State lotteries are grappling with the rapid spread of unregulated skill gaming machines, which are found in convenience stores, bars, restaurants and taverns across the country.

While these machines have existed for some time, their manufacturers and operators have become increasingly aggressive in their roll out strategy, placing these machines in the front of stores and even replacing lottery self-service terminals with them. Individual lotteries predict these machines could reduce their revenue by hundreds of millions of dollars. Legislators, regulators and lottery officials are trying to figure out how to deal with this new threat.

Lotteries and casinos refer to these machines as "gray machines" because legally, they are in a gray area. Unlike traditional gambling machines where a win is determined entirely by probability, gray machines are influenced by a skill mechanic that has left courts befuddled in how to classify them.

What is a skill/pre-reveal game?

In some cases, gray machines look and play like a slot machine. A player inserts money, selects a game and decides how much to wager. Players who win money can cash out and receive payment from the store cashier. However, unlike a slot machine, once the slot wheel has stopped, the player can make a slight adjustment to create a winning outcome, adding a component of skill to the game.

In other cases, the skill component can be more significant. Games could be tic-tac-toe based or a memory game.

In still other cases, the games don't involve any skill. Instead it informs players whether the next play will result in a win or not, which is called a pre-reveal machine.

Slot machines that incorporate skill aren't new to the gambling industry. Casinos in Las Vegas and elsewhere have been rolling out skill-based slot machines on their floors for years–from bonus puzzle games on traditional slots to games like Danger Arena, a first-person shooter that allows players to win money depending on how well they did.

Potential regulators need to consider how many times a player is given a chance to win. For instance, if the player only has 1 out of 10 chances to improve his odds through "skill" to create a winning experience, then is it a gambling game or a skill game? Even a memory game can vary the level of skill required to win thereby hiding a random outcome. Imagine the difference between having to remember five things compared with 1,000 over a five-second period.

In pre-reveal games where the win is forecasted ahead of time, the situation is more confusing. The immediate next play isn't gambling because the player knows the outcome. The real gambling is hidden in the set of future plays. For instance, the player has no idea how many winning opportunities will be presented over the next 10, 100, or 1,000 plays, and might be willing to take an immediate loss for the potential to win on the following rounds.

State examples

Governments and courts are struggling with how to define gray machines, but they need to do something quickly. The rise of skill gray machines is detrimental to the lottery. Pennsylvania Governor Tom Wolf's administration accuses the machines of siphoning off $200 million of the lottery's revenue in the past year. The Virginia Lottery Director Kevin Hall stated that the lottery expects to lose $140 million in sales. The Missouri Lottery Executive Director May Scheve Reardon, stated these machines cost Missouri Lottery $50 million. With no regulations, money that was going to help good causes around the state is being lost to private interests. In Pennsylvania, the situation has become quite extreme. There are an estimated 52,000 to 82,000 machines across the state. Pace-O-Matic (POM) is one company that markets roughly 5,000 gray machines in Pennsylvania alone. After POM machines were confiscated by authorities, POM sued the state. POM alleged that if their games were considered illegal then so are arcade games at Chuck E. Cheese, an establishment known for providing arcade games to toddlers and young children.

In November 2019, Judge Patricia McCullough, a Commonwealth Court of Pennsylvania judge, wrote in her decision that "if POM's activities are subject to the Pennsylvania Racehorse Development and Gaming Act (Gaming Act), then the POM Game fits within the definition of 'Slot machine' under the Gaming Act." This would make them illegal. Unfortunately, she continued stating that the Gaming Act authority does not cover unlicensed games in unlicensed retailers. She declared, "we conclude that the POM Game is not subject to the Gaming Act," thereby POM games shouldn't be considered slot machines. (At press time, Judge Ellen Ceisler noted that POM's games have not been considered illegal, and the machines cannot be confiscated by the state.)

Likely, the matter will be settled not in a judicial arena but a legislative one. And, as is traditional in political matters, both sides of the argument immediately published statements claiming a victory after Judge McCullough's decision was released.

Parx, a legal casino in Pennsylvania that has been fighting the gray machines wrote in a press release: "The Commonwealth Court's clarification that the 'Pennsylvania Skill' games are 'slot machines' under Pennsylvania law provides concrete and clear legal justification for law enforcement at the state and local levels to confiscate such machines and prosecute those responsible for manufacturing, distributing, leasing, or owning these machines."

POM came out with the statement immediately after Parx, "Pace-O-Matic of Pennsylvania (POM of PA), the entity that markets Pennsylvania Skill games, won a decisive court ruling in Commonwealth Court."

Pennsylvania is not the only state having difficulty defining gray machines. Virginia has seen a dramatic increase in the number of gray machines in the state. Although it is impossible to know exactly how many machines are in the state, estimates are around 9,000 as of October 2019, generating between $83 million to $468 million in revenue. Queen Machines, a subsidiary of Pace-O-Matic, is one of the major distributors. "What's alarming here, beginning in spring, is the acceleration of the deployment of these machines into the retail spaces where we conduct the overwhelming majority of our business," Virginia Lottery Director Kevin Hall said in a presentation to state budget writers on the Virginia House Appropriations Committee.

In Virginia in 2017, the Alcoholic Beverage Control (ABC) was given authority by the Office of the Attorney General to determine the machines' legality. The ABC determined they did not violate the Code of Virginia's prohibition of illegal gambling devices because they required significant levels of skill. In 2019, the ABC issued a new policy advising that local attorneys should determine the legality of gray machines on a county by county basis.

Due to potential legislation that would legalize casinos and other gambling activities in Virginia, a comprehensive study, Gaming in the Commonwealth 2019, was published that detailed the effects of gray machines in Virginia. It strongly recommended against local attorneys being allowed to decide the legality of gray machines. "Leaving the determination... to local prosecutors likely will be problematic. There is potential for jurisdictions to reach different conclusions about the legality of gray machines. This inconsistency across the state has the potential to create confusion among consumers, law enforcement, and businesses . . ."

Virginia legislators also vocalized their discontent over the ABC's decision. Appropriations Chairman Chris Jones, R-Suffolk, said he found it "incredible" that the ABC had taken it upon itself to decide whether the machines were games of chance or skill. Del. Steve Landes, R-Augusta, said that instead of leaving it to a "hodgepodge" of local prosecutors, the state Attorney General office could provide a consistent interpretation.

Missouri currently estimates there are 14,000 gray machines in the state, including pre-reveal machines by Torch Games as well as skill machines by Pace-O-Matic. Over the past two years, Missouri has also seen a drastic proliferation of gray machines statewide. "On a recent trip to St. Louis, I stopped into a retailer where four illegal gaming devices were being installed and the worker unplugged the Missouri Lottery's equipment to plug in the illegal machines," Scheve Reardon said.

Lt. Roger Phillips of the Missouri Highway Patrol said investigators have deemed the skill machines illegal. However, Missouri Governor Mike Parson in January 2020 has said that he is not convinced the terminals are illegal. "We first need to clarify what machines constitute gambling and what machines are video games," Parson told the St. Louis Post-Dispatch.

Currently, there are cases in Platte, Polk and Cass counties to define gray machines. The Platte County case appears to be the lynchpin case. The county prosecutor, Eric Zahnd, has stated that multiple counties are waiting for the verdict. However, the Platte case has been delayed three times. Currently, the case has been rescheduled for February. However, then it will almost certainly be appealed, delaying the process even longer.

For this very reason, in December 2019, the House of Representatives Special Interim Committee on Gaming, in a report, stated that a "judicial resolution of the gray machine issue is unlikely prior to late 2021 and it may be desirable to act to regulate such machines immediately to resolve uncertainty and prevent further loss of revenue that could be used for educational purposes." (This report was released a month before the statements by Gov. Parson.)

The Lottery has joined forces with the Missouri Gaming Association, the Highway Patrol, the Division of Alcohol and Tobacco Control and the Department Department of Public Safety to help regulate or ban gray machines.

To ban or to regulate

Ultimately, states will have to decide whether to ban these machines or to regulate them.

Colorado banned skill machines in 2018. Under HB-18 1234, a gambling device was redefined as a device that combines "the elements of chance and skill, in accordance with the Colorado Constitution." The bill further explains that a simulated gambling device is illegal if the user is paid indirectly, "or in a nonmonetary form for use of a simulated gambling device, and that time of payment (i.e. before or after the use of the device) is irrelevant."

In Ohio, skill machines have effectively been banned through regulation. The Attorney General has been fighting gray machines for over a decade. In 2007, the office estimated there were 50,000 gray machines throughout the state. In 2015, the Ohio General Assembly expanded the Ohio Casino Control Commission (OCCC) to include licensing and reporting for all gray machine manufacturers, distributors and operators. In 2016, regulations were updated by the OCCC. The regulations meant that everyone that operates a skill game must be licensed, including family establishments, like Chuck E. Cheese. OCCC Executive Director Matt Schuler explained that "In order for us to be able to go after illegal casinos, we have to license everybody."

"Our goal is to make it easy to identify the people doing this legitimately and make it easy to weed out and shut down the illegal slot machines," Jessica Franks, OCCC spokeswoman, said.

In April of 2013, the Georgia Lottery Corporation assumed regulatory duties for enforcing Coin Operated Amusement Machines (COAM), which include games found in family establishments and gray skill machines. In Georgia, players can win prizes by earning points. But points can only be redeemed for things that the location sells: merchandise, gas, Georgia Lottery tickets, or future plays on machines.

A unique problem

While in many states the gray machines are an issue for all legal gambling establishments, the lottery industry has a unique problem. As discussed, many of the establishments that house gray machines are traditional lottery retailers: convenience stores, gas stations, even bars and restaurants. Lottery sales representatives frequent these locations and know which retailers have gray machines. Legislators and enforcement officials have sought information on which retailers operate potentially illegal machines. The lottery has this information and is also losing substantial revenue because of these machines. It could easily be argued that the lottery should provide this information.

Here is the problem. If the lotteries report a retailer as having an illegal machine, then they eliminate the competition. But lotteries do not want to jeopardize the retailer relationships that have been years in the making. "Lotteries work hard to develop and maintain strong partnerships with our retailers. It would be counter-intuitive for us to continue that relationship, while at the same time we are reporting the retailer to the authorities for operating illegal machines," Scheve Reardon said.

Need to do something

The choice is difficult. The decision to regulate gray machines would require a state agency to be created to oversee them, or the responsibilities would need to be given to an already existing agency. As the environment changes, the agency would likely need a significant increase in resources to be able to handle the large amount of machines around the state.

Consider the additional cost to the Georgia Lottery as described in the Virginia Gaming in the Commonwealth 2019 Report mentioned earlier:

Georgia's Lottery has a highly developed process of regulation and enforcement for these devices, but it is challenging and costly. Georgia Lottery staff indicated that even with substantial resources allocated to regulation and oversight of the devices, it is likely that not all violations are detected and enforced. Staff indicated that typical violations include 'inducements' paid to host retailers (sidebar), host retailers providing cash prize payouts instead of store or lottery credits, and host retailers not generating sufficient amounts of non-gaming revenue (i.e. acting primarily as a gaming parlor instead of selling merchandise). Furthermore, Georgia Lottery staff indicated that the agency conducts 20 to 30 judicial review hearings per month as part of their judicial review process for violations. The outcomes of the agency hearing can be challenged in state courts and appeals courts, which adds additional time and expense. In total, Georgia Lottery's cost of regulating gray machines was $15 million in the most recent fiscal year, which included the personnel costs of 47 additional agency staff (~$4 million) and the cost of a central monitoring and audit system (~$9 million), as well as other non-personnel expenses.

A state legislature attempting to regulate these machines would also need to determine the rate at which the manufacturers' net gaming revenue would be taxed. Tax rates on net gaming revenue from electronic gaming devices are 7% in Iowa, 10% in Georgia, and 30% in Illinois.

Banning the machines might not be an easy task either. Ohio now requires that all skill game operators be licensed, including family establishments. Businesses across the state will surely lobby against such a proposal. But if nothing is done, then the state is risking a crisis.

Choosing either option will require education for the regulatory bodies, businesses that operate the machines and citizens. There will likely be a lot of fines issued and machines confiscated. If banned, some businesses will struggle to replace the revenue or, if regulated, struggle to pay the licensing fees. But a decision needs to be made. The best time to do something was yesterday. The next best time is today.