The Wild West of Unregulated Gambling: Binary Options and Internet Cafés

A central tenet of the modern gaming industry is the prevalence of strong regulatory oversight. Particularly in North America, legal gambling is the subject of robust regulations that govern not only the licensing of industry participants and individual employees, but also typically require licensees to demonstrate ongoing compliance with applicable laws and rules. The gaming industry did not always operate under intense regulatory scrutiny. From a historical perspective, gaming activity was often conducted within the ambiguous gray area of the law or simply in outright violation of gambling prohibitions.

History has demonstrated that unregulated gambling can often fall prey to unscrupulous promoters that tilt the odds so far in their favor that it is virtually impossible for players to win. Among the many policies behind the regulation of the gaming industry is the goal to protect the public and the integrity of the games to ensure that games are fair. In the unregulated arena, there is no oversight to actually assure that games are conducted fairly and give the public confidence that games are indeed fair.

History is replete with examples of individuals that will promote scams or flaunt the law if easy money can be made. The allure of gambling and the expectation to get rich quickly is no different.

The Internet is the new frontier. The Internet has often been characterized as the Wild West. Innovative and creative individuals have adapted to offer products and develop profitable e-commerce businesses. In the mid- and late-1990s, as the use of the Internet rapidly expanded, innovative entrepreneurs launched the first i-gaming websites. At that time, i-gaming operated in, arguably, a gray area of the law in the United States. The Department of Justice (DOJ) had early success prosecuting an i-gaming operator by securing the criminal conviction in 2000 of Jay Cohen under the Wire Act. In 2006, Congress enacted the Unlawful Internet Gambling Enforcement Act, which ostensibly attempted to directly prohibit i-gaming in the U.S. through prohibitions on gambling-related money transfers by money processors, such as banks and credit card companies.

The regulated gambling industry has slowly warmed up to the concept of regulated i-gaming. In North America, several Canadian provinces have led the charge to authorized regulated i-gaming in North America. Individual U.S. states have followed suit, led by the bell-weather gaming states of Nevada and New Jersey. The expansion of regulated i-gaming in the United States has not resulted in the elimination of unregulated i-gaming. Rather, creative entrepreneurs continue to search for the next gray area that may turn a quick profit. Two Internet-related activities have gained the attention of the gaming law bar as the next wave of unregulated Internet gaming: binary options and Internet cafés.

Binary Options—Gambling or Securities Transactions?
A binary option is a bet on the outcome of a yes/no proposition. The assets underlying the proposition are usually securities or commodities.1 Binary options have been primarily marketed as securities transactions or investments. In fact, an investor can legally purchase a binary option on certain regulated securities markets in the U.S.

The common terms of the binary options offered via Internet sites provide a winning payout of $0.70 on each dollar bet. Some websites will return $0.15 on each dollar bet for losing propositions. The purchaser usually cannot sell the option. That is, once purchased, the purchaser is locked in to the proposition until the outcome is determined. Ordinarily, the binary proposition is premised on the price movement of an underlying security or commodity within a short time period. For example, a person may purchase an option on the proposition that the price of the shares of General Motors will go up or down within a five-minute period. Part of the scrutiny of the Internet binary option industry has arisen due to the mathematical probability not favoring a purchaser’s ability to be “in the money” over the long run. For instance, a purchaser usually must win more than 50 percent of the time to actually break-even or post a small gain from the purchase of binary options.2

Websites offering binary options have popped up exponentially in recent years. These websites are most often operated by Israeli companies that are based in Cyprus and ostensibly regulated by Cyprus securities regulators. The binary option websites typically do not restrict consumers from engaging in transactions based on the consumers’ geo-locations. Thus, the websites have offered the binary options to consumers in North America.

The interesting legal question pertaining to binary options is whether the purchase of a binary option is gambling or a securities transaction. At common law, gambling is defined to occur when three elements are present: consideration (the wager of something of value), chance (the outcome of the wager is premised on chance) and prize (if the outcome is in favor of the bettor, he receives something of value).

Where do binary options fall under the common law definition of gambling? No doubt the consideration and prize elements are satisfied. As is often the case in analyzing whether an activity constitutes “gambling” under the law, the analysis turns on whether the outcome is based on chance. While not offering a conclusion, a couple of points are worth nothing. First, the time period covered by the proposition is extremely short, often a five- or 10-minute period. Moreover, the options are not freely transferable by the holder after the purchase. This means that the consumer may have a short period to make a decision whether the price of a particular security or commodity will rise or fall. This raises a substantial question whether there is any opportunity for the skill of the purchaser to come into play. Second, many jurisdictions in the U.S. apply the “predominate factor test” to determine whether skill predominates over chance. Essentially, the test examines what factor—skill or chance—predominates in predicting the outcome of the proposition. The legal analysis under the predominate factor test can often be fact intensive. It is also worth noting that some jurisdictions simply examine whether any element of chance is present and yet other jurisdictions simply define a given activity (e.g., playing card games for money) as prohibited gambling.

The legal question may ultimately be academic in the U.S. The U.S. Securities and Exchange Commission (SEC) and the U.S. Commodity Futures Trading Commission (CFTC) have recently taken joint enforcement action against a website offering binary options. The SEC and CFTC take the position that the offering of binary options to consumers in the U.S. is subject to securities laws. This typically means that the option must be registered as securities unless an exemption applies. The party offering the options may also be subject to registration requirements. If the SEC and CFTC are unsuccessful in their efforts to shut down unregistered parties offering unregistered binary options, the next enforcement wave may turn to action under gaming laws.

Internet Cafés: Sweepstakes or Gambling Dens?

According to the American Gaming Association (AGA), Internet sweepstakes cafés are a $10 billion industry annually.3 The general business model of the cafés is to sell a product, typically Internet access or long-distance calling cards. The products offered often go unused by the purchasers. With the purchase of the product, the purchaser receives one or more entries to play an Internet-based game. The games are often not discernable from slot machines found on the casino floor in terms of the physical appearance of the game terminals and the actual play of the games. The games include predetermined payouts to winners in a fashion similar to sweepstakes. Internet cafés also typically offer a free method of entry to comply with typical state sweepstakes laws. The Internet sweepstakes café business model is intended to be structured in form to comply with state sweepstakes laws and, thus, convert the activity to a lawful business activity. However, state sweepstakes laws typically permit sweepstakes only where they are ancillary to the primary business of the sweepstakes offer (e.g. McDonald’s). This places the focus on what is the primary business of the Internet café. Quite often, the answer is running a sweepstakes business—which does not meet state statutory requirements for a legal sweepstakes.

While the form of the Internet sweepstakes café business model may appear to fall within the technical confines of state sweepstakes laws, the cafés have been the target of numerous high-profile enforcement actions. Additionally, state legislatures and local governments have enacted legislation aimed at curtailing Internet sweepstakes cafés. Furthermore, some state courts have construed sweepstakes laws as requiring a definitive beginning and end to the sweepstakes tied to the product promotion. Thus, offering a continuous sweepstakes to promote the sale of Internet access or telephone cards would not be a permissible sweepstakes and, consequently, would likely cause the activity to be illegal gambling.

The next frontier of unregulated Internet gaming has arrived in the form of binary options and Internet sweepstakes cafés. While the dance to get rich may have just begun for websites offering binary options and the Internet cafés, it appears that policymakers and law enforcement are both moving quickly to pull the plug on the music. That being said, creative minds will nonetheless continue to conjure up new approaches to fleece the public, challenging regulators, legislators and the courts to continue to refine what constitutes illegal gambling activity.

1 See U.S. Securities and Exchange Commission, Investor Alert: Binary Options and Fraud (June 6, 2013) available online at….
2 See, e.g., Gordon Page, Don’t Gamble on Binary Options, Forbes (July 27, 2010) available online at….
3 American Gaming Association, Internet Sweepstakes Cafés, available online at http://www.americangaming.orgt/government-affairs/priority-issues/intere….