On November 12, 2008, the U.S. Department of the Treasury and the Federal Reserve Board issued a final regulation to implement the Unlawful Internet Gambling Enforcement Act of 2006, 31 U.S.C. §§ 5361 et seq. That statute does not make Internet gaming illegal, as that was already the position of the United States Department of Justice (DOJ) for many years. Rather, the statute seeks to choke off the transmission of funds between Americans and Internet gaming sites, regardless of where the gaming sites are located. The statute prohibits acceptance of credit cards, funds, bank instruments, or proceeds of any other form of financial transaction in connection with unlawful Internet gaming.
This regulation, codified at 31 C.F.R. Part 132 (Nov. 12, 2008), creates compliance problems for numerous types of entities, in addition to those directly engaged in Internet gaming operations. These include U.S. financial institutions and similar businesses, especially those subject to the Bank Secrecy Act (BSA) and USA PATRIOT Act of 2001, which will now have specific gaming obligations superimposed on their more generalized obligations not to facilitate illegal activities.
Any individual or business that may be involved with Internet gaming activities, whether knowingly or inadvertently, should understand the sweep of these proposed regulations and take steps to comply with them.
The regulation is slated to go into effect on January 19, 2009, and all affected businesses must be in compliance by December 1, 2009, unless the enforcement of this regulation is stayed by judicial challenges, which is a distinct possibility.
The government believes that trying to isolate illegal Internet gaming transactions from the billions of daily transactions in the United States would be expensive, so much so that it could adversely affect the economy. Accordingly, the regulatory compliance requirements are driven by whether any benefits would likely be outweighed by the associated costs of compliance with the proposed regulations. The new regulation requires credit card processors, money-transmitting businesses, check-cashing businesses, wire-transfer businesses, automated clearing house (ACH) processing businesses, and financial institutions (for certain types of transactions) to establish and implement written compliance policies and procedures reasonably designed to identify and block or otherwise prevent or prohibit unlawful Internet gambling payment transactions.
To that end, consistent with the statute, there are two major safe harbors included in these regulations — exemptions from compliance with the statute and adoption of programs and procedures reasonably designed to prevent or prohibit restricted transactions. If a funds transfer to an illegal gaming operation is effected, the unknowing participant in the restricted transfer is absolved of statutory civil penalties if it falls into one of these safe harbors.
To aid with compliance, the final rules set out specific procedures that a non-exempt participant could choose to follow to conduct adequate due diligence of commercial customers with respect to the risk of unlawful Internet gaming. They also provide non-exclusive examples for each designated payment system of what would constitute adequate due diligence. This process, in the absence of “actual knowledge” that funds are being used in connection with illegal Internet gaming activities, will hopefully alleviate some of the concerns about illegal transactions slipping through and provide clarity and certainty to a covered institution that is attempting in good faith to comply.
The rule also focuses on “commercial customers” and not on individuals, apparently to make it easier to identify illegal transactions and to avoid targeting individual “amateurs” that would require a significant increase in enforcement resources.
In addition, these rules exempt U.S. participants processing outbound, cross-border credit transactions such as ACH credits and wire transfers because there are no reasonably practical steps that a U.S. participant could take to prevent their consumer customers from sending restricted transactions across borders.
In enacting this statute, former Rep. James Leach (R-Iowa), one of the law’s principal sponsors, stated, “[b]asically, we are shutting down the payment system for Internet gaming” by making it “illegal to use a financial instrument to settle an Internet wager.”
There also are changing political dynamics surrounding Internet gaming in general and the funds transfer statute and rule in particular. Last month, the Democrats substantially increased their majorities in Congress and gained control of the White House.
Rep. Barney Frank (D-Mass.), Chair of the House Financial Services Committee, has publicly criticized what he characterizes as “midnight regulations” promulgated without much, if any, input from his committee. He has expressed concern in hearings about procedural and substantive flaws in the rulemaking process and has urged that these rules “be scrapped.” Mr. Frank also wishes to focus on the legality of Internet gaming generally during the coming Congress.
Earlier this month, The Washington Post ran a series about Internet gaming cheats and advocated legalizing Internet poker and other gaming in order to stop cheating, regulate excesses, and raise tax revenues. Links to those articles follow:
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Scott L. Fredericksen
Pamela L. Johnston
Los Angeles, California
Robert A. Burka