Regulators Stumped on Implementing Internet Gambling Ban

Without definitions of “restricted transactions” and even “unlawful Internet gambling,” financial entities probably will choose to “overblock” transactions to be safe, subcommittee Chairman Luis Gutierrez, D-Ill., said. “It is easy to see how these regulations… could wreak havoc on electronic commerce,” with institutions acting as “final arbiter” of what’s legal and closing innocent customers’ accounts, he said. Gutierrez worries particularly about the rules’ impact on immigrants sending money to the homelands, and about how they could worsen burdens on institutions during the mortgage crisis.

Bachus noted strong support for the law among all but a few state attorneys general and the professional and college sports leagues. The “repeal” bill by full Committee Chairman Barney Frank, D-Mass., to regulate Internet gambling with an opt-out for states (WID April 27/07 p1) simply would help foreign gambling operators, said Bachus. Internet gambling “ruins lives and tears families apart,” he said, citing data showing that nearly three people in four who try Internet gambling become addicted. The FBI says Internet gambling may be used to launder money and finance terror, he said. Since the law’s 2006 enactment, college students’ online wagering has fallen from roughly 6 percent to about 1.5 percent, a victory that lessened enforcement imperils, Bachus said.

“You are setting the precedent for the federalization of the Internet based on the moral views of Congress,” Frank told Bachus. Just about every affected sector has complained about the controls as making them “anti-gambling cops” and distract from their job of processing financial transactions, he said. His time as a small businessman taught him that without legal clarity businesses get “risk-averse,” Jeb Hensarling, R-Texas, said: “We need black and white, not shades of gray.” Rep. Maxine Waters, D-Calif., said she voted for the original legislation, added at the last minute to a port security bill. “Today I'm not so sure how to vote” after doing more research, she said.

Rep. Peter King, R-N.Y., another full committee member, sees a “severe risk of going too far” if institutions decide what’s lawful online. He cited conservative icon Grover Norquist’s letter attacking the regulations as harmful to privacy and an unnecessary burden on banks. King suggested paring back the regulations to only cover sports betting, which is said to be easier to track than other forms online.

‘Underlying Ambiguity of the Statutes’

The regulators who wrote the draft rules seemed unenthusiastic about the results of their work but said they had no choice. The regulations are based on varying federal and state laws that are “not well settled” and are “subject to varying interpretations,” said Louise Roseman, director of the division of reserve bank operations and payment systems at the Federal Reserve. Roseman noted federal law’s exception for horse racing, subject of a long-running dispute between DoJ and U.S. courts. The WTO cited the exemption in ruling against the U.S. in its gambling dispute with Antigua (WID April 2/07 p4).

The Federal Reserve will consider revising the draft but can’t provide “complete certainty, given the underlying ambiguity of the statutes,” Roseman said. She told Gutierrez that some commenters see the term “actual knowledge” as a better trigger for financial institution actions against gambling transactions than the rules’ less precise “becomes aware” phrasing. The Fed and Treasury gave “reasonable examples” of how institutions could respond to such revelations but didn’t make them binding, Roseman said. The agencies still are deciding whether to give further guidance on, say, how many violations of an institution’s prohibition on gambling transactions would require closing an account, she told Gutierrez. He urged them to “tread carefully.” Several comments raised multiple issues requiring research, so “we're still considering all aspects” of final regulations, said Valerie Abend, Treasury Department deputy assistant secretary for critical infrastructure protection and compliance policy.

Some financial transactions’ structures make it difficult to see what’s going on, Roseman said, explaining exemptions. Financial commenters on the regulations generally said they would be able to perform due diligence on new customers to see if their businesses handle prohibited Internet gambling -- but not on existing customers, whose lines of business aren’t identified, she said. The main hurdle to effective regulation is that the U.S. is nearly alone in banning Internet gambling. That gives foreign banks -- which initially process most online gambling payments -- no incentive to flag wagering transactions for the sake of U.S. companies, Roseman said.

Authorities can track money laundering, terror financing and other prohibited activities, so why won’t those methods work to track Internet gambling, Bachus said. He cited his staff’s “cursory review” of laws that led to their invoking the Office of Foreign Assets Control blacklist as a possible model for a blacklist Bachus want to create for gambling Web sites. Roseman said that wouldn’t work because the foreign assets blacklist targets “restricted parties,” not “restricted activities,” as the gambling law puts it. “They're illegal,” Bachus shot back. “They're criminal enterprises.” Gambling operators may have other commercial transactions “totally unrelated to gambling,” Roseman said. It’s a different matter for money laundering, an activity banned worldwide and so one for which banks watch out, she told Rep. Brad Sherman, D-Calif.

Internet Gambling at ‘Joe’s T-Shirt Shop’

Lawmakers asked regulators to say whether specific kinds of online bets would be banned under the law and regulations. The Fed is “really struggling” with how to treat remote bets on horse racing under the law, Roseman told Rep. Kenny Marchant, R-Texas. She said Frank’s hypothetical “nice little bank” would probably refuse to process an online bet on horse racing. Roseman told Frank that she assumed banks under the jurisdiction of the 5th U.S. Circuit Court of Appeals, which ruled in 2002 that remote betting on horse racing was legal, would be safe taking such wagers.

King’s idea about limiting regulations to sports betting probably wouldn’t fly, Roseman told him. Several gambling sites offer multiple kinds of bets, including on sports, and processors would be hard pressed to identify a bet’s nature. Congress would have to bar all companies from offering online sports bets on the Internet to U.S. customers, she said.

Frank’s joke about betting on elections didn’t amuse Roseman, who said DoJ recently told her that “predictive markets” of that kind are governed by “chance” and so illegal in the U.S. Rep. Robert Wexler, D-Fla., said New Hampshire defines games of chance as those in which players “cannot affect the outcome,” asking if that means Internet poker -- deemed a game of skill by players -- would be exempt there, under the regulations. Roseman pleaded for a reprieve from hypothetical questions.

But Marchant’s hypothetical front for online gambling, “Joe’s T-Shirt Shop,” would probably elude payment processor suspicion, and regulators would have no reason to punish the processors, Roseman said. If a bank saw a suspicious “pattern of transactions” from Joe’s, it would have a moral duty to investigate, she said. Banks would have no “affirmative obligation” to look for such a pattern, but simply be required to conduct due diligence on customers, Roseman told Franks.

Bachus said DoJ could answer the questions better than the Fed and Treasury, complaining that he requested three times that the agency be invited to the hearing. Frank said the committee never has asked DoJ to testify, to his knowledge, because it’s not under committee jurisdiction. Gutierrez said he had never chaired a hearing with “this kind of participation and activity.”