02/04/2010 12:00AM

Cap on signal fee rife with conflicts

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On Jan. 25, the Illinois Racing Board approved a simply stated rule that would put a cap on the amount that out-of-state tracks could charge account-wagering companies for bets made in Illinois. That simple act has opened a complex debate about the proper pricing of simulcast signals and the efforts of local racing interests to protect their territory in the Internet era.

According to supporters and opponents of the rule, the 5 percent cap is several percentage points lower than what most premium Thoroughbred tracks receive as a host track fee in the account-wagering marketplace. Ostensibly, the rule is designed to protect Illinois tracks and horsemen from rising simulcast fees by reserving a larger portion of the takeout for distribution to local interests, but many racetrack executives and horsemen's groups - including some in Illinois - contend that it artificially penalizes tracks that have the most popular and valuable signals.

The board had initially planned to implement the rule as early as Feb. 1, using emergency rule-making procedures authorized by the legislature. However, the board backed off that plan late in January after receiving a host of complaints from Thoroughbred horsemen's groups, the Churchill Downs-owned racetrack Arlington Park, and TrackNet Media, a simulcast-marketing company owned by Churchill and Magna Entertainment Corp. As a result, the board plans to post the rules for a 45-day public comment period before taking additional action.

"We're more than likely going to go through the regular procedures," said Marc Laino, the executive director of the board, on Feb. 1. "And that's because of the sensitivity and the controversy surrounding the rule itself."

The rule has revealed an array of conflicting interests that are enmeshed in a struggle over the pricing of simulcast content that is pitting account-wagering companies and racetracks against other account-wagering companies and racetracks. Also involved are horsemen's groups, which have the power to approve or reject simulcast contracts.

Led by TrackNet, many racetracks are aggressively attempting to push up host-track prices in order to squeeze out middlemen - the account-wagering companies - and reset a simulcast business model that has been criticized for awarding the lion's share of revenue to sites that are not hosting live races. But criticism of the rule is also coming from some unanticipated corners, revealing the complex web of incentives in the account-wagering market.

For example, Churchill's Arlington Park would benefit under the rule if the cap provides more money to be distributed to local interests, since it would receive more money for operating funds and purses. Churchill's account-wagering company, twinspires.com, would also benefit, because it would have to pay less for signals from premium racetracks.

However, TrackNet's primary goal is to push account-wagering host track fees well above the 5 percent cap, and because Churchill owns several tracks outside of Illinois, any effort to cap rates for its Internet platform could have dramatic effects on its national account-wagering business, while also providing a precedent for other states to attempt to place caps on host-track fees.

As if that conflict wasn't enough, Churchill has reached an agreement to buy Youbet.com, the second-largest account-wagering company by handle in the U.S. The transaction, expected to close later this year if it passes muster with government antitrust investigators, will make Churchill the market leader in account wagering and perhaps triple the number of customers using the company's account-wagering services.

"There's strange bedfellows in all these issues, all these mixed marriages," said John Johnston, the president of Balmoral Park, a harness track that supports the rule (the Illinois harness industry unanimously supports the cap). "Arlington Park would be in our position, but they're owned by Churchill, so they're serving a greater god."

Roy Arnold, the president of Arlington Park, disputed Johnston's contention that Arlington would support the rule if the track were independently owned. According to Arnold, the cap will almost certainly mean a net loss of revenue to local interests, in part because account-wagering companies will seek to keep a larger share of the revenue that would have gone to the host track if the cap were not in place. Also, Arnold said, racetracks will almost certainly seek to push the rates up for bricks-and-mortar sites in Illinois in response to the cap on the account-wagering sites.

"That's what we would do," Arnold said. "You have to make that money up somewhere."

Arnold echoed comments made by TrackNet officials that said the cap reverses years of work by racetracks to gain a greater share of the revenue from simulcasting.

"We support what most of the industry supports right now, and that's that we are no longer going to give our signal away so that other companies are making more on our product than we do," Arnold said.

Some horsemen's groups also have come out against the cap. Under the federal Interstate Horse Racing Act, horsemen must approve all simulcasting sites in a track's network, and several horsemen's groups said this week they would rescind their approvals for account-wagering distribution in Illinois if the cap is implemented.

"We're not going to let them kill us, and we told them that before the [Jan. 25] meeting," said Sam Gordon, the president of the Florida Horsemen's Benevolent and Protective Association, which represents owners and trainers at Calder Race Course and Gulfstream Park (Calder is owned by Churchill, Gulfstream by Magna). "We haven't made up our mind about the bricks-and-mortar sites, but there's no way they're getting an ADW signal from us if that cap is in place."

The Illinois Thoroughbred Horsemen's Association, for its part, has said it would support a cap, but only if that cap were 9 percent. Mike Campbell, the president of the group, said the 5 percent cap was unfair to racetracks such as Arlington that have been able to boost their host-track fees in the account-wagering market to 8 percent.

Other account-wagering companies licensed in Illinois have kept quiet during the debate, mostly so they do not appear to be supporting a rule that will benefit them financially.

"We're not going to comment on it," said John Hindman, the legal counsel for TVG, the largest account-wagering company in the U.S. "The positions were staked out by local interests, and that was how the matter was decided."

Regulatory officials in Illinois said they modeled the cap on a California law that limits host track fees to 3.5 percent, a more onerous requirement than the proposed Illinois cap. That law has been in place since account-wagering was legalized in 2002, and account-wagering companies have worked within the cap for almost a decade.

Legal experts said the constitutionality of such a cap is murky. Robert Penchina, an attorney who has represented account-wagering companies in the past (and who is currently representing Daily Racing Form in an unrelated matter), said the caps would be hard to justify in a court of law because they treat out-of-state racetracks differently than in-state tracks.

"If a state wants to prohibit an activity, they have every right to," said Penchina. "If a state wants to tax an activity, they have every right to. But when a state wants to regulate an activity in which the primary burden falls on out-of-state interests engaged in substantially the same activity as in-state interests, then it becomes challengeable."

Still, no one has lodged a legal challenge to the California cap in the eight years it has been in place. According to Scott Daruty, the president of TrackNet, that's because it hasn't been worth it, so far, to get in a legal fight in the state. That could change, however, if the cap is implemented in Illinois and other states jump on the bandwagon.

"California provides half of the account-wagering handle in this country," Daruty said. "You can't not play there, so you play by those rules."