Unintended Consequences of the Law

In 1996, an Indian software developer named Anurag Dikshit wrote a program to allow people to play poker against each other on the Internet.

It turns out people love playing poker against each other on the Internet. Since Dikshit got there first, everyone went to his website. It’s called Party Poker, and it’s now the biggest name in the online poker industry.

Party Poker isn’t the boiler-room scam you might think. It has offices all over the world, including a large call center in India with a staff of thousands. It owns a world-renowned brand name and a listing on the London Stock Exchange. Its founders can be found in Forbes’ list of billionaires.

Its no surprise the founders of Party Poker are wealthy. The business generates tons of cash. In 2005, Party Poker generated $977 million dollars in revenue.

Online gambling is illegal in the United States, yet 80% of the online poker industry’s revenue was coming from American residents. So in September 2006, the United States government tried to kill the online poker industry.

It couldn’t go after the website’s operators – they are all based off-shore – so Congress went after the banks and credit-card companies that process poker players’ deposits. It passed legislation that made it illegal for payment processors to do business with online casinos.

The announcement caused a stampede... Party Poker and the other market-listed operations got nailed. Party’s stock price fell from around 150 pence to 30 pence.

Now, three months later, it’s clear the Feds’ attempt to kill Internet poker has totally failed.

1) The game hasn’t changed. I played last night. Internet poker is as easy to play for American residents as it was before.

2) Illegal offshore casinos have cleaned up. Full Tilt Poker and Poker Stars are now the biggest poker sites in the world.

Conclusion: The U.S government drops a very lucrative industry into the laps of offshore gambling criminals, while stock market investors in regulated casinos lose around $20 billion.

Congratulations, senators. Nice work.

I’m always looking for unintended consequences of the law. They almost always create juicy investment opportunities. In this case, I think Party Poker’s stock may bounce back to its former glory as the poker boom goes global. We'll see.

If the poker business is not your idea of investment grade, here’s another “unintended consequence of law” opportunity:

Sarbanes-Oxley was a piece of legislation designed to toughen up American corporate accounting standards after Enron and WorldCom. It makes companies produce an “internal control report,” which must be certified by the auditors and signed off by two company executives.

The thing is, this “internal control report” costs several million dollars to produce. For a large firm, that’s fine. But small firms can’t afford it. So instead of complying with Sarb-Ox, they ditch their U.S. stock market listing and seek financing in London instead.

According to the Economist, “50 American firms have already done so, most of them since 2004. Hundreds of others are said to be considering it.”

And according to the Financial Times, last year, only one of the top-25 IPOs by value took place in New York.

While the FT and the Economist declare the death of American financial hegemony, I’ve been looking for ways to profit. The giant financial service conglomerates, like HSBC and JPMorgan Chase, are one group I’ve identified. Their stocks have gone nowhere, while more nimble investment banks, like Goldman Sachs and Lehman Brothers, have soared.

I suspect the banking conglomerates could get carved up in a push for greater efficiency. This should release billions of dollars in pent up value and enrich shareholders. More to follow on this idea.

Good investing,

Tom