Internet Gaming: Boundless Potential in a Bounded Statutory Framework

The Internet has become the most efficient medium operators use in order to disseminate online gaming, sweepstakes and contests to participants worldwide. With this unbridled growth, however, have arisen opposing moral viewpoints, conflicting statutory interpretations and challenges as to the legality of these online activities in the U.S.

This article will not address the U.S. government’s statutory exemption of certain activities such as interstate pari-mutuel horse race wagering, as evidenced in The Interstate Horseracing Act, nor will it attempt to rectify the dissidence of the legalization of Internet poker and debate stemming from passage of the Unlawful Internet Gambling Enforcement Act (“UIGEA”), 31 U.S.C. § 5361–5367. Rather, the purpose of this article is to discuss the types of activities that can be offered via the Internet to users located in the U.S. given the confines of the current statutory framework.

To begin, the U.S. operates under a dual-sovereign system of both Federal and state governance. Under this framework, the U.S. Constitution and Federal law are the supreme law of the land and thus circumscribe the state and territorial laws in the fifty U.S. states. The Federal sovereign, however, possesses only the limited supreme authority enumerated in the Constitution. In contrast, the states are plenary sovereigns.

The Federal government has not traditionally played a major role in the regulation of gaming. Instead, gaming regulation has been viewed as most appropriate for state and local jurisdictions with enforcement being mainly left to the individual states. Most Federal restrictions, therefore, merely prohibit the offering of gambling activities in states where such activities are already illegal under state law. The most notable exception, however, is the Federal Wire Act (“Wire Act”), 18 U.S.C. §1084. This Act preempts state law by prohibiting the use of almost any known interstate telecommunications medium for transmitting bets or wagers, or information assisting in placing bets or wagers, on any sporting event or contest.

With regard to state laws, most states have some commonality in their general approach to gambling. Prohibited gambling involves any activity in which the following elements are present: (1) the award of a prize, (2) determined on the basis of chance, and (3) where consideration is required to be paid. If any of these three elements are missing, then the activity is generally allowed under state law.

Removal of Consideration
The removal of consideration from a prohibited gambling activity generally creates a lawful activity within the U.S. This is referred to as a sweepstakes. A sweepstakes always contains the elements of chance and prize, so the element of consideration must be eliminated to avoid violating the various prohibitions against lotteries.

States typically fall into three general categories when evaluating consideration (i) pecuniary/economic value jurisdictions, (ii) traditional contract principals jurisdictions, and (iii) any consideration jurisdictions. Federal regulators and most states have adopted a pecuniary/economic value approach. The rationale under this approach is that consideration requires some measurable economic value flowing from the participant to the promoter. Consideration is usually in the form of the transfer of money. A promotion that requires participants to buy a product or pay a monetary amount to participate in the promotion presents a clear example of the element of consideration. A less clear situation exists where a promotion requires participants to expend some degree of effort that ultimately benefits the promoter, e.g., completing a questionnaire on consumer demographics or product preference. Unfortunately, neither Federal nor state law specifies how much effort is required before it is deemed consideration. Generally, however, the more effort that is required, the greater the chance it will be deemed consideration.

Two methods of removing consideration are typical. The first is not to charge any participants for the right to enter the sweepstakes. Here, revenues must derive from the increased sales of goods created by advertising value of the sweepstakes or collecting fees from third parties such as sweepstakes sponsors. This is known as advergaming.
The idea underlining advergaming is that sweepstakes will assist in branding. By way of an example, a Hanes sweepstakes promoted the apparel company's new "tagless" t-shirt by using a tag as the virtual game piece - "lifting" it with the mouse revealed the visitor's prize. Another example is a permanent sweepstakes site where the prizes for the chance-based games are provided by sponsors whose advertising is prominently displayed on the site. The sweepstakes does not need to be a traditional raffle or instant win promotion, but can extend to any game of chance including casino style gaming.

A second sweepstakes model involves some participants paying consideration but providing an opportunity for anyone to enter the promotion for free. In more traditional retail settings, a common example is fast food promotions where participants receive game pieces based on purchasing hamburgers or soft drinks. These game pieces, either by themselves or in combination, could entitle the purchaser to win valuable prizes in lottery-type games. The key feature to this type of promotion that distinguishes it from illegal gambling is the opportunity to play without having to purchase anything. This method is commonly referred to as a free Alternative Method of Entry (“AMOE”).
AMOEs are permitted in the majority of states even though most entrants receive their entries into the sweepstakes through the purchase of the product being promoted. Common examples of popular AMOEs are mail-in entries or entry via an 800 telephone number.

To take advantage of an AMOE operators, must disclose the existence of the non purchase method of entry in a clear and conspicuous manner. Often the words “no purchase necessary” are displayed prominently on the online sweepstakes site and all accompanying sweepstakes materials. As important, the AMOE also must have “equal dignity” with the purchase method of entry. This means that non-paying participants must have equal opportunity to both enter and win the sweepstakes. Non-paying participates should not face greater odds or obstacles to winning the prizes and should have equal chances to win all prizes offered. For instance, a person that enters by paying cannot get a disproportionate number of entries compared to non-paying entries. Similarly, deadline dates should be identical for paying and non paying participants. Any material disparity (actual or perceived) between paying and non-paying entrants can invalidate the AMOE.

Finally, interactive activities where the participants directly or indirectly pay fees to play a game tend to come under greater legal scrutiny. This higher scrutiny results from situations where operators attempt to make money not from the sale of a product unrelated to the sweepstakes but from paying customers desiring to win prizes in the sweepstakes. This is a very real distinction in some courts. For instance in F.A.C.E Trading, Inc. v Carter, the Indiana Court of Appeals approvingly cited the trials court’s conclusion that:

A distinction exists between promotion of a primary business of selling a meal or a drink for valuable consideration together with a chance to win a business related prize, in kind or, albeit, as a sweepstakes prize which attracts sales, and promotion of a non-primary business related and incidental activity for valuable consideration together with a chance to win a prize unrelated to either the primary business activity or attraction of sales. The difference in the distinction is in the essence of the product: [t]he former promotes sales of the primary business product, e.g., food, while the latter promotes the prize and the product (coupon) is unrelated to either the primary business purpose of the promoter, of the distributor, or of [FACE].

Operators of online sweepstakes therefore must note that AMOEs cannot be implemented merely as a ruse designed to offer gambling.

Removal of Chance
Another common and effective technique to operate within the confines of the current statutory framework is to remove the element of chance. If the element of chance is removed, generally a lawful skill game is created.

Skill games have long been segregated from games of chance. From carnival midways to bowling tournaments, the opportunity to win prizes based on the demonstration of skill has long drawn the interest of both young and old. More recently, the Internet has brought a myriad of new opportunities and gave witness to an explosion of pay-for-play skill game sites. The leading Internet sectors are fantasy sports and casual games such as solitaire, checkers, Tetris, and other puzzle or strategy games. A growing sector, however, is the genre of hardcore games preferred by teenagers. These games include first-person shooter and role-playing games.

The determination of whether a pay-for-play skill game with prizes is a permitted game as opposed to a prohibited game of chance is typically based on the relative degrees of skill and chance present in the game. Most states use the predominance test. In other words, if the element of skill in a particular game predominates over chance, then the game is permitted. Unfortunately, this is not the only test that courts employ in the various states. In some states, a game is prohibited if chance plays a material element in determining win or loss. This is a lesser standard than the predominance test and effectively makes it more difficult to offer skilled-based gaming to residents of those states if the games in question resort to a chance component in determining the outcome. A few states adhere to the “any chance” test. This means that if a particular game contains any chance affecting the outcome of the game then the game is chance-based. As virtually every game has some element of chance, most skill games will not survive scrutiny in these few states. Finally, some states simply prohibit pay-for-play skill games regardless of skill level.

When evaluating a game on the basis of skill vs. chance, operators must recognize that several types of chance exist. The most common type is systemic chance. Systemic chance exists when the game itself has elements created either by a random number generator or some other random event such as the throw of a dice. For instance, in Scrabble, systemic chance is the random selection of tiles and in poker, it is the shuffle and deal of the cards.

A second type of chance is imperfect knowledge or information. Whereas, perfect information is a state of complete knowledge about the rules of the game, factors that can impact outcome and information about the actions of other contestants that is instantaneously updated to allow a skilled response, imperfect information exists where there are factors unknown to the players in the game. For example, some may assume that duplicate bridge has no chance elements because the players have identical “draws.” Nevertheless, the players have imperfect information because they need to make decisions based on the unexposed cards and the unpredictability of their opponents’ play. Consequently, if the unknown factors in the game are such that imperfect information can impact the result, an increased risk exists that the game will be found one of chance.

Still other forms of chance may exist. One such example is where a game is designed to negate skill by either making the skill levels beyond the capabilities of the participants. By way of an example, imagine administering a multiple choice test on quantum physics to ordinary eight year olds. Would the test results be based on skill or chance? Likely, most fifth graders would simply resort to guessing at the correct answer.

Operators of Internet skill game sites, therefore, need to fully understand the concept of chance, or risk their services being found prohibited games of chance.

Removal of Prize
Finally, if the elements of consideration and chance are present but the award of a prize is eliminated, then the activity will be legal, in most, if not all states. Until recently, however, it was said that if the elements of consideration and chance are present but the award of a prize is eliminated operators may have a lawful activity but one no one would play. Such cynics, however, need only look to the masses that pay to vote for their favorite contestants on such hit television shows as “American Idol” and “Dancing with the Stars.” Likewise, several Internet business models exist today where participants pay a fee to play a variety of games even though no “traditional” prizes are awarded.

While many states do not define what constitutes a “prize” within their statutes and have no case law on the matter, traditionally, prizes have been considered to be things such as monetary remuneration and tangible items etc. With the rise in popularity of the Internet and social networking sites, however, non-traditional prizes are increasingly being awarded. Non-traditional prizes include free plays, avatars, the accumulation of points or poker chips for bragging rights and other items collected and used in electronic games.

Therefore, the increasingly important question is whether the awarding of chips or other virtual items based upon the outcome of games constitutes a prize. Two issues arise when considering whether an item has value. The first issue is whether the item itself has a market value. While a prize does not have to consist of money, it does have to have a reasonably determined value. This is the difference between a honor and a prize. The first merely being crowned a champion or receiving an acknowledgement in the form of a virtual item versus receiving goods or services that have a defined market value. The second issue is whether the item itself, despite having no market value, can be exchanged for cash or an item of value. An example would be tickets from arcade games that can be exchanged for prizes.

In practice, the notion of virtual items or goods having value is a novel argument that has yet to be clarified by statute or case law. A strong argument exists that awarding such virtual objects would not be considered a prize (for the purposes of gambling law) if they are non-refundable nor exchangeable, replaceable, redeemable or transferable for any real-world funds or prizes. By way of an example, if a player winning virtual chips has absolutely no way to redeem them for either cash, tangible objects or other things of value during game play the items he/she has won therefore have no independent market value when originally acquired. As important, operators also need to ensure no secondary markets exist for these objects, meaning the objects cannot be purchased, sold or transferred outside the game. Secondary markets, even if operated by independent third parties, create a reasonably determinable value for the items. One way to limit these secondary markets is to bind the virtual items to a player. If the virtual items are bound to the player, their ability to transfer or exchange the items is eradicated and, consequently, so is the secondary market. Eliminating a secondary market for these items supports the argument that they are merely bragging rights with no market value.

If, however, third party or black markets do arise for the virtual items issues may arise. Despite not authorizing or supporting a secondary market, a contention may be made that the operator profits from the secondary market and does so knowingly. Therefore, a key in analyzing potential liability will be an operator’s efforts to stop the secondary markets. Prosecutors will scrutinize the measures taken by a operator to determine whether they are effective or not in stopping secondary markets when determining whether or not to pursue prosecution. Therefore, companies need to extremely diligent and aggressive in developing technology that prevents virtual items from being sold or exchanged and eradicating these secondary markets.

Finally, in addition to being aware of the potential impacts in awarding “traditional” and non-traditional virtual items, operators also need to recognize the risks posed by awarding free play. Some states have defined the prize element to include an extension of a service as something of value. For instance, Alabama statute expressly mentions “free plays” within its definition. Specifically, Alabama defines gambling as risking “something of value … upon an agreement or understanding that he or someone else will receive something of value in the event of a certain outcome.” Whereas, something of value is defined as “[a]ny money or property, any token, object or article exchangeable for money or property or any form of credit or promise directly or indirectly contemplating transfer of money or property or of any interest therein, or involving extension of a service entertainment or a privilege of playing at a game or scheme without charge.”

The basis for such prohibitions stems from sly entrepreneurs placing poker machines in bars that did not pay out money but only additional credits. While ordinarily this would not pose a problem, certain operators instituted a procedure whereby players, upon getting ready to leave the establishment, would notify the bartender and the bartender would verify the credits left on the machine, pay the player the amount of the remaining credits in cash, and then unplug the machine, thereby, resetting the machine for the next customer. In essence, it was gambling using hand pays. Upon recognition of these business ventures, legislatures subsequently passed laws specifically defining the awarding of additional plays to constitute a prize. Consequently, in states that find something of value to include extended play, a gaming application would likely be determined to be an unlawful gambling activity if players risk something of value (consideration), on the outcome of a game of chance on the understanding that the users will receive extended play (prize).

As the title suggests, current law offers a number of opportunities for operators to disseminate their online games to citizens in the U.S. Nevertheless, those wishing to use the Internet as a method to conduct sweepstakes and contests must recognize they are entering an intricate and specialized industry and be conscious of the complex legal boundaries in which they must operate. Operators must comply with Federal law as well as the laws of all the states where they accept participants. It is not enough that they comply with the laws where the company has its offices or houses its servers. Gaming counsel, therefore, plays a pivotal role in the design, review, and, ultimately, dissemination of any online gaming services.


Karl F. Rutledge
Karl F. Rutledge
Partner, Chair - Commercial Gaming Group

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