ON INNOVATION BEING OFF-SHORED FROM THE US, GROKSTER ET AL

LET THE PARTY BEGIN...HERE TOO

VC Fred Wilson posted the following reaction to the Grokster ruling yesterday:

It's a terrible decision, a really bad precedent, and I guess it means more innovation will happen outside the US going forward and less will happen here.

Because you can't stop technology and its a flat world.

Funnily enough, I felt the exact way yesterday for a different reason.  Not because of the Supreme Court's decision on Grokster, which I think is OK for technology innovation in the US, but because a ten billion dollar market cap Internet company went public outside our shores, with no US interests benefiting as investors, employees, or services suppliers.

I'm referring of course to the successful and wacky IPO of PartyGaming of course, a company based in Gibraltar (as in "rock of"...and now "rock on"...).  As noted on the company's "careers" page, it's a right, nice place to live in with a lot of benefits, of course if you have these silicon valley skills.

If you haven't heard the story yet, the New York Times has a great piece on it, brought to you here in its entirety without registration requirements, by TuscaloosaNews.com.  Here are a couple of snippets that might catch your eye:

The company had revenue of just $9 million from its poker business in 2002; by the end of 2004, revenue had climbed to more than a half-billion dollars.

and the crux of the matter that made me empathize with Fred:

But there will be no Wall Street investment houses lapping up fees in the giant deal, no victory dances in the offices of American corporate lawyers. That is because PartyGaming, based in Gibraltar, has no assets in the United States, and its officers or directors could risk being served with a civil suit - or an arrest warrant - if they came to the United States on business.

The reason? The Justice Department and numerous state attorneys general maintain that providing the opportunity for online gambling is against the law in the United States - and PartyGaming does it anyway. Indeed, of its $600 million in revenue and $350 million in profit in 2004, almost 90 percent came from the wallets and bank accounts of American gamblers.

To justify this, PartyGaming walks a very thin line. Providing online gambling is not illegal per se in the United States, the company argues - federal prosecutors just say it is. The company has already received an e-mail message from the Louisiana attorney general demanding that it cease providing online gambling in that state; PartyGaming simply ignored the communication and waited for additional action that never came.

Reuters, via Yahoo! has another informative story on how the four founders have benefited to the tune of billions. 

Very salacious reading, and the media will likely live off this story for some time, what with "a California lawyer who earned her first fortune in online pornography and phone-sex lines" and two new Indian "Larry and Sergey" types across the pond . 

But again, the economics of the business are more eye-popping:

PartyGaming, which does not take a risk in the game but takes a "rake" of the pot, now reaps a profit of almost $1,000 every minute as it pulls in revenue of $100,000 every hour of the day. Up to 70,000 people play simultaneously on its sites.

Pretty amazing, huh...presumably 90% of the company's revenues come from US customers, yet the company "has no assets" in the US...talk about off-shoring genius.  Hello, Lou Dobbs, you wanna see "Exporting America"?

Here's why this newest Internet "success story" is borne off the ambiguities and murkiness of historical US legal statutes, much like the issues in the Grokster case.  As the New York Times story explains:

And American law enforcement argues that providing online poker is simply illegal.

It is called the Interstate Wire line Act - known colloquially as the wire act. Passed in 1961 and aimed primarily at mobsters, the law prohibits anyone involved in the gambling business from using wire communication to transmit bets on "sporting events or contests."

The question becomes this: Is poker a contest? The Justice Department has historically maintained that it is and, as a result, has argued that operators of online poker, including PartyGaming, are acting in violation of the law.

But it is hardly that simple. In an astonishing bit of luck, in 2001 - just as PartyGaming was preparing to start its poker business - Federal Judge Stanwood Duval in New Orleans ruled in a case pertaining to MasterCard International that the wire act "does not prohibit Internet gambling on a game of chance." That position has since been upheld by the Fifth Circuit Court of Appeals.

Due to these uncertainties, the established and institutionalized US gaming industry is fated to watch the US gambling action move off-shore without being able to do much about it.  And the US itself increasingly steps with other governments and world regulatory organizations on this matter.  Again, from the Times article:

Indeed, among international bodies and foreign governments, the American position on Internet gambling is becoming an object of derision. A 2003 report by the Department for Culture, Media and Sport in Britain, for example, found that there was a "growing global market for online gambling where national boundaries" no longer had any meaning.

So you may see why after looking at the PartyGaming IPO, followed by the Grokster case decision yesterday, I too was pessimistic for a moment, of tech innovation flowing away from the US.  But of course, it's not "tech innovation" we're talking about...it's the regulatory and legal environment that is going to dictate how meaningful chunks of new, digital businesses operate, and where.

 

Comments

[Alex Rowland]

Yeah. The problem is not where the business operate, but where the profits ultimately get spent. There will be no shortage of coutries looking to provide attractive regulatory arbitrage havens for companies like PartyGaming. But I don't see how the US can backtrack on everything. We're a highly regulated entity. I say let other coutries benefit from there opportunities. They'll need all the help they can get and the result will still be greater benefits to all consumers, regardless of physical location. I think the sooner everyone starts to see themsleves as citizens of the world and not one specific country, the better.