All bets are off for online gambling

The sector and its investors need the US market, but operating there is a game of Russian roulette

It's not as if the warning signs weren't there. Laws were already in place and loopholes were being closed; Wall Street lawyers were advising clients not to get involved; and listing prospectuses spelt out the risks. So if you didn't know that online gambling in the US was at best a grey area and at worst outright illegal, you didn't really have much excuse.

But still, the arrest of BetonSports's chief executive sent shock waves through the industry. "We're not saying anything officially, for the obvious reasons," says a source close to a rival online operator. "But it has not been a great week."

En route from London to Costa Rica, David Carruthers was sitting in a transit lounge in Dallas Fort Worth airport when the FBI arrested him last Sunday on charges of racketeering conspiracy. After spending the week in custody, he was transferred to Missouri, where the case will be heard. An application for bail is expected to be made later this week. An arrest warrant still remains for founder Gary Kaplan.

There have already been dire consequences for the company. When the news broke, its market value slumped by 20 per cent. On Tuesday, at BetonSports' request, the shares were suspended. And on Thursday it announced it had complied with a US restraining order and closed around 85 per cent of its online gambling business, leaving only its Asian websites.

The only glimmer of hope came from reports that a deal had been struck with the US Department of Justice (DoJ), but the rumours were firmly rebutted by the company.

"It's going to be immensely difficult for BetonSports to recover from this," says one analyst at a leading investment bank, who asked not to be named. "People are going to continue gambling, and so in the medium term they are going to use other sites. Whether they will reopen accounts with BetonSports when all this is over, I don't know."

But the shock has been felt not only by BetonSports, which is listed on the London market but based in Costa Rica, with subsidiaries and staff in the US.

Shares across the online gaming and gambling sector have dived and companies are becoming twitchy. A big industry conference, bodog.com, due to be held in America, has been postponed and will now be held outside the US. No one wants to speak openly for fear of fanning the flames.

"Is this just about BetonSports or are we all going to be tarred by the same brush?" asks the gaming industry insider. "What are the ramifications?"

Other online operators have tried to distance themselves from the crisis. "Following recent events in the US, the board of ukbetting reiterates that it is the group's long-standing policy not to take wagers from the US," was that company's terse statement.

But many others do take these bets. The US is a huge market for gaming and gambling, and some groups earn the vast majority of their revenues from American punters. At Party- Gaming, the figure is around 87 per cent; at Sportingbet it's 65 per cent. Listing prospectuses all warn about the US legal position, but that has not stopped investors piling in.

The relevant law is the Wire Act, introduced in 1961 to crack down on gambling networks run by organised crime. Under the Act, it is illegal for a business to take bets on a sporting contest over any form of wire communication. As the industry has moved on, however, the Act has become ambiguous. For example, what about non-sports gambling, such as poker? And while there is a widespread acceptance that the Act applies to the internet, the growing adoption of wireless links is now undermining this.

Which is why, to avoid the murk, most operators are based offshore. This means that the country's authorities should have no jurisdiction over their trading activities, and that management will be safe - as long as they stay out of the US. But with the City already on edge over the NatWest Three and the controversial Extradition Act, few are taking anything for granted.

Then there is the so-called Goodlatte-Leach Bill. Introduced by two anti-gambling Republicans, Jim Leach and Bob Goodlatte, the Bill is designed to widen the Wire Act's scope, allowing the DoJ to go after all forms of online gambling and not just sports betting.

Congress passed the Bill earlier this month. But shares in the sector actually rose as analysts predicted that, in a busy election year, it was unlikely it would pass through the Senate and into law in the near term.

Most also believed that with the Bill only recently approved by Congress, any legal action against the sector under the current Wire Act would be delayed until it had gone through the Senate. "I was surprised. Everyone was," notes the analyst.

The most pressing question for companies now, however, is whether this is about the US market in general or a BetonSports-only investigation. Founder Gary Kaplan, for instance, has been arrested before - on gambling charges in New York in 1993 - and BetonSports has faced civil proceedings in New Jersey for running books on sports events, although it said in its listing prospectus that the action appeared to have "lapsed".

Many are holding on to this. Says one industry figure, who asked not to be named: "If you read the indictment, nearly every- thing relates to sports wagering. The intimation I'm getting is this is isolated to BetonSports and the way it has conducted its business."

PartyGaming was at pains last week to point out that it is not involved in sports betting.

Others, however, are more pessimistic. "Some of this is obviously specific to BetonSports," says the analyst. "But other parts of this are a benchmark. "It's a testing - about how the DoJ is going to interpret the Wire Act."

And on one thing he is adamant: "The DoJ is making a clear statement about its attitude to online gaming."

Should the Goodlatte-Leach Bill become law, the omens are not good. Even before this, Wall Street lawyers were advising investor clients to resist the boom and avoid the sector. Now it looks as if they could be proved right.

"The news is negative for the US-facing online gaming names," notes Patrick Hargreaves, an analyst at Goldman Sachs. "Although the arrests do not mean there is any certainty of conviction, they will heighten the uncertainty over the legal outlook for Sportingbet, in particular, given the apparent focus on sports betting.

"In a worst-case scenario, it is not entirely in inconceivable that the US could cease to be a viable market for online gaming firms."

In the past few years, online gaming and gambling has soared in popularity, with both punters and the City. But those warning signs are becoming harder to ignore: the party could be over.

WHO'S WHO IN INTERNET GAMBLING?

PartyGaming

Listed last year, the Gibraltar-based firm runs various casino sites, including PartyPoker.com. It reported pre-tax profits of $558m (£300m) last year.

888 Holdings

Runs 888.com and claims to be the world's biggest online casino. Like PartyGaming, it is listed in London but based in Gibraltar. Profits came in at $67m last year.

BetonSports

The Costa Rica-based group, listed on the Alternative Investment Market (AIM), offered gambling on American football, basketball, baseball and other events. Revenues were $978m in 2005. Of this, some 60 per cent is thought to have come from the US.

Sportingbet

The AIM-listed company, which acquired Paradise Poker in 2004, is expected to produce sales of £1.9bn this year.

Ladbrokes

Owns over 2,000 bookmakers but online gaming and gambling is a growing part of the business.

William Hill

Another bookmaker that now has a profitable internet businesses.

Betfair

A betting exchange, which allows punters to lay and match bets online. Tipped for a flotation.

Sporting Index

A spread-betting firm that claims 70 per cent of the UK market.

By Miranda McLachlan