K&LNGAlert. Internet Gaming Internet Gambling How Will (or Will) the U.S. Respond to the WTO s Ruling?

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1 K&LNGAlert MARCH 2006 Internet Gaming Internet Gambling How Will (or Will) the U.S. Respond to the WTO s Ruling? Since Antigua and Barbuda ( Antigua ) first filed a formal complaint against the United States with the World Trade Organization ( WTO ) in 2003, Internet gambling operators have been waiting to see whether the United States would come under additional pressure to permit Internet gambling. As the April 3, 2006 deadline for implementing the WTO ruling approaches, however, questions still abound as to when and how (and whether) the United States will act. The answers to these questions have the potential to profoundly impact Internet gambling operators, many of whom are waiting for the opportunity to tap the United States gambling market. This Alert examines the issues surrounding the dispute, possible scenarios for the United States to come into compliance with the WTO ruling, and the implications for the United States of not complying with the ruling. WHAT IS THE WTO? The WTO was created in 1995 as the international organization responsible for governing trade among nations. The WTO provides an institutional framework for conducting international trade relations among its 148 member countries in accordance with the approximately 60 agreements it recognizes. The recognized agreements cover the three broad areas of trade goods, services and intellectual property as well as dispute resolution and other organizational and administrative matters. The top decision-making body in the WTO is the Ministerial Conference, which is composed of representatives of all WTO members. The General Council, which also is composed of representatives of all WTO members, handles the day-to-day operations of the WTO. The General Council is responsible, through subsidiary bodies, for the administration of the trade agreements. The General Council reports directly to the Ministerial Conference. Both the General Council and the Ministerial Conference make decisions by consensus, if possible, or by majority vote, with each member entitled to cast one vote. The WTO s smallest member, Antigua, therefore, has equal weight in voting as the WTO s largest member, the United States. HOW DOES THE WTO RESOLVE DISPUTES? The General Council convenes when necessary as the Dispute Settlement Body. The Dispute Settlement Body is responsible for settling trade disputes between member nations in accordance with the Dispute Settlement Agreement. The Dispute Settlement Agreement provides that disputing countries have up to 60 days to consult and determine if they can settle their differences without WTO intervention. If such consultations fail, the complaining country may ask for a dispute panel to be appointed. The panel hears each country s case, submits preliminary drafts of a panel report to the disputing countries, and then submits a final panel report to all WTO members. The panel report becomes the Dispute Settlement Body s ruling within 60 days of issuance unless a consensus of all WTO members rejects it. The disputing countries are permitted to appeal the panel report. If a panel report is appealed, the appeal is heard by three members of the permanent seven-member Appellate Body that is set up by the Dispute Settlement Body. The seven-member Appellate Body broadly represents the range of WTO membership. During the appeal, both sides again present their case and the Appellate Body issues an Appeal s Report that either upholds, modifies or reverses the panel s legal findings and conclusions. The Dispute Settlement Body may accept or reject the Appeal s Report.

2 Once the case has been decided, the losing country must follow the recommendations of the panel report or appeal report and must state its intention to do so at a Dispute Settlement Body meeting. If the losing party is unable to comply immediately, the country will submit an implementation report with proposed implementation within a reasonable period of time. When the Dispute Settlement Body or disputing parties agree to the implementation proposal, the case ends at that point; however, when the parties disagree, the implementation plan may be submitted to an arbitrator to resolve the dispute. The losing party is required to comply with the implementation deadlines established by the arbitrator. WHAT WAS ANTIGUA S COMPLAINT AGAINST THE UNITED STATES? The dispute between Antigua and the United States arises under the General Agreement on Trade in Services ( GATS ), one of the two most prominent trade agreements the WTO administers. Specifically, Antigua claimed that certain provisions of United States law effectively prohibited the cross-border supply of gambling and betting services to consumers in the United States in contravention of GATS. The United States asserted, among other things, that the prohibition of gambling and betting services was authorized by a general exception to GATS allowing the adoption of measures necessary to protect public morals or maintain public order. Article XVI of GATS, cited by Antigua, provides that each member shall accord services and service suppliers of other members no less favorable treatment than that provided for in the member s schedule of market-access commitments agreed to and adopted in accordance with GATS. In essence, under GATS, each member sets out in a schedule the specific commitments it undertakes in each sector, and the terms, limitations and conditions of such commitments. Where a member has undertaken a specific commitment, Article XVI defines certain measures that the member may not adopt or maintain, unless otherwise specified on the schedule. Included among the prohibited measures are limitations on the number of service suppliers or the number of service operations. Antigua asserted that the United States GATS schedule included specific commitments, without limitation, with respect to gambling and betting services, i.e., that the United States had agreed to allow full market access for such services. Accordingly, Antigua asserted, the prohibitions of cross-border supply of such services embodied in United States law violated Article XVI. The laws at the heart of Antigua s claim of crossborder prohibitions are the Wire Act, the Travel Act and the Illegal Gambling Business Act. These statutes provide as follows: n n n The Wire Act makes it illegal for anyone engaged in the business of betting or wagering to knowingly use a wire communication facility for the transmission in interstate or foreign commerce of bets or wagers or information assisting the placing of bets or wagers on any sporting event or contest, or for the transmission of a wire communication that entitles the recipient to receive money or credit as a result of bets or wagers, or for information assisting in the placing of bets or wagers. [18 U.S.C. 1084] The Travel Act makes it illegal for anyone, with requisite intent, to travel in interstate or foreign commerce, or use the mail or any facility in interstate or foreign commerce, to distribute the proceeds of any unlawful activity (specifically including any business enterprise involving gambling), commit any crime of violence to further any unlawful activity, or otherwise promote, manage, establish, carry on or facilitate any unlawful activity. [18 U.S.C. 1952] The Illegal Gambling Business Act makes it illegal for anyone to conduct, finance, manage, supervise, direct, or own all or part of an illegal gambling business, i.e., a gambling business of five or more persons, in continuous operation in excess of 30 days and with gross revenue of $2,000 in any day, that is a violation of the state or local subdivision in which it is conducted. [18 U.S.C. 1955] Antigua complained to the WTO that the Wire Act, the Travel Act and the Illegal Gambling Business Act effectively prohibited the cross-border supply of gambling and betting services to consumers in the United States, contrary to the United States GATS commitments. 1 1 The United States Department of Justice interprets the Wire Act to prohibit all forms of Internet gambling, although courts in most jurisdictions have not considered the question of whether the Wire Act prohibition extends beyond sports betting or wagering. Certainly, though, there seems little doubt that the Wire Act prohibition extends to sports betting or wagering over the Internet. 2

3 In its defense, the United States pointed to a general exception to GATS, embodied in Article XIV, allowing the adoption of measures necessary to protect public morals or maintain public order. The United States argued that the restrictions on betting, wagering and gambling contained in the Wire Act, the Travel Act and the Illegal Gambling Business Act were allowed by GATS Article XIV. Antigua, however, argued that the Interstate HorseRacing Act created an exception to the subject acts for domestic off-track wagering only, which constituted arbitrary and unjustifiable discrimination between domestic and foreign suppliers and precluded application of the public morals exception. The general exceptions to GATS provided by Article XIV apply only to measures that do not constitute a means of arbitrary or unjustifiable discrimination between countries where like conditions prevail, or a disguised restriction on trade in services. The Interstate HorseRacing Act [15 U.S.C et seq.] expressly allows interstate off-track wagering on horse races within the United States through offtrack betting systems a wager may be accepted in one state with respect to the outcome of a horse race in another state, provided that such activity is lawful in each of the states involved but it does not expressly allow foreign off-track wagering. According to Antigua, the distinction between interstate and foreign off-track wagering created by the Interstate HorseRacing Act was unjustifiable, amounted to a disguised restriction on trade in services, and precluded the United States public morals defense. HOW DID THE WTO RESOLVE ANTIGUA S COMPLAINT? Antigua initiated its complaint to the WTO in March 2003 with a request for consultations. In June 2003, after consultations proved unsuccessful, Antigua requested the establishment of a panel to determine whether the actions of the United States constituted a violation of GATS. In November 2004, the panel found that (i) the United States GATS schedule included commitments of open access for gambling and betting services, (ii) United States law failed to accord Antigua service suppliers required access in accordance with those commitments, and (iii) the Wire Act, the Travel Act and the Illegal Gambling Business Act were not shown to be necessary under the public morals exception of Article XIV. In short, the WTO panel rule that the United States violated GATS by not permitting Antigua to offer Internet gambling services to United States citizens. The United States appealed the panel s decision. The WTO Appellate Body circulated its report in April 2005 upholding in part and overruling in part the Panel Report. The Appellate Body overruled the panel determinations that the United States GATS schedule includes a commitment of full market access to gambling and betting services and that, by maintaining the Wire Act, Travel Act and the Illegal Gambling Business Act, the United States acts inconsistently with its GATS commitment. The Appellate Body overruled the panel finding that the subject statutes were not necessary to protect public morals or to maintain public order, but it declined to grant in full the United States public morals defense. Rather, the Appellate Body found, in light of the Interstate HorseRacing Act, that the United States had not demonstrated that the Wire Act, the Travel Act and the Illegal Gambling Business Act are applied in a nondiscriminatory manner to both foreign and domestic service suppliers. As required by WTO rules, the Appellate Body s Report was submitted to the Dispute Settlement Body for consideration. On April 20, 2005, the Dispute Settlement Body adopted the Appellate Body Report and the Panel Report, as modified by the Appellate Body Report. Antigua and the United States then attempted to reach an agreement as to a reasonable period of time for implementation; but, because an agreement could not be reached, Antigua requested that the reasonable period of time be determined by binding arbitration. On August 19, 2005, the arbitrator determined that the United States must have a solution that is compliant with the Appellate Body s ruling in place by April 3, WHAT ARE THE POSSIBLE RESPONSES BY THE UNITED STATES? When the Appellate Body s Report was announced, the Acting United States Trade Representative, Peter F. Allgeier, immediately proclaimed: This win confirms what we knew from the start WTO Members are entitled to maintain restrictions on Internet gambling. Mr. Allgeier s position was simply that if we clarify U.S. Internet gambling restrictions in certain ways, we ll be fine. Despite Mr. Allgeier s apparent jubilance, this proposition is not such an easy task. Essentially, since both domestic and foreign Internet gambling operators must be treated the same, the United States, in order to comply with the WTO 3

4 ruling, must permit all gambling operators to accept bets on horseracing in accordance with the requirements of the Interstate HorseRacing Act or permit no gambling operators to accept off-track bets. There are a number of ways that one or the other of these opposing options could be accomplished, five of which are considered here: (1) enactment of legislation that specifically prohibits all Internet gambling and repeals all inconsistent legislation, i.e., the Interstate HorseRacing Act; (2) enactment of legislation that permits all Internet gambling; (3) enactment of legislation that repeals the Interstate HorseRacing Act; (4) enactment of legislation that amends the Interstate HorseRacing Act to afford all licensed gambling operators, domestic or offshore, the opportunity to meet the requirements of the Interstate HorseRacing Act, or promulgation of regulations that interpret the Interstate HorseRacing Act to accomplish the same purpose; (5) judicial decision that construes the Interstate HorseRacing Act to apply to all licensed gambling operators regardless of country of residence or that determines the Interstate HorseRacing Act is unconstitutional under the dormant commerce clause. Alternatively, none of the above could occur and the United States could decide not to meet the WTO s compliance criteria and face trade sanctions from Antigua. PROHIBITION OF ALL INTERNET GAMBLING Since the mid-1990s, the United States Congress has considered, but not enacted, legislation that would directly, or effectively, prohibit Internet gambling. Senator John Kyl (R-Arizona), a longtime opponent of Internet gambling, recently introduced legislation that would restrict Internet gambling in the United States by requiring banks and credit card companies to block payments to Internet gambling sites. Senator Kyl s attempt failed when another Senator successfully objected to the amendment as an inappropriate rider to an appropriations bill. On November 18, 2005, Representative James A. Leach (R-Iowa) introduced a bill, H.R. 4411, that was nearly identical to Senator Kyl s failed amendment. On January 5, 2006, H.R was referred to the House Subcommittee on Financial Institutions and Consumer Credit. H.R. 4411, like Senator Kyl's latest attempt, would thwart Internet gambling by preventing the use of certain payment methods such as credit cards. This legislation would make Internet gambling difficult to conduct but not illegal. It also would not impact the Interstate HorseRacing Act exclusion and solve the WTO compliance problem. Most recently, however, legislation has been proposed that, if enacted, would conclusively prohibit all Internet gambling, including wagering on horseracing. On February 16, 2006, Representative Robert Goodlatte (R-Virginia) reintroduced a bill, titled the Internet Gambling Prohibition Act, that would amend the Wire Act to specifically cover all forms of gambling and new technologies. The bill also would expand the Wire Act s prohibitions to include all bets and wagers (not merely bets on sporting events) and prohibit the acceptance of credit cards, checks and wire transfers for the payment of gambling transactions. The bill, as introduced, does not provide any exclusion for horse race betting. But when previous versions of Rep. Goodlatte s Internet gambling bills were considered (none were ever enacted), they were amended to insert exemptions for horseracing. If Rep. Goodlatte's proposed Internet Gambling Prohibition Act were to be enacted as introduced, it would bring the United States into compliance with the WTO ruling. However, if amended as prior attempts were, the WTO compliance problem would not be resolved. LEGALIZATION OF INTERNET GAMBLING The United States could come into compliance with the WTO s ruling by changing its schizophrenic position on Internet gambling. Congress, instead of explicitly permitting some Internet gambling (offtrack wagering on horse races) and explicitly prohibiting other Internet gambling (all sports wagering except on horse races), could explicitly legalize all Internet gambling and then regulate it. The same concerns that energize the opponents of gambling organized crime, money laundering, gambling addictions and ease of accessibility to minors might be just as effectively addressed through regulation rather than prohibition. Under this scenario, the United States would have the possibility of a new source of revenue. To date, however, no legislation has been introduced to legalize Internet gambling or to regulate Internet gambling operations. As noted above, the proposed legislation currently before Congress concerns the prohibition of all Internet gambling. It would seem unlikely that the United States would legalize Internet gambling at this time. 2

5 REPEAL OF THE INTERSTATE HORSERACING ACT While the repeal of the Interstate HorseRacing Act would, on its face, appear to be the simplest way for the United States to come into compliance with the WTO ruling, the probability that such will happen is slim. The horseracing lobby, which has proven powerful, would strongly oppose such a prohibition, because it would be detrimental to the horseracing industry. Moreover, Congress, as recently as 2000, amended the Interstate HorseRacing Act to permit pari-mutuel betting on horse races by computer. AMENDMENT OF THE INTERSTATE HORSERACING ACT OR PROMULGATION OF REGULATIONS Under the Interstate HorseRacing Act, United States citizens are permitted to bet on horse races via the Internet, provided such bets are with operators located within the United States who have complied with the provisions of the Act. The Act s wording seems to be limited to domestic activity and not to international activity. It was this apparent discrimination that underpins the WTO decision. Accordingly, another seemingly simple way for the United States to come into compliance with the WTO ruling would be to amend the Interstate HorseRacing Act to permit both domestic and foreign Internet gambling operators to provide remote horse race betting services or to promulgate regulations that interpret the Act to permit the same opportunity to foreign gambling operators. This solution, while simple, may not satisfy all concerned. Antigua s legal counsel is reported to take the position that simply permitting foreign Internet gambling operators to provide betting services for horseracing will not bring the United States into compliance with its WTO obligations. According to news reports, Antiqua s counsel believes that the Interstate HorseRacing Act was used by the WTO as an example of United States discrimination in trade, but is not the only way that the United States fails its WTO obligations; if the United States permits foreign Internet gambling operators to offer horse race wagering, it must also permit poker and casino gambling over the Internet. In other words, Antiqua s counsel appears to take an all or none position, i.e., the United States can only be in compliance with its WTO obligations if it either permits or prohibits all forms of Internet gambling, including domestic and foreign horse race wagering. If the United States were to do nothing other than amend the Interstate HorseRacing Act to permit offshore entities the same opportunity as domestic entities with respect to horse race wagering, Antigua might not be satisfied. JUDICIAL ACTION If a foreign gambling operator were to attempt to avail itself of the Interstate HorseRacing Act and be refused that opportunity solely because the entity was not a United States entity, that entity might have a federal cause of action under the dormant Commerce Clause that it could bring in the federal district court located in the jurisdiction that declined its application to offer off-track wagering. This could tee up the question of the construction of the Interstate HorseRacing Act and its constitutionality. If a court were to construe the Act as allowing off-shore gambling entities the same opportunity to offer offsite wagering on horse races as it allows domestic entities, the resulting situation would be analogous to the amendment of the Interstate HorseRacing Act or the promulgation of regulations to allow access by foreign enterprises, at least in the jurisdiction in which the district court is located. If a court were to declare the Interstate HorseRacing Act unconstitutional, that would have the effect of repealing the Act in the jurisdiction in question. WHAT IF THE UNITED STATES DOES NOT RESPOND? Perhaps the most likely outcome is that the United States will do nothing prior to the April 3, 2006 WTO compliance deadline. The possible ramifications of such would at first seem rather limited. There are, nonetheless, risks for the United States with a do nothing approach. Certainly the United States would face trade sanctions from Antigua if it fails to respond to the WTO deadline. Given Antigua s small population and limited international influence, however, such sanctions would probably not have much direct effect on the United States. Antigua, however, is only one of many countries that currently license and regulate Internet gambling operators. Countries such as the U.K., Canada, Australia, South Africa, Israel, Costa Rica, India and others license Internet gambling operators and may take umbrage at the United States 2

6 position. If the United States simply ignores the WTO ruling because of the perceived inconsequentiality of any trade sanctions that Antigua might impose, the United States may face more serious trade ramifications from major international trading partners. Should those countries take this issue to the WTO and win, the trade sanctions they might impose on the United States could have a significant impact. Craig P. Wilson cwilson@klng.com Robert A. Lawton rlawton@klng.com Ashley J. Camron acamron@klng.com If you have questions or would like more information about K&LNG s Betting and Gaming Practice, please contact one of our lawyers listed below: HARRISBURG David R. Overstreet doverstreet@klng.com Linda J. Shorey lshorey@klng.com BOSTON Deborah J. Peckham dpeckham@klng.com LONDON Warren L. Phelops wphelops@klng.com LOS ANGELES Dennis M. P. Ehling dehling@klng.com BOSTON DALLAS HARRISBURG LONDON LOS ANGELES MIAMI NEWARK NEW YORK PALO ALTO PITTSBURGH SAN FRANCISCO WASHINGTON Kirkpatrick & Lockhart Nicholson Graham (K&LNG) has approximately 1,000 lawyers and represents entrepreneurs, growth and middle market companies, capital markets participants, and leading FORTUNE 100 and FTSE 100 global corporations nationally and internationally. K&LNG is a combination of two limited liability partnerships, each named Kirkpatrick & Lockhart Nicholson Graham LLP, one qualified in Delaware, U.S.A. and practicing from offices in Boston, Dallas, Harrisburg, Los Angeles, Miami, Newark, New York, Palo Alto, Pittsburgh, San Francisco and Washington and one incorporated in England practicing from the London office. This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer. Data Protection Act 1988 We may contact you from time to time with information on Kirkpatrick & Lockhart Nicholson Graham LLP seminars and with our regular newsletters, which may be of interest to you. We will not provide your details to any third parties. Please cgregory@klng.com if you would prefer not to receive this information KIRKPATRICK & LOCKHART NICHOLSON GRAHAM LLP. ALL RIGHTS RESERVED.