United States: Pa. Internet Gaming Bill Goes Beyond Internet Gaming

As Pennsylvania's budget season presses on, there has been no shortage of proposals to increase state revenue without raising taxes. Internet gaming has generated much interest lately, with several bills introduced that would legalize and regulate Internet gaming. The latest one, SB 900, introduced on June 9, is sponsored by state Sens. Kim Ward, R-Westmoreland; Robert Tomlinson, R-Bucks; Elder Vogel, R-Lawrence; Senate President Pro Tempore Joseph Scarnati; Camera Bartolotta, R-Greene/Beaver/Washington; and Patrick Stefano, R-Fayette. Unlike other bills that have been introduced, the bill goes beyond Internet gaming and touches numerous aspects of operating brick-and-mortar casinos. Is this bill an elegant compromise among many different groups or is it a kitchen-sink wish list? While it is impossible to predict the ultimate outcome of the legislative process, the bill contains intriguing provisions, some of which may be problematic from an industry or political perspective in that they could erect high barriers to entry and make it challenging to facilitate growth.

Internet Gaming

The bill would allow Pennsylvania casino licensees to offer Internet gaming on a full-scale basis. This differs from some earlier legislation that would permit Internet poker only rather than a full suite of Internet games. While at least one earlier bill was silent on which existing casinos could offer Internet gaming, this bill specifically excludes Category 3 facilities — the two smaller casinos (Valley Forge and Nemacolin) that are part of resorts — from offering Internet gaming. Excluding facilities from participating in Internet gaming would be a change from the general model that has been implemented in U.S. Internet gaming.

In order to receive an Internet gaming permit, a casino would have to pay a $10 million license fee — up from $5 million in some earlier legislation — which is a high price of entry into the market, particularly when factoring in the cost of establishing an online gaming system.

While other legislation was vague on where servers for Internet gaming must be located, under the latest bill, servers used for Internet gaming must be located within the casino's facility in a secure space. The bill does not contain a provision for the use of off-site data sites, except for backup servers which may be located at another site that must also be within Pennsylvania. As Internet gaming matures, states may want to consider entering into compacts or legislative authorizations for data centers to be located in other states that already offer Internet gaming. Data centers are a high-cost item when establishing and maintaining an Internet gaming system and the requirement for each state to have its own data center puts added burden on Internet gaming operators. While some legislators may be reluctant to relinquish the jobs and investment that come with having data centers in-state, this lost investment can be recouped with a more efficient operating system through the use of a consolidated data center.

Under the latest bill, gross Internet gaming revenue would be taxed at 54 percent, the same tax rate as brick-and-mortar casinos and a significant increase from the earlier-proposed 14 percent. By way of comparison, New Jersey's tax rate is 15 percent. A 54- percent tax rate on Internet gaming revenue could present a significant hurdle to operators (and would likely dissuade some from entering the field at all). Internet gaming systems rely on a host of providers, such as payment processors, game and platform providers and geolocation services (companies that ensure a player is physically located in a place where acceptance of a wager is permissible). Thus far, the model has been for the casino to compensate these providers based on a percentage of revenue. If, however, 54 percent of that revenue is being paid to the state as taxes, the overall pie that can be split among these providers shrinks significantly. It may lead to considerable challenges in pricing these services profitably, which may result in either the failure of Internet gaming or a very limited number of participants in the market. Unless a critical mass of players can be quickly attained, the revenue to support many operators in the market may not be obtained. The legislature may want to consider a reduced tax rate, at least at the outset, in order to allow the market to develop.

Finally, the legislation includes a geographic restriction in terms of account opening. If a person lives within 20 miles of a casino that offers Internet gaming, that person must open an account in person and may not do so online. While it is understandable that casinos would want to attract the customers who live the closest geographically, in order to make an Internet gaming system work, it is necessary to have the liquidity of a high number of customer accounts. Anything that makes it more difficult to open an account increases the challenge of converting a prospective customer into an actual customer.

Land-Based Casino Implications

Unlike earlier legislation, this bill contains two key provisions that would significantly alter the dynamic of land-based casinos in Pennsylvania. The first change would be access to Category 3 casinos. These resort casinos are not open to the general public unless a patron either utilizes other amenities of the resort, such as restaurants or hotel rooms, or purchases a membership. This requirement affects the number of customers who might otherwise visit a Category 3 facility. The bill would allow Category 3 facilities to escape the membership requirement, provided that the casino pays a fee. This would significantly change the dynamics of Category 3 casinos, which have been the subject of controversial proceedings already brought by other casinos before the Pennsylvania Gaming Control Board. Nearby Category 1 or Category 2 casinos would likely object on the grounds that this change affects the market to which they expected access when they were initially awarded a license. However, Category 3 casinos will be excluded from Internet gaming, which would probably cause objections from those casinos. Perhaps this is a form of legislative compromise.

Second, the bill allows for the establishment of "nonprimary locations" and "ancillary facilities" — essentially, satellite casinos limited to 250 slot machines each. Category 1 facilities (racetracks) would be allowed to open four such facilities each and Category 2 facilities would be allowed to open two. Geographic restrictions exist as to where these facilities may be opened — no closer than 20 miles to another facility, except for within the City of Philadelphia, where that restriction is 10 miles. These facilities would have a $5 million license fee, which also would change the overall dynamics of casino location in Pennsylvania and may generate significant objections from existing operators and from those already concerned about the potential cannibalization effect of adding more gaming in Pennsylvania.

In light of the new ideas and disparity with other legislation contained in this bill, it remains to be seen whether this is a compromise bill that has taken into account the wide variety of constituents in the Pennsylvania gaming industry or whether it is a bill that only drives those constituents further apart. Internet gaming is unlikely to happen without a broad-based consensus among industry stakeholders. The key question now is whether the desire for additional revenue is enough to bring these constituents to consensus or whether Internet gaming is simply too controversial and implicates too many interests to be resolved in the short time remaining in this year's budget cycle.

Originally published by Law360, June 16, 2015.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.

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