14.1: Lotteries

A lottery is defined in section 319 of the California Penal Code.

A lottery is any scheme for the disposal or distribution of property by chance, among persons who have paid or promised to pay any valuable consideration for the chance of obtaining such property or a portion of it, or for any share or any interest in such property, upon any agreement, understanding, or expectation that it is to be distributed or disposed of by lot or chance, whether called a lottery, raffle, or gift enterprise, or by whatever name the same may be known.¹¹¹

Rent-Seeking Games

The world is full of strange contests: cockroach racing, toe wrestling, cow-chip tossing. To date, no contest has been held for Best Example of Public Choice Theory. But if one ever does take place, the dispute over “skill games” will be a championship contender. Skill games resemble slots but include just enough non-random elements to avoid being labeled outright gambling and thus fall under state gambling regulations (and prohibitions). States do not like them. This past summer, for example, the Virginia Lottery sent a financial report to the governor warning darkly of a revenue threat on the horizon — namely, “an aggressive expansion” of “untaxed, unlicensed, and unregulated machines” allowing users to wager money. “By our unofficial count,” the report said, “nearly 4,300 of these unregulated games-of-skill machines now operate in” — here comes the pinch point — “1,350 Lottery licensed retailers,” or “one quarter of our retail locations.”

You can see the problem right away. For much of their existence, state lotteries have enjoyed something close to a monopoly on licit gambling. Some states have allowed horse racing and expanded into pari-mutual wagering, and some have gone full-bore into casino gambling, and the internet offers another outlet for those who want to wager. But outside of the occasional office betting pool or basement poker game, anybody who wants to take a socially acceptable risk with a few dollars is pretty much stuck with some sort of state-controlled racket.

The result of this market dominance has been a fire hydrant of cash. In Virginia, the Lottery had $2.29 billion in ticket sales — and $650 million in profits — in just the last fiscal year. That is a profit margin of 28% which is well above the average profit margin for the ostensibly rapacious pharmaceutical industry.

But if “untaxed, unlicensed, and unregulated machines” begin to horn in on the state’s gambling business, the result could be — gulp! — a loss of revenue. Indeed, the Richmond Times-Dispatch reported that Virginia’s secretary of finance, Aubrey Layne, had heard that some businesses had replaced their lottery machines with skill games. “We’re going to have to come to grips with this,” Layne said.

He is not alone in this worry. In Pennsylvania, state lawmaker Tommy Tomlinson has introduced legislation targeting skill-game machines. According to news accounts, “There are 5,050 machines being used at convenience and liquor stores, gas stations, thrift shops, and shopping malls throughout the state, each diverting $2,284 from the lottery each month.” The horror. Pennsylvania devotes its lottery proceeds to medical benefits for seniors’ ineligible for Medicaid. “These machines are picking the pockets of Pennsylvania senior citizens,” Tomlinson insists. He notes that the gaming devices are often “placed next to a lottery machine to mislead the public into thinking these machines are actually Lottery machines.” To the contrary, he says, “they are illegal gambling devices.”

That might seem like splitting an exceptionally fine hair, but lotteries bill themselves as good, clean fun that serves a worthy cause. Virginia’s proceeds, for instance, go to public schools. Or at least they do in theory. In practice, the money frees up funds that legislators otherwise would spend on K–12 education. Governmental alarm over the prospect of gambling competition surely contains a degree of institutional self-dealing, and that is where the public choice angle comes in. Public choice theory holds that government agents are not purely disinterested actors pursuing the general welfare at all times; like everyone else, they are motivated at least in part by self-interest.

And indeed, from a completely disinterested perspective, the optimal gambling regime would be one that allows the greatest number of people to pursue their own best interests as they define them. If people would rather play games of skill than games of chance, then the state should not stand in their way. States, however, are not likely to take this view. And with so much money on the line, why would they?

To be fair, states have no monopoly on self-seeking in this realm (or any other). Game machine provider Queen of Virginia Skill & Entertainment is certainly not making any kind of case for laissez-faire. “We agree that there are many gambling machines masquerading as skill devices across the Commonwealth and those illegal machines must be cleaned up,” a company spokesperson told the Times-Dispatch. Tom Lisk, a lobbyist for the company, notes that “it would benefit us to have some sort of regulatory structure.” Michael Barley, spokesperson for Queen of Virginia’s parent company, Pace-O-Magic, is even more direct: “Our goal in every market we’re in is to get more of a regulated system,” he says. Naturally. If you can’t beat ‘em in the game of rent-seeking, the best strategy is to join ‘em.¹¹²

Figure \(\PageIndex{1}\): Bingo Chips.^xix

Bingo Games

The crime of participating in an illegal bingo game is defined in section 326.5 of the California Penal Code.

(a) Neither the prohibition on gambling (commencing with Section 330) applies to any bingo game that is conducted in a city, county, or city and county pursuant to an ordinance enacted under Section 19 of Article IV of the State Constitution, if the ordinance allows games to be conducted only in accordance with this section and only by organizations exempted from the payment of the bank and corporation tax by Sections 23701a, 23701b, 23701d, 23701e, 23701f, 23701g, 23701k, 23701w, and 23701l of the Revenue and Taxation Code and by mobile home park associations, senior citizens organizations, and charitable organizations affiliated with a school district; and if the receipts of those games are used only for charitable purposes.

(b) It is a misdemeanor for any person to receive or pay a profit, wage, or salary from any bingo game authorized by Section 19 of Article IV of the State Constitution. Security personnel employed by the organization conducting the bingo game may be paid from the revenues of bingo games, as provided in subdivisions (j) and (k).

(c) A violation of subdivision (b) shall be punishable by a fine not to exceed ten thousand dollars ($10,000), which fine is deposited in the general fund of the city, county, or city and county that enacted the ordinance authorizing the bingo game. A violation of any provision of this section, other than subdivision (b), is a misdemeanor.

(d) The city, county, or city and county that enacted the ordinance authorizing the bingo game may bring an action to enjoin a violation of this section.

(e) Minors shall not be allowed to participate in any bingo game.

(f) An organization authorized to conduct bingo games pursuant to subdivision (a) shall conduct a bingo game only on property owned or leased by it, or property whose use is donated to the organization, and which property is used by that organization for an office or for performance of the purposes for which the organization is organized. Nothing in this subdivision shall be construed to require that the property owned or leased by, or whose use is donated to, the organization be used or leased exclusively by, or donated exclusively to, that organization.

(g) All bingo games shall be open to the public, not just to the members of the authorized organization.

(h) A bingo game shall be operated and staffed only by members of the authorized organization that organized it. Those members shall not receive a profit, wage, or salary from any bingo game. Only the organization authorized to conduct a bingo game shall operate such a game, or participate in the promotion, supervision, or any other phase of a bingo game. This subdivision does not preclude the employment of security personnel who are not members of the authorized organization at a bingo game by the organization conducting the game.

(i) Any individual, corporation, partnership, or other legal entity, except the organization authorized to conduct a bingo game, shall not hold a financial interest in the conduct of a bingo game.

(j) With respect to organizations exempt from payment of the bank and corporation tax by Section 23701d of the Revenue and Taxation Code, all profits derived from a bingo game shall be kept in a special fund or account and shall not be commingled with any other fund or account. Those profits shall be used only for charitable purposes.

(k) With respect to other organizations authorized to conduct bingo games pursuant to this section, all proceeds derived from a bingo game shall be kept in a special fund or account and shall not be commingled with any other fund or account. Proceeds are the receipts of bingo games conducted by organizations not within subdivision (j). Those proceeds shall be used only for charitable purposes, except as follows:

(1) The proceeds may be used for prizes.

(2) (A) Except as provided in subparagraph (B), a portion of the proceeds, not to exceed 20 percent of the proceeds before the deduction for prizes, or two thousand dollars ($2,000) per month, whichever is less, may be used for the rental of property and for overhead, including the purchase of bingo equipment, administrative expenses, security equipment, and security personnel.

(B) For the purposes of bingo games conducted by the Lake Elsinore Elks Lodge, a portion of the proceeds, not to exceed 20 percent of the proceeds before the deduction for prizes, or three thousand dollars ($3,000) per month, whichever is less, may be used for the rental of property and for overhead, including the purchase of bingo equipment, administrative expenses, security equipment, and security personnel. Any amount of the proceeds that is additional to that permitted under subparagraph (A), up to one thousand dollars ($1,000), shall be used for the purpose of financing the rebuilding of the facility and the replacement of equipment that was destroyed by fire in 2007. The exception to subparagraph (A) that is provided by this subparagraph shall remain in effect only until the cost of rebuilding the facility is repaid, or January 1, 2019, whichever occurs first.

(3) The proceeds may be used to pay license fees.

(4) A city, county, or city and county that enacts an ordinance permitting bingo games may specify in the ordinance that if the monthly gross receipts from bingo games of an organization within this subdivision exceed five thousand dollars ($5,000), a minimum percentage of the proceeds shall be used only for charitable purposes not relating to the conducting of bingo games and that the balance shall be used for prizes, rental of property, overhead, administrative expenses, and payment of license fees. The amount of proceeds used for rental of property, overhead, and administrative expenses is subject to the limitations specified in paragraph (2).

(l) (1) A city, county, or city and county may impose a license fee on each organization that it authorizes to conduct bingo games. The fee, whether for the initial license or renewal, shall not exceed fifty dollars ($50) annually, except as provided in paragraph (2). If an application for a license is denied, one-half of any license fee paid shall be refunded to the organization.

(2) In lieu of the license fee permitted under paragraph (1), a city, county, or city and county license is denied, one-half of the application fee shall be refunded to the organization. An additional fee for law enforcement and public safety costs incurred by the city, county, or city and county that are directly related to bingo activities may be imposed and shall be collected monthly by the city, county, or city and county issuing the license; however, the fee shall not exceed the actual costs incurred in providing the service.

(m) A person shall not be allowed to participate in a bingo game, unless the person is physically present at the time and place where the bingo game is being conducted.

(n) The total value of prizes available to be awarded during the conduct of any bingo games shall not exceed five hundred dollars ($500) in cash or kind, or both, for each separate game which is held.

(o) As used in this section, “bingo” means a game of chance in which prizes are awarded on the basis of designated numbers or symbols that are marked or covered by the player on a tangible card in the player’s possession and that conform to numbers or symbols, selected at random and announced by a live caller. Notwithstanding Section 330c, as used in this section, the game of bingo includes tangible cards having numbers or symbols that are concealed and preprinted in a manner providing for distribution of prizes. Electronics or video displays shall not be used in connection with the game of bingo, except in connection with the caller’s drawing of numbers or symbols and the public display of that drawing, and except as provided in subdivision (p). The winning cards shall not be known prior to the game by any person participating in the playing or operation of the bingo game. All preprinted cards shall bear the legend, “for sale or use only in a bingo game authorized under California law and pursuant to local ordinance.” Only a covered or marked tangible card possessed by a player and presented to an attendant may be used to claim a prize. It is the intention of the Legislature that bingo as defined in this subdivision applies exclusively to this section and shall not be applied in the construction or enforcement of any other provision of law.

“Commission” means the California Gambling Control Commission.

“Department” means the Department of Justice.

“Person” includes a natural person, corporation, limited liability company, partnership, trust, joint venture, association, or any other business organization.¹¹³

Chain Letters and Pyramid Schemes

The crime of participating in chain letters and pyramid schemes is defined in section 327 of the California Penal Code.

Every person who contrives, prepares, sets up, proposes, or operates any endless chain is guilty of a public offense, and is punishable by imprisonment in the county jail not exceeding one year or in state prison for 16 months, two, or three years.

As used in this section, an “endless chain” means any scheme for the disposal or distribution of property whereby a participant pays a valuable consideration for the chance to receive compensation for introducing one or more additional persons into participation in the scheme or for the chance to receive compensation when a person introduced by the participant introduces a new participant. Compensation, as used in this section, does not mean or include payment based upon sales made to persons who are not participants in the scheme and who are not purchasing in order to participate in the scheme.¹¹⁴

Figure \(\PageIndex{2}\): How Pyramid Schemes Work Diagram.^xx

Ponzi Schemes

A Ponzi scheme is a form of fraud that lures investors and pays profits to earlier investors with funds from more recent investors. The scheme leads victims to believe that profits are coming from product sales or other means, and they remain unaware that other investors are the source of funds. A Ponzi scheme can maintain the illusion of a sustainable business if new investors contribute new funds, and as long as most of the investors do not demand full repayment and still believe in the non-existent assets they are purported to own.

Typically, Ponzi schemes require an initial investment and promise above-average returns. They use vague verbal guises such as “hedge futures trading “, “high-yield investment programs “, or “offshore investment” to describe their income strategy. It is common for the operator to take advantage of a lack of investor knowledge or competence, or sometimes claim to use a proprietary, secret investment strategy to avoid giving information about the scheme. The basic premise of a Ponzi scheme is “to rob Peter to pay Paul. “Initially, the operator pays high returns to attract investors and entice current investors to invest more money. When other investors begin to participate, a cascade effect begins. The schemer pays a “return” to initial investors from the investments of new participants, rather than from genuine profits. Often, high returns encourage investors to leave their money in the scheme, so that the operator does not actually have to pay very much to investors. The operator simply sends statements showing how much they have earned, which maintains the deception that the scheme is an investment with high returns. Investors within a Ponzi scheme may even face difficulties when trying to get their money out of the investment.

Operators also try to minimize withdrawals by offering new plans to investors where money cannot be withdrawn for a certain period of time in exchange for higher returns. The operator sees new cash flows as investors cannot transfer money. If a few investors do wish to withdraw their money in accordance with the terms allowed, their requests are usually promptly processed, which gives the illusion to all other investors that the fund is solvent and financially sound.

Ponzi schemes sometimes begin as legitimate investment vehicles, such as hedge funds that can easily degenerate into a Ponzi-type scheme if they unexpectedly lose money or fail to legitimately earn the returns expected. The operators fabricate false returns or produce fraudulent audit reports instead of admitting their failure to meet expectations, and the operation is then considered a Ponzi scheme.

A wide variety of investment vehicles and strategies, typically legitimate, have become the basis of Ponzi schemes. For instance, Allen Stanford used bank certificates of deposit to defraud tens of thousands of people. Certificates of deposit are usually low-risk and insured instruments, but the Stanford certificates of deposit were fraudulent.

According to the U.S. Securities and Exchange Commission (SEC), many Ponzi schemes share similar characteristics that should be “red flags” for investors. The warning signs include:

• High investment returns with little or no risk. Every investment carries some degree of risk, and investments yielding higher returns typically involve more risk. Any “guaranteed” investment opportunity is often considered suspicious.
• Overly consistent returns. Investment values tend to go up and down over time, especially those offering potentially high returns. An investment that continues to generate regular positive returns regardless of overall market conditions is considered suspicious.
• Unregistered investments. Ponzi schemes typically involve investments that have not been registered with the SEC or with state regulators. Registration is important because it provides investors with access to key information about the company’s management, products, services, and finances.
• Unlicensed sellers. Federal and state securities laws require that investment professionals and their firms be licensed or registered. Most Ponzi schemes involve unlicensed individuals or unregistered firms, the few exceptions usually being the aforementioned investment vehicles that started out as legitimate operations but failed to earn the expected returns.
• Secretive or complex strategies. Investments that cannot be understood or do not give complete information.
• Issues with paperwork. Excuses are given regarding why clients cannot review information in writing about an investment. Also, account statement errors and inconsistencies are frequently signs that funds are not being invested as promised.
• Difficulty receiving payments. Clients have failures to receive a payment or have difficulty cashing out their investments. Ponzi scheme promoters routinely encourage participants to “roll over” investments and sometimes promise even higher returns on the amount rolled over.

Theoretically it is not impossible at least for certain entities operating as Ponzi scheme to ultimately “succeed” financially, at least so long as a Ponzi scheme was not what the promoters were initially intending to operate. For example, a failing hedge fund reporting fraudulent returns could conceivably “make good” its reported numbers, for example by making a successful high-risk investment. Moreover, if the operators of such a scheme are facing the likelihood of imminent collapse accompanied by criminal charges, they may see little additional “risk” to themselves in attempting cover their tracks by engaging in further illegal acts to try and make good the shortfall (for example, by engaging in insider trading). Especially with lightly regulated and monitored investment vehicles like hedge funds, in the absence of a whistleblower or accompanying illegal acts any fraudulent content in reports is often difficult to detect unless and until the investment vehicles ultimately collapse.

Typically, however, if a Ponzi scheme is not stopped by authorities, it usually falls apart for one or more of the following reasons:

1. The operator vanishes, taking all the remaining investment money. Promoters who intend to abscond often attempt to do so as returns due to be paid are about to exceed new investments, as this is when the investment capital available will be at its maximum.
2. Since the scheme requires a continual stream of investments to fund higher returns, if the number of new investors slows down, the scheme collapses as the operator can no longer pay the promised returns (the higher the returns, the greater the risk of the Ponzi scheme collapsing). Such liquidity crises often trigger panics, as more people start asking for their money, similar to a bank run.
3. External market forces, such as a sharp decline in the economy, can often hasten the collapse of a Ponzi scheme (for example, the Madoff investment scandal during the market downturn of 2008), since they often cause many investors to attempt to withdraw part or all of their funds sooner than they had intended.

Actual losses are extremely difficult to calculate. The amounts that investors thought they had been never attainable in the first place. The wide gap between “money in” and “fictitious gains” make it virtually impossible to know how much was lost in any Ponzi scheme.

In the United States, individuals can halt a Ponzi scheme before its collapse by reporting to the SEC. Under the SEC Whistleblower Program, individuals can receive monetary awards for reporting violations of the federal securities laws, including information about Ponzi schemes, if their information leads to a successful SEC enforcement action in which over $1,000,000 in sanctions is ordered. To report a Ponzi scheme and qualify for an award under the program, the SEC requires that whistleblowers or their attorneys report the tip online through the SEC’s Tip, Complaint or Referral Portal or mail/fax a Form TCR to the SEC Office of the Whistleblower.¹¹⁵

Gaming

The crime of participating in gaming is defined in section 330 of the California Penal Code.

Every person who deals, plays, or carries on, opens, or causes to be opened, or who conducts, either as owner or employee, whether for hire or not, any game of faro, monte, roulette, lansquenet, rouge et noire, rondo, tan, fan-tan, seven-and-a-half, twenty-one, hokey-pokey, or any banking or percentage game played with cards, dice, or any device, for money, checks, credit, or other representative of value, and every person who plays or bets at or against any of those prohibited games, is guilty of a misdemeanor, and shall be punishable by a fine not less than one hundred dollars ($100) nor more than one thousand dollars ($1,000), or by imprisonment in the county jail not exceeding six months, or by both the fine and imprisonment.¹¹⁶

Bookmaking

The crime of bookmaking is defined in section 337a of the California Penal Code.

(a) Except as provided in Section 336.9, every person who engages in one of the following offenses, shall be punished for a first offense by imprisonment in a county jail for a period of not more than one year or in the state prison, or by a fine not to exceed five thousand dollars ($5,000), or by both imprisonment and fine:

(1) Pool selling or bookmaking, with or without writing, at any time or place.

(2) Whether for gain, hire, reward, or gratuitously, or otherwise, keeps or occupies, for any period of time whatsoever, any room, shed, tenement, tent, booth, building, float, vessel, place, stand or enclosure, of any kind, or any part thereof, with a book or books, paper or papers, apparatus, device or paraphernalia, for the purpose of recording or registering any bet or bets, any purported bet or bets, wager or wagers, any purported wager or wagers, selling pools, or purported pools, upon the result, or purported result, of any trial, purported trial, contest, or purported contest, of skill, speed or power of endurance of person or animal, or between persons, animals, or mechanical apparatus, or upon the result, or purported result, of any lot, chance, casualty, unknown or contingent event whatsoever.

(3) Whether for gain, hire, reward, or gratuitously, or otherwise, receives, holds, or forwards, or purports or pretends to receive, hold, or forward, in any manner whatsoever, any money, thing or consideration of value, or the equivalent or memorandum thereof, staked, pledged, bet or wagered, or to be staked, pledged, bet or wagered, or offered for the purpose of being staked, pledged, bet or wagered, upon the result, or purported result, of any trial, or purported trial, or contest, or purported contest, of skill, speed or power of endurance of person or animal, or between persons, animals, or mechanical apparatus, or upon the result, or purported result, of any lot, chance, casualty, unknown or contingent event whatsoever.

(4) Whether for gain, hire, reward, or gratuitously, or otherwise, at any time or place, records, or registers any bet or bets, wager or wagers, upon the result, or purported result, of any trial, or purported trial, or contest, or purported contest, of skill, speed or power of endurance of person or animal, or between persons, animals, or mechanical apparatus, or upon the result, or purported result, of any lot, chance, casualty, unknown or contingent event whatsoever.

(5) Being the owner, lessee or occupant of any room, shed, tenement, tent, booth, building, float, vessel, place, stand, enclosure or grounds, or any part thereof, whether for gain, hire, reward, or gratuitously, or otherwise, permits that space to be used or occupied for any purpose, or in any manner prohibited by paragraph (1), (2), (3), or (4).

(6) Lays, makes, offers or accepts any bet or bets, or wager or wagers, upon the result, or purported result, of any trial, or purported trial, or contest, or purported contest, of skill, speed, or power of endurance of person or animal, or between persons, animals, or mechanical apparatus.¹¹⁷

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¹¹¹California Penal Code (2024)

¹¹²Hinkle (2020)

¹¹³California Penal Code (2024)

¹¹⁴California Penal Code (2024)

¹¹⁵Klingensmith (2022)

¹¹⁶California Penal Code (2024)

¹¹⁷California Penal Code (2024)