Economic Analysis of the

Final Rule for 25 CFR Parts 502, et al.

For the

National Indian Gaming Commission

Submitted by:

August 25, 2008

Table of Contents

Executive Summary .......................................................................................................i

Relation of this Analysis to Previous Analyses .....................................................................i

Number of Affected Entities under Different Baselines .........................................................ii

Social Costs.............................................................................................................iii

Social Benefits of the Regulation.................................................................................... v

Summary of Social Costs of Alternatives ........................................................................... v

Chapter 1: Introduction and Background to the Issue ....................................................... 1-1

Purpose of this Analysis ............................................................................................ 1-1

Summary of Statutory Framework ............................................................................... 1-1

Regulatory History .................................................................................................. 1-2

Regulatory Alternatives ............................................................................................ 1-5

Economic Framework for this Analysis .......................................................................... 1-6

Relation of this Analysis to Previous Analyses ................................................................. 1-8

Organization of the Analysis ...................................................................................... 1-9

Chapter 2: Provisions of the Regulation......................................................................... 2-1

25 CFR Part 502 ..................................................................................................... 2-1

25 CFR Part 546 (Referenced in Part 502)...................................................................... 2-2

25 CFR Parts 542 (Deleted) and 543 ............................................................................. 2-3

25 CFR Part 547 ..................................................................................................... 2-4

Summary of Incremental Changes................................................................................ 2-5

Chapter 3: Market and Regulatory Conditions for Affected Entities....................................... 3-1

Number of Affected Entities if Current Market Conditions Continue ...................................... 3-1

Minimum Internal Control Standards...................................................................... 3-2

Technical Standards.......................................................................................... 3-2

Definition of Class II and Electronic Facsimile .......................................................... 3-3

Effects of Recent Compacts ................................................................................ 3-5

Growth Rate of Class II Machines .......................................................................... 3-6

Number of Class II Machines Affected by the Rule ..................................................... 3-9

Summary of Entities Affected under the Current Practices Baseline ............................... 3-9
ii

Number of Affected Entities if Greater Enforcement Occurs ............................................... 3-9

Legal and Regulatory Baseline ............................................................................ 3-10

Factors Affecting Future Commission Activity and Market Activity without

Regulatory Change .......................................................................................... 3-11

Projected Class II Machine Compliance Rate with Increased Enforcement ....................... 3-15

Summary of Entities Affected under the Greater Enforcement Baseline.......................... 3-15

Chapter 4: Social Costs .............................................................................................. 4-1

Social Costs for MICS and Technical Standards ................................................................ 4-1

Social Costs for the Classification Standards: Changes in Consumer Demand .......................... 4-2

Measuring Consumer Demand: Pre-Regulation Demand .............................................. 4-2

Measuring Consumer Demand: Change in Game Duration............................................ 4-2

Measuring Consumer Demand: Net Gaming Revenue After Shift from Class III to Class II ..... 4-3

Costs of Minimum Internal Control Standards.................................................................. 4-4

Promulgation of Tribal Rules ............................................................................... 4-4

Increased Cost of Contracting Certified Public Accountants ......................................... 4-5

Retraining Enforcement Officials and Operation Personnel .......................................... 4-5

Security ........................................................................................................ 4-6

Caveats ......................................................................................................... 4-6

Total Cost of Revised MICS.................................................................................. 4-6

Costs of Technical Standards ..................................................................................... 4-6

Cost of Modifying Machines ................................................................................. 4-7

Contracting with a Laboratory to Conduct Certification Testing .................................... 4-8

Administrative Cost to NIGC............................................................................... 4-10

Costs of Definitions and Classification Standards ............................................................ 4-10

Alternatives Considered and Categories of Costs ...................................................... 4-10

Replacement and Reprogramming Costs ................................................................ 4-11

Effect of Grandfathering Provision....................................................................... 4-13

Direct Gaming Revenue Losses............................................................................ 4-15

Non-Gaming Revenue Loss ................................................................................. 4-18

Potential Lost Jobs for Tribal Members ................................................................. 4-19
Loss in Bargaining Power................................................................................... 4-20

Summary of Social Costs of Alternatives ....................................................................... 4-21

Summarized Comparison with February 2008 Analysis ...................................................... 4-21

Chapter 5: Social Benefits .......................................................................................... 5-1

Benefits of Minimum Internal Control Standards .............................................................. 5-1

Preventing Externalities from Fraud ...................................................................... 5-1

Regulation as the Most Efficient Approach to Reducing Fraud ....................................... 5-7

Benefits of the Definitions and Classification Standards..................................................... 5-8

Avoidance of Litigation...................................................................................... 5-8

Increased Legal Certainty Reduces Capital Costs....................................................... 5-9

Protection of the Integrity of the Law................................................................... 5-11

Appendix 1: Gaming Facilities with Class II Machines by State............................................. 6-1

Appendix 2: Summary of Opinions and Decisions Concerning the Scope of

Class II and Class II Bingo ............................................................................ 7-1

What Constitutes as Class II Gaming ............................................................................. 7-1

Types of Bingo ................................................................................................ 7-1

Pull-Tab ........................................................................................................ 7-2

What Does Not Constitute as Class II Gaming and Thus is Class III Gaming ............................... 7-2

Bingo............................................................................................................ 7-2

Pull Tab ........................................................................................................ 7-2

Important Cases and Advisory Opinions .................................................................. 7-3
iv

Tables and Figures

Table ES-1: Summary of Affected Entities ..........................................................................iii

Table ES-2: Estimated Non-Gaming and Employment Losses ..................................................... v

Table ES-3: Summary of Costs for the Rulemaking Alternatives ................................................ vi

Table 2-1: Summary of Proposed Regulatory Changes and Affected Entities .............................. 2-6

Table 3-1: Total Number of Class II Machines in 2006 .......................................................... 3-3

Table 3-2: Future Reduction in Class II Machines in States with Recent Compacts........................ 3-6

Table 3-3: Growth in Class II Machines ............................................................................ 3-8

Table 3-4: Predicted Number of Class II Machines............................................................... 3-8

Table 3-5: Summary of Affected Entities in Current Market Scenario ....................................... 3-9

Table 3-6: Hypothetical Decision Analysis of Choice to Install New Machine.............................. 3-12

Figure 3-1: Past and Projected NIGC Expenditures ............................................................. 3-13

Figure 3-2: Past and Projected NIGC Staffing ................................................................... 3-14

Table 3-7: Summary of Affected Entities in Greater Enforcement Scenario............................... 3-15

Table 4-1: Cost of Certification to Part 547 Standards ......................................................... 4-8

Table 4-2: Budget Estimate for Machine Compliance Department .......................................... 4-10

Table 4-3: Annualized Cost of Replacement and Reprogramming Costs Assuming

50 Percent Compliance Rate (in $ millions) ........................................................ 4-15

Table 4-4: Comparison of Per Capita Income.................................................................... 4-17

Table 4-5: Lost Revenue Associated with Compliance with Revised Proposal............................. 4-18

Table 4-6: Decrease in Gaming Revenue in the Greater Enforcement Scenario .......................... 4-18

Table 4-7: Estimated Non-Gaming and Employment Losses .................................................. 4-20

Table 4-8: Summary of Costs for the Rulemaking Alternatives............................................... 4-21

Table 4-9: Comparison of Major Differences Between the Analyses ........................................ 4-22

Table 5-1: Top Five Victim Organizations, by Frequency ...................................................... 5-3

Table 5-2: Selected Occupational Fraud Schemes in the Industry............................................ 5-3

Table 5-3: Median Loss Based on Presence of Anti-fraud Controls ........................................... 5-4

Table 5-4: Breakdown of Primary Internal Control Weaknesses by Scheme Type ......................... 5-5

Table 5-5: Comparison of Regulatory and Litigation Transaction Costs ..................................... 5-9
Table 5-6: Long-Term Debt Borrowing Rates for Multimedia Games ........................................ 5-11

Table A2-1: Summary of NIGC Opinions Related to Bingo, Pull Tabs, and Similar Games ................ 7-3

i

Executive Summary

The purpose of this analysis is to provide a comprehensive estimate of the social benefits and costs of

possible final rule options that the National Indian Gaming Commission (NIGC) can take to address

classification and technical issues of various gaming activities by Indian tribes.

Specifically, this analysis examines the benefits and costs associated with four regulatory sections

proposed by the National Indian Gaming Commission in May 2006 and revised in October 2007

1 which

include the following:

 the definition of “Electronic or Electromechanical Facsimile” in Part 502 of the existing

regulations;

 the Classification Standards for Bingo, Lotto, other games similar to Bingo, Pull Tabs and

Instant Bingo as Class II Gaming When Played Through an Electronic Medium Using ‘‘Electronic,

Computer, or Other Technologic Aids’’ in Parts 502 and 546 of the existing regulations;

 the Minimum Internal Control Standards (MICS) for Class II gaming in Parts 542 and 543; and,

 a new Part 547 to the Commission’s regulations establishing technical standards for electronic,

computer, or other technologic aids used in the play of Class II games.

This analysis examines the following three regulatory alternatives available to the NIGC:

 The first option is to take no action;

 The second alternative is to promulgate the 2007 proposal in total; or,

 The third alternative is for the NIGC to promulgate the proposed MICS and technical standards

for Class II facilities and machines.

Relation of this Analysis to Previous Analyses

The goal of the analysis is to update and to supplement the analysis performed for the Commission in

February 2008.2This update reflects important additions to that analysis:

1. Affected Facilities. This analysis adopts significant changes in the market, specifically the

adoption of gaming compacts by states representing a substantial share of the recent Class II

gaming market. In addition, this analysis considers several potential future scenarios from

which to measure the costs and benefits of the final regulation.

1

See 72 FR 60482.

2 Meister, A. The Potential Economic Impact of the May 2006 Proposed Class II Gaming Regulations, Analysis Group, February 1, 2008.
ii

2. Costs. The analysis reexamines some of the key assumptions regarding replacement cost and

revenue losses used in the February 2008 analysis. In addition, it systematically attempts to

examine the impact of the grandfathering provision on the cost of the rule. The analysis will

also attempt to update the costs associated with the other parts of the rule in addition to the

classification standard.

3. Benefits. Previous economic analyses were intended to be an analysis of potential costs and

economic impact on tribes. As such, they considered primarily the worst-case cost impact and

did not consider the social benefits of the regulation. This document describes and, where

possible, quantifies the benefits of the regulation.

Number of Affected Entities under Different Baselines

When estimating the future effect of the regulation, the analysis must project the current and future

number of affected entities. This projection requires predictions of not only how market forces will

change the number of entities, but also how the regulation will affect them.

The Class II industry is expected to continue its growth. Where states and tribes have negotiated new

compacts, the gaming operators are expected to convert their Class II machines rapidly into Class III

machines. Under these conditions, this section estimates the number of gaming entities and tribal

gaming authorities that must comply with MICS. It also estimates the number of entities that must

comply with the technical standards. Finally, we present our estimated number of compliant and noncompliant Class II machines and the future growth rate of Class II machines.

There are two major issues in establishing the appropriate baseline for measuring the incremental

benefits and costs of the classification standards. First, the size of the Class II market has changed

dramatically in the past four years. Second, technology has moved faster than the regulatory system in

this industry. As a result, under current practices in the industry, operators run a number of gaming

machines that NIGC believes do not meet the definition of Class II under Indian Gaming Regulatory Act

(IGRA), current regulations, or any previous case-by-case determination made by the NIGC. As a result,

the baseline in practice may not represent the baseline under the current law as interpreted.

Guidance for benefit-cost analysis recommends using different baselines when current practice is

different than full regulatory compliance. We present both baselines (current practices or greater

enforcement) to measure the effect of the final rule and its alternatives.

Table ES-1 below lists the entities which will have compliance costs with the proposed regulation,

assuming NIGC increases enforcement and compliance oversight.
iii

Table ES-1: Summary of Affected Entities

Social Costs

A change in the regulations that changes

the types of gaming machines that are

available, the gaming experience, or the

revenue potential of gaming, imposes

new costs on a variety of stakeholders.

Casinos and tribes lose potential

revenues; consumers lose entertainment

value; game manufacturers potentially

lose revenue; ancillary services (hotel,

food service, etc.) lose revenue. In

addition, although it is not a separate

and independent cost traditionally

considered in benefit-cost analysis, a

reduction in gaming activity could result

in fewer opportunities for employment

(for both tribal and non-tribal

individuals).

The various sections of the proposed rule

impose costs on different stakeholders in different ways. Promulgation of the MICS would impose costs

primarily on tribal regulators and gaming operators. The proposed rule requires that tribal regulatory

authorities revise their existing regulations to incorporate the new control standards for paper bingo

and electronic bingo and similar games. The resources expended by the tribes in revising their rules

are social costs of the rule.

In addition to the costs to tribal regulators, gaming facility operators also face additional costs as a

result of the rule. Gaming operators must devote resources to updating their own systems to ensure

compliance with the revised regulations. Gaming operators must also ensure that their employees are

properly trained to implement the revised control systems; such training involves a real expenditure of

resources. Lastly, gaming operators may need to devote additional resources to the actual

implementation of the revised MICS. The revised MICS require additional Certified Public Accountant’s

(CPA) time and may require the dedication of new staff to the performance tasks required by the

revised MICS.

To comply with the technical certification requirements, operators must submit Class II gaming

machines for testing and certification before they can be used in a Class II facility. The resources

associated with conducting and documenting the results of such tests are social costs attributable to

the rule.

In addition, if major changes in machines were required to meet the certification standards, the rule

would also result in additional social costs through increases in development costs. Since game

manufacturers are already familiar with the types of requirements contained in the technical standards

due to their operation in other markets, we do not assign an increase in development costs to this rule.

Since we also have no reason to believe that certifiable machines will be inherently more expensive

than machines already on the market, we have not included a cost to account for increased

manufacturing costs.

Provision Number of

Entities in

2006

Number of

Entities in

2017

MICS 161 161

Tribal Regulatory

Authorities

72 72

Tribal Regulatory

Staff

900 900

Gaming Systems 25 25

Class II Machines –

Current Practice

50,950 5,000 – 20,000

Class II MachinesGreater Enforcement50,950 2,500 – 10,000
iv

We do, however, account for accelerated upgrade of existing systems to meet the technical standards

within five years of the effective date of the rule. In fact, we over account for these costs by assuming

that in the absence of these standards, such upgrades would never occur. We calculate that operators

will be required to spend $25.5 million five years after the effective date of the rule to resolve any

residual issues relating to the ability of existing capital stock to meet the technical requirements. This

one time expenditure increases the annualized cost of the rule by $2.6 million.

The social costs associated with a change in the standard for Class II games are less intuitive. While

the rule requires some additional resources to be expended to convert games from non-compliant to

compliant games, the primary measure of social cost is how consumers react to the change in the

gaming experience. We use changes in net gaming revenue as the best measure of the change in

consumer demand caused by the proposed Class II standards.

In addition to the lost revenue from changes in consumer demand, operators and gaming manufacturers

may face additional costs associated with the proposed rule. Even though consumer demand is

reduced, gaming operators may not be able to meet this reduced demand with the same machines.

While Chapter 4 estimates conversion costs, the reduced consumer demand comprises the majority of

social costs.

Unlike the MICS and the technical standards, for which the only alternative we examined was the

proposed option relative to a baseline of not adopting new standards, we evaluate alternative

scenarios in estimating the costs of changes to the classification standards. We evaluate the revised

proposal baseline that includes increased enforcement of existing standards.

Tribes also derive revenue and consumers derive benefits from non-gaming activities at casinos,

ranging from hotel services to entertainment. However, for the majority of these facilities, demand

for these additional services did not exist before gaming was established. Therefore it is logical to

assume that there is some connection between gaming revenue and non-gaming revenue, especially

where the fall in gaming revenue is significant – probably indicating a drop in the number of consumers

as well as consumption per consumer.

Gaming operators hire workers and invest capital to offer Class II gaming. Since the rule reduces

consumer demand for Class II gaming as it currently is offered, operators will cut back on employment

and their investments. In this way, the losses due to shifts in consumer demand already include the

direct loss of wages.

Table ES-2 presents the estimated gaming and non-gaming revenue loss and the associated potential

number of workers that could lose their jobs. Total job losses are estimated to be 280 to 920 positions.

If employment reductions are equally applied to tribal members and non-tribal members, the

employment impact for tribal members is estimated to be between 71 and 231 jobs on an annualized

basis.

The estimates are created using national average values in several instances. This approach masks

variations in job loss and nongaming revenue losses. If a tribe depends on the nongaming revenue for a

more significant share of the operation’s profitability or if the revenue per machine per day is much

lower than the national average, the employment and revenue losses could be more significant.
v

Table ES-2: Estimated Non-Gaming and Employment Losses

Greater Enforcement Baseline

Annualized Decrease in Gaming Revenue

Revenue

Loss

(mil $2006)

Non-Gaming

Revenue

Loss

(mil $2006)

Total

Gaming

Organization

Loss

(mil $2006)

Potential

Lost

Jobs

Lost Jobs

for Tribal

Members

Class II Only Lower Bound (5%) 7.5 0.3 $7.8 80 20

Upper Bound (17%) 15.4 0.7 $16.1 164 41

Class II and III Lower Bound (5%) 19.3 0.8 $20.1 206 52

Upper Bound (17%) 47.5 2.0 $49.5 506 127

Total Lower Bound (5%) 26.7 1.1 $27.8 284 71

Upper Bound (17%) 62.9 2.7 $65.6 670 168

Current Market Conditions Baseline

Annualized Decrease in Gaming Revenue

Revenue

Loss

(mil $2006)

Non-Gaming

Revenue

Loss

(mil $2006)

Total

Gaming

Organization

Loss

(mil $2006)

Potential

Lost

Jobs

Lost Jobs

for Tribal

Members

Class II Only Lower Bound (5%) $13.6 0.6 $14.2 145 36

Upper Bound (17%) $23.1 1.0 $24.1 246 62

Class II and III Lower Bound (5%) $31.5 1.4 $32.9 336 84

Upper Bound (17%) $63.3 2.7 $66.0 674 169

Total Lower Bound (5%) $45.1 1.9 $47.0 480 120

Upper Bound (17%) $86.5 3.7 $90.2 922 231

Social Benefits of the Regulation

The social benefits accrue from reducing the externalities arising from preventable fraud, the

increased public goods from more revenue available to promote tribal welfare, lowering unnecessary

litigation, and strengthening of the Congressional process to resolve externalities outside of tribal

boundaries.

Summary of Social Costs of Alternatives

Table ES-3 summarizes the social cost of the rule for the three alternatives. Without a regulation,

there are no incremental changes in social benefits and costs. Promulgation of the MICS and technical
vi

standards is estimated to cost $7.8 million annualized over ten years at a seven percent real discount

rate. Promulgation of all four components of the October 2007 proposed rule will have estimated

social costs of between $36 million to $98 million (annualized over 10 years at a seven percent discount

rate). Since these estimates likely overstate social costs, the expected value is toward the lower end

of the range. Based on these estimates, promulgating the MICS and technical standards would not be a

“major rule” under the Congressional Review Act.

Table ES-3: Summary of Costs for the Rulemaking Alternatives

Alternative Costs under Current

Practices Baseline

($ mil 2006)

Costs under Greater

Enforcement Baseline

($ mil 2006)

No Regulation 0 0

MICS and Technical Standards 7.8 7.8

MICS, Technical Standards,

Classification Standards, and

Definitional Changes

55 - 98 36 -73
1-1

Chapter 1: Introduction

and Background to the Issue

Purpose of this Analysis

The purpose of this analysis is to provide a comprehensive estimate of the social costs and social

benefits of possible final rule options that the National Indian Gaming Commission (NIGC) can take to

address classification and technical issues of various Indian tribal gaming activities. The focus of the

analysis is not exclusively on the benefits and costs to tribes, but seeks to examine the impact of the

regulatory alternatives on society as a whole – both tribal and non-tribal entities.

Specifically, this analysis examines the implications associated with four new and revised regulatory

sections proposed by the National Indian Gaming Commission in May 2006 and revised in October 2007.3

As proposed, these regulatory provisions would change four major sections of the existing regulations

governing the operation of Class II games by Indian tribes:

1. The proposal would have updated the Minimum Internal Control Standards (MICS) applicable to

the operation of bingo and bingo-like games.

2. The proposal would have added technical certification requirements for Class II systems and

games similar to those that are in place in many non-tribal jurisdictions governing the

operation of Class III gaming machines (e.g., slot machines).

3. The rule would have clarified the definition of electromechanical facsimile of a game of chance

consistent with interpretations made by the Commission in individual cases.

4. The proposal also would have clarified the definition of bingo, lotto, pull tabs, other games

similar to these, and “electronic or electromechanical facsimile” consistent with findings made

by the Commission in individual cases.

In this chapter, we give the statutory background to Class II gaming and the history of these

regulations. We also present the different alternatives for the final regulation analyzed in this

document. We discuss how we apply economic theory and the practice of benefit-cost analysis to

these regulations. Finally, we summarize how this analysis supplements and updates the February 2008

economic analysis of the proposed regulation. All of these topics are discussed in more detail in

subsequent chapters.

Summary of Statutory Framework

Congress enacted the Indian Gaming Regulatory Act (IGRA) in 1988. The law established the National

Indian Gaming Commission to oversee the regulation of certain types of gaming in Indian country. The

Act divided Indian gaming into three classes, each with different levels of Federal regulatory oversight:

3

See 71 FR 30232 and 72 FR 60841.
1-2

Class I: Class I gaming is regulated exclusively by Indian tribes, i.e., it is outside of state and

Federal jurisdiction. It is limited to social games played for prizes of minimal value and

traditional forms of Indian games played in connection with tribal ceremonies or celebrations.

Class II: Class II games are regulated by the tribes with the NIGC providing oversight of tribal

regulatory authorities. In addition, any card games (non-banked) operated at Class II facilities

must be operated consistent with state laws governing card games offered elsewhere in the

state. Class II includes games such as bingo, pull-tab, lotto, punch boards, tip jars, and instant

bingo. Electronic or electromechanical aids may be used in the conduct of Class II games;

however, if these aids encompass all of the relevant components of a game, they become

“electronic or electromechanical facsimiles” and are expressly excluded from Class II. Class II

also explicitly excludes slot machines and banked card games (e.g., blackjack and baccarat).

Class III: Class III games are all games, electronic and non-electronic, not defined as Class I or

Class II. This category includes other “games of chance” most commonly associated with

casino-type gambling such as slot machines, roulette, and banked card games (e.g., blackjack

and wagering). Games that fall under this class are primarily regulated pursuant to a tribalstate compact and are illegal in the absence of such a compact. The NIGC has limited

regulatory oversight role at Class III facilities.

As a result of this statutory framework and this rulemaking, this analysis focuses on Class II games and

facility operations.

Regulatory History

After Congress defined the broad parameters for game classification in the IGRA, the Commission

adopted regulations in 1992 that included definitions for many terms used in the statutory

classification scheme, including ‘‘electronic or electromechanical facsimile’’ (25 CFR 502.7),

‘‘electronic computer or other technologic aid’’ (25 CFR 502.8), and ‘‘other game similar to bingo’’ (25

CFR 502.9).

In 1992, the NIGC adopted a definitional regulation that defined “technological aid” as:

A device such as a computer, telephone, cable, television, satellite, or bingo blower

and which when used: is not a game of chance but merely assists a player or the

playing of a game; and is readily distinguishable from the playing of a game of chance

on an electronic facsimile; and is operated according to application Federal

communications law.

The NIGC also set its initial facsimile definition in 1992, which defined it as a gambling device as

defined by the Johnson Act. This approach raised problems since the Johnson Act’s definition of

gambling devices includes almost all gaming related equipment including component parts and all Class

II aids whether technological, electronic, mechanical or otherwise.
1-3

The Johnson Act defines gambling devices as those:

Designed and manufactured primarily for use in connection with gambling, and (A)

which when operated may deliver, as the result of the application of an element of

chance, any money or property, or by the operation of which a person may become

entitled to receive, as the result of the application of an element of chance, any

money or property.4

After the NIGC promulgated its 1992 definition of facsimile, much litigation ensued. The Justice

Department followed the 1992 definition with efforts to advance the Johnson Act theory even further.

One of their main arguments addressed the appearance of bingo machines. As technology advanced,

gaming manufactures developed games that were more appealing to players, including electronic bingo

terminals. These terminals consisted of cabinets containing a video screen that simulates slot machine

imagery. Player terminals were linked together through a central computer allowing players to

compete against each other. Other manufacturers created games with pull tab dispensers and readers,

which also mimicked the appearance of a slot machine. While the government tried to reject games

based on these characteristics, the courts consistently found that the use of electronic aids that

stimulate appearance and operation of slot machines do not fundamentally alter the game of bingo as

defined by IGRA.

For example, in Seneca-Cayuga Tribe of Oklahoma v. NIGC, the 10th Circuit Court determined that:

Absent clear evidence to the contrary, we will not ascribe to Congress both the intent

to carefully craft through IGRA this protection afforded to users of Class II

technological aids and to simultaneously eviscerate those protections by exposing

users of Class II technologic aids to Johnson Act liability for the very conduct

authorized by IGRA.

5

The Federal courts also rejected the argument that the use of electronic aids that simulate the

appearance and operation of slot machines fundamentally altered the classification of the game of

bingo as defined by IGRA. Instead they held that bingo games are transformed into Class III games

based on the speed with which they are played, the use of ante-up features, or the use of a retention

ratio.6

In response to this situation, and all of the legal issues surrounding Class II gaming, NIGC revised the

definition of Class II gaming devices in 20027based on the following foundations:

 So long as the equipment facilitates play between players, it is an aid permissible under IGRA

and exempt from the Johnson Act.

4

15 U.S.C. 1171 Johnson Act. Retrieved from: http://www.nigc.gov/LawsRegulations/JohnsonAct/tabid/102/Default.aspx

5

Seneca-Cayuga Tribe of Oklahoma v. NIGC, 2003

6

Case examples: US v. 103 Electronic Gambling Devices, 2000; US v. 162 Mega Mania Gambling Devices, 2000; US v. Burns, 1989

7

67 FR 41116
1-4

 If the game is played in a wholly electronic format on a stand alone terminal in which the

player is competing only against the machine and not other players, the equipment constitutes

a Class III electronic facsimile.

The exact text is as follows:

Electronic or electromechanical facsimile means a game played in an electronic or

electromechanical format that replicates a game of chance by incorporating all of the

characteristics of the game, except when, for bingo, lotto, and other games similar to

bingo, the electronic or electromechanical format broadens participation by allowing

multiple players to play with or against each other rather than with or against a

machine.8

This 2002 definition dropped the reference to the Johnson Act and provided the “except” clause for

bingo like games to be played in an electronic format in an effort to broaden participation as long as

players are still paying against each other. The NIGC rested their 2002 revisions on the notion that

IGRA specifically provides for an electronic draw in bingo games and that greater freedom with regard

to Class II games was intended by Congress.

The decade of litigation following the 1992 definition had created an unstable legal gaming market

that may have discouraged manufacturers from investing in innovative new games and devices. After

the 2002 definition clarification, gaming manufacturers started to develop new technology and invest

substantial amounts in the growth of the Class II industry.

Since the NIGC’s promulgation of the 2002 definition, there have not been any Johnson Act

prosecutions in Indian country for the unlawful possession or operation of gambling devices. After 2002

and as Class II gaming grew dramatically, it became clear that there was a great deal of interpretation

and lack of clarity between Class II and Class III machines. Since the 2002 definition became effective,

the NIGC’s Office of General Counsel has issued 41 game classifications opinions.9 Of those, 13 were

related to card games, three were on Class II games that required virtually no analysis by the NIGC, and

four were for modifications of previously approved games. The NIGC Office of General Counsel applied

the 2002 definition of electronic or electromechanical facsimile to 21 cases that required analysis of

whether a game was Class II or Class III.

Although the NIGC continues to issue individual opinions, it decided a rulemaking would be the quickest

way to achieve greater clarity. The 2006 proposed changes (and the revised proposal issued in 2007)

were developed through extensive consultation with the tribes.

10 The proposed classification standards

would incorporate the notion that an electronic or electromechanical facsimile must replicate a game

of chance by incorporating the fundamental characteristics of the game to be an acceptable Class II

device. The proposed rule now would affirm that bingo and bingo-related games are facsimiles if an

element of the games’ format allows players to play with or against a machine rather than broadening

participation among players.

8

See 57 FR 12392, Apr. 9, 1992, as amended at 67 FR 41166, June 17, 2002

9

http://www.nigc.gov/ReadingRoom/GameClassificationOpinions/tabid/789/Default.aspx

10 See 71 FR 30239-30241 for a full discussion of the consultation process used by the NIGC to seek tribal input on the design of the rule.
1-5

While there was extensive consultation with the tribes and the formation of a Federal-tribal advisory

committee, no consensus was reached on all of the provisions of the proposal.11 There were certain

changes favored by the tribes that the Commission did not feel could be supported given the existing

statutory language. These provisions of the rule have remained an area of contention.

Based on the extensive comments on the 2006 proposal, the Commission issued another proposal on

October 24, 2007 to modify existing regulations applicable to the conduct of Class II games by Indian

tribes. Specifically the NIGC proposed changes to:

 the definition of “Electronic or Electromechanical Facsimile” in Part 502 of the existing

regulations;

 the Classification Standards for Bingo, Lotto, other games similar to Bingo, Pull Tabs and

Instant Bingo as Class II Gaming When Played Through an Electronic Medium Using ‘‘Electronic,

Computer, or Other Technologic Aids’’ in Parts 502 and 546 of the existing regulations;

 the Minimum Internal Control Standards for Class II gaming in Parts 542 and 543 of the existing

regulations; and,

 add a new Part 547 to the Commission’s regulations establishing technical standards for

electronic, computer, or other technologic aids used in the play of Class II games.

The content of the October 2007 proposed changes and their incremental effect on the existing market

is discussed in Chapters 2 and 3 of this analysis.

Regulatory Alternatives

As it considers the final rule, the analysis examines several regulatory alternatives available to the

Commission.

The first option is to take no action. Under this alternative, the existing MICS would remain in place

for the operators of Class II facilities and for Class II operations at Class III facilities. For Class II

machines, there would be no technical certification requirements. The classification standards, which

include the definition of electronic facsimile, would be implemented through advisory opinions,

enforcement action, and litigation based on the existing regulations. There are no incremental social

benefits or costs of this alternative.

The second alternative is to promulgate the 2007 proposal in total. Under this alternative the

proposed MICS would replace existing MICS for the playing of bingo at all facilities operating these

games as Class II. This option would also institute technical certification requirements for Class II

machines. Manufacturers and operators would have to adhere to the technical design standards. In

comparison to the current practice, the classification standards could be more stringent for certain

facilities. For example, games where the machine daubs the calls automatically, “one-touch

machines” would not be allowed. Gaming facility operators would have to replace non-compliant

machines by the effective date of the rule. A five-year grandfathering provision would allow for the

transition of Class II to Class III machines and for the orderly replacement of non-compliant machines.

11 See 72 FR 60486
1-6

The third alternative is to proceed with some portions of the four-part proposal. Specifically, in this

alternative, the NIGC would promulgate the proposed MICS and technical standards for Class II facilities

and machines. The classification standards and the additional definitions for electromechanical

facsimile would remain as in current regulation. On June 5, 2008, NIGC Chairman Hogen announced

that this alternative would be the one considered by the Commission for any upcoming final rule.12

Economic Framework for this Analysis

To evaluate the benefits and costs of these regulatory alternatives, we apply economic theory to this

potential regulatory action. The regulations have an opportunity to mitigate inefficiencies in the Class

II market. In doing so, the regulations generate

social benefits.

Compliance with the regulations also imposes

social costs. As a public agency and to fulfill its

statuatory obligations, the NIGC is primarily

concerned with social benefits and costs.

Congress requires agencies to estimate the social

benefits and costs of “major” rulemaking under

the Congressional Review Act.

13 At the same

time, the NIGC fulfills an important role in the

special relationship between the Federal

government and recognized tribes. For that

reason, the analysis also identifies when tribal

members or tribal organizations bear the

compliance costs. Because of this dual focus,

the analysis will distinguish between social and

private costs.

Not all changes in private costs are social costs

of a regulation. Regulations that change Class II game play have two effects. They can decrease

attractiveness of Class II games and they can raise the cost of manufacturing and operating a Class II

game. Players who decrease their Class II play due to regulation spend their money on substitutes such

as Class III games or bowling. The private costs to Class II operators include the loss in revenue.

However, this revenue is not lost; private Class III and bowling alley operators would enjoy increased

revenue. The social cost of the regulation are the net reduction in consumer spending across Class II

gaming and all substitutes.

Economic theory suggests that government intervention – through regulation or otherwise – could

generate net benefits to society if there is some systematic failure that prevents the market from

responding to address the problem itself. Classic market failures include the existence of

12 See http://www.nigc.gov/ReadingRoom/PressReleases/PR92062008/tabid/839/Default.aspx.

13 See PL 104-121, Congressional Review Act. Under the CRA, a major rule is defined, in part, as a rule that will have an annual effect on the

economy of $100 million or more. (Section 804(2)(A)) Since Congress defers to the Administrator for the Office of Information and Regulatory

Affairs for interpreting this provision, the effect is usually interpreted as $100 million or more of social costs or benefits to be consistent with

Executive Order 12866 as amended.

Difference Between Social and Private Costs

Social benefits and costs are different from private

benefits and costs. Social costs are the full resources

society spends for an economic activity. Private costs

are the costs each private consumer or producer pays

for a good or service. Adding up all private costs for an

economic activity may or may not equal the social cost.

In the classic example, as a factory produces 100 shoes,

it releases a puff of smoke that soils the laundry on a

nearby wash line. The private cost of the activity is the

labor, capital, and materials to produce the 100 pairs of

shoes. The social costs include all of these private

costs and the resources necessary to rewash the soiled

laundry. As discussed above, the uncompensated costs

of the soiled laundry is an externality. In general, the

social costs are the sum of all real resource costs and

the costs of any and all externalities.
1-7

externalities14, the inability to properly allocate resources to the production or protection of public

goods, asymmetric information in the market, and the existence of monopolies.15 The Indian gaming

market has elements of all of these market failures. In addition, because the Indian gaming market is

already regulated, there is a possibility that the existing regulatory structure creates additional

distortions in the market and thus additional economic inefficiency.16

The regulations proposed by the NIGC address these potential market failures and one issue related to

improving the efficiency of the regulatory system itself. We discuss each of these economic

justifications for regulation below.

The Indian Gaming Regulatory Act circumscribed the sovereignty of tribes by establishing a process to

address potential costs to the state in which tribes are located and by prescribing the allowable uses of

gaming revenues. In limiting tribal authority to the operation of Class I and Class II games in the

absence of a compact with the state, Congress recognized that casinos could impose uncompensated

costs (“externalities”) on the communities in or near where casinos were located.17 By requiring a

compact for Class III operations, which tend to be larger and with greater potential to impose

externalities, Congress mandated a process designed to allow potentially affected outside parties to

negotiate with the tribes to address concerns (and to receive compensation in exchange). By

protecting a meaningful distinction between Class II and Class III, the NIGC upholds the protections

against externalities provided by this mandated process.

Congress also sought to promote tribal gaming operations as a public good for members of the tribe.

The following language from the IGRA highlights Congress’ intent that revenues from tribal gaming are

to be viewed as a common property resource that is to be protected:

The Congress finds that...(4) a principal goal of Federal Indian policy is to promote

tribal economic development, tribal self-sufficiency, and strong tribal government18

The purpose of this chapter is— (1) to provide a statutory basis for the operation of

gaming by Indian tribes as a means of promoting tribal economic development, selfsufficiency, and strong tribal governments19

Economic theory suggests that, because these revenues are essentially the property of everybody (in

the tribe), fewer resources may be devoted to the protection of these revenues than is socially

optimal.20 As a result, the Federal government can increase the revenues devoted to tribal public

purposes by requiring tribal regulatory authorities to increase oversight through financial controls and

effective tribal regulatory programs.

14 “Externalities” are actions by one party that cause uncompensated losses or gain by another party.

15 OMB Circular A-4 pp. 4-5.

16 Zeckhauser, R. and Stokey, E. A Primer for Policy Analysis. New York: W.W. Norton & Company, 1978

17 See Public Law 100-497 Section 2702 Purposes. (2) to provide a statutory basis for the regulation of gaming by an Indian tribe adequate to

shield it from organized crime and other corrupting influences, to ensure that the Indian tribe is the primary beneficiary of the gaming

operation, and to assure that gaming is conducted fairly and honestly by both the operator and players; and

18 § 2701 Findings. U.S.C. Title 25 Chapter 29. Retrieved from http://www.law.cornell.edu/uscode/25/usc_sec_25_00002701----000-.html

19 § 2702 Declaration of Policy. U.S.C. Title 25 Chapter 29. Retrieved from http://www.law.cornell.edu/uscode/25/usc_sec_25_00002702----

000-.html

20 See for example, Office of Management and Budget, Circular A-4 Regulatory Analysis, September 2003.
1-8

The regulations may also address an issue of asymmetric information. Small tribal gaming operations

may have less experience with gaming industry best practices than their larger competitors. Even with

ample experience, small operations may not have the capital to invest in the most current technology

or in the most skilled personnel. In addition, tribal regulators may have less familiarity with

appropriate control systems than the contractors the tribe may hire to operate its gaming facilities.

The MICS attempt to address all of these issues by creating a level playing field regarding the use of

industry best practices to avoid losses through fraud or error.

The proposed classification standards also address an inefficiency introduced by the regulatory system

itself. The NIGC has historically implemented the enforcement of Class II determinations through

individual opinions or through enforcement action. As is discussed in Chapter 3, there has been

extensive litigation over the distinction between Class II and Class III machines. By replacing case-bycase decisions with a bright line regulatory definition (that is essentially the same as that which is

implemented through enforcement), the Commission may reduce the cost to the regulated community

of implementing the standard (i.e., “transaction costs”).

Our framework for the analysis is to compare the final rule to current regulation and market conditions

to estimate the incremental effect of the rule. As owners and operators spend real resources to

comply and as consumers react to the regulatory changes, these resource expenditures are the

incremental social costs. As the regulatory provisions reduce the market failures identified above, the

rule also generates social benefits for the United States. The analysis calculates, compiles, and

compares the total social benefits and costs created by the final rule and its alternatives.

Relation of this Analysis to Previous Analyses

The goal of the analysis is to update and to supplement the analysis performed for the Commission in

February 2008.21 This analysis updates a previous paper that analyzed the impact of the Commissions

May 2006 proposal. This update reflects important additions to the February 2008 analysis:

1. Affected Facilities. This analysis adopts significant changes in the market, specifically the

adoption of gaming compacts by states representing 76 percent of the recent Class II gaming

market. In addition, this analysis considers several potential future scenarios from which to

measure the costs and benefits of the final regulation.

2. Costs. The analysis reexamines some of the key assumptions regarding replacement cost and

revenue losses used in the February 2008 analysis. In addition, it systematically attempts to

examine the impact of the grandfathering provision on the cost of the rule. The analysis will

also attempt to update the costs associated with the other parts of the rule, other than the

classification standard.

3. Benefits. Previous economic analyses were intended to be an analysis of potential costs and

the potential future economic impact on tribes. As such, they considered primarily the worstcase cost impact and did not fully consider the social benefits of the regulation. This

document describes and, where possible, quantifies the benefits of the regulation.

21 Meister, A. The Potential Economic Impact of the May 2006 Proposed Class II Gaming Regulations, Analysis Group, February 1, 2008.
1-9

4. Linkage Between Incremental Costs and Benefits. Where possible, the analysis will link the

incremental costs and benefits to the corresponding provisions of the rule. Specifically, there

are three broad sections of the regulation:

 Sections 502 and 546 provide the definitions necessary to distinguish between a gaming aid

to bingo and an electronic facsimile of a game of chance (and by extension, Class II and

Class III games). Because these definitions are mirror images (one describes what Class II is

and the other describes what it is not), we analyze these provisions as one.

 Section 543 is the Minimum Internal Control Standards (MICS) and involves physical and

communications security. It regulates the control of money and operational systems, but

not the machines themselves.

 Section 547 contains the Technical Standards. These regulations govern certification of the

machines themselves. There are two broad areas of certification: (1) that the games and

related systems operate properly and are resistant to tampering; and, (2) the games must

be certified compliant with the definitions of a Class II machine (i.e., consistent with

Sections 502 and 546). This second certification is analytically indistinguishable from those

earlier sections – although it will reduce the cost of enforcing those standards. Since we do

not believe that this second certification adds significantly to the cost of Section 547, its

benefits are included in the benefits of 502 and 546. As a result the analysis of this

provision is largely the same whether or not the certification includes reference to 502 and

546.

In Chapter 4, we provided a more detailed comparison between this analysis and previous ones to

highlight similarities and differences in data sources, methodologies, and results.

Organization of the Analysis

Chapter 2 analyzes the proposed regulation, comparing it to currently promulgated rules for Class II

gaming operations. The purpose is to identify the new or changed regulatory requirements so that the

incremental social benefits and costs of the rule can be calculated. In Chapter 3, we identify market

changes that are reducing the number of Class II machines. We also project continued growth in the

market, reflecting the very large growth that has occurred in the past decade. At the same time,

there is evidence of a wide range of interpretation of the current classification standards for Class II

and Class III machines. This potential non-compliance, or uncertainty of what is compliance, can be

resolved in the future through litigation and enforcement actions. Further legal action will reduce the

number of non-compliant machines subject to future regulation. Chapter 3 lists the number of entities

that will bear the direct costs of the rule. In Chapter 3, we construct an alternative estimate of Class

II machines subject to the standard based on a reduced percentage of non-compliant machines.

Chapter 4 estimates the incremental costs of the regulatory alternatives. Chapter 5 is the counterpart

to Chapter 4 and estimates the social benefits of the final rule and its alternatives. The benefits arise

from reducing fraud, reducing litigation costs, and strengthening the IGRA process for states and tribes

to resolve any externalities with Class III gaming.

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Chapter 2: Provisions of the Regulation

The purpose of this chapter is to delineate clearly the incremental effects of the final regulations. For

the purpose of this analysis, we assume the final rule promulgates the October 2007 regulatory

language unchanged. With the incremental changes identified, the subsequent chapters estimate the

benefits and costs of those changes.

This chapter summarizes the main requirements for the following:

 Definition and Classification of Class II Games and Machines;

 Minimum Internal Control Standards; and,

 Technical Standards for Machines and Systems.

25 CFR Part 502

The proposed rule would have revised two of the definitions in Part 502 related to Class II gaming.

Section 502.8 defines “electronic or electromechanical facsimile” and §502.9 defines “other games

similar to bingo.”

Congress explicitly excluded electronic or electromechanical facsimiles of games of chance from the

definition of Class II gaming (i.e., classifying them Class III). The NIGC clarified these terms in 1992

and revised these regulatory definitions in 2002. Courts have taken a plain meaning approach to

defining “facsimile,” finding that facsimiles are exact copies or duplicates.22 Courts have also

recognized that facsimiles of Class II games would be considered a Class III game under the IGRA.23 It

has likewise been affirmed that facsimiles of games of chance including bingo would be violations of

the IGRA.24 Lastly, courts have been determined that, even if a player is playing against another player

and not simply the machine, the game may nonetheless be a facsimile.25

The proposed revision of §502.8 further would have clarified that machines that incorporate all of the

fundamental elements of a game of chance (including bingo) are facsimiles and, therefore, Class III

machines. The proposed revision also references Part 546 which clarifies the standards applicable to

the conduct of bingo and other games similar to bingo as Class II games. The reference to Part 546 is a

revision to the language proposed in 2006 that explicitly defined when a machine used to play bingo

became a Class III facsimile.

22 Sycuan Band of Mission Indians v. Roach, 54 F.3d 535 (9th Cir.1995); U.S. v. 162 Megamania Gambling Devices, 231 F.3d 713, 724 (10th Cir.

2000).

23 Diamond Game v. Reno, 230 F.3d 365, 366 (D.C. Cir 2000).

24 U.S. v. 103 Electronic Gambling Devices, 223 F.3d 1091, 1102 (9th Cir. 2000).

25 Sycuan Band, 54 F.3d at 542–43 (concluding that an electronic pull-tab game in which one player played with a machine, though not against

it, was a class III electronic facsimile thereof).
2-2

The proposed change to §502.9 would remove the phrase “provided that such game is not house

banked” from the definition of other games similar to bingo. Given that the prohibition on house

banking applies primarily to the playing of cards, this change would not seem to have a significant

impact.

25 CFR Part 546 (Referenced in Part 502)

The proposed Part 546 would clarify standards applicable to electronic aids used to play bingo or games

similar to bingo as Class II games. It distinguishes how a game of bingo or lotto, “other games similar to

bingo,” or a game of pull-tabs or “instant bingo,” when played electronically, primarily through an

“electronic, computer or other technologic aid” differs from a Class III “electronic or

electromechanical facsimile.” Finally, the proposal would institute a process for the determination of

a Class II gaming machine before that game is placed in a Class II gaming facility. This proposed

process would require a tribe’s gaming regulatory authority to require that all games/aids, or

modifications to games/aids, be submitted to a qualified, independent testing laboratory for review

and analysis. The laboratory would provide a written certification and report of its analysis and

conclusions both to the tribal gaming regulatory authority for its approval of the game or aid and to the

Commission for its review.

In order to help clarify the distinctions between the Class II gaming and Class III gaming, the October

2007 proposed regulation would change a number of aspects of the definition of an allowable Class II

machines. For example:

 The proposal would clarify that players must interact with the machine to initiate play and to

claim their prize if they are the winner. This proposed standard would result in one-touch

bingo machines – a machine with no requirement that the player take action to daub his/her

card to declare a winner – being classified as Class III. Requiring daubing slows the game by a

minimum of two seconds relative to a one-touch machine.

– This change represents a modification of the 2006 proposal that would have required a

minimum of two daubing rounds, with a minimum time requirement between the two

rounds. The 2006 proposal would have slowed the play of electronic bingo by a minimum

of six seconds relative to a one-touch machine.

 Players in an electronic game must be linked through a networked system. Each game must be

played by multiple players, with a minimum of two players. Unless six players join the system

must wait at least two seconds to begin from the start of the first player. The game may have

more than six players. For a win, a player must take overt action after numbers are released

by touching a screen or designated button. Under the proposed rule, the electronic bingo

games which currently give a player an “automatic” win would have to be changed in order to

comply. Many games currently also have an auto-covering; operators would have to remove or

disable auto-covering under the proposed rule.

 The proposed regulation would also require machines to prominently display the message “This

is a Game of Bingo” or “This is a Game Similar to Bingo,” but does not define the size or

method of the term “prominently.”

 Bingo cards must be at least 2” by 2” and have 25 spaces in a 5” by 5” grid. Free spaces could

exist but must be in the same location on all cards. Electronic cards would be permissible but

must be at least two inches by two inches squared.
2-3

 Pull tabs must be in a tangible medium and have at least three equally sized spaces. Free

spaces in pull tabs would be allowed as long as there are at least other spaces.

 Progressive and bonus prizes would be permissible, but limited. A bonus or progressive

prize could be awarded based on pre-designated patterns and based on the play of bingo,

lotto, or other games similar to bingo in the same manner as the game-winning prize. If

there is a bonus prize, it is awarded at random draw and after a game-winning pattern. A

progressive prize could only be awarded if the game provides a game-winning prize. All

prizes, whether game-winning, bonus, or progressive would be awarded based on outcome

of the game of bingo.

 Gaming devices must be certified by a testing laboratory approved by the tribal gaming

regulatory authority in order to ensure compliance with the regulations found in Part 546

before the device can be placed on the gaming floor.

 The proposed rule includes a grandfathering period which would allow all current Class II

systems to remain in use for up to five (5) years. Under the proposed rule, all new Class II

gaming devices entering the market would have to comply with the regulations within 120

days. Machines that do not meet the qualifications listed in this part would have to either

be adapted to meet the qualifications or would have to be removed after the five (5) year

grandfathering period.

25 CFR Parts 542 (Deleted) and 543

The proposed rule would clarify the specific MICS for Class II gaming and would therefore affect tribes,

tribal regulatory authorities, and gaming operations. The proposed rule would also combine

requirements from various sections of the existing MICS codified in Part 542 into sections more related

to function than specific game. These organizational changes were made in response to suggestions

made by a tribal advisory group.

Tribes generally use the current MICS for live bingo and for electronic bingo as well. Technological

changes in Class II gaming necessitates new MICS to standardize electronic practices in the industry.

Therefore, the Commission proposed a new Part 543 that would apply to both live and electronic Class

II gaming. The Commission felt it was necessary to structure, in phases, the migration of many of the

controls currently contained in Part 542 into new Part 543. These controls were addressed first so that

the current MICS would not conflict with the new proposed technical standards (Part 547). As would be

expected, many of the MICS found in Part 543 are very similar to the subparts in 542 which were

deleted.

Since instituting a new MICS would have disproportionately greater burden on small gaming facilities,

the proposal it would raise the MICS exemption threshold from revenue of $1 million to $2 million for

small and charitable gaming operations. Although these gaming operations would be exempt from the

MICS, they would still be held accountable to create, prepare, and maintain records in accordance with

Generally Accepted Accounting Principles (GAAP).

The proposed MICS would require a number of different measures to be put in place to prevent

unauthorized access, theft, or fraud. The number of changes which need to be made as a result of the

proposed rule would entirely depend on the level and method of security most tribes currently

practice. Some of the major requirements of the MICS include (but are not limited to the following):
2-4

 Gaming facilities would be required to revise their internal control standards to include the

new requirements proposed in Part 543. While the existing standards in Part 542 require tribes

to engage an independent certified public accountant (CPA) to audit the facility and ensure

MICS compliance, the checklist associated with audit functions is longer as a result of the

proposed requirements – requiring more auditor time.

 While MICS for the security of bingo cards and transactions already exist in Part 542, the

proposal would increase verification procedures. The MICS of manual payouts and short pays

expand on the MICS for machine games in the existing Part 542. The rule provides multiple

security provisions (e.g., multiple signatures) by at least two authorized agents to ensure that

fraudulent payouts or other illegal activities are avoided.

 The proposed MICS would establish control standards for the use of voucher systems as well as

cashless systems or patron accounts. These changes are required to remain current with

technology advances in gaming that allow the use of vouchers, smart cards, patron accounts,

and other electronic media. Such systems can be more secure than cash provided sufficient

protections of these systems are in place. To this end, the proposed MICS specifically ban

smart cards (i.e., cards that possess the means to electronically store or retrieve data) that

provide the only source of account data. According to the preamble of the October 2007

proposal, the present definition of smart cards contained in Part 542 is unclear and essentially

not all smart cards are prohibited by the MICS.26 Accordingly, the proposed MICS would specify

which smart cards would be prohibited and essentially only those smart cards that possess the

sole source of patron account data would be prohibited.

 The proposed MICS would update user controls for all information systems such as mandating

that each individual with access to the system have individual user identification and

passwords. The proposed MICS for access of records could add an additional compliance cost

when the “system shall record unsuccessful log on attempts” if a computer system cannot deny

access after a predetermined number of unsuccessful attempts to log on.

 Part 543 proposes that a random sample of Class II gaming devices be tested to ensure accurate

accounting and logging of transaction events. This proposal requirement would also ensure

security regarding the number of identifiers of propriety gaming equipment, and periodic check

of the equipment.

 All MICS established by tribal authorities and subsequently gaming facilities must equal or

exceed those set forth in the proposed rule. Tribal authorities may not, however, adopt

alternative procedures to those set forth by the new part.

 Tribal regulatory authorities must ensure that tribal internal control standards meet the

standards set forth in this part within sixty days of the implementation of the rule unless they

seek and receive an extension. Tribal regulatory authorities must submit their control

standards to the NIGC.

25 CFR Part 547

This proposed rule would add specific technical standards to the Indian Gaming Regulatory Act’s

standards for Class II games that are played using “electronic, computer, or other technologic aids.” It

also would institute a process for establishing the integrity of a Class II gaming machine before its

26 72 FR 60497
2-5

placement in a Class II tribal gaming operation. The purpose of this proposed rule is to increase the

integrity and security of Class II games and ensure the accountability of gaming revenue.

Currently, there are no uniform, national technical standards that govern the implementation of

electronic, computer, and other technologic aids used in the play of Class II games. The intent of this

part is to establish regulations which allow for flexibility in the implementation and the advancement

of future technology.

A central challenge in writing technical standards is how to address all the manners in which a Class II

game is played. The language seeks to be sufficiently narrow to prevent tampering, yet general

enough to cover the different mechanisms of Class II gaming. This part describes “financial instrument

acceptors” and the standards they must meet. It also explicates minimum standards for the security of

financial instruments that facilities accept. Even though there is a broad range of standards that

address different types of Class II games, the Class II machines must only adhere to the standards that

are applicable.

The proposed technical standards would control all of the electronic standards of the Class II game.

The technical review must show that the game is fair, that it does not draw too much electrostatic

discharge (electricity), and also that it has a demonstration mode. The game must also be able to

recall the last game. The machine has to have accurate accounting systems and have system events in

the occurrence of system faults or errors.

Under the proposal, a tribal gaming authority could establish and implement additional technical

standards as stringent as, or more stringent than, those set out in Part 547. Class II gaming systems

shall meet only applicable standards with fairness, approved equipment and software, and proper

functioning.

These proposed standards are not intended to stand alone but rather stand in conjunction with the

proposed MICS. In addition, like the MICS, the level of current compliance with these regulations may

vary. Many states and tribes already require testing and certification of Class III gaming machines.27

Summary of Incremental Changes

The following table summarizes the October 2007 proposed rule requirements and the affected entities

in the market that may bear incremental costs or benefits from the regulatory change. The next

chapter examines these affected entities in more detail.

27 See for example, http://www.wsgc.wa.gov/egl/appendix_y.pdf
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Table 2-1: Summary of Proposed Regulatory Changes and Affected Entities

Provision Section/

Subsection

Differences between Proposal and Current Regulation Who is Potentially Affected

§ 502.8 Definition of

electronic or

electromechanical

facsimile

The proposal clarifies that machines are facsimiles and Class III if

they incorporate all of the fundamental characteristics of a game

of chance including bingo. The key components of an electronic

aid to bingo – Class II machine are:

 Broadens participation by allowing multiple players to

play with or against each other rather than with or

against a machine; and,

 Requires competitive action or decision making on the

part of the player.

Games that are not networked or that only require a single action

by the player, i.e., one-touch machines, are electronic or

electromechanical facsimiles.

Tribes operating one-touch and/or stand-alone

machines. These machines would be Class III

and only allowed under a compact.

Manufacturers leasing or selling non-compliant

machines. Manufacturers would need to replace

these machines where they cannot legally be

operated. Manufacturers who do not produce a

compliant alternative would be forced to

develop one or leave the Class II market.

Requiring multiple players and multiple actions

can slow the game, making the game less

attractive and less profitable. Manufacturers,

tribes, and players all lose value if games are

less attractive.

Bright line standard makes future design,

financing, and other business decisions less

speculative by reducing the threat of

enforcement.

502.9. Other games

similar to bingo

No substantive change.

Part 546 This part establishes the standards for differentiating between a

Class II machine and a Class III machine when used to play bingo

or a game like bingo (e.g., pull tabs).

Tribes operating one-touch and/or stand-alone

machines. These machines would be Class III

and only allowed under a compact.

Manufacturers leasing or selling non-compliant

machines. Manufacturers would need to replace
2-7

Provision Section/

Subsection

Differences between Proposal and Current Regulation Who is Potentially Affected

these machines where they cannot legally be

operated. Manufacturers who do not produce a

compliant alternative would be forced to

develop one or leave the Class II market.

Requiring multiple players and multiple actions

can slow the game, making the game less

attractive and less profitable. Manufacturers,

tribes, and players all lose value if games are

less attractive.

Bright line standard makes future design,

financing, and other business decisions less

speculative by reducing the threat of

enforcement.

546.1 What is the

purpose of this part?

Not a substantive provision.

546.2 What is the

scope of this part?

Limits scope of standards to electronic games.

546.3 What are the

definitions for this

part?

Clarifies that the regulatory definition of bingo is the same as the

common understanding of bingo – random determination of

numbers that players check against a pre-designated pattern on

cards (or electronic cards) held by players.

Implies that other games, even if centrally determined (e.g.,

centrally-determined slots) or played against others, are not

bingo and, therefore, not Class II games.

Manufacturers and tribes operating machines

playing something other than bingo or a game

similar to bingo would be required to reprogram

or replace such machines or reclassify them as

Class III.

Manufacturers and tribes operating machines

that do play bingo or a game similar to bingo

would have certainty regarding the compliance

of the machine (if the other standards are also

met).

546.4 What are the

criteria for meeting

Establishes criteria for the format and display of electronic cards

and for player interaction with the cards. Game must display

Manufacturers and tribes operating games that

do not meet these standards would be required
2-8

Provision Section/

Subsection

Differences between Proposal and Current Regulation Who is Potentially Affected

the first statutory

requirement that the

game of bingo, lotto,

or other games similar

to bingo be played for

prizes, including

monetary prizes, with

cards bearing numbers

or other designations?

player’s winning or closest to winning card at the end of game.

Cards must be purchased before a game begins. Players must be

able to see all of their cards.

Establishes criteria for the awarding of other prizes (bonus and

progressives). Such prizes must be awarded based on the

outcome of the game of bingo.

Prizes must be known or predictable.

Alternative displays must be able to be disabled by the player.

Machine must prominently display a notice that the game is bingo

or a game similar to bingo.

to modify or replace them.

The analysis assumes that systems exist that

meet all of the requirements. To the extent

that no single system meets all of the

requirements the costs of modification could be

understated.

All tribes operating Class II machines that are

not labeled will incur costs associated with

notification.

Bright line makes demonstration of compliance

easier to determine for regulators and tribes.

546.5 What are the

criteria for meeting

the second statutory

requirement that

bingo, lotto, or other

games similar to bingo

be games in which the

holder of the card

covers such numbers

or other designations

when objects similarly

numbered or

designated are drawn

or electronically

determined?

Clarifies that players must take overt action to cover spaces

(daub) to claim a prize.

All players must daub whether or not they are the winning player.

Only one overt daub is required by players. A two-touch

machine, where players hit a button to start and a button to end

the game or claim a prize, would meet the requirements of

546.5. A one-touch machine would not comply with 546.5.

Manufacturers and tribes operating one-touch

machines will be required to modify or replace

such systems.

Players will have to pay closer attention to the

game.

Games may be marginally slower than some

current offerings.

546.6 What are the

criteria for meeting

the third statutory

requirement that

The game must have multiple players.

The game cannot start until two seconds after two players have

joined or until six players have joined, whichever is sooner.

Manufacturers and tribes operating stand-alone

machines would be required to replace them

with a networked system.
2-9

Provision Section/

Subsection

Differences between Proposal and Current Regulation Who is Potentially Affected

bingo, lotto, or other

games similar to bingo

be won by the first

person covering a

previously designated

arrangement of

numbers or

designations on such

cards?

Events outside of bingo may not be used to determine any prize.

Every game must generate a game winning prize.

If only one player remains in a game, results are void and wagers

are returned.

Potential for a delay in the start of some games

that trigger the minimum delay.

Players have to stay until the end of game for a

prize to be awarded.

546.7 What are the

criteria for meeting

the statutory

requirement that Class

II pull-tabs or instant

bingo not be

electronic or

electromechanical

facsimiles?

Pull-tabs or instant bingo cards must exist in a physical medium.

Electronic aids can be used to read cards and display prizes.

Manufacturers and tribes operating pull-tabs or

instant bingo will have to comply with this

requirement.

There is a marginal increase in the cost of pulltabs (electrons are cheaper than paper),

however this cost is not quantified in the

analysis.

546.8 What is the

process for approval,

introduction, and

verification of

electronic, computer,

or other technologic

aids under the

classification standards

established by this

part?

Requires certification of a game as meeting the substantive

requirements of Part 546 as part of the technical certification

required in Part 547.

We assume that this provision does not

significantly add to the cost of the certification

required under Part 547.

The purpose of this provision is to facilitate

enforcement of the substantive provisions of

Part 546. Therefore, all other benefits and

costs are incorporated in the analysis of the

substantive provisions themselves.

546.9 What are the

steps for a compliance

program administered

by a tribal gaming

Requires that tribal regulators have a compliance program to

ensure that machines operated in casinos in their jurisdiction

comply with the classification standards.

Costs of developing and implementing a general

program are contained in the analysis of the

MICS.
2-10

Provision Section/

Subsection

Differences between Proposal and Current Regulation Who is Potentially Affected

regulatory authority to

ensure that electronic,

computer, or other

technologic aids in

play in tribal gaming

facilities meet the

Class II certification

requirements?

Requires keeping a list of all machines in operation at facilities in

their jurisdiction.

Requires periodic random tests of system and games.

To the extent that periodic testing is not part of

the tribal MICS, this requirement is a new cost

to tribes. However, it is not quantified in the

analysis.

546.10 When must a

tribe comply with this

part?

New machines and systems must comply within 120 days of the

effective date.

Machines and systems currently in place can remain in operation

for five years.

Manufacturers with systems that do not comply

with Part 546 would be unable to sell these

systems into the market after 120 days and

could have stranded capital.

All non-compliant systems will have to be

modified or replaced in five years.

546.11 What is the

effect on this part if a

section is declared

invalid?

Severability provision, not substantive.

543.1 What does this

part cover?

Clarifies that MICS contained in new Part 543 apply to the

operation of Class II games. Not a substantive provision.

543.2 What are the

definitions for this

part?

Not a substantive provision.

543.3 How do I comply

with this part?

Tribal regulatory authorities must adopt MICS at least as stringent

as those set forth in Part 543.

Gaming operators must comply with the tribal internal control

standard.

Tribes with no existing MICS (should be a null

set) and those with MICS less stringent than Part

543 will be required to adopt new rules. The

analysis assumes that all Class II gaming tribes

will be required to adopt the new rules.
2-11

Provision Section/

Subsection

Differences between Proposal and Current Regulation Who is Potentially Affected

Annual CPA audit of internal control procedures is required. CPA audit of MICS is required under existing Part

542. The analysis assumes that new audits will

be more costly.

543.6 Does this part

apply to small and

charitable gaming

operations?

MICS do not apply to small and charitable gaming operations with

revenues below one million dollars per year. This threshold is not

a change from the existing rule.

All small and charitable gaming operations must create, prepare,

and maintain records in accordance with Generally Accepted

Accounting Principles.

Small and charitable gaming organizations will

need to keep records in accordance with GAAP.

The analysis does not attribute any incremental

costs to this requirement.

543.7 What are the

minimum internal

control standards for

bingo?

This section describes the MICS for bingo cards, draws, manual

payouts and short pays, operational controls, gaming equipment,

voucher systems, patron accounts and cashless systems,

promotions, and accounting.

The provisions of 543.7 update and consolidate provisions from

multiple sections of Part 542.

A number of the updated requirements contain

additional requirements to bring the MICS up to

industry standards. Since the actual cost of

these marginal changes is hard to estimate, the

analysis does not assign a cost to these

provisions.

543.16 What are the

minimum internal

controls for

information

technology?

Substantially similar to requirements currently contained in

542.16.

Some specific new requirements are added, e.g., requirement to

remove access for terminated employees within 72 hours of

termination.

Some terms used in 542.16 are clarified, e.g., what “offsite

storage” means with respect to backup data.

These MICS are sufficiently similar to those

already applicable to tribal gaming facilities

that the analysis does not estimate either costs

or benefits associated with these provisions.

Part 547 – Technical

Standards for

Electronic, Computer,

or Other Technologic

Aids Used in the Play

Part 547 establishes the minimum technical standards governing

the use of electronic aids to bingo.

This part covers gaming machines (player interfaces), the gaming

system, as well as systems used to handle cash or cash
2-12

Provision Section/

Subsection

Differences between Proposal and Current Regulation Who is Potentially Affected

of Class II Games

547.1 What is the

purpose of this part?

equivalents and player information.

This set of provisions is entirely new.

547.2 How do these

regulations affect

State jurisdiction?

This provision states that nothing in this part shall be construed

to grant to a state jurisdiction in Class II gaming or to extend a

state’s jurisdiction in Class III gaming.

Not a substantive provision.

547.3 What are the

definitions for this

part?

No substantive requirements independent of other sections.

547.4 How do I comply

with this part?

New systems must comply within 120 days of the effective date of

the rule.

All systems must be submitted within the first 120 days (including

those that will be operating under the grandfathering period

provision).

Replacement of individual components or changes that move the

system closer to compliance with applicable standards do not

constitute violations of the grandfathering period.

Tests must be performed by independent laboratories.

All tribal gaming operators will be required to

determine whether the systems they use have

been submitted to an independent laboratory

for certification.

Game manufacturers will have to design new

systems to comply with technical standards.

All systems must be upgraded to compliant

systems within five years of the effective date

of the rule.

547.5 What are the

rules of interpretation

and of general

application for this

part?

Administrative provisions of the 547 with the exception of

547.5(c) which defines fairness to include a minimum probability

of winning a prize – 1 in 50 million for a progressive prize and 1 in

25 million for any other prize.

No substantive effect included in analysis.

547.6 What are the

minimum technical

(a) General requirements. Class II gaming systems shall provide a

method to:

Administrative provision -- does not affect costs

or benefits of rule
2-13

Provision Section/

Subsection

Differences between Proposal and Current Regulation Who is Potentially Affected

standards for enrolling

and enabling Class II

gaming system

components?

1. Enroll and unenroll system components; and,

2. Enable and disable specific system components.

(b) Specific requirements. Class II gaming systems shall:

1. Ensure that only enrolled and enabled system components

participate in gaming; and,

2. Ensure that the default condition for components shall be

unenrolled and disabled.

547.7 What are the

minimum technical

hardware standards

applicable to Class II

gaming systems?

Systems certified under this part must:

1. Comply with FCC regulations regarding interference with

communications; and,

2. Be certified by a safety laboratory regarding dangers

associated with electricity e.g., spills and electrostatic

shock.

Circuit boards that can affect the outcome of the game must be

identified and any switches or jumpers that can affect function

must be sealable. The electronic components must be able to

resist malfunction due to electrostatic shock.

The physical structure of the system or machine must be robust

and resistant to attempted forced entry.

The player interface must display information to the player and

allow the player to interact with the game.

The account access system, financial instrument storage, and

financial instrument dispensers must be secure and resistant to

tampering.

All manufacturers will need to incorporate these

requirements into future systems. If doing so

increases the cost of such systems, these costs

will be passed on to the tribes or be borne by

the manufacturers.

All of the technologies to meet these standards

are currently available, but we do not know if

they are all present on any or all systems

currently in operation or design.

The analysis does not explicitly associate any

costs with these provisions as most of them

seem consistent with industry practice.

These standards assist in protecting against

losses to tribes through theft and tampering.
2-14

Provision Section/

Subsection

Differences between Proposal and Current Regulation Who is Potentially Affected

Financial instrument acceptors must be secure and allow

communication with the gaming accounting system.

The door that protects all other components of the system must

have an open door sensor that cannot be disabled.

This provision is not included in the current regulation.

547.8 What are the

minimum technical

software standards

applicable to Class II

gaming systems?

Defines minimum information that must be provided to the player

and information that must be available in recall mode.

Requires that the software play the game per the posted rules.

Requires that players affirmatively enter a game.

Player interface may not accept money or wagers when it is

registering a fault condition.

Establishes minimum audit data requirements (for components of

the system that are involved in the audit mode).

Requires that games not be playable during test, diagnostic, or

demonstration modes and that these modes create no permanent

modification to game or financial records. (Note: Test,

diagnostic, and demonstration modes are not required by this

provision.)

Establishes minimum standards for interfaces offering multiple

games.

Establishes minimum standards for operation of progressive

controllers.

Defines data that must be stored in critical memory and minimum

procedures and protections associated with critical memory.

Game designers will be required to incorporate

these elements into their systems. To the

extent that this adds additional cost, these

costs will either be passed on to tribes or borne

by the manufacturer.

None of these standards appear onerous

although all of the standards may not be met by

all current systems. The grandfathering

provision should allow any inconsistencies to be

addressed in systems that will remain in

operation after the end of the grandfathering

period.

The analysis attributes no incremental cost to

these provisions.

These standards will assist regulators and

operators in the oversight of machine operation.

These standards will also protect players from

losses through error and potential confusion.
2-15

Provision Section/

Subsection

Differences between Proposal and Current Regulation Who is Potentially Affected

547.9 What are the

minimum technical

standards for Class II

gaming system

accounting functions?

Establishes minimum standards for accounting functions (tracking

of player credit and amount in and amount out data).

New systems must be designed to comply with

these standards. Costs of doing so should be

negligible.

547.10 What are the

minimum standards for

Class II gaming system

critical events?

This section provides standards for addressing and documenting

events such as system critical faults, deactivation, door open or

other changes of status, and lockup within the Class II gaming

system.

Manufacturers will be required to design these

protections into new game systems.

Players and tribes will benefit from protection

of the integrity of the game in the event of

unexpected events.

547.11 What are the

minimum technical

standards for money

and credit handling?

Standards for validating, tracking, and protecting the handling of

cash or cash equivalents by game systems.

Manufacturers will be required to design these

protections into new game systems.

Players and tribes will benefit from protection

from error and fraud.

547.12 What are the

minimum technical

standards for

downloading on a Class

II gaming system?

Standards for secure downloading of programs or data to Class II

systems.

Also requires that downloading not interfere with accounting

information stored in the system.

Ability to change programming or content

through downloading reduces costs to

manufacturers and tribes.

547.13 What are the

minimum technical

standards for program

storage media?

Standards to protect program storage media (e.g., EROMs, CDs,

DVDs, etc) from tampering or inclusion of foreign code.

No discernable cost.

Protection from fraud and theft.

547.14 What are the

minimum technical

standards for

electronic random

Requires that output of random number generator be random,

unpredictable, and non-repeating.

No discernable cost for new systems.

Costs for verification included in the cost of

independent laboratory testing of a system.
2-16

Provision Section/

Subsection

Differences between Proposal and Current Regulation Who is Potentially Affected

number generation?

547.15 What are the

minimum technical

standards for

electronic data

communications

between system

components?

Requires secure communications between system components and

documentation of attacks on, or failures of, a communication

system.

No discernable cost for new systems.

Costs for verification included in the cost of

independent laboratory testing of a system.

547.16 What are the

minimum standards for

game artwork, glass,

and rules?

Rules and information necessary for player to understand the

game must be provided in artwork or electronically.

No discernable cost for new systems.

Costs for verification included in the cost of

independent laboratory testing of a system.

547.17 How does a

gaming operation

apply for a variance

from these standards?

Tribal regulatory authority may grant a variance from the

standard if the same amount of protection will be provided.

NIGC reviews tribal regulatory determination.

Provides additional flexibility to tribes and

manufacturers.

Neither costs nor benefits of this provision are

included in analysis.
3-1

Chapter 3: Market and Regulatory Conditions

for Affected Entities

Tribal gaming organizations, tribal regulatory authorities, and other entities must carry out the

incremental changes identified in Chapter 2. They will implement these changes in the course of

navigating through changing market conditions. When estimating the future effect of the regulation,

the analysis must also project how dynamic conditions will change the market. Future market

conditions are the baseline from which the incremental benefits and costs are measured.

There are two major issues in establishing the appropriate baseline for measuring the incremental

benefits and costs of the final rule and alternatives. First, the size of the Class II market has changed

dramatically in the past four years. Second, technology has moved faster than the regulatory system in

this industry. As a result, under current practices in the industry, operators run a number of gaming

machines that NIGC believes do not meet the definition of Class II under IGRA, the proposed

regulations, or previous case-by-case determinations made by the NIGC. As a result, the baseline in

practice may not represent the baseline under the current regulation as interpreted. Guidance for

benefit-cost analysis recommends using different baselines when current practice is different than full

regulatory compliance.28 We present both baselines (i.e., current market conditions and “full

compliance”) to measure the effect of the final rule and its alternatives.

For both the current market conditions and the full compliance scenario, the analysis constructs

different paths for the industry - with or without the regulation. These paths become the two

baselines against which we measure the incremental benefits and costs of the final regulation and

alternatives. Also, as market conditions change in the future, the size, number, and financial

conditions of gaming organizations change. For each future path, this chapter estimates the annual

number of operating entities, the number of Class II machines, and other market characteristics

needed for the analysis.

Number of Affected Entities if Current Market Conditions Continue

In this baseline scenario, NIGC maintains its current level of enforcement. The current estimated noncompliance rate with the classification standards persists into the future. The Class II industry is

expected to continue its growth. Where states and tribes have already negotiated new compacts, the

gaming operators are expected to convert their Class II machines rapidly into Class III machines. We do

not assume any new states to become Class III or tribes to rescind their compacts. Under these

conditions, this section estimates the number of gaming entities and tribal gaming authorities that

must comply with MICS. It also estimates the number of entities that must comply with the technical

standards. Finally, we present our estimated number of compliant and non-compliant Class II machines

and the future growth rate of Class II machines and revenue.

28 OMB, Circular A-4 Regulatory Analysis, pp. 4-5.
3-2

Minimum Internal Control Standards

In October 2006 the United States Court of Appeals for the District of Columbia (Colorado River Indian

Tribes [CRIT] v. NIGC) found that the National Indian Gaming Commission did not have jurisdiction to

require MICS at Class III facilities.29 As a result, the MICS standards currently found in §542 no longer

apply to such facilities.

To avoid confusion regarding the applicability of the provisions of the current Section 542, the

Commission is proposing to promulgate a new Section 543 that clarifies the MICS applicable to Class II

operations. Most of the requirements in the revised MICS are merely restatements of existing Section

542 requirements. However, as discussed in Chapter 2, there are some changes being proposed as part

of the repromulgation.

The MICS will apply to Class II activities at any facility operating Class II games above a revenue

threshold. In 2006, there were eleven facilities operating solely Class II games and an additional 150

facilities that operate Class II games in facilities that also offer Class III gaming. These facilities are

listed in Appendix 1. Since the MICS implement the existing best practice in the industry, some of

these incremental requirements may already be in place at facilities with Class II operations. However,

we have limited data to estimate which practices are in place at which facilities. This analysis assumes

that all 161 facilities will incur some incremental costs and generate benefits associated with

implementation of the final rule’s MICS. In the short term, this approach will include tribes operating

facilities in Florida, Oklahoma, and California. Over time Florida and most Oklahoma facilities are

expected to become fully Class III facilities. All but one California facility is also likely to complete the

conversion to offering only Class III games.

Tribal gaming authorities are also affected by the final MICS. They must update their regulations and

then oversee compliance with their revised regulations. Thus, they will have training and

administrative costs due to the final rule. According to a 2000 survey of the National Indian Gaming

Association, tribal regulatory authorities employed 2,800 workers.30 However, tribal regulators will

only require training if their tribe operates Class II games. There are 225 tribes that are involved in

gaming. Of these 72 are, or have been, involved with Class II gaming. If we assume that regulators are

distributed roughly evenly across these tribes, then roughly 900 of these regulators would be associated

with tribes that could be affected by the revised MICS.

Technical Standards

Class III machines, such as slot machines, are subject to testing and certification in states (such as

Nevada and New Jersey) where casino gambling is allowed.31 Testing verifies that the hardware and

software achieves the minimum required payout, is resistant to tampering, and meets other safety and

security requirements. Whether tribes require proof of such certification before deploying is subject

to the determination of the particular tribal regulating authority. However, the tribe and its patrons

benefit from requirements in other jurisdictions because game manufacturers tend to design their

machines to meet the most stringent state or tribal standard.

29 383 F Supp: 2d 123 (D. DC 2005)

30 See http://www.viejas.com/vbki/html/tg_game-reg.htm, accessed July 25, 2008.

31 See http://www.state.nj.us/lps/ge/tsb_enforce.htm
3-3

However, there are no such requirements for Class II machines or operating systems. According to its

most recent information collection request (ICR) under the Paperwork Reduction Act, NIGC estimates

that there are 25 unique Class II gaming systems in use today.32 The proposed testing requirements

would apply to the 25 current operating systems and any new systems developed in the future.

Definition of Class II and Electronic Facsimile

Although promulgated as two separate parts of the final rule, these two definitions are inextricably

linked. Those machines that are not Class II, or that are electronic facsimiles, are Class III machines

and may not be operated as Class II. The final standards only impose costs, or generate benefits, at

those facilities operating a given game or machine as Class II that will not meet the final classification

standard as Class II.

To start estimating the machines affected, Table 3-1 reviews states with Class II machines to estimate

the total number of Class II machines in operation in 2006. For states with Class II and III machines, we

researched the state-tribal compacts to determine if there are limits on Class III machines. In states

with limits, the number of Class II machines may continue to grow if the tribes have already installed

the maximum allowed.

Table 3-1: Total Number of Class II Machines in 200633

State Class II,

or II & III

Number

of Class

II

Machines

Number

of Class III

Machines

Cap on Class III Gaming

Machines (if applicable)

Alabama II only 2,101 0 N/A

Alaska II only 30 0 N/A

Arizona II & III 56 12,770 According to the state compact,

Class II machines count towards

a tribe’s cap. Operating as a

Class III machine is thus a viable

alternative for all 56 machines.

California II & III 4,215 61,657 N/A

Colorado III N/A 1,128 Cap not reached

Florida II & III 8,615 26 34 Tribes in Florida are expected

to shift to the operation of

Class III games in the future.

The recent Florida state

32 National Indian Gaming Commission, Supporting Statement for Information Collection Request 3141-0009, Minimum Internal Control

Standards, October 17, 1998.

33 Much of this data is taken from the February 2008 report. The data has not been updated for changes since there was no more recent data

available at the time of this report. The data on Class III limits on compacts, if any, is taken from a review of applicable tribal-state compacts.
3-4

State Class II,

or II & III

Number

of Class

II

Machines

Number

of Class III

Machines

Cap on Class III Gaming

Machines (if applicable)

compact does not limit the

number of Class III gaming

devices, but does limit them to

seven sites. The compact also

does not limit Class II gaming.

Minnesota II & III 113 20,822 The state does not allow

“mechanical” versions of Class

III gaming machines in the state

compacts. This restriction

leaves a residual demand for

Class II games.35

Montana II & III 535 806 While the gaming market may

not be “saturated,” Class II

gaming machines have been

installed to supplement Class III

machines in some facilities.

These Class II machines will be

affected by the rule.

Nebraska II only 314 0 N/A

New York II & III 1,287 9,620 The gaming facilities with

compacts are not limited by the

compact. All 1,287 Class II

devices reside on tribal land

without compacts.

Oklahoma36 II & III 30,044 11,727 Many tribes in Oklahoma are

already shifting to Class III

gaming. There is no cap on

Class III games and Class III

games are subject to revenue

sharing.

South Dakota II & III 64 2,145 There is a cap on Class III

gaming devices. Class II devices

in the state are used by

facilities to supplement their

Class III devices.

Texas II only 1,325 0 N/A

34 This number is outdated as the Florida Seminole Tribe has begun installing Class III gaming machines and has ordered 15,000 more.

http://www2.tbo.com/content/2008/may/01/bz-vegas-style-slots-officially-launch/. However, the compact with the Seminole tribe and Gov.

Crist is being challenged by the state legislature.

35 http://sec.edgar-online.com/2004/11/30/0000950134-04-018366/Section11.asp

36 The total number of machines increased from 31,000 in 2005 and 27,000 in 2004. We expect the number of Class III machines to continue to

increase rapidly as many tribes in Oklahoma switch from Class II to Class III gaming.
3-5

State Class II,

or II & III

Number

of Class

II

Machines

Number

of Class III

Machines

Cap on Class III Gaming

Machines (if applicable)

Washington II & III 1,771 18,235 Washington has a cap on Class

III gaming machines that was

recently modified.

Wisconsin II & III 361 15,321 There is room for expansion in

Class III gaming devices in all of

the facilities except one

operated by the Ho-Chunk

tribe. Numerous hurdles

prevent that tribe from

creating a compact.

37

Wyoming II & III 94 385 There is no limitation to Class

III gaming machines.

Total 50,925

Effects of Recent Compacts

In 2006 Oklahoma and Florida possessed 59 percent and 17 percent of the national Class II gaming

market, respectively. California constituted eight percent of the machines in that year. Since 2006,

the applicable legal situation for Class II and III gaming in these states has changed. For example, new

compacts in California will result in the replacement of 3,140 Class II machines with Class III machines.

It has become clear that tribal gaming operators in Oklahoma are shifting from Class II to Class III

operations. A recent compact in Florida temporarily cleared the way for Class III machines in that

state.38 Due to the additional revenue from Class III games, these conversions are expected to be

complete before the expiration of the final rule’s five year grandfather provisioning. As a result of

these changes, the number of machines and facilities potentially affected by the new NIGC rules is

much smaller than previously estimated.

Table 3-2 shows how we estimate the conversion to occur in each of the major states. Based on recent

experience, operators remove virtually all of their Class II machines when they have the legal option to

install Class III machines. Computer control of gaming allows fairly rapid conversion of properlyequipped machines. We do not expect all Class II machines to be eliminated in Oklahoma. The large

number of existing machines suggests that there may be a long-term market for Class II play.39 In

addition, since the legislature instituted Class III games without a formal compact with affected tribes,

the terms of the Class II/III market may be revisited. For these reasons, we assume 25 percent of the

number of 2006 Class II machines remain at the end of the grandfathering period. For Florida, the

recently-overturned compact allowed the affected tribes to replace 75 percent of its Class II machines

in the first two years and then the remaining 25 percent over the subsequent three years. We continue

37 For a description of the dispute, see http://www.indianz.com/IndianGaming/2008/009570.asp for example.

38 SC07-2154 Florida House of Representatives, et al., v. The Honorable Charles J. Crist, Jr., decided July 3, 2008.

39 For example, in July 31, 2008 filing, Multimedia Games Reports Installed Base of Player Terminals and Product Mix at July 31, 2008, the

company reports over 300 “legacy” units, meaning non-electronic consoles and pre-2002 units.
3-6

assuming Florida will convert to Class III machines, recognizing that this assumption may understate the

costs of the rule if a new compact and conversion is not concluded before the end of the

grandfathering period. Finally, all but one of the tribes in California has rapidly converted to Class III

machines since 2006.

The Oklahoma estimate for the future is first based on the annual rate of decline in the number of

machines from 2006 to mid 2008.40 The number of Class II machines has fallen rapidly, by nearly 40

percent in less than two years. In the future, the rate is expected to decline at a constant rate equal

to the annualized rate experienced from 2006 to mid-2008.

As a practical matter of compliance with this rule, all of the Class II machines in Florida are expected

to be converted by the end of the grandfathering period. Therefore, only the 1,060 machines in

California and the 7,500 machines in Oklahoma would be subject to the classification standards from

these three states.

Table 3-2: Future Reduction in Class II Machines in States with Recent

Compacts

41

State 2006 2007 2008 2009 2010 2011

Oklahoma 30,044 24,122 18,200 10,300 7,500 7,500

Florida 8,615 9,583 10,600 6,600 2,600 880

California 4,215 4,215 1,060 1,060 1,060 1,060

Growth Rate of Class II Machines

In addition to shifts to Class III gaming, the Class II gaming market is expected to expand. To estimate

effect on tribal gaming facilities over the next ten years, the growth of the industry is projected.

Potential future growth is difficult to estimate; there is no certainty. However, in recent years Class II

gaming has grown very quickly. In 1992, the Indian gaming industry generated revenue of $1.6 billion.

Industry revenues exceeded $25 billion of gross gaming revenues in 2006. The industry currently has

423 gaming operations in 28 states. These operations are owned, operated, or licensed by 228 tribal

governments. Annual growth rates for the industry have been over ten percent a year for many years.

In the four states in which only Class II gaming is available, the industry has been growing on average

by over 40 percent per year in the last five years. Even states with larger and more mature Class II

industries like Oklahoma and Florida were experiencing double digit percentage growth in Class II

gaming devices before transitioning to the Class III market. Therefore it is not unreasonable to expect

rapid growth to continue in other solely Class II states.

40 Email from Derek Campbell, CPA, CIA, Gaming Compliance Lead, Office of State Finance, State of Oklahoma dated July 11, 2008.

41 Numbers are rounded to two significant digits.
3-7

In those states with only Class II gaming, the growth of Class II games is estimated by averaging the

number of new machines installed per year over the last five years (2002-2006). This past five-year

average is used as the estimate for the annual average number of machines expected to be installed

for the next ten years as shown in Table 3-3. This assumption may underestimate the rapid growth of

the market since it is lower than the annual percentage growth rate. Using the states’ annual growth

rate in the number of machines, sometimes 50 percent or more, leads to a potentially unrealistic

number of machines. However, using the five-year average growth in the number of machines could

lead to an underestimate in the number of new devices in certain states, especially in Alaska, which

are new to the Class II gaming market. Tribes in Alaska installed 30 devices in the past two years, but

may experience strong and rapid growth if the venture is profitable.

To estimate the future of the Class II gaming market in states with tribes that have gaming compacts,

using the recent growth of Class II machines may be inaccurate. Class II machines in these states are

part of the entire Class II and Class III market and must be evaluated in that context. Rather than

install more Class II machines, tribes in these states may re-negotiate their gaming compacts to allow

more Class III machines, effectively capping the growth of Class II in that state. Other tribes in states

like Washington have used Class II gaming machines to supplement Class III machines until the state

decided to re-negotiate. Wisconsin has a tribe which does not have a compact for reasons unrelated to

the negotiation of compacts with other tribes in their state.

Because of the interrelated markets for Class II and Class III, this analysis assumes that the number of

Class II gaming devices will remain steady in the next ten years in states with both Class II and Class III

machines. This assumption introduces an unknown error in the analysis. As some tribes add more Class

II machines to supplement their compacted maximum limits, other tribes may have less Class II

machines when caps are extended or lifted. Since Class III machines can be more lucrative for both

states and tribes, we assume that states and tribes eventually recognize the advantages of lifting caps

to meet growing demand for gaming. This political process can be time-consuming, creating an

continuous opportunity for some unrestricted Class II machines to exist in these states. In the February

2008 report, there were 5,341 Class II gaming machines in 11 states with both Class II and Class III

machines in 2006.

42 We use that number as the estimated average of the number of machines in mixed

Class II and III states over the next ten years.

Tables 3-3 and 3-4 presents our assumed net growth for Class II machines from 2006-2017 for the states

with Class II machines. States with only Class II machines will continue to experience growth, while

states with both classes of machines will have a steady number of machines throughout the period. In

summary, the Class II market declines from over 50 thousand machines in 2006 to an estimated 29,900

in 2017.

42 Meister, A. The Potential Economic Impact of the May 2006 Proposed Class II Gaming Regulations, Analysis Group, February 1, 2008.
3-8

Table 3-3: Growth in Class II Machines

State Number of

Class II

Devices in

2006

Growth in

Class II

Machines Per

Year

Growth in

Number of Class

II Machines in

2017

Alabama 2,101 393 6,400

Alaska 30 15 200

Nebraska 314 62 1,000

Texas 1,325 285 4,500

All others 47,155 ---- 5,300

Total 50,925 ---- 17,40043

Table 3-4: Predicted Number of Class II Machines

Year State

Oklahoma Florida Class II

Only

States

All

Other

States

Total

2006 30,044 8,615 3,770 8,496 52,931

2007 24,122 9,583 4,525 8,496 46,726

2008 18,200 10,551 5,280 5,300 39,331

2009 10,304 6,600 6,035 5,300 28,239

2010 7,500 2,600 6,790 5,300 22,190

2011 7,500 880 7,545 5,300 21,225

2012 7,500 880 8,300 5,300 21,980

2013 7,500 880 9,055 5,300 22,735

2014 7,500 ---- 9,810 5,300 22,610

2015 7,500 ---- 10,565 5,300 23,365

2016 7,500 ---- 11,320 5,300 24,120

2017 7,500 ---- 12,075 5,300 24,875

43 Estimate, rounded.
3-9

Number of Class II Machines Affected by the Rule

Not all of the Class II machines in Tables 3-3 and 3-4 face incremental costs due to the regulation. The

final classification standards are largely a codification of the opinions used by the Commission to guide

its ongoing inspection and enforcement activities. Some tribal operations and gaming systems have

already been evaluated using these standards and found to be compliant. While the baseline of current

market conditions may not be fully consistent with the classification standard, systematic data is not

available to inform a determination of the baseline level of compliance. We then considered expert

opinion on this question. Public statements by the Commission give an estimate that 50 percent of

current Class II machines would not be in compliance with the classification and definitional

standards.44 Since this estimate was given a few years ago and since the market has changed, we use a

range of values. We base our calculations of incremental costs and benefits on assumed baseline levels

of compliance of 20 percent, 50 percent, and 80 percent for the current market scenario. This range

provides a reasonable means of characterizing the uncertainty related to the baseline level of

compliance.

Summary of Entities Affected under the Current Practices Baseline

Table 3-5 lists the entities which will have compliance costs with the proposed regulation, assuming

current market and enforcement conditions continue into the future.

Table 3-5: Summary of Affected Entities in Current Market Scenario

Provision Number of Entities in

2006

Number of Entities in

2017

Tribal Regulatory Staff 900 900

Gaming Systems 25 25

Class II Machines 50,950 5,000 – 20,000

Number of Affected Entities if Greater Enforcement Occurs

If the National Indian Gaming Commission did not promulgate these regulations, it is still likely that

Class II Indian gaming would look significantly different in ten years than it does now. Taking no

regulatory action does not guarantee (or even imply) that the status quo (current market conditions) is

the most likely future market condition. To measure the incremental benefits and costs, we project

another baseline where greater enforcement reduces the number of non-compliant machines by the

end of the grandfathering period.

44 “Hogen estimated that Class II games make up only about 10 percent of the Indian gaming industry. The more lucrative Class III machines

make up 80 percent. Another 10 percent are machines that are marketed as Class II devices but are closer to slot machines,” DOJ Proposes

major change in Indian gaming law Friday, September 16, 2005, www.Indianz.com
3-10

In the absence of a new regulation, existing classification definitions would be enforced through

greater inspection, administrative fines, and litigation. Both the NIGC and the Department of Justice

have brought enforcement actions against alleged non-compliant tribal gaming operations in the past.

Such enforcement will continue in the future with or without promulgation of a bright-line standard

defining Class II gaming. However, litigation costs, and other costs of remedying non-compliance, such

as machine replacement, are likely to be higher in the absence of such a standard – particularly in the

absence of a grandfathering provision that eases transition to full compliance.

We assume that there is no difference in the compliance rate with the MICS and technical standards

between the two baselines. The new regulations are implementing requirements that the Commission

could not enforce through application of current regulation. For the purpose of this analysis, we are

interested in the likelihood that the estimated 50 percent non-compliance rate with the Class II

machine classification standards under current market conditions will increase or decline in the near

future. This rate will be determined by market forces and NIGC enforcement activity. As for market

forces, gaming operators have an incentive to blur the distinction when they face increase

competition, declining consumer demand, or increased consumer interest in Class III games. These

incentives are present and strong in Class II markets. Added to these existing incentives is the

increasing power of technology – a resource that can be used more fully in the Class III market due to

the absence of the classification and definitional constraints. We assume these forces and incentives

remain constant in the future and neither increase or decrease the non-compliance rate.

The NIGC, however, can alter the non-compliance rate through its level of enforcement activity.

Therefore, to create an estimate of the number of Class II machines that will require modification by

the end of the grandfathering period, we must estimate the effect of NIGC’s future activity on the

number of non-compliant machines. We project the effectiveness of future NIGC activity by examining

the current enforcement process and examine the influences that may signal greater or lesser

enforcement in the next five years. We then apply this information to judge the likely level of noncompliance by the end of the grandfathering period.

Legal and Regulatory Baseline

The NIGC has enforcement authority for the IGRA. NIGC can carry out inspections, conduct reviews of

gaming devices, and institute enforcement actions against non-compliant Class II machines. While the

current MICS are carried out through detailed regulation, the classification standards are based on

relatively little regulatory text. Determining what constitutes Class II gaming versus Class III gaming

relies on a factual determination and a careful assessment of Commission opinions and court cases.

The NIGC’s guide or “NIGC Classification Rulings” encompasses more than seventy opinions and court

rulings. The decisions relevant to the proposed classification standards are summarized in Appendix 2.

The NIGC devoted significant effort from 2002 to 2004 to establish a clear division between Class II and

Class III machines through regulation. The Commission continues these efforts. Since the 2002

definition became effective, the NIGC has issued 41 game classifications opinions. Of those, three

pertained to Class II games that required virtually no analysis by the NIGC. Four opinions evaluated

modifications of already approved games. In the remaining 34 opinions that required analysis of

whether a game was Class II of Class II, the Commission applied its interpretation of the 2002

definitions and classifications.

The current enforcement process has elements relevant to estimating future enforcement activity.

First, it requires NIGC staff to initiate action. A gaming operation does not have to seek NIGC approval

before installing a new, potentially non-compliant game. Second, the legal analytic framework that
3-11

has arisen is based on the physical features of the game. Determining these features requires NIGC to

spend resources for each case. It also necessitates that decisions are made on a case-by-case basis,

giving opportunities for recalcitrant operators to make cosmetic changes and then claim compliance.

Third, the NIGC opinions are not legally binding on the tribal gaming authority. The NIGC must

affirmatively act against the gaming operator to enforce its opinions. Finally, in the past, some

Federal courts have not given deference to NIGC opinions, raising the question of whether a NIGC

opinion is definitive. In summary, achieving greater compliance can only occur if NIGC has a greater

level of resources to inspect, decide case-by-case situations, and successfully defend these decision

through multi-year litigation in Federal courts.

Factors Affecting Future Commission Activity and Market Activity without Regulatory

Change

Given these resource demands, we believe it is unlikely that 100 percent all of all machines in the

future will comply into the NIGC’s current Class II framework through enhanced enforcement efforts.

There are several reasons to expect some continued rate of non-compliance:

Shifting Priorities of NIGC and DOJ

Increased enforcement in the future is not a certainty since the NIGC’s leadership will change.

Although a principal mission for any commissioner is administration and enforcement of the Act,

different commissioners may pursue alternative means of compliance in the future.

Success of Tribal and Manufacturers’ Legal Challenges

As NIGC issues future compliance determinations, tribal authorities and manufacturers retain the right

to challenge these administrative actions in court. In the recent past, it appears that several judicial

districts have given little deference to NIGC’s determinations and framework for distinguishing Class II

and Class III machines. Therefore, in the face of increased NIGC enforcement activity,

owners/operators of contested machines may pursue judicial remedies. If they are successful, the

future boundary between Class II and Class III will shift. What is viewed as non-compliance today could

be legally allowed at least in some jurisdictions in the future if courts rule against the Commission.

From the standpoint of what machines are viewed as compliant today, court decisions rejecting NIGC

challenges would expand the number of compliant machines.

Strong Financial Incentives for Non-Compliance

Operators and manufacturers have strong financial incentives to seek out the boundary between Class

III and Class II machines. As shown in the next chapter, Class III machines produce greater revenue per

machine per day than Class II machines. If an operator’s sole goal is profit maximization, he or she will

weigh the risks and costs of litigation against the increased revenue gained during the period the game

is under review. Specifically, a profit-maximizing operator will compare the certain legal costs against

the expected value of two possible outcomes:

 The NIGC finds the machine non-compliant with Class II and requires it to be shut down; and,

 The NIGC finds it compliant or a challenge to a NIGC opinion is successful.
3-12

An example can illustrate the financial incentives to maximize the scope of Class II permissibility, even

at the risk of an adverse decision. In the table below, a simplified example of the two options

available to an operator are shown. Suppose the difference in revenue between a new machine and a

known Class II machine is $30 per day. The annual revenue from that machine is approximately

$11,000. The operator is contemplating adding 11 new machines.

The operator then considers his or her options. Installing the machine will trigger an inspection or

litigation from the NIGC that will cost $200,000 to administer, defend, and challenge. Resolving the

litigation is assumed to require two years. During those two years, the operator can receive the

$11,000 per machine. If the operator successfully defends against NIGC’s challenge, the operator can

gain the $11,000 payout for the assumed five-year life of the machine.

The operator then estimates the probability of winning the challenge. In this case, the operator

predicts that there is a 95 percent chance that NIGC will rule the new machine a Class III device and

that the NIGC position will be upheld. For this scenario, the expected value of the total revenue from

the 11 machines is $218,000, while the litigation costs is $200,000. Even with a low probability of

litigation success, the operator can gain more revenue by installing the new machines.

Most operators are likely to have more machines, believe their chance for litigation success is greater,

or expect to prolong their case more than the value given in this example. All of these factors increase

the expected revenues and support the decision to install the new machines and risk an adverse NIGC

or court finding. This simplified example illustrates why there is a strong financial incentive to

continually introduce new machines that push the boundaries of Class II compliance.

Table 3-6: Hypothetical Decision Analysis of Choice to Install New Machine

Install Machine;

Lose Challenge

Install Machine;

Win Challenge

Difference in Hold per Machine Per Day 30 30

Revenue Per Year Per Machine $10,800 $10,800

Number of Machines at Facility 11 11

Years of Operation 2 5

Present Value of Option $206,182 $450,345

Probability of Outcome 0.95 0.05

Expected Value $218,390

Total Litigation Costs $200,000

We note that this example simplifies many important factors that cause operators not to install

machines with a low probability of compliance. First, reputations matter. An operator may have many

matters subject to NIGC review and would recognize the adverse effect a pattern of non-compliance

would have on those other matters. Second, manufacturers that are public companies also would be

concerned with a pattern of adverse rulings. Investors and gaming regulatory authorities in other

jurisdictions would question the company’s financial stability and integrity. These and other factors

limit the incentives to install machines that have a very low probability of being ruled a Class II

machine.
3-13

In spite of these institutional obstacles and market incentives, we expect NIGC to apply site-specific

enforcement and compliance determinations more frequently in the future in the absence of

regulation. There are several reasons to believe the NIGC can take more administrative action in the

future:

Fewer Class II Machines and Facilities

Because the Class II universe has decrease substantially with the compacts in Oklahoma and California

the number of potentially non-compliant machines has declined. NIGC’s resources will be spread

across fewer Class II locations in the future, allowing more concentrated oversight.

Greater Commission Funding

Prior to 1997, the Commission was legislatively prohibited from collecting fees in excess of $1.5 million

per year.45 The 1998 Interior Appropriations expanded the fee to include Class III gaming revenue and

raised the limitation on annual fee collections to $8 million. From 2003 to 2006, Congress increased

the limit to $12 million. On May 12, 2006, the Native American Technical Corrections Act of 2006 was

enacted. This law replaced the annual limit with a formula allowing fees up to 0.08 percent in any

fiscal year of the gross gaming revenues of all regulated gaming operations. As the chart shows, the

NIGC forecasts that this fee structure will allow substantial growth in its budget.46 Compared to the

last period of numerous Class II classification decisions, 2002-3, funding levels in the next few years are

expected to be double the 2002-3 levels.

Figure 3-1: Past and Projected NIGC Expenditures

45 U.S. Department of Interior, Budget Justifications Fiscal Year 2009 National Indian Gaming Commission, pg. 7.

46 Ibid.
3-14

Increased Number of Field Personnel

The NIGC is investing these increased funds in enforcement and inspection personnel. In its FY 09

budget justification, NIGC is requesting six new positions to respond to the expanding Indian gaming

industry.47 Three of these positions are field auditors to examine gaming operations for criminal

influences, fraud, and compliance with the MICS. NIGC seeks three other full-time enforcement

officials. In addition to processing background investigations of gaming facility employees,

enforcement officials monitor gaming operations for compliance with current regulations. As shown in

the Figure 3-2 below, NIGC staff levels are expected to be nearly double the number during the 2002-

2004 time period.

Figure 3-2: Past and Projected NIGC Staffing

More Attention to Class II Due to Court Decision

In the 2006 Colorado River Indian Tribes [CRIT] v. NIGC decision, a court held that Congress did not

give the NIGC the authority to promulgate MICS for Class III gaming.48 In some manner, this reduction

in the NIGC’s regulatory scope allows the agency’s resources to be more concentrated on Class II

operations.

47 Ibid. pg. 13.

48 383 F Supp: 2d 123 (D. DC 2005)
3-15

Projected Class II Machine Compliance Rate with Increased Enforcement

As discussed in the previous section, generating compliance under the current regulations and

procedures is a fact-based, resource-intensive, and lengthy process. It does appear that NIGC has

greater resources to engage in these enforcement activities than in the past. Moreover, since the

Commission can now set its own fee rate and control its budget to a large measure, the Commission

can sustain increased efforts. Therefore, in the absence of regulation, we expect the non-compliance

rate to be lower than the current estimated rate of 50 percent, but not to be zero.

Any quantitative estimate is speculative since it is a statement about the future. In our judgment, a

reasonable estimate for the long-term non-compliance rate is 25 percent, or half of the current rate.

We derive this estimate from the increased concentration of oversight on Class II machines. Compared

to recent years, the NIGC will bring twice as many staff backed by a doubled budget to oversee a Class

II market half the current size. The NIGC’s resource intensity may bring the rate even lower; however,

the financial incentives, the cumbersome process to shut down non-compliant machines, and the

uncertainty over judicial backing of NIGC’s opinions will dilute the effectiveness of these resources.

Summary of Entities Affected under the Greater Enforcement Baseline

Table 3-7 lists the entities which will have compliance costs with the proposed regulation, assuming

NIGC increases enforcement and compliance oversight.

Table 3-7: Summary of Affected Entities in Greater Enforcement Scenario

Provision Number of

Entities in

2006

Number of

Entities in

2017

MICS 161 161

Tribal Regulatory Staff 900 900

Gaming Systems 25 25

Class II Machines 50,950 2,500 – 10,000

4-1

Chapter 4: Social Costs

A change in the regulations that changes the types of gaming machines that are available, the gaming

experience, or the revenue potential of gaming, imposes new costs on a variety of stakeholders.

Casinos and tribes lose potential revenues; consumers lose entertainment value; game manufacturers

potentially lose revenue; and, providers of ancillary services (hotel, food service, etc.) lose revenue.

In addition, although it is not a separate and independent cost traditionally considered in benefit-cost

analysis, a reduction in gaming activity could result in fewer opportunities for employment (for both

tribal and non-tribal individuals).

Social Costs for MICS and Technical Standards

As discussed in Chapter 2, the various sections of the proposed rule would impose costs on different

stakeholders in different ways. Promulgation of the MICS would impose costs primarily on tribal

regulators and gaming operators. The proposed rule would require that tribal regulatory authorities

revise their existing regulations to incorporate the new control standards for paper bingo and

electronic bingo and similar games. The resources expended by the tribes in revising their rules are

social costs of the rule.

In addition to the costs to tribal regulators, gaming facility operators also face additional costs as a

result of the rule. Gaming operators must devote resources to update their own systems to ensure

compliance with the revised regulations. Gaming operators must also ensure that their employees are

properly trained to implement the revised control systems; such training involves a real expenditure of

resources. Lastly, gaming operators may need to devote additional resources to the actual

implementation of the revised MICS. The revised MICS require additional CPA effort and may require

dedicating new staff to perform the required tasks.

To comply with the technical certification requirements, manufacturers must submit Class II gaming

machines for testing and certification before they can be used in a Class II facility. This requirement

applies to titles and systems, rather than individual machines. The resources associated with

conducting and documenting the results of such tests are social costs attributable to the rule. It does

not matter for purposes of the analysis whether these costs are borne by manufacturers or passed on to

the tribes; the costs still represent real expenditures of society’s resources.

In addition, if major changes in machines were required to meet the certification standards, the rule

would also result in additional social costs through increases in development costs. Since game

manufacturers are already familiar with the types of requirements contained in the technical standards

due to their operation in other markets, we do not assign an increase in development costs to this rule.

Since we also have no reason to believe that certifiable machines will be inherently more expensive

than machines already on the market, we have not included a cost to account for increased

manufacturing costs.
4-2

Social Costs for the Classification Standards: Changes in Consumer Demand

The social costs associated with a change in the classification standard for Class II games are less

intuitive. While the rule requires some additional resources to be expended to convert games from

non-compliant to compliant games, the primary measure of social cost is the shift in social resources

spent on Class II gaming. This shift is determined by consumers and how they react to the regulations.

If the regulations reduce consumer demand, supplies of Class II gaming will decrease also. Measuring

how consumers react to the change in the gaming experience is the starting point for tracking shifting

resources.49

Measuring Consumer Demand: PreRegulation Demand

The example shows that it can be an

overestimate to assume that a regulation’s cost

is the incremental compliance cost multiplied

by the pre-regulatory demand. By ignoring how

a regulation changes consumer demand, an

analysis can substantially overstate estimated

compliance costs. The primary change of the

regulation for the player is the increased length

of the game. However, slowing of a game may

make the game alternatively both more

attractive to some players and less attractive to

others. There are a number of adaptive

behaviors available to both players and

operators to mitigate the effects of a slowing of

game play.

Measuring Consumer Demand: Change in

Game Duration

Another approach to estimate changes in

consumer demand is to link consumer demand

to the increased length of the game. . First,

players get some pleasure out of playing the

game itself and seek to maximize the amount of

time they spend playing with a given bankroll.

If this were not the case, players would be

indifferent between going to a casino and

playing a single game for $100 and losing $100 over the course of a number of hours playing a series of

$1 games. Actually, given the value of their time, we would expect the single bet to be more

attractive. In fact the opposite is true. Payouts are proportionally lower on lower denomination

49 See for example, OMB, Circular A-4 Regulatory Analysis, September 2003.

Example of Private Costs vs Social Costs

An example can help illustrate why tracking consumer

demand is essential to measuring the social cost of a

regulation accurately. Suppose a regulation requires

certain shoe manufacturers to spend $5 per pair to

change their shoe design and also reduces the

attractiveness of the shoes to consumers. Before the

regulation, consumers were willing to pay six dollars per

pair and bought 100 pairs of shoes; after the regulation

consumers only were willing to buy ten of the regulated

pairs at the new price of $11 dollars. The social costs of

the regulation are not the additional manufacturing cost

of $500 to produce the same 100 pairs of unwanted

shoes. Rather the estimate starts with the reduced

consumer demand of the regulated shoes – i.e., ten pairs.

The social costs include the additional manufacturing

cost required by the regulation to meet the reduced

demand – $50 (10 x $5) – for a total of $50. The other 90

consumers still have choices besides unattractive shoes

or walking barefoot. These consumers turn to a

substitute, their second most favorite type of shoe. If

their second favorite style of shoe costs seven dollars a

pair, then the 90 consumers pay $630 after the regulation

instead of $540 before the regulation. So, after the

regulation, consumers meet their demand (i.e., they

have shoes) for a total cost of $740 ($110 + $630). Thus

the social costs are equal to $190, the additional

resources spent by consumers ($140 + $50).

Manufacturers of the regulated shoe have a real resource

cost of $50, but suffer a much greater loss as revenue

($490) from their sales shift to another shoe

manufacturer. However, these losses are not social costs

since the revenue loss by one manufacturer is largely

offset by revenue gains by other manufacturers.
4-3

machines and per machine; revenues do not increase proportionally to bet size (i.e., revenue from

dollar machines do not earn four times as much as the revenue from quarter machines on a per

machine basis).50 Based on this consumer behavior, we would expect to see a slowing of play to result

in a greater willingness to play. The question is whether the increase in demand is sufficient to offset

the reduction in the number of games playable over a given time period due to the regulation’s slowing

of play.

Second, there are a number of adaptive behavior changes available to both player and operator that

would mitigate any effect from a slowing of game play. For example, a player can increase bet size,

play more cards/machines simultaneously, play for a longer period, or any combination of such

changes. This behavior modification will allow the player to risk (and presumably lose) the same

amount of money with a slower machine. The combined effect of these behavioral changes

compensate to some degree for the slowing of game play.

To understand these opposing possibilities, consider two scenarios. If consumers stop playing Class II

games because they run out of time, then the effect of the regulation to slow down games will

decrease their satisfaction and the revenue of operators. In this scenario, consumers on a bus trip to a

casino have only a limited amount of time or must wait to use a limited number of machines. If they

must leave before they are satisfied, then slowing down the pace of the games may decrease revenue.

If, on the other hand, consumers stop playing Class II games because they reach their internal limit of

losses (or gains), slowing down the pace of the games through the rule will not change gaming revenue.

On the same bus trip, players may reach their limit at 1 pm instead of noon. If their bus doesn’t leave

until 4 pm, consumers and the casino have still exchanged the same amount of money as prior to the

rule.51

As a result, physical throughput of the gaming machine (dollar-in/dollar-out) is, at best, an imperfect

measure of the consumer demand to potential changes in the gaming experience. Using reduced

physical throughput as a proxy for net gaming revenue loss or other costs measures also assumes that

all machines are running at full capacity at maximum bet amount, and that the only variable that

affects revenue is the speed of the game (rather than bet size, budget of players, etc.). Clearly,

assuming games are fully used is too strong of an assumption and will overstate social costs.

Measuring Consumer Demand: Net Gaming Revenue After Shift from Class III

to Class II

We use net gaming revenue as a way to measure how consumer demand changes. The difference

between the amount wagered and the prizes paid is the net gaming revenue. It is a measure of the

amount players are willing to pay for the gaming experience.52 Actually, net revenue understates the

50 See for example, http://www.revenue.state.co.us/Gaming/documents/FY08.xls

51 The gaming operator may lose other ancillary revenue from food, beverages, or other sales since the consumer has one less hour of nongaming time.

52 Another characteristic that is peculiar to the gaming market is the degree to which price discrimination is possible. Unlike goods where there

is a market clearing price that results in surplus to producer and consumer (except for the marginal purchase), gaming allows consumers to
4-4

total value to the consumer of gaming since it does not include the value of their time and their costs

to travel to the casino.53 However, if we assume that this regulation does not change any of these

consumers’ costs changes, net gaming revenue is a good estimate of the incremental change in

consumer demand before and after the regulation.

Using net gaming revenue we look for actual market experiences to observe how consumer demand

shifted as a non-compliant machine was replaced with a compliant machine. By observing the change

in net gaming revenue at the same gaming facility with roughly the same consumers, who have the

same choices of substitute forms of entertainment, we isolate the consumer response to the regulation

as much as possible.

The net gaming revenue reduction approach also overstates social costs. Consumers weigh the

incremental change as part of the total value they enjoy from Class gaming and against the total value

of substitutes (e.g., Class III experiences or other travel/entertainment options). The resources

consumers shift from Class II gaming becomes gains for other entertainment suppliers.

Costs of Minimum Internal Control Standards

Based on this framework, we estimate the increased social resources necessary to comply with the

rule. The MICS reflect industry-best practices intended to reduce the possibility of theft or fraud from

gaming facilities. Estimating costs for this section is somewhat difficult since different facilities

currently have a variety of internal control procedures. In addition, many of the specific provisions of

the proposed revisions to the MICS are being repromulgated from other parts of the existing MICS.

Other provisions are clarifications of requirements that already exist in §542.7 or elsewhere in Part

542. Therefore, the incremental costs may be relatively small. This analysis focuses on those

requirements that are new to the MICS for Class II facilities and those that require action on the part of

tribal regulators or operators.

Promulgation of Tribal Rules

The MICS create a requirement that tribal authorities promulgate new MICS rules. Using the

rulemaking costs for a small rule and a non-controversial procedural amendment in the State of

Minnesota as a proxy, the promulgation of new tribal rules to comply with Part 543.3 may range from

$7,754 - $30,320per tribe. 54 There are eight gaming tribes (operating eleven gaming facilities) with

only Class II gaming and 64 others who can or currently operate Class II gaming devices (but are also

compacted) for a total of 72 tribes. We assume all of the tribes will have to promulgate a rule to

change at least one aspect of their internal controls. This MICS requirement creates a one-time burden

continue to spend all the way to their personal point of indifference. This feature allows each player to effectively set her own market clearing

price. The producer therefore is able to capture more of the consumer’s demand as revenue.

53 The total consumer cost of the experience includes a number of items that are not included in the price of the game. For example, the price

does not include the opportunity cost of the players’ time, the costs incurred in traveling to the gaming facility, and any ancillary costs such as

food and lodging associated with visiting the facility.

54 Minnesota Rulemaking Manual: A Reference Book For The Practitioner Issued: September 18, 2007 pages: 201-203
4-5

of between $500,000 and $2 million. Annualized over ten years at a seven percent interest rate, the

social costs are between $70,000 and $285,000 per year.55

Increased Cost of Contracting Certified Public Accountants

The MICS also require that the gaming facilities hire an independent CPA to audit compliance.

However, since gaming facilities are already required to hire CPAs for the current internal controls by

Part 542, the marginal increase in burden is the additional checklist which the CPAs are required to

certify as a result of these provisions. Audits of Indian gaming facilities tend to be performed by a

fairly small group of CPAs. In discussions with some of these auditors, the Commission’s financial

compliance staff determined that the additional audit requirements imposed by the revisions to the

MICS could add $15,000 per year to the cost of audit services. The maximum number of affected

facilities is the 161 gaming facilities that can offer Class II games, including eleven facilities that offer

only Class II games. If all 161 gaming facilities were required to comply with this portion of the Class II

MICS, we estimate an incremental compliance cost of $2.5 million per year for this requirement.

However, since not all 150 facilities offer Class II games and, since we expect the number offering

Class II games to fall over time, this estimate overstates the likely compliance costs.

Retraining Enforcement Officials and Operation Personnel

Once the revised MICS are adopted as tribal law, tribal enforcement officials must be trained in their

implementation. There are roughly 2,800 tribal gaming regulators associated with tribes operating

gaming within the borders of the United States. 56 However, tribal regulators will only require training

if their tribe operates Class II games. There are 225 tribes that are involved in gaming. Of these 72

are, or have been, involved with Class II gaming. If we assume that regulators are distributed roughly

evenly across these tribes, then roughly 900 of these regulators would be associated with tribes that

could be affected by the revised MICS. If all of these regulators received additional training on the

new MICS requirements (keeping in mind there is no need for such training for tribes in states where no

Class II gaming is taking place) at a cost of $100 per person – to account for materials and the time of

the regulator, such training would add $90,000 to the first year cost of the proposed rule.

Employees of Class II gaming facilities (or Class II portions of Class III facilities) would also require

training on the new procedures. There are approximately 178,000 Indian gaming employees

nationwide.57 However, most of these employees are working in Class III facilities not affected by the

revised MICS. Class II gaming revenue earned $3.6 billion in 2006. The February 2008 report estimated

that Class II tribal gaming operations would employ one worker for every approximately $98,000 in

revenue.58 If we apply this ratio of revenue to the number of employees, we calculate an estimated

37,000 people employed in Class II facilities.

55 All future benefits and costs are annualized at a real discount rate of seven percent, corresponding to OMB’s recommended social discount

rate.

56 http://www.gaminglawmasters.com/layman/regulated.html

57 The Economic Impact of Indian Gaming in 2006. The National Indian Gaming Association. Retrieved from

http://www.indiangaming.org/info/pr/press-releases-2007/NIGA_econ_impact_2006.pdf

58 Meister, A. The Potential Economic Impact of the May 2006 Proposed Class II Gaming Regulations, Analysis Group, February 1, 2008.
4-6

If we again assume a training cost of $100 per employee, we calculate a training cost of $3.7 million in

the first year. There would also be costs associated with the training of new employees. We

conservatively assume that gaming facilities will bear an additional annual cost of $1.6 million in the

future to train new workers and provide refresher training to existing employees; the annualized cost is

equal to $1.9 million.

Security

Section 543.7 lists all of the new procedures necessary for the MICS. Some of these requirements are

clarification of authorities already in parts of 542. Others may be similar to or consistent with

standards already applicable through tribal regulation. While many of them have the potential to

impose additional costs, we do not have sufficient information to develop a reasonable approximation

of the total marginal effect of these changes. In addition, these provisions represent industry best

practice. There is no guarantee that they will prevent all fraud, theft, or error (in fact, we are certain

that they will not). As a result, we discuss the MICS more fully with respect to their potential benefits

and leave it to the reader to determine whether the costs of these provisions are likely to greatly

exceed the benefits.

Caveats

The MICS are based on best industry practice. Some tribes may currently use everything in the MICS;

all tribes may be doing some of what is in the MICS. For those areas where the MICS merely codify

existing practice, the regulations will have neither marginal costs nor benefits.

Total Cost of Revised MICS

The quantified costs of the proposed revisions to the MICS are estimated as an annualized cost over ten

years (using a discount rate of seven percent) of $4.7 million.

Costs of Technical Standards

The technical standards potentially impose two sets of costs. The first is any actual changes that will

be required to certify to the standards themselves. For example, if a game is being run on a machine

that does not have a door open sensor, the cost of installing such a sensor would be attributable to the

rule. We do not have sufficient information on the physical properties of games currently in operation

to definitively describe the baseline. However, with the exception of bingo specific requirements that

reference Part 546, most of these requirements mirror either the existing MICS for machines or

requirements in other gaming jurisdictions. Therefore, we assume that the technologies necessary to

meet the minimum standards are readily available and will be applied to existing machines to varying

degrees. As is the case with conversion costs, discussed elsewhere in this chapter, the cost of meeting

the technical standards can never exceed the full cost of replacing the machine with a compliant

system.

The second set of costs is the transaction costs associated with obtaining a certification to the

technical standards. These costs are estimated based on the information provided in the Information

Collection Request (ICR) accompanying the proposed rule.
4-7

Cost of Modifying Machines

As mentioned above, we do not have reliable information on the baseline level of compliance with the

substantive requirements of the minimum technical standards. However, the substantive requirements

fall into three broad categories: Physical requirements; Software requirements, and; Accounting

requirements. We assume that software and accounting requirements will be addressed through the

frequent and routine updates required as part of normal operations during the grandfathering period.

However, we assume that physical requirements, including structural security, money handling, and

other requirements that could require physical modification of a machine could take longer to

implement through normal turnover and maintenance.

There is always some level of turnover and upgrade of existing physical stock. Operators upgrade their

systems to better compete in the marketplace. Leases of equipment expire and are renegotiated.

Machines break and are repaired or replaced. All of these events offer the opportunity to upgrade

system components to comply with the technical standards. As a result, it is not appropriate to

attribute the entire cost of upgrading these systems to the rule, since these changes would eventually

occur anyway. The appropriate measure of social cost is the loss in value associated with the

acceleration of these modifications relative to the baseline. However, in the interest of both

simplicity and conservatism, we attribute the entire cost of modification of systems in year five to the

rule.

For purposes of this analysis, we assume that 50 percent of the machines covered by the rule at the

end of the grandfathering period would have become compliant with the technical standards through

replacement or upgrade during the grandfathering period. This estimate likely understates the true

level of compliance since the numbers of machines are dominated by a few operations and tribes and

states with very active markets. Those markets are likely to have newer equipment and replace it

more frequently. Older machines that may require more modification to come into compliance are

likely to be concentrated in smaller markets with less competition driving change. In addition, the rule

is specifically written to facilitate marginal change moving toward compliance by allowing

modifications and maintenance to systems and machines without triggering a violation of the

grandfather period. To the extent that the true level of compliance is understated, our estimated

costs of the rule will be overstated.

It is important to note that the baseline compliance assumption here is slightly different from the

assumption used in estimating the effects of the classification standard. For purposes of the

classification standard, it is assumed that all systems are compliant at the end of the grandfathering

period. This is because the changes necessary to comply with the classification standard tend to be

software changes that occur more frequently than changes in hardware.

We assume that the remaining machines (approximately 12,000) will require some degree of

modification in year five to meet all of the technical requirements. We assume that 6,000 of these

machines will be nearly compliant, but will require minor modification to be 100 percent compliant.

This assumption reflects the fact that the hardware associated with many of the minimum technology

standards has become available over time and machines may already have some, but not all of the

required hardware installed. For example, such a machine may meet all of the other standards, but

require an installation of a door sensor, an upgrade of the money handling hardware, or sealing of the

motherboard. For these systems we assume costs of $500 per machine including parts and labor to

make required modifications.
4-8

We assume that 2,500 of the machines represent antiquated systems that are simply incompatible with

full compliance with the technical standards. We are not certain that such systems exist, but at some

point it becomes cheaper to replace a system than to upgrade. We assume a cost of $6,000 per

machine for a full replacement (see discussion of the classification costs for a full description of this

estimate). This amount represents the cost of a player interface as well as potential replacement of

some or all of the gaming system itself.

The remaining 3,500 machines are assumed to fall somewhere in the middle of these two extremes.

Such machines may require multiple upgrades to become compliant, but not so many as to justify full

replacement of the system. For these systems we assume a cost of $2,500 per machine.

The total cost of upgrading and replacing systems to comply with the technical standards, therefore, is

$25.5 million. All of these costs occur in the fifth year after the effective date of the rule. The

annualized cost at a discount rate of seven percent is roughly $2.6 million.

Contracting with a Laboratory to Conduct Certification Testing

The technical standards will be implemented in two phases. In the first phase, the 25 existing systems

will be submitted to independent laboratories for review and certification. Systems that comply with

the technical standards will be certified compliant. Systems that do not meet all of the standards will

receive a report certifying that the system was submitted. Under the rule, the system can then be

operated for five years after the effective date of the rule before changes must be made to bring the

system and its components up to the technical standards. This initial submission will take place in the

120 days following the effective date of the rule.59

The second phase will involve the testing of new machines and systems that manufacturers wish to

place in Class II facilities (including those designed to replace non-compliant systems in operation

during the grandfathering period). The cost estimate of this second phase is based on the historical

rate of introduction of new games of five per year.

Table 4-1: Cost of Certification to Part 547 Standards

Provision Respondents Hours Per

Collection,

1

st 120

days

Total

Hours

Total

Cost

Hours Per

Collection,

Day 121

Forward,

Per

Annum

Total

Annual

Hours

Annual

Cost

25 C.F.R.

547.4

Laboratories 10 250 $25,000 5 1500 $150,000

25 C.F.R.

547.4

Manufacturers 8 200 $8,000 4 1200 $48,000

25 C.F.R.

547.4

Tribal gaming

regulatory

authorities

0.5 12.5 $500 0.1 30 $1,200

59 National Indian Gaming Commission, Supporting Statement for Information Collection Request 3141-0009, Minimum Internal Control

Standards, October 17, 1998.
4-9

Costs to Independent Labs

Laboratories perform certification testing for gaming machines used in non-tribal and Class III

jurisdictions. The ICR estimated that five laboratories will be responsible for writing reports analyzing

the 25 grandfathering submissions. Each such analysis and report is estimated to take between five

and ten hours on average. The average hourly charge for performing these services is $100.00.

Proposed 25 C.F.R. §547.4(f) requires a determination of suitability for each testing laboratory. This

determination can include financial information, qualification of engineering staff, information and/or

inspections of their facilities, and personal information from principals. Tribal facilities typically use

only one gaming laboratory. Since existing laboratories are already licensed in numerous jurisdictions,

the ICR estimates that 90 percent or 203 tribes would accept suitability determinations from other

jurisdictions. Thus the submission by a testing laboratory of an existing suitability determination

amounts to writing a letter. For the remaining ten percent of the tribes (23), the labs will need to

spend 20 hours preparing this information. In total this represents a burden of 561.5 hours and a cost

of $25,000 per year.

Costs to Manufacturers

The 25 games currently in operation are produced by 20 manufacturers. The manufactures are

responsible for preparing, reviewing, and submitting documentation and descriptions of their games

and aids to the laboratories. The ICR estimates a cost of $8,000 for each of these initial reports.

The ICR estimates that subsequent reports will take less time (four hours rather than eight) for

manufacturers to prepare. Such a reduction is consistent with increased familiarity with the system as

well as the fact that such documentation can be developed as part of system design. In addition,

future submissions are likely to be smaller in scope, representing components of systems as well as

entire systems.

The commission estimated 300 submissions, covering new systems and modifications would be

submitted each year (after the first 120 days). Using the same $40.00 per hour of technical expert

time used in the estimate of preparing the initial reports, results in an annual estimated cost of

$48,000 for manufacturers.

Costs to Regulators

Tribal gaming regulatory authorities will be responsible for issuing grandfathering certificates and

gaming system descriptions. This function has a total estimated cost of $500 (25 certificates x 0.5 hrs x

$40.00). After the first 120 days of the adoption of the rule, the total cost is estimated at $1,200 (30

hours at a rate of $40.00) per year.

Cost of Preparing and Processing Variance Requests

Proposed 25 C.F.R. §547.14 allows gaming operations to apply for a variance from these standards.

The annual cost of compliance to gaming operators for making variance requests is $1,200 to $9,600.
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This range assumes four variances per year, and the difference depends on the complexity of the

variance requests. The total costs of certifying to Part 547 standards, therefore, are expected to be

approximately $250,000 in the first year leveling off to $200,000 per year in future years. This cost

does not account for the fact that manufacturers selling into non-tribal markets may already be

required to submit machines for certification pursuant to other regulatory authorities (e.g., Nevada

does have technical standards for electronic bingo equipment).

Administrative Cost to NIGC

The NIGC will create a new Machine Compliance Department that will be responsible for day-to-day

work in implementing the rule, including the information collections for the agency that result. The

proposed budget for the new department is as follows:

Table 4-2: Budget Estimate for Machine Compliance Department

It is anticipated that

the Machine

Compliance

Department will

maintain the

information provided

under proposed 25

C.F.R. § 547.4 and the

marginal cost for

doing so is nominal.

Therefore, the total

cost of implementing

the requirements of

Part 547, including

certification, testing

documentation and NIGC oversight is estimated at approximately $500,000 per year.

The total cost of all of the provisions of Part 547 is, therefore, estimated at $3.1 million per year.

Costs of Definitions and Classification Standards

Alternatives Considered and Categories of Costs

Unlike the MICS and the technical standards, for which the only alternative we examined was the

proposed option relative to a baseline of not adopting new standards, we evaluate three separate

alternative scenarios in estimating the costs of changes to the classification standards. We evaluate

the revised proposal, a version of the revised proposal without the grandfathering provision, and a

baseline that includes increased enforcement of the existing regulation. These three alternatives are

discussed in more detail in Chapter 3.

Position Budget

Supervisor $102,000

Specialist $74,000

Travel $65,000

Rent, Communications & Utilities $55,000

Printing & Reproduction $3,000

Supplies, Materials & Equipment $15,000

Other Services $0

Misc. $0

Total $314,000
4-11

Replacement and Reprogramming Costs

In the event that tribes are operating non-compliant machines, the tribe is faced with a variety of

alternatives, each with different costs:

1. Replace or reprogram Class II machines with compliant alternatives over time during the

five-year grandfathering period;

2. Operate existing non-compliant Class II machines, without modification, as Class III

machines under an existing, new, or renegotiated compact;

3. Replace Class II machines with Class III machines pursuant to a new or renegotiated

compact; or,

4. Cease operations.

The February analysis assumes that 100 percent of facilities must replace their machines with

compliant machines. It further assumes that replacement involves either complete replacement of an

entire system or extensive software reprogramming to achieve compliance. As discussed earlier, the

analysis combines these costs along with an estimate of lower gaming revenue.

This approach provides a worst-case estimate of the potential costs to tribal gaming operators.

However, as a measure of the social costs of the proposed rule, this estimate of private costs to game

operators overstates social costs because of the ability for consumers to adapt their behavior in

response to a change in game play.

We adopt different assumptions to simulate how rational operators would behave to find the lowest

cost of compliance.

First, it is an overstatement to assume that all gaming operators are currently operating fully noncompliant systems that could require substantial upgrades. The standards established in the rule are

consistent with Commission in its current enforcement, inspection, and opinions. Machines determined

by the courts and the NIGC Office of General Council to be Class II machines are installed and operating

at gaming facilities. As discussed in Chapter 3, it may be that 50 percent of the machines in operation

at Class II facilities are already essentially compliant with the proposed requirements.60 We use a 50

percent rate of compliance in the baseline in calculating our estimate of the incremental costs and

benefits for the proposed standards. We also conduct sensitivity runs at baseline rates of compliance

of 80 percent and 20 percent.

Second, there are actions short of complete replacement that would allow a game to be converted into

a compliant game. An electronic aid to bingo consists of roughly six main components, a cabinet, a

user interface (buttons or touch screen), a display (may be same as user interface), a computer (for

graphics processing and communication), a central system (to process the conduct of the game), and

the game software. There is no reason the cabinet would require wholescale replacement as a result

60 We recognize that it is unlikely that a machine will meet all of the provisions of the proposed rule, especially the labeling requirement that a

machine is a game of bingo. However, the changes necessary to bring some machines into compliance are nominal compared to a fundamental

redesign of software programming.
4-12

of the rule. User interfaces and displays would only be required to be replaced if, for some reason,

there was no game software that could be made compatible with these components. It is possible that

the internal computer would need to be replaced with one that runs a compliant game. However,

these upgrades may already be scheduled as part of the normal operation. Future systems are also

more likely to be fully networked where the computer at the player terminal merely receives and

sends information to and from the central computer.61 In a networked system, most changes can take

place at the central computer with little need to even send technicians into a gaming facility. The

software and some property of the central computer will need to be changed in order to come into

compliance in these instances.

Third, the fact that there is a baseline rate of compliance strongly suggests that there are already

systems in the market that essentially comply with the proposed requirements as well. In fact, the

Commission’s Office of General Council has issued seven decisions since 2002 affirming systems as Class

II games, including both new and modified systems. As a result, there would be no need to develop a

new Class II system to replace those that are non-compliant; a gaming operator can purchase a system

off-the-shelf. Because these systems are available, the cost of replacing a non-compliant system

cannot exceed the cost of producing (i.e., the price) a compliant, off-the-shelf Class II gaming system.

This insight is important to evaluate how a rational gaming operator will minimize compliance costs.

Operators will first ask their current manufacturer to modify their existing gaming equipment to come

into compliance with the standards. In the best case this modification will involve changing the

software on the central server to an already existing compliant alternative. If the operator’s game

manufacturer charges too high a price for this change (reflecting the need for more extensive upgrades

to terminals, cabinets, software, etc.), the operator will simply switch to an off-the-shelf compliant

alternative. In other words, the maximum price an operator would be willing to pay for conversion of

an existing system is the price of a brand-new compliant game system. This rule would not require the

ground-up redesign of a new system or very costly modifications to every game in the Class II market

now.

To validate this understanding of gaming systems, we used a real case of machine conversion as the

basis for our estimate of the replacement and reprogramming cost. In 2002 the Commission challenged

the Class II status of one of Multimedia Games, Inc.’s (MGMA) bingo games, MegaNanza. Multimedia

also had a compliant alternative system called Reel Time. As part of its agreed upon remedy with the

Commission, the company replaced all of its MegaNanza machines with Reel Time Bingo machines.62

This process involved sending technicians into the field to make conversions to the game and replace

some glass and other components as necessary to change the game.

Before undertaking the modification, one of the financial officers provided a worst-case estimate of

the cost of conversion to investors. He estimated that the cost to convert 4,000 machines and the

relevant servers, software, and glass could cost the company three million dollars. This cost is

equivalent to an average of $750 per installed terminal. 63

There are a number of factors that could affect the reasonableness of this number as an estimate of

conversion cost for all Class II machines. First, MGAM had a readily available alternative that was

61 See for example, https://www.igt.com/Content/base.asp?pid=8.17.36.15&bhcp=1

62 Multimedia Games Inc, 10-K filing with the Securities and Exchange Commission, December 12, 2004, pg. 26.

63 Conference call for investors see http://www.multimediagames.com/Investors/ConfCalls/StatusUpdateJune2002.htm
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compatible with its current equipment. The reprogramming costs could be lower than for a

manufacturer without a compliant alternative. Second, the company’s representative had an incentive

to report an overestimate of the actual costs so as to provide the company with some margin of error

or a good news story for the next investor call. Third, the system was server-based, which would have

allowed some portion of the upgrades to be made from a central location (even though the company

apparently chose not to take advantage of this option).

64 Nevertheless, we use this number as a

reasonable estimate of a lower-bound cost of conversion of non-compliant machines to compliant

machines.

As an upper-bound, we use the cost of producing a new Reel Time Bingo machine. This machine is

available and has been determined to be compliant. The cost of producing such a machine was $5,000

in 2003.65 Inflating this to current dollars we get an upper bound replacement cost of about $5,400.

We increase the estimate to $6,000 to account for other potential costs, such as training for tribal

facility operators. Other alternatives may cost slightly more or less. If an operator chooses a more

expensive alternative, the additional cost is a business decision, not a consequence of the rule. If

alternatives cost less, we have overstated our upper bound estimate by using this single system.

Effect of Grandfathering Provision

The February analysis made the assertion that the grandfathering provision of the rule did not reduce

costs to the tribes, merely delay them.66 While this claim is the case for any net gaming revenue

losses, routine replacement of machines with compliant alternatives as part of the natural capital

replacement cycle does reduce any costs associated with the premature replacement of capital. In its

proposal, the Commission estimated that systems have a five year useful life. Some commenters

suggested that this five year estimate is too short for Class II systems.

67 However the commenter did

note that this estimate is reasonable for the software component of games. Other than the glass, we

cannot identify a provision in 546 that would require replacement of the hardware component of

games. Since the classification standards can be met with mostly software changes, the grandfathering

provisions should obviate most, if not all, costs associated with reprogramming or replacement.68

Companies are upgrading the game software on shorter cycles than five years to take advantage of the

lower costs, increased reliability, and increased flexibility offered by advances in electronics,

computers, and networked information systems. In the recent five year period, for example,

companies have introduced several new operating systems for their machines. These upgrades provide

a low-cost means to incorporate the regulatory changes. In addition to lower their operating costs,

competitive forces provide another incentive to upgrade systems frequently. Hardware and software

upgrades can introduce new titles, more graphics, and create side bet opportunities. These changes

64 http://www.multimediagames.com/investors/RothCapitalPartnersGrowthStockConf031803.htm

65 Ibid.

66 Meister, A. The Potential Economic Impact of the May 2006 Proposed Class II Gaming Regulations, Analysis Group, February 1, 2008, pg. 15.

67 NIGC-2007-0010-0038, NIGC-2007-0010-0041, NIGC-2007-0010-0046 (Kickapoo Traditional Tribe of TX, Absentee Shawnee Tribe of OK,

Comanche Nation) “The NIGC assumes a 20 percent turnover rate in games per year and a useful life of 2 to 5 years. While this might not be

unreasonable for the software component of the game, it vastly underestimates the useful life and turnover rate of the hardware. Because

both rules impose a fundamentally new set of standards that will take effect all at once, they will likely lead to significantly higher number of

games and gaming systems being turned over all at once and thereby impose a much more significant burden than has been estimated by the

NIGC. “ Retrieved from http://www.regulations.gov/fdmspublic/component/main?main=DocketDetail&d=NIGC-2007-0010

68 Provisions of Part 547, such as tamper proof cash boxes, could require hardware changes, but the provisions of 547 are considered

elsewhere.
4-14

can reduce the perceived differences between Class II and Class III games and can encourage more

Class II customers to patronize a certain facility.

With these competitive forces in mind, it is useful to envision the characteristics of a gaming operation

that would not benefit from the grandfathering provision. First, this facility would have to own its

gaming equipment and thus not have an opportunity to have them replaced during the five-year period.

Second, the equipment is durable and does not reach the end of its natural life during the five year

period. It is possible that well-maintained electronics could persist for long periods of time. It is more

likely that some equipment will have to be replaced during the five year period. Third, the gaming

facility would not have much Class II or Class III competition in its market area. Like other monopolies,

it would tend to under-invest in capital since it did not have the same incentive to stay competitive.

Examining the distribution of Class II gaming nationally, these conditions are more likely to exist in

places with relatively few Class II machines (e.g., Alaska) rather than in places with relatively more

competition (e.g., Oklahoma). However, we do not have specific information that these conditions

exist.

Without the grandfathering clause, the situation is quite different. Non-compliant machines would

need to be converted in the first year. The MegaNanza to Reel Time transition demonstrates that it is

possible to transition a large number of machines to a compliant alternative over the course of a single

year. However, it does not give us an indication that the industry is capable of transitioning 50 percent

or more of its machines in a similar time period.

To calculate conversion costs in the absence of the grandfathering clause we rely on our estimate of

installed Class II games in 2009. We estimate that there will be just over 28,000 Class II machines

operating in 2009 including those still in place in Oklahoma and Florida awaiting conversion to Class III.

We assume that 50 percent of these machines are non-compliant, meaning 14,000 would need to be

replaced. As discussed above, the costs of such a conversion range from $750 to $6,000 per machine.

However, we cannot attribute all of the costs of conversion in Florida or Oklahoma to the rule, since

some machines in those states are already being replaced with Class III alternatives. The social costs of

the rule are not the full conversion costs, but the time-value of capital that now is spent in 2009 as

opposed to a few years later. On the other hand, the rule would require acceleration of the

replacement and that does increase costs. To account for these countervailing effects, we make the

simplifying assumption that all Oklahoma and Florida conversions can be accomplished at our lower

bound cost estimate. Machines outside of Florida and Oklahoma could fall anywhere in the range

between $750 and $5,400 per machine.

Under these assumptions, the cost of conversion without the grandfathering provision range from $10.5

million to $40 million. All of these costs are incurred in 2009. The annualized costs over ten years at

seven percent range from $1.5 to $5.3 million. Table 4-3 shows the difference in reprogramming costs

with and without the grandfathering period.
4-15

Table 4-3: Annualized Cost of Replacement and Reprogramming Costs

Assuming 50 Percent Compliance Rate

(in $ millions)

Lower Bound Upper Bound

Revised Proposal with Current

Market Conditions

Minimal Minimal

Revised Proposal Without

Grandfathering Provision and

Current Market Conditions

1.5 5.3

Baseline with the Greatest

Enforcement Scenario

0.3 2.8

These numbers are based on the assumption of a current 50 percent rate of compliance. If, we assume

a greater or lesser degree of compliance in the baseline, it has a significant effect on the estimated

costs of the rule in the absence of the grandfathering provision. If we assume that only 20 percent of

current systems could comply with the new standards, the conversion costs in 2009 increase to

between $17 million and $65 million. If, on the other hand, we assume a greater level of compliance

in the baseline, say 80 percent, the costs fall to between $4 million and $16 million.

If NIGC does not proceed with a regulation to change the classification standards, tribes will also face

conversion costs as enforcement actions lead to forced conversion to compliant machines. To estimate

the cost of such conversions, we make the following assumptions:

 NIGC (and DOJ) will successfully reduce the level of non-compliance from 50 percent to 25

percent over a period of 10 years.

 Such improvement will occur evenly over time (e.g., five percent improvement per year).

 Enforcement will focus on states other than Florida and the 75 percent of machines in

Oklahoma where Class III conversion there is already underway.

Under this set of assumptions, the annualized cost of conversion ranges from $350,000 to $2.8 million.

Direct Gaming Revenue Losses

As stated previously, the incremental social cost of the regulation change is reflected in the reduction

in net gaming revenue from a switch to a Class III to Class II machine. Ideally, we would be able to

observe this change in the same facility over a relatively short time to avoid confounding variables such

as changes in economic conditions, the demographics of consumers, and in the relative availability of

substitutes. By examining the change in consumer demand for the new game relative to its

predecessor, we would be able to estimate the reduced value consumers place on Class II gaming.

Fortunately, this experiment occurred in 2002 and 2003. In 2002 the NIGC Office of General Counsel

challenged the classification of one of Multimedia Games Incorporated’s games. Multimedia entered

into a settlement agreement with the Commission under which it replaced its non-Class II machines –
4-16

MegaNanza – with a compliant alternative – Reel Time. The Commission has issued several opinions

that Reel Time is a Class II game.69 In fact, Multimedia claims to have designed Reel Time as a

compliant fall back machine in the event that MegaNanza was not accepted by the Commission.70

The result of this situation was that both machines were in operation in significant numbers (about

3,000 of one machine and 1,000 of the other machine) in roughly the same market at the same time.71

Therefore, by looking at the relative revenues of these two systems over the same time period, we

should be able to determine how large the net revenue difference between compliant and noncompliant bingo machines might be. In its 8-K filed with the SEC on April 29, 2003, Multimedia makes

the following statement:

For the quarter ended March 31, 2003, the net revenue per player station per day for

Reel Time Bingo and MegaNanza was approximately $40 and $41, 72 respectively. The

Company's net revenue per player station per day represents gross revenues, less

amounts allocated to the Tribal facility or casino, divided by the average number of

player stations and the number of days in the period. The lower net revenue per

player station per day for Reel Time Bingo compared to MegaNanza in the March 2003

quarter is primarily attributable to the Company's converting larger numbers of lowerperforming MegaNanza units while higher performing units remain in operation. On a

casino-to-casino comparison, where MegaNanza player stations have been

converted to Reel Time Bingo, those units have generally performed better than or

equal to the MegaNanza units following a familiarization period." [emphasis

added]73

Therefore, the net loss in revenue associated with the replacement of these non-compliant machines

with a compliant alternative is somewhere between zero percent and 2.5 percent. We examined

recent history to find other examples of conversions using machines similar to those in the market

today. We could not find any reported in public financial disclosure s in sufficient detail to perform

the analysis.

Because we only have one observed case (although with many observations), we will use a five percent

revenue loss as a conservative estimate of direct losses due to slower machines.

This revenue loss, however, may not account for all costs associated with transition from noncompliant to compliant machines. For example, it is clear that there is a learning curve that players

must climb before the games reach parity. If one looks at the same two machines over the year prior

to the filing of the 8-K referenced above, it is clear that there was a period during which revenues from

Reel Time were lower (per machine) than those of MegaNanza. This early period of depressed revenue

brought the annual average daily revenue per Reel Time machine down to $35 (or a 15 percent

reduction in revenue).74 Although this transition period is temporary and brief, this 15 percent

reduction in revenue may be another potential level of revenue losses.

69 http://www.nigc.gov/ReadingRoom/GameClassificationOpinions/tabid/789/Default.aspx

70 See for example, Multimedia Games, Inc. Form 8-K, April 29, 2003.

71 Multimedia Games, Inc. Form 8-K, April 29, 2003.

72 These numbers represent revenue to the manufacturer.

73 Multimedia Games, Inc. Form 8-K, April 29, 2003

74 Multimedia Games, Inc. Form 10-K for 2003
4-17

While the MegaNanza and Reel Time example provide us with evidence that a conversion from Class III

to Class II need not result in significant revenue losses, it may not account for machines that have a

higher pre-regulatory daily revenue. Revenue per machine is likely to be greater in states with a

higher per capita income. As the table below shows, Oklahoma had a comparable, if lower, per capita

income in 2003 than other Class II-only states.

Table 4-4: Comparison of Per Capita Income

To account for this possibility, we compare the revenues from

Reel Time machines reported in 2006 to the average revenue

per day for all Class II machines in Class II only states. Tribes in

these states along with Oklahoma will comprise the majority of

Class II games in the future. We used Reel Time’s revenues as a

proxy for the 50 percent of machines that are assumed to be

compliant and calculated the average revenues of noncompliant machine revenues necessary to achieve the average

revenues per day in Class II States.

We calculate Reel Time revenues per machine per day based on

information contained in the 10-K filed by Multimedia in 2006. That document indicated revenues of

$89 million from the placement of 8,400 machines, or approximately $29 per machine per day.

Previous data from Multimedia indicate that their revenues reflect 30 percent of the net gaming

revenue generated by their machines.76 If we assume this experience is representative of currentl

contracts, then the total net gaming revenue per machine per day is $97. We use this value as an

estimate for all Class II compliant machines.

From the data provided by the Commission, we calculate the average net gaming revenue per day from

Class II operations in the four Class II only states at $107 per machine in 2006. If we assume 50 percent

of the machines are compliant, then the average daily revenue per non-compliant machine is $117 in

these states. The reduction in revenue associated with switching from the average non-compliant

machine to a compliant machine would therefore be $20 per day – a 17 percent reduction in revenue.

To calculate the revenue loss associated with the proposed regulation, we assume that there would be

no loss in gaming revenue associated with the first five years due to the grandfathering provision.

After five years, we assume that all machines become compliant with the classification standards. For

those already operating compliant machines, there will be no change in revenue. For the 50 percent of

machines that are not assumed to be compliant, we calculated losses in net revenue of five and 17

percent.

In Class II only states, tribes operating Class II machines are expected to sustain an annualized net

gaming revenue loss of between $14 million and $23 million. In states with Class II and Class III gaming

(including Oklahoma), the annualized net gaming losses are greater, ranging from $32 million to $63

million. The total estimated change in Class II gaming revenue is between $45 million and $87 million,

annualized over ten years at a seven percent discount rate. For reasons stated above, the net revenue

75 US Department of Commerce, Bureau of Economic Analysis, State Annual Personal Income. Retrieved from: www.bea.gov/bea/regional/spi/ .

76 SEC Info - Multimedia Games Inc - S-3 – April 2, 2002 - EX-10.2.htm

Per Capita

Income - 200375

Oklahoma $26,457

States with Class II Only Machines

Alabama $26,371

Alaska $32,543

Nebraska $30,778

Texas $29,404
4-18

loss could be at the low end of the range due to consumers’ willingness to adapt to compliant

machines. It is also important to recall that this net gaming revenue loss overstates the loss in

consumer welfare and social costs. Some of this predicted net revenue loss shifts to other activities.

The net revenue loss is most appropriate as a measure of the economic impact of the regulation on

tribes offering Class II games.

Table 4-5: Lost Revenue Associated with Compliance with Revised Proposal

Current Market Conditions Baseline

Annualized Decrease in Gaming Revenue

Revenue Loss

(mil $2006)

Class II Only Lower Bound (5%) $14

Upper Bound (17%) $23

Class II and III Lower Bound (5%) $32

Upper Bound (17%) $63

Total Lower Bound (5%) $45

Upper Bound (17%) $87

Just as conversion costs are still incurred in the absence of the rule due to greater enforcement,

revenue losses associated with these enforcement actions also occur. Using the same assumptions

regarding machine population and rate of enforcement, we calculate revenue losses for the greater

enforcement scenario and present the results in the table below.

Table 4-6: Decrease in Gaming Revenue in the Greater Enforcement Scenario

Greater Enforcement Baseline

Annualized Decrease in Gaming Revenue

Revenue Loss

(mil $2006)

Class II Only Lower Bound (5%) $7.5

Upper Bound (17%) $15

Class II and III Lower Bound (5%) $19

Upper Bound (17%) $48

Total Lower Bound (5%) $27

Upper Bound (17%) $63

Non-Gaming Revenue Loss

Tribes derive revenue and consumers derive benefits from non-gaming activities at casinos, ranging

from hotel services to entertainment. Since demand for most of these additional services did not exist
4-19

before gaming was established, there is a direct connection between gaming revenue and non-gaming

revenue.

For small changes in gaming revenue, non-gaming revenue may not be affected. A one or two percent

change in willingness to pay for gambling does not mean that a consumer will stay fewer nights or eat

fewer meals. These transactions are inherently “lumpier” than spending on gambling.

While it is not certain that non-gaming revenues are directly proportional to gaming revenues, we will

use that assumption for the purposes of this analysis. The non-gaming facilities were put in place to

service the customers drawn by gaming. So, any gaming revenue losses will be multiplied by an

additional factor to account for losses in non-gaming revenue.

As noted in the February 2008 report, and confirmed by examination of Class II facility financial

reports, the non-gaming revenues associated with Class II facilities are lower, as a percentage of total

revenue, than they are at Class III facilities. Non-gaming revenues average between four and five

percent for Class II facilities. We use five percent to calculate non-gaming revenue losses associated

with the proposed change in the classification standards for machines. Using this methodology we

estimate annualized non-gaming revenue losses at between $1.9 million to $3.7 million in Table 4-7.

Potential Lost Jobs for Tribal Members

Gaming operators hire workers and invest capital to offer Class II gaming. Since the rule reduces

consumer demand for Class II gaming as it currently is offered, operators will cut back on employment

and their investments. In this way, the losses due to shifts in consumer demand already include the

direct loss of wages. However, we estimate potential employment effects for three reasons:

 Jobs provide other benefits besides wages, including self-esteem and skills that an individual

can use in later employment.

 In most cases, jobs are not costs since workers are not “lost” – they can move to other jobs.

However, in areas of extreme high unemployment as is found in some tribal lands, the labor

resource may not find other employment and could effectively be lost.

 As part of NIGC’s mission to assist the social welfare of tribal members, this information is

important for the Commission’s consideration.

The February 2008 report estimated that Class II tribal gaming operations would employ one worker for

every approximately $98,000 in 2008 revenue. In Table 4-7 we divide the estimated gaming and nongaming revenue loss to estimate the potential number of workers that could lose their jobs. Total job

losses are estimated to be 280 to 920 positions. If employment reductions are equally applied to tribal

members and non-tribal members, the employment impact for tribal members is estimated to be

between 71 and 231 jobs on an annualized basis.

The estimates are created using national average values in several instances. This approach masks

variations in job loss and nongaming revenue losses. If a tribe depends on the nongaming revenue for a

more significant share of the operation’s profitability or if the revenue per machine per day is much

lower than the national average, the employment and revenue losses could be more significant.
4-20

Table 4-7: Estimated Non-Gaming and Employment Losses

Greater Enforcement Baseline

Annualized Decrease in Gaming Revenue

Revenue

Loss

(mil $2006)

Non-Gaming

Revenue

Loss

(mil $2006)

Total

Gaming

Organization

Loss

(mil $2006)

Potential

Lost

Jobs

Lost Jobs

for Tribal

Members

Class II Only Lower Bound (5%) 7.5 0.3 $7.8 80 20

Upper Bound (17%) 15.4 0.7 $16.1 164 41

Class II and III Lower Bound (5%) 19.3 0.8 $20.1 206 52

Upper Bound (17%) 47.5 2.0 $49.5 506 127

Total Lower Bound (5%) 26.7 1.1 $27.8 284 71

Upper Bound (17%) 62.9 2.7 $65.6 670 168

Current Market Conditions Baseline

Annualized Decrease in Gaming Revenue

Revenue

Loss

(mil $2006)

Non-Gaming

Revenue

Loss

(mil $2006)

Total

Gaming

Organization

Loss

(mil $2006)

Potential

Lost

Jobs

Lost Jobs

for Tribal

Members

Class II Only Lower Bound (5%) $13.6 0.6 $14.2 145 36

Upper Bound (17%) $23.1 1.0 $24.1 246 62

Class II and III Lower Bound (5%) $31.5 1.4 $32.9 336 84

Upper Bound (17%) $63.3 2.7 $66.0 674 169

Total Lower Bound (5%) $45.1 1.9 $47.0 480 120

Upper Bound (17%) $86.5 3.7 $90.2 922 231

Loss in Bargaining Power

The tribes argue that the inability for them to operate competitive Class II gaming machines reduces

their bargaining power during the state compact renewal process. While this situation may be the

case, unless the renegotiated compact fundamentally reduces the level of gaming activity (which

would not be in the interest of the state from a revenue perspective), the shift of resources from the

tribe to the state represents an economic transfer, not an economic cost. To the extent that this is a

cost of the rule – not an underlying statutory requirement – its magnitude is difficult, if not impossible,

to estimate. Factors other than the availability of Class II gaming are likely to play a large role in

compact negotiations. Teasing out the value of this bargaining chip to the tribes is beyond the scope

of this analysis. Nevertheless, this effect is important in the context of the mission of the NIGC to

protect viable gaming as a public resource for tribes relative to other participants in the gaming

industry.
4-21

Summary of Social Costs of Alternatives

Table 4-8 summarizes the social cost of the rule for the three alternatives. Without a regulation, there

are no incremental changes in social benefits and costs. Promulgation of the MICS and technical

standards is estimated to cost $7.8 million annualized over ten years at a seven percent real discount

rate. Promulgation of all four components of the October 2007 proposed rule will have estimated

social costs of between $36 million to $98 million (annualized over 10 years at a seven percent discount

rate). Since these estimates likely overstate social costs, the expected value is toward the lower end

of the range. Based on these estimates, promulgating the MICS and technical standards would not be a

“major rule” under the Congressional Review Act.

Table 4-8: Summary of Costs for the Rulemaking Alternatives

Alternative Costs under Current

Practices Baseline

($ mil 2006)

Costs under Greater

Enforcement Baseline

($ mil 2006)

No Regulation 0 0

MICS and Technical

Standards

7.8 7.8

MICS, Technical Standards,

Classification Standards,

and Definitional Changes

55 - 98 36 -73

Summarized Comparison with February 2008 Analysis

This analysis supplements a previous analysis prepared for the Commission. The purpose of this

analysis was to compare the incremental social benefits and costs to fulfill the Commission’s statuatory

obligation under the Congressional Review Act. Since the analytic focus of this report is estimating

social benefits and costs, it is reasonable that the two analyses may have different results.

While this report uses the same data and approaches as the February report, there are important

differences. These differences have a substantial impact on the final estimates of economic impact on

Class II facilities. While Table 4-9 below highlights some of the similarities and differences, the major

differences are the following:

 The reports use different units to present costs. Both reports must present costs that occur in

different years in a common measuring system. The February 2008 report presents discount

costs occurring in the future and presents a present value estimate in current dollars. This

report annualizes the flow of benefits and costs over a ten-year period using a seven percent

real discount rate. Based on our interpretation of the February 2008 results for Scenario 2A in

that report, the net gaming revenue loss is estimated to be $1.2 billion in current dollars.

Assuming these losses occurred within 10 years, the equivalent annualized amount is $160

million. Based on this interpretation, Scenario 2A in the February report estimates 1.8 to six

times more net revenue loss than this analysis.
4-22

 For one measure of net gaming revenue loss, the February report uses a similar approach as

this report. However, the assumed compliant game is an older offering from Multimedia that

had lower revenues than the Reel Time game used in this analysis. In this report, we assume

that tribal gaming operators will chose the Class II game that gives the highest possible net

revenues and that complies with the regulation. This difference led to the substantial

difference in the reduction in Class II gaming revenue in the two analyses.

 The February report estimates that all machines and titles will undergo conversion,

reprogramming, and replacement costs. For Scenario 2 in the February report, these costs

equate to roughly $20,000 per Class II player interface. In this report, we assume operators

will not pay for (and thus suppliers will not provide) reprogramming that exceeds the cost of a

new compliant system (estimated to be $6,000). In addition, this analysis finds that the

grandfathering provision will reduce compliance costs substantially.

 The February report assumes all current Class II machines are noncompliant. While it may be

unlikely that current machines are in full compliance with every provision of the classification

and technical standards, many machines that have opinion letters deeming them Class II may

only require nominal upgrades. We use the Commission’s estimate of compliance rate as the

basis for this analysis.

Table 4-9: Comparison of Major Differences Between the Analyses

Data/Assumption February 2008 Report This Analysis

Data Year 2006 2006

Number of Affected Class II

Machines

15,765 (Scenario 2A) 5,000 to 20,000

Growth Rate of Class II

Market

10-yr compound annual growth rate

of Indian gaming (14.6 percent)

State-specific growth rate.

For Class II only states,

annual average of machine

growth in the past five years.

Estimated Change in Gaming

Revenue

42 percent (range of 21-64) 5-17 percent

Compliant Game Used to

Model Gaming Revenue Loss

MegaMania Reel Time

Basis for Change in Class II

gaming revenue

Both observed revenue loss from

current Class II revenue per game to

MegaMania and measured increase in

game time

Market observation of the

difference in Reel Time and

MegaNanza’s net revenue

Baseline Compliance Rate 0 20 – 80 percent

Effect of Grandfathering No change; costs are just shifted in

time

Substantial

Classification Costs 1.2 billion (current $ for Scenario 2A) 27 – 87 million (annualized $)

Estimated

Replacement/Reprogramming

$350 million (current $ for Scenario

2A)

$1.5 to $5.3 million

(annualized $)
4-23

Data/Assumption February 2008 Report This Analysis

Costs

Estimated Nongaming

Revenue Loss

$127 million (current $ for Scenario

2A)

$1.1 - $3.7 million

(annualized $)

Estimated Potential Tribal

Member Job Losses

3,336 71 – 231

Benefit Estimate None or qualitative Partially Quantified

5-1

Chapter 5: Social Benefits

As a companion to Chapter 4, this chapter discusses, and estimates when possible, the social benefits

of the final rule. Since they are not revealed in day-to-day market transactions, the social benefits are

harder to quantify.

The social benefits accrue from reducing the externalities arising from preventable fraud, the

increased public goods from more revenue available to promote tribal welfare, lowering unnecessary

litigation, and strengthening of the process established in statute to resolve externalities outside of

tribal boundaries.

All of the provisions also provide benefits through the streamlining of the current oversight and

enforcement system. By standardizing the process and creating certainty, costs are reduced for

operators, gaming manufactures, and the Commission and other regulators.

Benefits of Minimum Internal Control Standards

Both the MICS and the technical standards potentially have financial benefits that accrue to tribal

operators and tribal members. These flow from greater efficiency, lower capital costs, and smaller

losses associated with facility operation and cash handling. As was the case in estimating the costs of

the MICS, the benefits are limited to those facilities that are not already operating with such

procedures in place.

Preventing Externalities from Fraud

In any organization, fraud does occur. As these examples indicate, Indian gaming operations can fall

victim to thieves:

Fifteen people have been arrested in Ontario in connection with a ring that allegedly

scammed millions of dollars from casinos across North America by bribing dealers and

rigging card games. Among those arrested were four employees of Casino Rama —

located north of Toronto near Orillia — who are accused in a scheme that swindled the

casino out of more than $2 million, police said Friday.77

Two years ago, a former Pechanga casino executive was sentenced to four years in

prison for embezzling $500,000 from the casino to fuel an online gambling addiction.78

77 http://www.cbc.ca/canada/toronto/story/2007/05/25/casinos-scam.html, referenced July 8, 2008.

78 Carvajal, J. (2006, March 25). Former Penchanga controller-turned-embezzler speaks out on his compulsive gambling. The Californian.

Retrieved July 30, 2008, from http://www.nctimes.com/articles/2006/03/26/news/californian/22_10_113_25_06.txt
5-2

In addition, the NIGC has issued notice of violations in several instances where gaming operators failed

to follow current requirements for internal financial controls:

A tribe was accused of allowing individual members of the tribal council and the tribal

council itself to award complimentary items to themselves at the tribe’s gaming

operation. Awarding complimentary items to tribal Council members for personal use

does not fall within the authorized uses of net revenues.79

A tribal casino issued credit cards to each member of the tribal Council and to the

General Manager. For several years, these cards were used for personal expenditures,

expenditures that had already been provided by the Casino through other means, and

tribal government business. The Casino accounting department and the tribe lacked an

effective system of internal controls necessary to track gaming revenues.80

The respondents unlawfully managed blackjack and gaming machine operations and

did not provide supporting documentation necessary to effectively evaluate the

validity of the reported blackjack figures and internal control procedures were not

followed.81

These examples are not meant to identify weaknesses in any specific organization, but to highlight that

financial losses from fraud are prevalent and significant.

In addition to these occurrences at tribal gaming operations, a major study gives a national overview of

the threat from fraud, the level of risk faced by organizations like gaming facilities, and the

importance of internal controls. The Association of Certified Fraud Examiners prepares a bi-annual

report with estimates on the costs and effects of occupational fraud.82 Occupational fraud is defined in

the report as “the use of one’s occupation for personal enrichment through the deliberate misuse or

misapplication of the employing organization’s resources or assets.” While the results of the study do

not directly address potential occupational fraud occurring in the Indian gaming industry, it provides

useful data to put the potential fraud losses in perspective.

This report constitutes one of the most complete sources available on business fraud. The results of

the study are based on data compiled from 959 cases of occupational fraud that were investigated

between January 2006 and February 2008 by the association’s members. In general, the report

estimates that a typical US organization loses seven percent of its annual revenues to fraud.83 In the

959 cases of occupational fraud that were part of this study, the median loss of fraud was $0.175

million per case. In addition, more than 25 percent of all cases studied involved losses of at least $1

million.

79 NIGC, Notice of Violation: NOV-00-09; Amendment to Settlement Agreement: SA-00-09, Confederated Tribes of Siletz Indians of Oregon

80 NIGC, Settlement Agreement (SA) Coyote Valley Band of Pomo Indians and NIGC

81 NIGC, Proposed Civil Fine Assessment: CFA-07-02, Ivy Ong and Carlo World Wide Operations, LLC

82 Association of Certified Fraud Examiners (2008). 2008 Report to the Nation on Occupational Fraud & Abuse.

83 This percentage is based on the opinions of the association and is not derived from any specific data or a statistical sample of US

organizations.
5-3

The study examines three main types of occupational fraud:

 Asset misappropriation: Fraud in which the perpetrator steals or misuses an organization’s

resources. The median loss in 2008 for this type of fraud was $0.15 million.

 Corruption: Refers to schemes in which fraudsters use their influence in business transactions

to obtain a benefit. The median loss in 2008 for this kind of fraud was $0.38 million.

 Financial statement fraud: Intentional misstatement or omission of material information from

the organization’s financial reports. The median loss in 2008 for this kind of fraud was $2

million.

Notably, the study revealed that, in the banking and financial services Industry, theft of cash

maintained on the premises was much more common than in other industries (see Tables 5-1 and 5-2).

Banking and retail establishments lost much more cash than manufacturing for example. As shown in

the table below, banking and retail are among the top five most victimized types of organization. The

median loss in a cash-on-hand case was $35,000 (28 percent of total cases of fraud in the industry).

Corruption costs were significant in the industry as well, with a median loss of $375,000 (33 percent of

total cases of fraud in the industry). Considering that Indian gaming operations handle significant

amounts of cash in their daily operations, it is reasonable to assume that fraud levels could be similar

to those in the banking/financial services sector.

Table 5-1: Top Five Victim Organizations, by Frequency

Industry Number of Cases Percentage of

Cases

Median Loss

Banking and Financial

Services

132 14.6% $250,000

Government and Public

Administration

106 11.7% $93,000

Healthcare 76 8.4% $150,000

Manufacturing 65 7.2% $441,000

Retail 63 7.0% $153,000

Table 5-2: Selected Occupational Fraud Schemes in the Industry 84

Industry Corruption Cash Larceny Cash on Hand

Banking and Financial

Services Industry

33.3% 11.4% 28%

Government and Public

Administration

26.4% 9.4% 14.2%

84 The sum of percentages exceeded 100 in the source data because several cases involved schemes in more than one category.
5-4

Industry Corruption Cash Larceny Cash on Hand

Healthcare 26.3% 15.8% 9.2%

Manufacturing 29.2% 1.5% 7.7%

Retail 22.2% 14.3% 19%

Average (all Industries in

the Study)

26.9% 10.3% 12.6%

The study also reviews how the fraud was detected and evaluates which detection methods proved

effective. In the study, 46 percent of the cases analyzed were detected by a tip or complaint from an

employee, customer, vendor, or other source. However, 19 percent of the cases were detected by

internal audits, 23 percent by internal controls, and 9 percent by external audits. This study suggests

that effective audits and internal controls can prevent over 50 percent of the cases of fraud.

The following table presents the importance of having internal controls in place and how they help

reduce fraud. The most effective control was to perform surprise audits, which reduced fraud losses

by up to 66 percent. The report and Table 5-3 below also show that fraud prevention benefits from a

variety of procedures, not just one approach. Many of the MICS in the proposed rule are similar to the

controls listed below.

Table 5-3: Median Loss Based on Presence of Anti-fraud Controls

Control % of Cases

Implemented

Yes No %

Reduction

Surprise Audits 25.5% $70,000 $207,000 66.2%

Job Rotation / Mandatory Vacation 12.3% $64,000 $164,000 61.0%

Hotline 43.5% $100,000 $250,000 60.0%

Employee Support Programs 52.9% $110,000 $250,000 56.0%

Fraud Training for Managers / Executives 41.3% $100,000 $227,000 55.9%

Internal Audit / FE Department 55.8% $118,000 $250,000 52.8%

Fraud Training for Employees 38.6% $100,000 $208,000 51.9%

Anti-Fraud Policy 36.2% $100,000 $197,000 49.2%

External Audit of ICOFR 53.6% $121,000 $232,000 47.8%

Code of Conduct 61.5% $126,000 $232,000 45.7%

Management Review of IC 41.4% $110,000 $200,000 45.0%

External Audit of F/S 69.6% $150,000 $250,000 40.0%

Independent Audit Committee 49.9% $137,000 $200,000 31.5%

Management Certification of F/S 51.6% $141,000 $200,000 29.5%

Rewards for Whistleblowers 5.4% $107,000 $150,000 28.7%
5-5

Table 5-4 shows how the lack of internal controls is the most important weakness contributing to the

types of fraud for which tribal gaming operations are most vulnerable.

Table 5-4: Breakdown of Primary Internal Control Weaknesses by Scheme

Type

Most Important Contributing Factor Financial Statement

Fraud

(% of Cases)

Corruption

(% of Cases)

Asset

Misappropriation

(% of Cases)

Lack of Internal Controls 29.3 27.8 36.8

Lack of Management Review 6.1 14.1 18.6

Override of Existing Controls 15.2 19.0 16.8

Poor Tone at the Top 19.2 15.6 7.8

Lack of Competent Oversight 8.1 6.8 6.8

Lack of Independent Checks / Audits 11.1 4.9 5.9

Lack of Employee Fraud Education 2.0 1.5 1.2

Lack of Clear Lines Of Authority 0.0 1.1 0.9

Lack of Reporting Mechanism 0.0 0.0 0.2

If this study’s findings hold true for gaming operations, the final rule will reduce the amount of funds

diverted from the gaming organization. Although preventing criminal activity has clear benefits, the

question is who gains these benefits? The MICS regulations provide a mix of both social and private

benefits (i.e., “transfers”). As a matter of public policy, the NIGC is primarily concerned with the

social benefits of regulation. In addition, since the NIGC’s mission is to ensure that the tribal gaming

enterprises are operated to promote the public welfare of tribal members, the NIGC has an interest in

promoting private benefits gained by tribes.

To understand the distinction between private and social costs for the MICS, it is useful to realize that

the MICS are analogous to an insurance policy. Operators incur daily costs for the procedures, audits,

and extra paperwork whether or not any fraud occurs. In contrast, fraud attempts occur with some

random, unpredictable frequency. As with all insurance policies, operators determine the probability

of fraud and the associated consequences to estimate whether investing in the financial controls will

produce net benefits.

85 It is economically rational not to insure very rare risks; few operators have

insurance against the risk of a meteor strike on their facility. Although the consequences would be

severe, the risk is so low that the expected value (the annual risk multiplied by the value of damages)

does not equal the annual premium.

However, if operators take too narrow a view of their exposure to fraud or underestimate the

consequences to others, their choices could impose costs on other parties. Growing research suggests

that many people have cognitive difficulty estimating rare risks. In cases where the private choice is

85 A similar argument can be made to assess the potential financial benefits of the Technical Standards. However, errors in the context of

machines represent a transfer from casino to player or from player to casino, not a true economic cost or social benefit.
5-6

different than the choice that is best for society as whole, government requiring owners to have

enough insurance to lower the third-party impact can produce social benefits.

An everyday example illustrates how requiring insurance can have both private and social benefits.

Virtually all states require car owners to have auto insurance. Even without regulation many drivers

estimate the risk and the potential financial and physical losses and purchase insurance. However,

other drivers either underestimate the chances of having an accident or prefer to spend their money on

other items, underestimating the losses they and others may suffer in a crash. If this underinsured

driver injures someone else and cannot pay the resulting costs, the third party suffers an

uncompensated loss. States intervene through regulation to require a minimum amount of coverage,

especially for third-party damages. If states set the optimal level of insurance, the externality is

eliminated.

In the case of internal controls, operators tailor internal controls to their perceived level of risk. If

they misjudge and suffer a major loss due to fraud, their operations could fail financially, have

increased insurance costs or financing costs, or scale back operations. Operators may then fire workers

and scale back purchases from other businesses, potentially leading to social costs if the surplus labor

and goods are not productively used elsewhere in the economy. Therefore, the externalities arise

when an operator fails to invest in a sufficient level of financial controls to contain the potential social

loss from fraud.86

In this framework, the next question is what are the specific private and social benefits of the final

rule’s MICS standards? As with the social costs, the social benefits of the MICS standards in the final

rule are the incremental benefits above current regulations. There then are several conditions for the

rule to have incremental social benefits. First, the MICS must require an internal control that the

gaming operator does not already have in place. Second, for those controls added by the MICS, they

must have some ability to detect and mitigate the consequences of fraud. Third, the type of fraud

must not be so rare that the control will not yield positive net benefits.

We did not have adequate data to prepare a full quantitative assessment of the potential incremental

social benefits of the MICS. Primarily, we do not have organization-specific information on the

effectiveness of existing MICS. Therefore, we do not have quantitative data on the incremental change

in internal controls provided by the final rule. However, to illustrate the likelihood to social benefits,

we can use the national data on fraud to show that, as an insurance policy, the MICS would only need

to prevent a small number of cases of fraud to pay for themselves.

The 2008 Report to the Nation on Occupational Fraud and Abuse87 reported that US organizations lose

seven percent of their annual revenues to fraud. The study also states that approximately 20 percent

of all fraud and theft can be detected by internal control standards. The other 80 percent are

identified through other controls and from tips. If a gaming organization had very few existing

controls, the new MICS may only prevent approximately 20 percent of theft and fraud. Since

86 In economic terms, the theft is a transfer from the casino operator to a criminal. It can be argued that this transfer is likely to have social

costs in the strict economic sense. Criminals rarely invest in socially productive activities, but rather typically consume their gains. Since tribal

operations invest their revenues in programs to improve overall tribal welfare and/or pay dividends to individual members of the tribe, they are

much more likely to generate positive externalities (e.g., increases in labor and capital productivity) than consumption of exotic cars or designer

clothing.

87 Association of Certified Fraud Examiners (2008). 2008 Report to the Nation on Occupational Fraud & Abuse. Retrieved from:

http://www.acfe.com/documents/2008-rttn.pdf
5-7

operations are required to have internal controls by the existing regulation, the marginal reduction in

fraud due in this rule is likely to be lower than 20 percent.

Because of frequent transfers of currency, the gaming industry is a particular target of corruption as

compared to other sectors. Corruption cases typically involved ten times as much financial loss as

occupational fraud (an average of $375,000 as compared to $35,000).

Class II gaming annual revenue is estimated to generate $3.6 billion at gaming facilities. Assuming a

seven percent fraud and corruption rate, gaming facilities could lose approximately $250 million per

year. This estimate understates the social costs of fraud because it does not include third-party

damages (e.g., loss of wages to laid-off employees). At an effectiveness rate of 20 percent, internal

controls could identify $50 million of that corruption and fraud.

In Chapter 4, we identified that annual cost of implementing the MICS at between $1.3 million and $1.9

million, plus the costs of implementing the redundancies and retraining tribal gaming authorities. In

other words, the regulations require gaming operations to spend an additional $2 million across the

industry that has some percentage chance of reducing a total of $50 million per year. In other words,

if the MICS in the final rule increase the effectiveness of existing internal controls by four percent or

more, they are a good investment and pay for the quantified private costs. Put another way, if the

changes in the MICS across the eleven Class II gaming facilities detect five additional cases of fraud,

the regulation will have net social benefits. While we do not know the actual incremental

effectiveness of the MICS over current practice and regulations, it would appear that the changes to

the MICS standards in the final rule are likely to generate net social benefits.

Regulation as the Most Efficient Approach to Reducing Fraud

Other forms of intervention besides regulation could encourage private parties to align their actions

with the public interest. Since the MICS represent the standard in the industry for best practice and

since the tribes have varying degrees of access to personnel with extensive gaming industry

experience, some tribal gaming operators (and tribal regulatory agencies) may be unfamiliar with these

procedures even though they could provide a positive return on investment. As an alternative to

regulation, the NIGC could distribute the MICS as voluntary guidelines to educate and train those tribes

that require assistance in their implementation. If most gaming operators already have adequate

internal controls and only a few do not, education and training those few operations could be more

cost-effective than imposing new, routine costs on every operation.

There are several reasons to believe that regulation may be more cost-effective than voluntary

programs in the long run. First, since fraud is unpredictable and random, it can strike at any time. A

gaming operation with good controls today could lapse. Education and training would have to be very

responsive to shore up operations whenever they might need it. Second, regulation and training do not

prevent fraud; potential is built when the gaming operation adopts and maintains the controls in its

day-to-day operations. The MICS require tools such as independent audits, certifications, and reporting

to the NIGC that incentivize an operation to follow their own internal controls. Therefore, while the

incremental social benefits of the MICS depend on how well organizations comply with them and

incorporate them into the day-to-day operations, it is likely that regulation could be the most efficient

mechanism to align private actions with the choices best for society as a whole.
5-8

Benefits of the Definitions and Classification Standards

Avoidance of Litigation

Virtually all economic change has transaction costs. They are the economic equivalent to friction, the

price paid for movement. Markets work to minimize transaction costs as producer and consumers

exchange goods and services. Where governments intervene through regulation, the social goal is the

same - to minimize transaction costs so that we spend as much of our resources as possible on items we

value.

A regulation can have net social benefits if it has less transaction costs than alternatives.88

Standardization can save time and resources. Many voluntary standards (e.g., keyboard layouts) arise

without government intervention.

In the current situation, to reduce non-compliance with NIGC’s interpretation of the law and its

definition, the agency can pursue case-by-case litigation or promulgate a regulation and then enforce

compliance with the new requirement. In the path of case-by-case litigation, each case requires

resources. On a regulatory path, NIGC and stakeholders invest resources to agree to a final rule.

Enforcing the rule is in theory less costly than case-by-case litigation since compliance standards are

clearer and fewer stakeholders will remain non-compliant. If both paths receive the same destination,

zero non-compliance, the path with the least total transaction costs is best.

NIGC determined that case-by-case litigation was not the least costly path to compliance. Switching to

regulation it finds is likely to have lower transaction costs for the agency, tribal gaming operations,

tribal regulatory authorities, game manufacturers, and other stakeholders. Table 5-5 below gives an

illustration of why regulation could have lower transaction costs than litigation.

In this example, all stakeholders pay $3 million to achieve a final regulation. This cost includes NIGC’s

direct and indirect costs, the costs of consultation and outreach meetings, and the costs commenters

spend to respond to the rule. As discussed in Chapters 3 and 4, if 50 percent of machines are noncompliant in the future, then approximately 4,000 non-compliant machines exist over the next ten

years. By promulgating clear rules, there is less uncertainty for litigation - once the rule are upheld

and the major disagreements settled, enforcement is straightforward. Litigation costs in this case are

assumed to average to $50,000 per machine. For the purposes of comparison, we assume NIGC

initiates on average 13 enforcement actions a year, each one affecting 10 machines. The net present

value over ten years to eliminate the number of non-compliant machines is $4.6 million. The total

costs of this option are upfront regulation development costs and the net present value of the stream

of future litigation costs for a total of $7.6 million.

As an alternative, if NIGC forgoes the regulation and purses case-by-case litigation, there are no

upfront costs. However, each instance of litigation is on average more expensive since the definition

88 This proposition holds true under the condition that the outcome is valuable and will happen under both scenarios. There is no value in

doing something well that is not worth doing in the first place.
5-9

of compliance is more uncertain. In this example, we assume the average litigation costs all parties a

total of $0.2 million. Assuming the same number of cases to reach 100 percent compliance over 10

years, the net present value is $18.2 million. Since there are no upfront costs, the total cost of this

approach is $18.2 million.

In this example, case-by-case litigation is more than twice as expensive as regulation. In this scenario,

by switching to regulation, NIGC is reducing transaction costs in society. Thus, it is very plausible that

this regulatory process could save social resources in the long-run.

Table 5-5: Comparison of Regulatory and Litigation Transaction Costs

Rulemaking

Costs

($ mil)

Litigation

Costs Per

Case

($ mil)

Cases

(Per

Year)

NPV (7%)

($ mil)

Total

Costs

($ mil)

Regulation 3 0.05 13 4.6 7.6

Case-by-Case 0 0.2 13 18.2 18.2

Increased Legal Certainty Reduces Capital Costs

Without clear standards, both facility operators and game manufacturers are operating in an uncertain

legal environment. Enforcement action could result in the seizure of gaming equipment and the

revocation of the license to operate both for the facility and the gaming manufacturer. This

uncertainty will be reflected in the cost of capital. Lenders calculate a risk premium above the rate of

return on capital, increasing borrowing cost for both tribes and manufacturers. The additional

financing cost will be reflected in the price of gaming machines, whether financed directly by the

tribes or jointly through a lease or revenue sharing agreement. By reducing the perceived compliance

risk through effective and clear regulation, the Commission reduces the risks in lending. Lower risks

can translate into lower financing costs, allowing more gaming to satisfy unmet consumer demand. By

meeting more of consumers’ demand for Class II gaming, the rule would provide incremental benefits.

The impact of even a small reduction in the risk premium could be significant. The gambling industry

has relatively low operating and labor costs compared to other industries. Capital expenditures are

needed to build the facility and to buy the Class II machines. If financing costs in the gaming industry

are ten percent of the $20 billion in operating costs, reducing the effective borrowing rate by even 0.1

percent saves $2 million per year. Many tribes lease their machines from the manufacturer, creating

an opportunity for a direct link between the risk premium and the tribe’s annual revenue. Holding

everything else the same, the effective interest rate for the lease for a machine more likely to be ruled

a Class III machine should be different than the lease rate for a compliant Class II machine.

Unfortunately, finding empirical evidence to quantify this benefit is difficult. Lenders apply many

criteria to an organization to assess the risk of a loan or investment. Since many gaming manufacturers

and tribal gaming operations are private companies, financing costs are often not available. There are

also many other terms of a loan, including call options and tiered financing. Comparing just interest

rates alone between two transactions can be potentially misleading. Organization ownership also

changes frequently in this fast-growing industry. As a smaller firm is acquired, it may gain the lower

borrowing costs of its larger parent company.
5-10

We examined two regulatory changes to determine if they affected the costs of capital for gaming

firms. One example is Australia’s regulation of internet gaming. Many countries have tried to deter

the detrimental effects of online gambling transactions by either enacting blanket prohibitions (e.g.,

the United States), or choosing to regulate online gambling by allowing some, but not all forms, of

internet gambling.

Australia is one country which has decided to address the matter by regulating to allow certain forms

of internet gambling, while banning others. Consequently, Australia is the market leader in online

gambling. In 2001, the Australian legislature passed the Interactive Gambling Act of 2001. This act

banned certain forms of interactive online gambling, while still allowing for online waging (e.g., waging

on horse races, sporting events) and online lotteries subject to certain regulations. The relevant

question for the analysis is did the online casinos see their capital costs decline when the Australian

gaming legislation passed.

Even prior to this legislation, which sought to distinguish different types of internet gambling activities,

Australia had regulations in place which addressed safety and privacy concerns, which augmented the

country’s success in the internet gambling field. As reviewed in a 1999 Australian senate report:

One reason for the success of Australian-based operations is that gamblers are

attracted to the credibility associated with Australian regulation. Regulation is the

responsibility of the States and Territories, which have developed a world class

reputation in this field. Mr. Desmond McKee, Manager, Taxation Services, Department

of Treasury and Infrastructure, Australian Capital Territory Government, stated that

‘Australia has a first-class reputation for regulation of gambling industries.

Australia’s entrance into this arena is known worldwide, and the rest of the world [is]

watching us to see how we perform. If Australia does it properly, and that is certainly

the intention, then I believe we will get a fair share of that marketplace.’

For example, Centrebet, an Australian gambling website that is regulated is regarded as one of the top

five gambling websites in the world.

The Australian Bureau of Statistics noted that from 2000-2001, the Australian internet gambling service

providers received $73.1 million (Australian) from online gambling. In 2004-2005 the net gains for

Australian internet gambling services providers increased to $114.3 million (Australian). Thus, in this

timeframe, during which the Interactive Gambling Act was passed, revenue received by Australian

internet providers increased by 11.8 percent. However, with respect to individual companies in

Australia that enjoy a steady stream of gamblers and revenue, little historical information is available

that would indicate the effect of the Interactive Gambling Act of 2001, thus the aforementioned

aggregate is the best reference as to the impact of the Act on companies that provide gambling

services.

In addition to the Australian experience, there is one publicly-traded firm that has specific exposure to

Class II regulatory decisions. Multimedia Games, as discussed in Chapter 4, offers a good case study for

the effects of classification decisions. The NIGC rulings on the company’s games in 2002 were material

events for the company and were disclosed to investors. The company also has a series of long-term

capital investors who, from the questions asked during analysts’ quarterly calls, were very familiar with

the company’s exposure to NIGC’s classification decisions. If regulatory certainty reduces borrowing

costs, this company’s financing may reveal the effect.
5-11

We examined the company’s annual financial results filed with the Security and Exchange Commission

for the three years before and after the MegaNanza/Reel Time classification decisions, or 2001-2003.

The reported amounts and interest rate for the company’s long-term debt is our indicator of financing

costs. Table 5-6 gives the results.

Table 5-6: Long-Term Debt Borrowing Rates for Multimedia Games

In 2001, the company was expanding and

developing its new line of gaming machines.

There was substantial uncertainty as to

their legality at noncompacted tribal

gaming operations. By the end of their

2003 fiscal year, the legal uncertainty was

mostly resolved. Comparing the price of

borrowing in 2001 and in 2003, the interest

rate declined by one-half of a percent. On

an annual basis, the interest rate reduction

saved the company $0.045 million in

financing costs. The company was also growing substantially during this period; banks may have been

offering more favorable terms since the company had more collateral and net income. However, there

is at least an indication that regulatory certainty over the company’s main products, Class II games,

reduced the risk premium charged by lenders. Regulatory certainty across the industry could benefit

both tribes and manufacturers. As these organizations have lower costs, society benefits as these

organizations offer more games to meet consumer demand.

Protection of the Integrity of the Law

The rule helps maintain differentiation between Class II and Class III so as to maintain the meaning of

the IGRA. While history reveals that some laws do not provide optimal benefits and can actually have

negative social benefits, promotion of law abiding activity does foster a sense of fairness and

community cohesion. Fostering cohesion between US residents, whether or not they are members of

tribes, has some social value.

For tribal members, regulatory clarity and a well-functioning process under the IGRA for tribes and

states to negotiate compacts have benefits. Congress is less likely to not feel compelled to revisit the

Act to either restrict tribal Class II or Class III gaming or, at a minimum, change current practices.

Tribes and gaming operators have made billions of dollars in capital investments based on the IGRA’s

statutory system regulating Indian gaming. While there may be a reduction in revenue resulting from

these regulatory changes, the tribes could stand to lose more if Congress passes legislation that

impacts other parts of tribal gaming. Again, this consideration is a private benefit that could accrue to

tribes, not society as a whole.

Year Amount of LongTerm Debt

($ millions)

Interest Rate

2001 5.2 9 % or Prime + 1.75%,

whichever is greater

2002 0.6 6%

2003 9.4 Prime + 1.25%

( = 5.5% at the time)

6-1

Appendix 1: Gaming Facilities with Class II

Machines by State

State Tribe Gaming Facility

Class II Only

Montana Crow Tribe Little Bighorn Casino

Texas Kickapoo Traditional Tribe of Texas Kickapoo Lucky Eagle Casino

California Lytton Rancheria of California San Pablo Lytton Casino

Alaska Metlakatla Indian Community Metlakatla Indian Community Bingo

Wyoming Northern Arapaho Tribe Little Wind Casino

Wyoming Northern Arapaho Tribe Wind River Casino

Alabama Poarch Band of Creek Indians Creek Entertainment Center

Alabama Poarch Band of Creek Indians Riverside Entertainment Center

Alabama Poarch Band of Creek Indians Tallapoosa Entertainment Center

Nebraska Santee Sioux Tribe of Nebraska Ohiya Casino & Bingo

Oklahoma Thlopthlocco tribal Town Golden Pony Casino

Total Number of Tribes

Total Number of Facilities

8

11

Class II and III

Oklahoma Absentee Shawnee Tribe of Oklahoma Thunderbird Wild Wild West Casino

Arizona Ak Chin Indian Community Harrah's Phoenix Ak-Chin Casino Resort

Oklahoma Apache Tribe of Oklahoma Silver Buffalo Casino

Montana Assiniboine and Sioux Tribes of the Fort Peck

Indian Reservation

Silver Wolf Casino

Montana Blackfeet Tribe Discovery Lodge Casino

Montana Blackfeet Tribe Glacier Peaks Casino

Oklahoma Cherokee Nation Cherokee Casino - Fort Gibson

Oklahoma Cherokee Nation Cherokee Casino - Roland

Oklahoma Cherokee Nation Cherokee Casino - Sallisaw

Oklahoma Cherokee Nation Cherokee Casino - West Siloam Springs

Oklahoma Cherokee Nation Cherokee Casino Resort

Oklahoma Cherokee Nation Cherokee Nation Outpost Tobacco Shop
6-2

State Tribe Gaming Facility

Oklahoma Cherokee Nation West Siloam Springs Smoke Shop

Oklahoma Cherokee Nation Cherokee Casino Tahlequah

Oklahoma Cheyenne-Arapaho Tribes of Oklahoma Feather Warrior Casino

Oklahoma Cheyenne-Arapaho Tribes of Oklahoma Lucky Star Casino - Clinton

Oklahoma Cheyenne-Arapaho Tribes of Oklahoma Lucky Star Casino - Concho

Oklahoma Chickasaw Nation Ada Gaming Center

Oklahoma Chickasaw Nation Ada Travel Stop

Oklahoma Chickasaw Nation Black Gold Casino

Oklahoma Chickasaw Nation Cash Springs Gaming Center

Oklahoma Chickasaw Nation Chisholm Trail Casino

Oklahoma Chickasaw Nation Davis Trading Post

Oklahoma Chickasaw Nation Gold Mountain Casino

Oklahoma Chickasaw Nation Goldsby Gaming Center

Oklahoma Chickasaw Nation Madill Gaming Center

Oklahoma Chickasaw Nation Newcastle Gaming Center I

Oklahoma Chickasaw Nation Riverwind Casino

Oklahoma Chickasaw Nation Texoma Gaming Center

Oklahoma Chickasaw Nation Thackerville Travel Plaza

Oklahoma Chickasaw Nation Treasure Valley Casino

Oklahoma Chickasaw Nation Washita Gaming Center

Oklahoma Chickasaw Nation WinStar Casino

Montana Chippewa-Cree Indians of the Rocky Boy’s

Reservation

Bear Paw Casino and Four C's Cafe

Oklahoma Choctaw Nation of Oklahoma Choctaw Casino - Broken Bow

Oklahoma Choctaw Nation of Oklahoma Choctaw Casino - Grant

Oklahoma Choctaw Nation of Oklahoma Choctaw Casino - Idabel

Oklahoma Choctaw Nation of Oklahoma Choctaw Casino - McAlester

Oklahoma Choctaw Nation of Oklahoma Choctaw Casino - Pocola

Oklahoma Choctaw Nation of Oklahoma Choctaw Casino - Stringtown

Oklahoma Choctaw Nation of Oklahoma Choctaw Casino Bingo

Oklahoma Choctaw Nation of Oklahoma Choctaw Inn - Durant

Oklahoma Choctaw Nation of Oklahoma Choctaw Casino Too
6-3

State Tribe Gaming Facility

Oklahoma Choctaw Nation of Oklahoma Choctaw Coliseum

Oklahoma Choctaw Nation of Oklahoma Durant Travel Plaza East

Oklahoma Choctaw Nation of Oklahoma Durant Travel Plaza West

Oklahoma Choctaw Nation of Oklahoma Idabel Travel and Smoke Shop

Oklahoma Choctaw Nation of Oklahoma Pocola Travel and Smoke Shop

Oklahoma Citizen Potawatomi Nation Baby Grand Casino

Oklahoma Citizen Potawatomi Nation FireLake Casino

Oklahoma Citizen Potawatomi Nation FireLake Grand Casino

Oklahoma Comanche Nation Comanche Nation Casino

Oklahoma Comanche Nation Comanche Red River Casino

Oklahoma Comanche Nation Comanche Spur Smoke Shop and Casino

Oklahoma Comanche Nation Comanche Star Casino and Smoke Shop

Montana Confederated Salish & Kootenai Tribes Best Western KwaTaqNuk Resort

Washington Confederated Tribes and Bands of the

Yakama Nation

Yakama Nation Legends Casino

Washington Confederated Tribes of Colville Reservation Coulee Dam Casino

Washington Confederated Tribes of Colville Reservation Mill Bay Casino

Washington Confederated Tribes of the Chehalis

Reservation

Lucky Eagle Casino

South Dakota Crow Creek Sioux Tribe Lode Star Casino and Hotel

Oklahoma Delaware Nation Gold River Casino

Oklahoma Eastern Shawnee Tribe of Oklahoma Border Town Casino

Oklahoma Eastern Shawnee Tribe of Oklahoma Eastern Shawnee Travel Plaza

South Dakota Flandreau Santee Sioux Tribe Royal River Casino & Hotel

Oklahoma Fort Sill Apache Tribe of Oklahoma Fort Sill Apache Casino

Wisconsin Ho-Chunk Nation Dejope Bingo and Entertainment

Washington Jamestown S'Klallam Tribe 7 Cedars Casino

Oklahoma Kaw Nation Kaw Southwind Casino

Oklahoma Kickapoo Tribe of Oklahoma Kickapoo Casino

Oklahoma Kickapoo Tribe of Oklahoma Kickapoo Conoco Station

Oklahoma Miami Tribe of Oklahoma Miami Tribe Entertainment

Florida Miccosukee Tribe of Indians of Florida Miccosukee Resort & Gaming Center

Oklahoma Modoc Tribe of Oklahoma/Miami Tribe of The Stables Casino
6-4

State Tribe Gaming Facility

Oklahoma

California Morongo Band of Mission Indians Casino Morongo

California Morongo Band of Mission Indians Morongo Casino Resort & Spa

California Morongo Band of Mission Indians Morongo Travel Center

Washington Muckleshoot Indian Tribe Muckleshoot Casino

Oklahoma Muscogee (Creek) Nation Bristow Indian Casino

Oklahoma Muscogee (Creek) Nation Checotah Indian Community Bingo

Oklahoma Muscogee (Creek) Nation Creek Nation Casino Eufaula

Oklahoma Muscogee (Creek) Nation Creek Nation Casino Okemah

Oklahoma Muscogee (Creek) Nation Creek Nation Casino Okmulgee

Oklahoma Muscogee (Creek) Nation Creek Nation Casino Tulsa

Oklahoma Muscogee (Creek) Nation Creek Nation Casino Muscogee

Oklahoma Muscogee (Creek) Nation Creek Nation Travel Plaza

Oklahoma Muscogee (Creek) Nation Duck Creek Casino

Oklahoma Muscogee (Creek) Nation Muscogee Travel Plaza

Washington Nooksack Indian Tribe Nooksack River Casino

Montana Northern Cheyenne Tribe Charging Horse Casino & Bingo

Nebraska Omaha Tribe of Nebraska Lucky 77 Casino

Oklahoma Osage Nation Osage Million Dollar Elm Casino -

Hominy

Oklahoma Osage Nation Osage Million Dollar Elm Casino - Sand

Springs

Oklahoma Osage Nation Osage Million Dollar Elm Casino -

Pawhuska

Oklahoma Osage Nation Osage Million Dollar Elm Casino - Tulsa

Oklahoma Otoe-Missouria Tribe of Indians 7 Clans Paradise Casino

Oklahoma Otoe-Missouria Tribe of Indians Lil Bit of Paradise Casino

Oklahoma Ottawa Tribe of Oklahoma High Winds Casino

California Pechanga Band of Luiseno Mission Indians Pechanga Resort & Casino

Oklahoma Peoria Tribe of Indians of Oklahoma Buffalo Run Casino

Oklahoma Peoria Tribe of Indians of Oklahoma Peoria Gaming Center

Oklahoma Ponca Tribe of Oklahoma Blue Star Gaming and Casino

Washington Puyallup Tribe of Indians BJ's Bingo
6-5

State Tribe Gaming Facility

Oklahoma Quapaw Tribe of Oklahoma Quapaw Casino

Washington Quinault Indian Nation Quinault Beach Resort and Casino

California Rincon Band of Luiseno Mission Indians Harrah's Rincon Casino and Resort

Oklahoma Sac & Fox Nation of Oklahoma Sac and Fox Casino

Oklahoma Sac & Fox Nation of Oklahoma Sac and Fox Casino - Stroud

California San Manuel Band of Serrano Mission Indians San Manuel Indian Bingo & Casino

Florida Seminole Tribe of Florida Big Cypress Casino

Florida Seminole Tribe of Florida Seminole Casino Brighton

Florida Seminole Tribe of Florida Seminole Casino Coconut Creek

Florida Seminole Tribe of Florida Seminole Casino Hollywood

Florida Seminole Tribe of Florida Seminole Casino Immokalee

Florida Seminole Tribe of Florida Seminole Hard Rock Hotel & Casino

Hollywood

Florida Seminole Tribe of Florida Seminole Hard Rock Hotel & Casino

Tampa

Oklahoma Seminole Nation of Oklahoma Mystic Winds Casino

Oklahoma Seminole Nation of Oklahoma Seminole Nation Trading Post

New York Seneca Nation of Indians Seneca Gaming and Entertainment

New York Seneca Nation of Indians Seneca Gaming and Entertainment 1

Oklahoma Seneca-Cayuga Tribe of Oklahoma Grand Lake Casino

Washington Shoalwater Bay Indian Tribe Shoalwater Bay Casino

Washington Skokomish Indian Tribe The Lucky Dog Casino

Washington Squaxin Island Tribe Little Creek Casino Resort

New York St. Regis Mohawk Tribe Mohawk Bingo Palace

Washington Stillaquamish Tribe Angel of the Winds Casino

Washington Suquamish Tribe Clearwater Casino

Washington Swinomish Indian tribal Community Swinomish Northern Lights Casino

California Sycuan Band of the Kumeyaay Nation Sycuan Casino & Resort

Arizona Tohono O'odham Nation Golden Ha:sa– Casino

Washington Tulalip Tribes Tulalip Bingo

Washington Upper Skagit Indian Tribe Skagit Valley Casino Resort

Minnesota White Earth Band of Chippewa Indians Berry's Bar

Minnesota White Earth Band of Chippewa Indians Callaway Municipal Liquor Store
6-6

State Tribe Gaming Facility

Minnesota White Earth Band of Chippewa Indians Cedar Crest Resort

Minnesota White Earth Band of Chippewa Indians D & G Lounge

Minnesota White Earth Band of Chippewa Indians Doc's Den

Minnesota White Earth Band of Chippewa Indians Elbow Lake Store

Minnesota White Earth Band of Chippewa Indians M & W Service Center

Minnesota White Earth Band of Chippewa Indians Mahnomen American Legion Bingo

Minnesota White Earth Band of Chippewa Indians Naytahwaush Village Store

Minnesota White Earth Band of Chippewa Indians Ogema Fire House

Minnesota White Earth Band of Chippewa Indians Pinehurst Resort

Minnesota White Earth Band of Chippewa Indians Shooting Star Casino and Hotel

Minnesota White Earth Band of Chippewa Indians Tulably Lake Inn

Minnesota White Earth Band of Chippewa Indians Wild Rice Lounge

Nebraska Winnebago Tribe of Nebraska Native Star Casino

Nebraska Winnebago Tribe of Nebraska Iron Horse Bar & Casino

Oklahoma Wyandotte Nation Lucky Turtle Casino

Total Number of Tribes

Total Number of Facilities

64

150

Source: Class II listing from Meister, Alan (2008). The Potential Economic Impact of the October 2007 Proposed Class II Gaming Regulations.

Indian Gaming Facilities that Operated Class II Machines in 2006. Appendix C, page 66. This list was then compared and triaged to delete any

gaming facilities that have state compacts (which indicates that a tribe is authorized to operate Class III gaming) with the National Indian

Gaming Commission. 2008. Compacts. Retrieved from http://www.nigc.gov/ReadingRoom/Compacts/tabid/760/Default.aspx

The remaining facilities have state compacts and operate Class III gaming.
7-1

Appendix 2: Summary of Opinions and

Decisions Concerning the Scope of Class II

and Class II Bingo

Determining what constitutes Class II gaming versus Class III gaming relies on a factual determination

and a careful assessment of Commission opinions and court cases. The “NIGC Classification Rulings”89

encompasses more than seventy opinions and court rulings. Although not all of the decisions are

reviewed below, the ones that are highlighted are those were the Commission developed tests for

determining how to classify a game and discussed criteria and factors applied in assessing the games.

In this appendix, we concentrate on the opinions and decisions concerning games subject to the

proposed classification standard.

What Constitutes as Class II Gaming

Types of Bingo

For a bingo game to classify as Class II gaming, it must meet the criteria defined in the IGRA and NIGC

regulations. These criteria are: (1) system must allow for and encourage multiple players and require a

minimum of two players; (2) the winning pattern or arrangement must be known before the game

begins; (3) players must obtain a card before numbers are drawn; (4) electronic cards are permissible

but must be readily visible on the screen (to determine readily visible consider whether prominently

sized and displayed, readable font, and contrasting colors); (5) the numbers are randomly drawn or

determined electronically, and (6) numbers drawn are used in real time and not stored for later use.

(Mystery Bingo, 9/26/2003). In Rocket Fast (10/18/2004), NIGC articulated a similar test where they

looked at whether: (1) the cards bear numbers, (2) the holder of the card covers when objects are

drawn, (3) if game is won by first person covering previously designated pattern, and (4) whether the

technological device is used as an electronic aid or facsimile.

In the Mystery Bingo decision the Commission held that the game met the aforementioned

requirements, and in particular highlighted that there was a predetermined winning pattern and that

selected numbers were used in the sequence that they were drawn. The Commission also looked at the

prize structure, and in Mystery Bingo, since the winner was determined by the play of the bingo game

and not an element of chance, the way the winner was awarded complied with Class II gaming

requirements.

In the Triple Threat Bingo Decision (12/23/2004), NIGC also held that the game classified as Class II

gaming because it met the aforementioned criteria. Triple Threat Bingo is a game played on a

computer graphic with individual player stations which involve cards with numbers on them.

Additionally to conclude the game multiple draws are necessary, thus meeting the requirement defined

by the IGRA that the game may not be won with just one draw to qualify as Class II gaming.

89 The NIGC Enforcement Actions and Classification Opinions discussed in the NIGC Classification Rulings document come from two online

sources: http://www.nigc.gov/ReadingRoom/EnforcementActions/tabid/124/Default.aspx, and

http://www.nigc.gov/ReadingRoom/GameClassificationOpinions/tabid/789/Default.aspx
7-2

Furthermore, here the Commission highlighted that the game met the criteria for Class II gaming

because Triple Threat Bingo allowed for participation of multiple players and allowed more than the

minimum two seconds for players to join in (it allowed for three seconds). NIGC stated that the broad

time frame was a critical reason as to why “Triple Threat Bingo” was classified as a Class II game.

In the NOVA Bingo decision (4/4/2005), NIGC also held that the activity classified as Class II gaming,

highlighting that the game is won by the first person who acquires the pre-determined pattern, and

that the electronic device used was an electronic aid and not a facsimile.

Pull-Tab

NIGC determined that Play Away Pull-Tab (8/26/2006) was a Class II game played with technological

aids, rather than an electronic facsimile, because: (1) PlayAway cards are pull tabs, (2) the website

used to reveal the results of the PlayAway pull tab cards is not an electronic facsimile, (3) the website

met the Commission’s definition of “technological aid,” and (4) the gambling is not done over the

internet and the website clearly states that the winning ticket must be redeemed at the casino where

it was purchased.

What Does Not Constitute as Class II Gaming and Thus is Class III Gaming

Bingo

Bingo in which the players do not experience real time player interaction does not count as bingo for

the purposes of Class II gaming according to the decision in National Indian Bingo (8/9/1999). In this

case, when a player purchases a ticket but then has to return to the gaming site to collect his winnings,

that does not qualify as real time play, and thus can not be categorized as Class II gaming.

Pull Tab

If the electronic device used in Pull Tab is an electronic facsimile instead of a technological aid, then

the game is classified as a Class III game.

The electronic game “Break the Bank” was deemed to classify as a Class III game because the

electronic device incorporated the entire game of paper pull-tabs, rather than just being a

technological aid to facilitate play of the game (5/31/2001). This determination was further affirmed

in Class II Pull-Tab system (6/24/2004) when the Commission also determined that that this game was

an electronic facsimile of paper pull-tab because the machine replicated the game of paper pull-tabs in

an electronic form.

In Play pull tab (3/30/1999) the Commission determined that when the device “performs all the actions

that a player of the traditional pull-tab game would have performed, including selecting a pull-tab

ticket, disclosing the hidden symbols on the ticket and determining whether a particular pull-tab ticket

is a ‘winner,’" the machine is a facsimile of the traditional game and thus a Class III game.
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Important Cases and Advisory Opinions

In U.S. v. 162 Megamania Gambling Devices, 231 F.3d 713 (10th Cir. 2002) the court considered what

kind of bingo classifies as a Class II game. In this case, the court held that Megamania was a class II

game because it met the three statutory criteria for bingo, and highlighted that “electronic cards for

participants in bingo games,” as used in Megamania, were examples of technological aids that are

allowable for class II games under 25 C.F.R. §502.3(a).

In Cabazon Band of Mission Indians v. National Indian Gaming Commission, 14 F.3d 633, 636 (D.C. Cir.

1994) (Cabazon II) the court held that when the electronic/video version of a pull-tabs game is the

same as the paper version, then that game does not qualify as a Class II game, because it is a facsimile,

exact copy or duplicate, of the original game. Noting, “by definition, a device that preserves the

fundamental characteristics of a game is a facsimile of the game.” Sycuan Band of Mission Indians v.

Roach, 788 F. Supp. 1498 (S.D. Cal. 1992). “Although there may be room for a broader interpretation

of “facsimile,” the video version of pull-tabs falls within the core meaning of electronic facsimile. It

exactly replicates the paper version of the game, and if that is not sufficient to make it a facsimile, we

doubt...that anything could qualify.” Cabazon Band of Mission Indians, 14 F.3d at 636. In Cabazon the

court also discusses the three distinct gaming categories that the IGRA defined for Indian land, which

are subject to different levels of Federal and state regulation.

But in Diamond Game Enterprises v. Reno, 230 F.3d 365 (D.C. Cir. 2000), the court held that the

gaming device, Lucky Tab II, which was used for pull-tabs did qualify as a technological aid to paper

pull-tabs and thus met the criteria for Class II gaming. In Lucky Tab II, the electronic device was used

to scan the paper roll of pull-tabs and display the contents of the paper pull-tabs on the screen, thus

the electronic device facilitated the play of the paper game instead of replacing it.

In Gaming Corp. of America v. Dorsey & Whifney, 88 F.3d 536, 544 (8th Cir. 1996) the court noted that

“states can influence class II gaming on Indian lands within their borders only if they prohibit those

games for everyone under all circumstances.”

In the Blackjack Advisory Opinion that the Commission issued on January 15, 2003, they emphasized

that the key question in determining whether a blackjack game classifies as class II gaming is whether

“[blackjack] is being played a legitimate card tournament...[and] [t]he key question is how the game

play actually functions. A fundamental point is that all play-every hand must be played as part of the

tournament and in a tournament format. Further, the revenue from tournament entry fees, the only

revenue to the gaming establishment from these events, should be treated as gaming revenue in the

normal course and accounted for as such, and not placed into a separate player pool account.”

Table A2-1: Summary of NIGC Opinions Related to Bingo, Pull Tabs, and

Similar Games

Game Highlighted Characteristics that

Make Game a Class II

Highlighted Characteristics that Make

Game a Class III

Mystery Bingo  a predetermined winning pattern

 selected numbers were used in

the sequence that they were

drawn

 prize structure - winner was
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Game Highlighted Characteristics that

Make Game a Class II

Highlighted Characteristics that Make

Game a Class III

determined by the play of the

bingo game and not an element

of chance

Triple Threat Bingo  allowed for participation of

multiple players

 allowed more than the minimum

two seconds for players to join in

(three seconds)

 technological aid, not electronic

facsimile - played on a computer

graphic with individual player

stations which involve cards with

numbers on them

 multiple draws are necessary to

win the game

NOVA Bingo  game is won by the first person

who acquires the pre-determined

pattern

 electronic device used was an

electronic aid and not a facsimile

Wild Ball Bingo  game is played in “real time”: (1)

the real-time or the near realtime selection of the winning

number in the bingo blower

drawn compared to the display of

the winning number, and (2) that

the players are playing against

each other in real time

In the decision the Commission

distinguishes what characteristics of a

game would make it a Class III game:

 if the game is a non-traditional

design

 if there is a secondary progressive

jackpot feature

 if there is a house-bank aspect

 if the device is an electronic

facsimile.

National Indian Bingo  players did not experience real

time player interaction - when a

player purchases a ticket but then

has to return to the gaming site to

collect his winnings, that does not

qualify as real time play

Play Away Pull-Tab Use of technology is in form of

technological aid and not an

electronic facsimile because: 1) cards

used are pull tabs, (2) the website

used to reveal the results is not an

electronic facsimile, (3) the website

met the Commission’s definition of

“technological aid,” and (4) the

gambling is not done over the

internet and the website clearly

states that the winning ticket must be

redeemed at the casino where it was

purchased.
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Game Highlighted Characteristics that

Make Game a Class II

Highlighted Characteristics that Make

Game a Class III

Break the Bank  electronic device incorporated the

entire game of paper pull-tabs,

rather than just being a

technological aid to facilitate play

of the game

Class II Pull-Tab  game is an electronic facsimile of

paper pull-tab because the

machine replicated the game of

paper pull-tabs in an electronic

form.

Play Pull Tab  game is electronic facsimile of the

traditional game because device

“performs all the actions that a

player of the traditional pull-tab

game would have performed,

including selecting a pull-tab

ticket, disclosing the hidden

symbols on the ticket and

determining whether a particular

pull-tab ticket is a ‘winner.’"

Digideal Digital Card System Commission outlines test for

determining whether electronic device

used is permissible:

 Test: (1) whether the table itself is

an electronic facsimile or a

technological aid. If the table is

an electronic facsimile then that

game is automatically not a Class II

game. If a technological aid then,

(2) does the IGRA define the use of

such aids with card games? If no,

then the table used in non-banking

games falls under Class III.