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Online poker investors lose big as rules change

Absolute Poker's hot streak was about to come to an end.

The online poker site was the creation of four Sigma Alpha Epsilon fraternity brothers. One of them grew up in St. Petersburg and tapped his family's wealth and network of well-heeled friends for startup cash. The pitch back in the early 2000s: Get in on the ground floor and hit the jackpot.

The site, one of the first of its kind, grew like wildfire. Soon nearly 30,000 players were logging on at once, trying their luck at games like Texas Hold'em. In just four years, annual revenues rocketed past $200 million.

Congress put a serious crimp in online gambling in 2006, but Absolute Poker found ways to keep dealing virtual hands. Even two cheating scandals didn't stop the cash flow.

But not everyone shared in the bounty. Some shareholders suspected the founders, living offshore in luxury, were skimming. They hatched a plan to take control and sell the company, encouraged by news that a major Las Vegas casino mogul might partner with a rival online site. That deal would surely help online gambling become legit. Absolute Poker could sell for millions. Everyone would win.

The shareholders, including about three dozen in the Tampa Bay area, had no idea that federal authorities were about to bring down the house.

• • •

They were frat brothers at the University of Montana, spending way too much time playing poker and dreaming up ways to get rich. Then the eureka moment: Start an online poker business. A couple of sites, including Party Poker, were already attracting insane numbers of players.

Scott Tom and Garin Gustafson were the poker experts; Shane Blackford had family money, as did St. Petersburg's Oscar Hilt Tatum IV. Tatum's father and grandfather were well-known dentists. Tatum became lead fundraiser.

Richard Borgner, a retired St. Petersburg dentist now living in Hudson, shared a dental practice with the two elder Tatums. He said "young Hilt" came to him with the site's business plan in 2002.

"I can recall saying it looks like a winner and I'd be happy to invest," said Borgner, who became a board member. "As long as no one got greedy, this is something that's a 'can't-miss.' "

At the time, online gambling occupied a legal gray area in the United States. To avoid run-ins with federal prosecutors, the sites set up offshore. Absolute Poker chose Costa Rica.

"We checked with attorneys and they said everything was legal as long as we were poker only," Borgner said.

The site tapped into burgeoning poker mania, catering to novices and pros alike. Beginners could hone their skills at play-money tables then move up to low-stakes games or big money tournaments. With a few clicks of the mouse, players could download the site's software, create an account and start playing cards against any one, anytime, anywhere in the world.

Play was fast, with nearly twice as many hands dealt an hour as in live poker. Players often juggled several hands at once. The site raked off a few cents or a percent from every pot.

Sharing a house in San Jose, Costa Rica, Absolute Poker's four founders worked around the clock. They opened a customer service center in a shopping plaza with about 100 workers. Through a Korean subsidiary, the company developed and owned its own software. The guys quickly spent $21 million to get the business running and raised an additional $11 million.

Everyone saw a big payout on the horizon. In 2005, Party Poker was valued at $8.5 billion when it went public in London. Absolute Poker wanted a similar windfall.

Then one morning everybody woke up to find part of the business — the most critical part — was illegal.

• • •

On Sept. 30, 2006, Congress passed a little-noticed law with far-reaching repercussions. Under the Unlawful Internet Gambling Enforcement Act, it became a crime for businesses to take payment for Internet gambling from U.S. players.

The government targeted the money flow, not players sweating over hands of Omaha Hi Lo on their laptop computers. But just as Prohibition failed to stop drinking, the new law didn't stop online gaming. The operators just got more inventive.

Robert Ronald Janusz, a Chicago-area resident brought onto the board by Tatum and his father, said the new law sparked panic.

"Everyone was running with their hair on fire," he said. "A number of entities were basically turning off the lights."

One of the sites, Party Poker, closed its tables to U.S. players and focused on markets elsewhere.

Absolute Poker took a riskier stance. In a press release, the site gave the green light to U.S. players, saying its payment transactions were done "within the framework of the international banking system, which the U.S. Congress has no control over."

Behind the bravado, however, Absolute Poker insiders and U.S. shareholders were scrambling. Lawyers advised U.S. citizens that they couldn't have any ties to the gaming business, so about 80 percent of the Americans working for Absolute Poker in Costa Rica came home.

"The handful who stayed behind were told they couldn't return to the U.S. because no one was sure how this new law would work," Janusz said. Among those remaining offshore and still active in the company were three of the four founders — Tatum, Tom and Gustafson.

Shareholders like Borgner also quit Absolute Poker's board while Janusz, a Canadian citizen, remained. But U.S. shareholders faced a conundrum: How could they recoup their investment from a business they could not legally own? Before the law changed, tight-fisted investors had kept close rein on spending. Now who was going to run the operation and how were the shareholders to get paid?

The solution sounded ingenious, though it was ultimately flawed: Create a firewall that insulated shareholders from the "toxic" gaming asset but let dividends flow to shareholders.

The poker business was sold for $1 million to Tokwiro Enterprises, owned by Joseph Tokwiro Norton, former grand chief of the Mohawk Council of Kahnawake in Canada.

The crew in Costa Rica still handled the operations. What Norton had was clout. While grand chief, he had established the Kahnawake Gaming Commission, which licenses and regulates Internet gaming sites around the world. Norton also started Mohawk Internet Technologies, which hosts offshore gaming sites' computer servers, including Absolute's.

Borgner said Norton's status as former chief was key. "If there were any issues (with the Kahnawake regulators), certainly he would be the person who would be most influential," he said.

In 2007, seeking even more distance from the gaming business, the shareholders transferred the company's software to Tokwiro. In exchange the shareholders got notes for $250 million, which were supposed to pay 12 percent annual interest.

The shareholders then set about creating a tax-favorable structure for funneling their 12 percent returns. Their shares were transferred to a new entity called Madeira Fjord in Norway which had a subsidiary on a tax-free island off Portugal. Interest income on the $250 million would come through Portugal tax free. Once in Norway, the dividends would be taxed at a lower rate than in the United States, then sent to shareholders.

Founders still active in the poker operation, including Tatum, Tom and Gustafson, put their shares in a nonvoting pool. They retained the right to take back the shares, representing more than 20 percent of the company, and to share in any sale of the gaming business.

The idea was to allow shareholders to say they were no longer involved in online gaming, but give them and the founders a cut if the poker company was sold.

"We built a firewall 13 feet thick," Janusz said.

But it turned out to be full of holes.

In 2007 and 2008, cheating scandals at Absolute Poker and its sister site, Ultimate Bet, raised the ire of Kahnawake regulators. Fearful the regulators would pull the license and shut the sites down, Janusz said Madeira Fjord secretly built duplicate software and a second server farm in Panama. It then simply moved the poker operation from Tokwiro to a company called Blanca Games in Antigua. Certain shareholders reached right through the firewall to make it all happen.

The gaming continued.

• • •

Meanwhile, most of Absolute Poker's shareholders were out of the loop and increasingly angry after dividends dried up in 2009. Though a few early investors bought in at 10 cents a share, late-comers paid as much as $3. Total payout amounted to only 18 cents a share. What about the windfall? It never came.

Shareholders heard that the founders were living luxuriously in Costa Rica and Panama, adding to their aggravation. Borgner and Janusz told the shareholders that the founders left the poker operation years ago. Few disgruntled shareholders believed it.

Shawn Mesaros, a Seattle investor, said another shareholder raised questions about the company's finances in late 2009 and immediately got two calls — one from Tom, the second from Tatum, who suggested a meeting.

"What would they care if they were no longer involved?" Mesaros asked.

The shareholders finally got a peek at the poker operations' finances in November. According to unaudited figures, in 2009 the company reported $215.3 million in commissions, down 14 percent from 2007. It reported a net loss of $33.7 million.

The shareholders wondered how the company could spend half its revenues on marketing, yet still lose market share? Why did it spent $10 million on software owned by the company? And which "consultants" received nearly $18 million in fees?

Another shocker: The site was paying 29 cents of every dollar from U.S. players to try to keep authorities from tracking the proceeds. The feds would later call it "money laundering."

Along with the bad news about Absolute Poker's financials, shareholders learned that Madeira Fjord might be in the crosshairs of tax officials in Norway. The company hadn't withheld taxes on the 2007 dividends. And that $250 million in notes held by the Portuguese subsidiary turned out to be taxable in Norway, creating a multimillion-dollar bill. To avoid the liability, Janusz simply canceled the notes. Norwegian officials are likely to question that move.

In early April, shareholders came up with a possible exit plan: Get out of Norway and sell the company.

That looked feasible after Steve Wynn, the Las Vegas casino owner, announced a partnership in late March with PokerStars. Experts speculated that when one of the biggest names in brick-and-mortar gambling was joining the leading online poker site, U.S. laws were bound to be relaxed.

The speculation was dead wrong.

• • •

Federal prosecutors dropped the hammer on April 15.

They shut down Absolute Poker as well as its two biggest competitors, PokerStars and Full Tilt. The government seized the websites and more than 75 bank accounts and indicted 11 people on charges of illegal Internet gambling, bank fraud and money laundering.

Among those indicted were Absolute Poker's Scott Tom, and his half-brother, Brent Beckley. If convicted, they face years in prison.

Tatum, who lives in Panama, was not named in the indictment and did not respond to a request for an interview. (Tatum, 30, is the son-in-law of St. Petersburg Times art critic Lennie Bennett.)

In late 2009, a blogger interviewed Tatum about a new safety deposit box business he was running in Panama City's banking district. Tatum told the interviewer he had been living in Panama for three years, tending his family's teak plantations. In his online resume, Tatum says he enjoys golfing and fishing and contributes to several charities.

Nowhere does Tatum mention his involvement — past or present — in Absolute Poker.

So far, Tom and Beckley, who reside in Costa Rica, remain free. Prosecutors said they are working with foreign governments to arrest them and other defendants living abroad.

Preet Bharara, U.S. attorney for the Southern District of New York, accused the defendants of "tricking some U.S. banks and effectively bribing others."

"Foreign firms that choose to operate in the United States are not free to flout the laws they don't like simply because they can't bear to be parted from their profits," he said.

Fallout was swift. Wynn immediately canceled his agreement with PokerStars. Borgner, who says he hasn't made a cent on Absolute Poker, said, "I hope the company survives. I'm not sure it can at this stage."

Times researchers Caryn Baird, Carolyn Edds and Natalie Watson contributed to this report.

Absolute Poker a timeline

2000-02: Four college students at University of Montana at Missoula develop a business plan for online poker company and begin soliciting investors.

2003: Parent company of Absolute Poker, then called SGS Inc., formed, incorporated initially in Belize but with operations headquartered in Costa Rica.

Sept. 30, 2006: Congress passes Unlawful Internet Gambling Enforcement Act making it a crime for online gambling businesses to knowingly accept most forms of payment from U.S. players.

Early October 2006: SGS sells Absolute Poker to Tokwiro Enterprises, owned by a former grand chief of the Mohawk Council of Kahnawake; Absolute Poker merges with Ultimate Bet, another poker site, giving it the highest number of players.

April 2007: Shareholders sell software and intellectual property to Tokwiro in exchange for $250 million in notes, paying 12 percent annually.

August 2007: SGS is dissolved and restructured as Madeira Fjord, with headquarters in Norway and subsidiary in Portugal.

Late 2007-08: Players at both Absolute Poker and Ultimate Bet uncover cheating scandals, costing the sites market share and $22 million in refunds.

Mid 2009: Last time dividends were paid to investors, who reportedly paid from 10 cents to $3 for shares. Over time, investors have received a total of about 18 cents a share in dividends.

July 2010: Shareholders, angry at the lack of information and dividends, petition Norwegian court to force meeting of Madeira Fjord.

August 2010: Absolute/UB's gaming operation moves from Tokwiro in Canada to Blanca Games in Antigua.

April 15, 2011: U.S. district attorney for the Southern District of New York seizes the three largest poker sites, including Absolute Poker/UB and indicts two of its principals on charges of bank fraud, illegal gambling offenses and money laundering.

Online poker investors lose big as rules change 04/30/11 [Last modified: Saturday, April 30, 2011 10:29pm]
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