The Interstate Horse Racing Act of 1978 is the only federal legislation with authority over pari-mutuel wagering in horse racing in the United States. Passed with broad industry support to regulate interstate wagering, the Act has not been significantly updated in the intervening 37 years to address the rapidly changing economics of the racing industry. What was intended to bring new revenue and create balance between competing interest groups, has evolved into a crippling burden that threatens to destroy the very things it was meant to protect. In a two-part story, equine attorney Joel B. Turner explains why major amendments to the Act are necessary to secure racing’s future.
Read about the history of the Interstate Horse Racing Act of 1978
Since the Interstate Horse Racing Act was passed in 1978 – and even since its only revision to date in 2000 – the landscape of American racing has drastically altered. The rise of purse supplements from alternative forms of gaming and the rapid expansion of advance deposit wagering driven by technological advances have transformed the economics of racing. Combined, these changes have rendered the Act not just impotent, but damaging to racing, while simultaneously masking the breadth and depth of their effects.
Purse supplements and handle
At the time the IHA became law, handle was the only source of purses. The migration of handle to simulcasting and ADWs has left on-track wagering a virtually meaningless part of the pari-mutuel landscape. Even at racing's most well-attended event last year, the Kentucky Derby, the 164,906 patrons at Churchill Downs wagered $23.4 million on track, just 13 percent of the total handle of $180.7 million. Overall, North American pari-mutuel handle peaked in 2003 at approximately $15.9 billion from all sources, including international co-mingled pool wagers. It has since declined 28 percent to roughly $11.5 billion in 2013.
North American purses cracked $1 billion in 2000, peaked in 2007 at approximately $1.18 billion, and since that time have floated between $1.03 and $1.12 billion, according to The Jockey Club Fact Book. A 2014 Thoroughbred Racing Associations report revealed that the approximately $1.13 billion in total purses paid in 2013 were supplemented by nearly $400 million in funds from other forms of gaming. Taking that into consideration, total purses from pari-mutuel handle were an anemic $732 million and have been virtually flat since 1992, the first year purses were supplemented by on track “racino” revenues.
Even in 2003, the year racing’s handle peaked, purses increased only marginally as a result of increased handle, with most growth coming in the form of purse supplements from other forms of gaming. Arguably, 2003 handle figures represented the peak positive effect of the IHA.. Since that time, the intended balanced distribution of the benefits afforded by the IHA has shifted markedly away from the horsemen and to the tracks that now control content by using their leverage over horsemen to drive off-track wagering dollars to their bottom line and away from purses.
The off-track wagering paradigm
Another history lesson is required to understand how the IHA has come to undercut purses. Once the Act became law, racetracks and horsemen quickly moved to enter into contracts to facilitate interstate simulcasting. The rates charged by a track for its races to be sent to off-track locations were significantly lower than on-track rates. A simplistic, but realistic example: the takeout rate for an on-track W/P/S wager would be 15 percent, which would be split roughly 7.5 percent to the track and 7.5 percent to the horsemen in the form of purses. The track would be responsible for payment of all taxes related to the wager from its half of the takeout, with the balance directed toward operating costs and profit. Pursuant to their contracts with the tracks, horsemen would allocate a certain small percentage (usually less than half a percent) to funds for backside improvement, health and welfare, or related needs.
Rates charged by the tracks for content varied somewhat by the quality of the content made available, but commonly a 4 percent simulcast fee was charged and paid 2 percent to the originating track and 2 percent to the originating track’s horsemen for purses. This rate was reciprocal among the tracks with the major racing states enjoying the most interest from simulcast operators in need of quality content.
The off-track wagers (subject also to source market fees paid in connection with bets made within a close radius to operating tracks to attempt to protect tracks from the ill effects of would be on track patrons betting at home, i.e. local market cannibalization by third-party bet takers) were co-mingled with on-track wagers, and standard takeout rates were paid on all wagers by the host tracks. When tracks valued on-track wagers, source market fees protected them from losing such patrons.
Although many small-market horsemen’s groups only consented to allow the major market content to be made available if reciprocal content agreements were in place, as a practical matter, the lion’s share of wagering was on the major market content. The initial 4 percent simulcast fees for content have been criticized by many as far too low for the value provided; small market tracks would benefit disproportionately from the value of the major market tracks’ better quality content and would be tempted to reduce racing dates and rely more heavily upon simulcasting to generate revenues.
This model remained virtually unchanged for the first 20 years following the passage of the IHA, and then a new player arrived on the scene – one that would change the wagering landscape entirely.
How ADWs changed the game
In 1999, TVG launched the first television network exclusively devoted to horse racing content coupled with in-home (then telephone) account wagering. Fast on the heels of this followed the concept of ADWs designed to take bets over the phone or on a wagering website. ADWs provided yet another opportunity to disseminate track content and develop new wagering patrons. ADWs were charged basically the same 4 percent rates as those charged to the simulcasting and OTB outlets. Because ADWs were paying only 4 percent for the content – and the actual takeout paid from the co-mingled pools ranged from 15 percent on straight wagers to 30 percent on exotics – ADWs were afforded significant margins (from 11-26 percent using the above rates, for example), which were soon being used to pay rebates to customers to entice them to bet first on the telephone and eventually on the Internet.
In 2000, because communications technology had moved into the digital world of cellular, satellite, and other forms of increasingly rapid wireless information transmission, a very narrow amendment to the IHA was passed. The amendment was intended to clarify that these wireless forms of transmission - specifically including the Internet and cellular data - were permitted. By the addition of four words, “or other electronic media…” in the definition of an “interstate off track wager,” (which had previously only permitted the transmission of betting information, “via telephone”) the IHA was adjusted to allow the use of the Internet.
What followed was a rapid expansion of ADWs using primarily online platforms. Many boutique ADWs popped up – offshore and domestic - providing opportunities for betting from virtually any location with an Internet connection. It also afforded sophisticated high-volume players access to computer-assisted and conditional wagering and nontraditional customer loyalty opportunities such as volume-based rebates. With fat margins and low overhead, the ADWs could offer benefits with which tracks, OTBs, and simulcast outlets could not possibly compete. TVG and HRTV were prompted to develop ancillary online wagering platforms, but they languished due to enormous production costs associated with their TV broadcasts. Ultimately, both were acquired by other competing wagering interests in the horse racing industry.
Some of the more nimble and aggressive ADWs prospered using rebates to lure customers away from conventional wagering outlets. In the mid ‘00s, some of the major track companies, many under new management, reassessed the wagering paradigm and saw that the ADW model, with its low-cost, high-margin opportunities, was perhaps the most profitable sector in the pari-mutuel market. If action reveals intent, the major tracks decided that ADWs could be a lucrative part of their business plans, particularly since they had an advantage provided by the IHA to be exploited – their status as providers of content. They quickly moved to acquire existing ADWs.
In the process, source market fees have vanished, as it became more lucrative for tracks to operate ADWs and increase profit margins by keeping simulcast fees low for their wholly-owned ADWs. High-volume players abandoned well-appointed on-track lounges to bet at home for 10-20 percent rebates - and it was more fruitful for tracks to drive those bettors to their wholly-owned ADWS and keep more of the margin for themselves.
Consolidation of many of the smaller ADWs soon followed, several of which were acquired by major racing companies and associations. Magna Entertainment Corporation (MEC) developed and continues to operate Xpressbet.com, and bought smaller ADWs and merged them with it. Churchill Downs, Inc. (CDI) developed and continues to operate TwinSpires.com as well as offshore high-roller rebate shop Velocity Wagering Services. Like Magna, CDI bought and merged smaller ADWs into TwinSpires.com. In 2007, CDI and MEC even formed a joint venture, TrackNet Media Group, to sell racing content controlled by the two companies to other wagering outlets. The entity was dissolved in 2010 after MEC declared bankruptcy, but during its short existence was the source of multiple disputes with horsemen's groups. The New York Racing Association (NYRA) entered the ADW space in 2007 with NYRA Rewards, and has since taken an additional step to protect its content. In 2013, legislation was passed imposing a 5 percent tax on all wagers made by New York residents through out-of-state ADWs. Pennsylvania soon followed with a similar tax. Texas went to court to ban out-of-state ADWs from operating all together and to date have succeeded at the trial court and the first level court of appeal.
Today, more and more, signals are being sold to entities not directly connected to Thoroughbred racing, and as a result, the industry receives less and less from each wager. While technological advances have expanded access to horse racing and wagering opportunities, the structure originally imposed by the IHA restricts that growth. Because the Act has not been amended to address changes in the way wagering is conducted today, it can no longer maintain the intended balance between competing interests in horse racing.
Some have tried to explain the precipitous decline in North American handle from $15.4 billion in 2007 to $11.4 billion in 2013 by citing the financial crisis of 2008 and the ensuing great recession. That is easily challenged by looking at the strong recovery as is now readily apparent by even a cursory review of many reliable economic indicators.
Others have cited competition from other forms of gaming, and there may be some validity to that argument. Although no published research exists to support the notion that racing has suffered as a result of the proliferation of casino gaming, it seems obvious. But now casino revenues are also flagging, and many facilities have been forced to close. Is the proliferation of legal and illegal sports betting to blame? Is online gambling, exchange wagering, or bookmaking to blame? Racing clearly does a poor job of analyzing and competing with other forms of gaming for the discretionary dollars. It may be that all of these activities are factors in the decline of pari-mutuel handle on horse racing in North America. Nevertheless, the most likely source of the decline is the legislation that was supposed to prevent it: the IHA.
The IHA was passed to provide a legal framework for orderly business operations consistent with public policy concerns. As with most legislation of this type, it is simply a matter of time before smart entrepreneurs (ADW operators, in this case) find an opportunity within the regulations to exploit. That is why government regulation must not be static, but should adjust to changes in the marketplace exposing an unforeseen (or as in this case, unforeseeable), unintended advantage created by such regulation.
Among other things, the IHA attempted to provide and maintain a balance among competing interests in the horse racing business by requiring, as a condition to conduct interstate wagering, the consents to any such wagers by, 1) the host racing association; 2) the racing commission with jurisdiction over the host track; and 3) the racing commission of the state where the off-track wager was placed.
As part of the contractual process, the host association and relevant local horsemen’s group were required to negotiate and agree upon the terms pursuant to which the host association could grant its consent for interstate wagering. The contracts between the track and the horsemen were to set forth the details of their economic deal, the most important of which were the rates charged for the racing content upon which interstate wagers would be placed, and certain other fee-based protections to prevent cannibalization of the local markets, i.e. source market fees.
In the early days after the passage of the Act, the horsemen readily agreed to the low rates referenced above and were able to gain certain concessions from track operators in return. But, as markets changed and the economic model began to shift more and more revenue off track, rates – until recently - stayed basically the same at 4 percent.
That 4 percent rate was initially justified by the supposition that simulcasting would create new markets for wagering patrons, and bring, essentially, an influx of money at no significant additional expense to the sending track or the receiving bet taker, with new profits and additional purse money accruing to each.
As the wagering landscape changed after the advent of ADWs, migration of the wagering dollar continued at a rapid, yet seemingly unnoticed rate. Tracks were not going to bring undue attention to this because their margins were greater for their in-house ADWs than for an on-track wager. The tracks began to capitalize in a big way on the favorable rates the nimble online ADWs had enjoyed. The independent ADWs could provide streaming video feed from each track, without the enormous television production costs incurred by TVG and HRTV. Maintaining high margins and low operating costs, the independent ADWs were very profitable, for a time. Unfortunately, the horsemen’s groups not only allowed the tracks to enter the ADW business without objection, they allowed them to do so at the same favorable rates as the independent ADWs. This actually made it far more profitable for racetracks to have its patrons make a bet using its ADW than to make a bet on-track. Less would be paid to purses and more to profits of the track-owned ADW.
The tracks did the proverbial end around on the horsemen. The horsemen’s groups did not use the bargaining power afforded by the IHA, i.e. the negotiation of fair contracts with the tracks, in exchange for the consent necessary to conduct interstate wagering, to rebalance the economic paradigm that was being used by racetracks to increase profits. In other words, the tracks successfully leveraged the horsemen. Recently the major tracks have doubled rates for content to the independent ADWs, and have cut some of them off completely, ostensibly to placate horsemen. Ironically, this too provides an added benefit to the tracks. The rate increase will squeeze the independent ADWs’ margins further and reduce their ability to rebate to encourage loyalty. Ultimately it will strengthen the track-owned ADWs with sweetheart deals on their rates from their parent content providers and diminish the ability of the independent ADWs to continue to offer innovations and much valued customer service to their patrons. It may, in fact, spell the beginning of the end for independent ADWs.
A blueprint for change?
How did this happen? It is a simple example of what is at the root of racing’s problems. The largest stakeholders by capital invested are owners and breeders of racehorses (it has been estimated that they collectively spend approximately $4 billion annually to purchase, breed, and maintain racing and breeding stock) and racing’s owners do not treat horse racing as a business. They play an insignificant role, if any, in the negotiations with the tracks or in the direct management of their assets. They delegate these responsibilities to trainers and other industry hacks with no real skin in the game. They continue to watch purses generated by pari-mutuel handle decline as the racetracks and their ADWs exploit the greater margins afforded in the off-track wagering arena and siphon profits that should be paid into purse accounts.
Horsemen’s groups are primarily populated and run by trainers, not owners and breeders. Trainers, with a few notable exceptions, rely upon racetracks for stall space, dormitories for employees, and for training facilities, without which they cannot conduct their business. That sounds very much like a landlord/tenant relationship. Is the bargaining power between the landlord and the tenant ever balanced? Can the IHA in its present form change that? The answer is no. Trainers’ interests and those of owners and breeders are not aligned. Yet trainers are left to negotiate for higher rates and better allocations of revenues to purses. Despite their earnest efforts, horsemen’s groups are no match for the business-minded management teams of major racetrack groups such as Magna, CDI, and NYRA.
To make the problem even worse, regulators stand by, underfunded and without any true incentive to pursue the offenders, acting as if licensed as well as illegal bookmakers, both on shore and off, are not actively exploiting Internet-based and conventional opportunities in racing to increase market share and pay nothing to tracks or to horsemen for purses. Horsemen’s groups do little to bring attention to this additional loss of wagering dollars and drain upon purses. The tracking of profitable versus unprofitable players by bookmakers is child’s play in the sophisticated world of data monitoring. Laying off into pari-mutuel pools or dropping the few profitable players is commonplace, further adversely affecting the liquidity in legal pari-mutuel pools, a practice of which many regulators are either unaware or choose to ignore. But these are subjects for another discussion.
For the first 25 years following the passage of the IHA, the legislation served its intended industry wide purpose - facilitating cooperation among states to further the racing and legal off-track betting business and protect competing stakeholders from unfairly capitalizing on racing content. For the 10 year period from 2003-2013, a dramatic shift in the allocation of racing revenues took place with the tracks and track owned ADWs successfully exploiting the IHA to push dollars to their bottom lines and away from purse accounts. In 2013, multiple jurisdictions passed new taxes on wagers placed by their citizens using out-of-state ADWs. This will likely prove to be a harbinger of increased conflict among the states in the interstate wagering space. It signals that the IHA needs to be reevaluated. The pace of technological innovation has changed the horseracing landscape forever. The economic paradigm has shifted, and no longer fairly protects the competing interests in the horse racing and legal off-track betting businesses in this country.
The IHA also tried to strike a balance among the participants in horse racing to ensure that none of the three major stakeholders (tracks, racing commissions, or the horsemen) could take undue advantage of another and cause an interruption in the commerce (interstate wagering on horse races) it desired to protect. In this attempt, the IHA has failed. The imbalance now existing between the vertically integrated major racetrack operators (they own their own tote companies, racing data companies, ADWs, and closely control branding and sponsorship opportunities) and the horsemen is being fueled in large part by the unchecked redistribution of wagering activity from on-track to off-track.
This critical shift has occurred without an appropriate economic adjustment to rebalance the inequitable distribution of revenues from off-track wagering that threatens the future of horse racing. This threat has been masked by the influx of alternative gaming-based purse supplements to maintain the status quo overall purse distribution in North America in the range of approximately $1.2 - $1.3 billion dollars per year for the last 14 years. During this same period, supplements from other forms of gaming have grown to more than 35 percent. Horse racing cannot expect these supplements to continue into the future nor should it rely upon them to shore up or mask an inequitable business model. To do so could be terminal to horse racing in its present tenuous form.
Legislation fostering commerce among the states always has an immediate economic component prompting its passage. Such economic considerations are not static, nor should be the legislation enacted to address them. Horse racing interests were fortunate to be able to come together to pass the IHA in 1978 and amend it in 2000. The Act facilitated the development of a new economic model for wagering on horse racing. Unfortunately, the legislation passed 36 years ago could not contemplate the revolutionary changes in technology. Nor could it anticipate the manner in which the IHA would be exploited by the economic forces at play in the horse racing business.
It is time for the stakeholders in horse racing to reconvene to revisit the IHA, reevaluate how the scales can be rebalanced, and amend the Act to address the challenges it has created and which are now facing a troubled industry. A simple change to redefine the stakeholders responsible for negotiating the contracts with the content providing tracks and receiving tracks could breathe new life into racing, force it to take stock in the economic realities of the 21st century and adjust accordingly for the long-term good of the entire industry, not just one sector. Owners and breeders should have a seat at the table and should not delegate or abdicate this critical process to others less able to stand on equal footing with competing interests. A further - yet limited - amendment to the IHA to correct the unforeseeable imbalance it has fostered can be an instrument of positive change in the horse racing business.
Joel B. Turner is chair of the equine law group at the Kentucky-based law firm Frost Brown Todd LLC and is involved in a full range of equine legal services; syndicate, co-ownership, partnership and limited liability company agreements, equine lending documentation, purchase and sale agreements, private and public placements, administrative hearings and appeals, gaming regulatory matters, tax and estate planning, and litigation. He is knowledgeable in racing legislation in the United States and is actively working with horsemen throughout the country to attend to the needs of breeders, owners and trainers.