companies called domain registrars are the ones who match up the names with the numbers. The domain registrars then pass this information to another company that is in charge of maintaining a master database of website names, their corresponding numbers, and who owns them.

The September 18^th order directed the domain registrars of the gambling websites to transfer the registration of the sites from the gambling companies to the Commonwealth of Kentucky. The judge then scheduled a hearing (originally set for November 17^th, but recently pushed back to December 3^rd) to determine if the website names should be returned to the original owners or forfeited to the state. In order to avoid forfeiture, the original owners would have to comply with Kentucky gambling laws, which essentially means they would have to block access by Kentucky residents.

But really? How do you seize the internet?

A state or commonwealth has power over property that is situated within its borders. This is called in rem jurisdiction. The state can use this power to settle disputes as to title or status of the property that has been seized due to violation of some law. To do so, the state brings an in rem action against the property itself. This results in a judgment as to the property’s title or status. It also results in some pretty hilarious case names… for example The United States of America v. Two Bronze Eagles, People v. One 1941 Chevrolet Coupe or The United States of America v. A Colossal Roman Marble Portrait of the Emperor Trajan.

On October 16^th, the court responded to briefs that questioned (among other things) the court’s jurisdiction over the domain names. In order to exert in rem jurisdiction over the website names, the court had to show that the domain names were property and were present in the Commonwealth. The court found that the relationship between people and the domain names — as well as the economic value represented by the domain names — meant that the domain names were property. In doing so, the court rejected the defendant’s assertion that domain names represent only contractual rights. The court went on to find that because the evidence showed that the domain names “transport the virtual premises of an Internet gambling casino inside the houses of Kentucky residents,” the names had a continuous and systematic presence in Kentucky. The court placed an exclamation point on its jurisdictional analysis with a quote from Gorman v. Ameritrade Holding Corp.:  “[c]yberspace is not some mystical incantation capable of warding off the jurisdiction of courts built from bricks and mortar.”

After dispensing of the jurisdictional challenges, the court affirmed the Commonwealth’s argument that a domain name is a “gambling device” subject to Kentucky law. The court likened the domain names to “virtual keys for entering and creating virtual casinos from the desktop of a resident in Kentucky.” Thus, the court reasoned, the domain names meet the statutory definition of a gambling device.

The decision has drawn fire from a number of sources. The Interactive Media Entertainment and Gaming Association has petitioned the Court of Appeals to vacate the order on jurisdictional grounds. One Los Angeles attorney and domain name expert compared the case to an attempt by the Commonwealth to seize the cameras and set of a TV show that isn’t even shot in Kentucky. John Levine, author of “The Internet for Dummies” said he thought it “bizarre” that the court even heard the case. Perhaps the most resounding criticism comes from the e-commerce industry, which warns that allowing a state to seize a website in order to enforce a local law could result in a chilling effect on e-commerce, and open a Pandora’s box of abuses on everything from free speech to interstate commerce. In an amicus brief filled with the Kentucky Court of Appeals on Wednesday, the Electronic Frontier Foundation, the Center for Democracy and Technology, and the American Civil Liberties Union urged the court to vacate the order. One of the attorneys warned that “If the mere ability to access a website gives every court on the planet the authority to seize a domain name if a site’s content is in some way inconsistent with local law, the laws of the world’s most repressive regimes will effectively control cyberspace.”

The deal is done

While the Kentucky gambit is riveting from a legal perspective, the actual effects felt by the average online consumer (outside of Kentucky) would be negligible. A win by the Commonwealth, after all, would only affect $170 million of the estimated $12 billion spent on online gambling worldwide–less than 1.5% of the world’s online gambling dollars flow from the Bluegrass State. On the other hand, a working Unlawful Internet Gambling Enforcement Act has the potential of removing the world’s largest market from the table, to the tune of an estimated $6 billion a year. Which leads some critics to wonder… why?

Why miss out on an opportunity to regulate and tax a multi-billion dollar per year industry? Over the past two years, Representatives Barney Frank and Jim McDermott have introduced bills that would do just that. PriceWaterhouseCoopers estimates that taxation of regulated internet gambling would produce somewhere between $8.7 billion and  $42.8 billion over the first 10 years. Those kinds of numbers leave proponents of regulation, fans of online gambling, and critics of the new rules hoping that the incoming administration will steer a new course on internet gambling.

What are the odds?