Risk Management

The 5 Cent Empire

Native American tribes parlayed legalized gambling into a $22 billion lifeline. Now states want a piece of the action.
John GoffDecember 1, 2006

The long buses start rolling into the parking lot at the Grand Casino Mille Lacs long before the morning mist has lifted from the marshlands and maple trees. A steady line of white-haired warriors, armed with supersized plastic cups and beaded change purses, pile out of the buses and head straight for the palace. Inside, the band of brothers mark off rows of saved machines with American Legion hats and walkers and prepare to stuff coin after coin into the one-armed bandits. It’s 7:00 A.M., a Tuesday, in the middle of nowhere, and whole banks of nickel slots are already occupied.

That’s good news for Mel Towle, former CFO and current director of the Mille Lacs’s Corporate Commission, which oversees the business ventures of the Ojibwe (Chippewa) tribe. Raised near this lakeside reservation in central Minnesota, Towle still remembers the desperation that once gripped the Mille Lacs. “It used to be when you drove around the reservation, you could see the poverty. We were just about down and out.”

Back then, in the early 1990s, more than 70 percent of the band lived below the poverty level — appalling even by Native American standards. Some elders survived by living off the wild rice that grows in the wetlands around Lake Mille Lacs. Well water, lousy with iron, wasn’t drinkable. Jim Hamilton, an attorney who practices extensively in Native American law, visited the reservation during those bleak years. “I’d never seen anything like it,” Hamilton recalls. “It was subhuman.”

Legalized gambling brought the tribe back from the brink. Beginning with a small bingo parlor in 1991, the Mille Lacs have since built two glittering casinos. Gambling revenue has been plowed into scores of tribally owned start-ups, and the number of Mille Lacs living in poverty has declined to 15 percent. Local infrastructure like water and sewage systems has been improved, too, funded in part by the first municipal bond ever backed by casino revenues.

The miracle in Mille Lacs is not an isolated incident. In the nearly two decades since Congress okayed reservation casinos with the Indian Gaming Regulatory Act (IGRA), native gaming has skyrocketed. Tribes now operate 409 gambling operations in 28 states. For families in those bands, poverty levels have declined dramatically, down nearly 40 percent between 1990 and 2000. Last year, tribal gaming revenues topped $22 billion. No wonder Phil Hogen, chairman of the government’s National Indian Gaming Commission (NIGC), calls gaming “the most effective economic tool ever brought to Indian country.”

In fact, the unexpected success of Indian gaming is stirring up jealousy and antagonism off the reservation, providing unpleasant reminders of the ways Native Americans and their possessions have been treated in the past. Rival commercial-casino operators, which operate in 11 states, have begun to back campaigns to head off Indian casinos. They have been joined by unexpected allies, including evangelic organizations opposed to gambling.

The biggest threat to Indian gaming, however, comes from state politicians, who see native-casino revenues as a quick fix to yawning budget gaps. Governors like California’s Arnold Schwarzenegger have seized on a loophole in IGRA to demand sweeter deals from tribes, even though IGRA prohibits states from assessing charges on Indian gaming revenues.

Despite the still-impoverished status of many tribes — not to mention the sovereign status of those tribes — some think native bands should pony up. “Indian gaming is taking money from states,” says Chad Hills, gambling research policy analyst at Focus on the Family, a religious group, “but it’s not giving anything back.”

This growing demand for cash puts plenty of pressure on tribal finance managers, who deal with a different list of stakeholders than do CFOs at publicly traded companies. Tribal finance executives must parcel out precious casino revenues to a long list of recipients, including the NIGC, tribal members, charities, municipalities, and state governments. They also have to set aside funds for vital services like police departments and schools. At the same time, they are expected to engage in long-term business planning that spans an astounding 140 years (see “Six Sigma? How about Seven Generations?” at the end of this article). And they must do all this while maintaining cordial relations with state officials — officials who could end a tribe’s gambling exclusivity at any time.

Such statesmanship is not easy, particularly when local politicians want to scrap existing agreements — a sore point with Native Americans. Certainly, Tim Pawlenty, the governor of Minnesota, won few friends in Indian country when he tried to convince the Mille Lacs and two other tribes to fork over a combined $350 million each year to the state. When that failed, Pawlenty began negotiating a deal with other native nations.

The move infuriated members of several tribes, which had signed compacts with the state in 1989. “We think the state should stick to its agreements,” says Towle, a former KPMG senior accountant. “We shouldn’t be blackmailed into revenue sharing.”

The Wonder of It All

Maybe not, but for now states seem to hold all the cards. When it passed IGRA in 1988, Congress intended to foster long-term economic development among tribes by setting up a framework for Indian gaming (then, mostly bingo). The act, which was established to regulate tribal gaming, requires tribes to send annual audits to the NIGC and stipulates that revenues from gaming go to fund native governments, local charities, and municipal agencies. It also permits bands to invest casino revenues in tribal businesses or projects aimed at promoting tribal welfare. “Our framework complies with each of the IGRA categories,” confirms John Christman, treasurer of the Viejas Band of Kumeyaay Indians, in Alpine, California. “That’s our working business model.”

While the IGRA framework is mostly designed to benefit tribes, it also gives states tremendous leverage. How? By granting state officials the power to regulate any Indian casino offering video slots and other Vegas-style games of chance (known as Class III games). In some states, the oversight role includes licensing, auditing payout ratios, and settling patron disputes (as with non-Indian casinos). In fact, a tribe cannot set up a Class III casino without first signing a contract with its home-state legislature. That contract — essentially a government-to-government treaty — is called a compact. Says Robert Chicks, president of the Stockbridge-Munsee Band of Mohican Indians, in Bowler, Wisconsin: “Compacting was intended solely to address regulatory oversight.”

Instead, state officials have used the compacting process to extract gaming revenues that go way beyond regulatory oversight. “The act entitles states to only a minor amount of regulation of certain Class III games,” notes David Wilkins, a professor of American Indian studies, political science, law, and American studies at the University of Minnesota. “But that’s all some states needed.”

The loophole was first hit upon in 1991. That’s when Connecticut struck a watershed deal with the Mashantucket Pequot, a once landless tribe that, just 15 years earlier, counted only two members in its tribe. The state had little choice but to negotiate, since the U.S. Supreme Court had ruled four years earlier that states could not prohibit reservation gaming if it allowed charitable bingo games or ran a lottery (a Class III game). Under the setup, Connecticut granted the Pequot a virtual gaming monopoly. In return, the Pequot agreed to share a percentage of net win revenue (gaming proceeds minus payouts) with Connecticut. This swap — market exclusivity for cash — was considered an exchange of equal value. Thus, it sidestepped one of the key provisions of IGRA: states shall not levy fees or charges on tribal gaming revenues.

The deal shocked many in Indian country. Some decried revenue sharing as little more than a legislative shakedown. Critics countered that the tribe was gaining a valuable asset — a monopoly — and should therefore be willing to pay up. Either way, the arrangement in Connecticut turned IGRA (and its stated goal of helping Indians) on its head. “The compacting process was intended to give states a voice in Indian gaming,” insists Kevin Washburn, associate professor at the University of Minnesota Law School. “It was not intended to give states an opportunity to demand a cut of the profits.”

And oh, what a cut. The Mashantucket Pequot agreed to pay Connecticut 25 percent of its net gaming profits (about $220 million last year). Since the inking of the Foxwoods Resort Casino compact, lawmakers in other states have started to ask why they’re not getting similar deals. Conly Schulte, a partner in the Omaha office of Monteau & Peebles, has represented several Native American tribes in talks with states. “Twenty-five percent now seems to be the measuring stick in compact negotiations,” he says.

That’s a stiff vig, considering the average state corporate tax rate is around 7 percent. In fact, the whole notion of covering regulatory costs seems to have been lost in the mad dash for gambling cash. According to the “Indian Gaming Industry Report,” by Alan Meister, an economist with the Analysis Group, gaming tribes paid $22 million to states to defray regulatory costs in 2005. By comparison, the tribes made nearly $1 billion in revenue-sharing payments to state governments. “The fees-for-services exemption,” says one attorney bluntly, “is the exception that swallowed the rule.”

You Can’t Tax Belgium

Indeed, states are asking tribes for money faster than their casinos can generate it. Last year, tribal sharing of gaming revenues with state and local governments shot up by 20 percent, says Meister, even though tribal gaming revenues rose by only 16 percent. The ever-increasing house rake doesn’t surprise the University of Minnesota’s Wilkins. “States are never going to stop,” he says. “They’re always going to try to extract more tribal revenues.”

Recent events in California seem to support that assertion. During the nasty recall election in 2003, then–gubernatorial candidate Schwarzenegger promised he would tap tribal gaming revenues to help plug the state’s budget deficit. The eventual winner, Schwarzenegger held up Foxwoods as the appropriate model. “During the campaign, the governor pointed to Connecticut,” says Darrel Ng, a spokesman for Schwarzenegger. “That was our high-end.”

To strengthen his hand, Schwarzenegger ran television advertisements portraying tribes as special-interest groups that avoided paying taxes. He was right; they don’t pay taxes. Then again, neither does Belgium or any other sovereign nation. The damage was done, though. “We took a lot of PR hits,” acknowledges Vincent Duro, vice chairman of the San Manuel Band of Mission Indians, in Highland, California. “We got bashed pretty good.”

Following the 2003 election, the governor convinced a handful of native nations to revisit their compacts. To help get the tribes to the table, Schwarzenegger offered to lift the cap on the number of slot machines they can operate in their casinos. “The governor said, ‘If you want to expand, let’s talk about the issues,’” explains Ng. “Local communities needed more protection. And there needed to be more clarity on how patron disputes were settled.”

Boosting the number of slots was a shrewd bit of horse-trading, one aimed at mollifying both tribes and fiscally minded lawmakers. The quid pro quo does not sit well with antigambling groups, however. Hills of Focus on the Family believes that states like California are becoming addicted to gaming revenues. “The state will become dependent upon it, putting gambling money toward vital expenditures,” he cautions. “It’s going to be a hard and painful process to remove that tumor from around the vital organs.”

To date, Schwarzenegger has signed off on 18 new or renegotiated tribal compacts. (Many await ratification, however.) The deal with the San Manuel, signed by the governor in August, is typical of the reworked arrangements. The amended compact allows the tribe to add as many as 5,500 new slots in its casino on its 820-acre hillside reservation. That would put the San Manuel operation in the same league as Foxwoods, the world’s largest gambling establishment — assuming, of course, the tribe has enough flat land for an additional parking lot.

In return, the San Manuel agreed to boost the percentage of net-win revenues it shares with the state. Under the tiered setup, the tribe will more than double the revenue share on its existing 2,000 slots to $45 million annually. If the tribe adds 3,000 slots beyond that, it will pay the state 15 percent of the net win on those machines. The rate then jumps to 25 percent on the next 2,500 slots. The California Department of Finance reckons that if the San Manuel puts all 7,500 machines into operation, the state will take in $7.2 billion over the 20-year life of the compact. Tom Harman, a state senator and member of the National Council of Legislators in Gaming States, thinks it’s a fair arrangement: “[The amended compacts] are definitely a shot in the arm to the state budget.”

It remains to be seen how the deal will work out for the tribes. Viejas treasurer Christman believes his band’s amended contract, signed in 2004, will “help us get a running start at the market.” But the Viejas tribe already competes with several other Indian casinos in San Diego County. Hence, the prospect of 5,000 or so more slots may be little more than a mirage. Even Christman grants that “the whole point is not to saturate the market.”

What’s more, it’s no certainty that future lawmakers won’t come back looking for an even bigger rake for the state. “The original 1999 compact was supposed to last for 20 years,” notes Duro of the San Manuel. “We had just signed it, and they wanted to renegotiate it.”

Death Match

Critics contend that tribes should simply walk away from unfavorable deals. That’s easier said than done. An Indian nation can appeal to the Department of the Interior to settle a compact dispute, but it’s often a long, drawn-out process. As Robert Anderson, director of the Native American Law Center at the University of Washington School of Law, explains: “Many tribes would prefer to get their compacts signed now rather than risk going to the Secretary of the Interior.”

Moreover, not all tribes are in the same financial boat. The Mashantucket Pequot’s Foxwoods takes in around $1 billion in revenues a year. By contrast, one out of every five Native American casinos generates less than $3 million in annual gross income. Thus, what looks like a bad deal to a tribe with a thriving casino business may look damned good to a tribe struggling to survive. Lawmakers no doubt know this. Says Michael Marchand, chairman of the business council of the Confederated Tribes of Colville Indians, a Washington State–based band: “There will always be a few tribes that want to make a deal.”

Case in point: in late 2004, Minnesota governor Pawlenty floated a plan that would have required the state’s three biggest tribes to pay $350 million each year to the treasury. At the time, the state was facing a $4 billion budget deficit and Pawlenty had pledged not to raise taxes. Mille Lacs planner Don Wedll says he was stunned when he heard of the governor’s proposal. He claims the tribes don’t make more than $300 million in profits each year. “If Pawlenty’s plan had been reasonable, it would have happened,” insists Wedll. “But he made it impossible with that number.”

In January 2005, in an apparent bid to put the squeeze on the Mille Lacs and others, Pawlenty began talks with three different tribes to open state-run casinos in the Twin Cities. Those tribes, with impoverished reservations in northernmost Minnesota, seemed only too willing to listen. “That would have been a devastating blow to us,” concedes Towle of the Mille Lacs. “Most of our customers come from the Minneapolis metro area.”

The coalition fell apart, apparently after Pawlenty reportedly demanded a $200 million initial payment from the three tribes. (CFO’s interview requests went unanswered by the governor’s office.) “He was playing one tribe against the other,” insists Wedll. “Now the tribes are willing to go to a death match on this.”

That’s risky business. Historically, Native Americans have not fared well in showdowns with lawmakers. When Indians resisted attempts in the late 19th century to be “assimilated” into American culture, Congress passed the General Allotment Act. The law, also known as the Dawes Act, ultimately stripped tribes of two-thirds of their land, or roughly 90 million acres. You can make a Montana with 90 million acres.

Past Performance as Future Indicator

For now, public sentiment appears to be running against tribes and their gaming operations. In November, residents of Rhode Island overwhelmingly rejected a ballot initiative that would have given the Narragansett band a monopoly on casino gambling in the state.

Fearing a backlash that could lead to even greater revenue sharing — or cost them their gaming monopolies outright — some casino tribes are starting to hedge their bets. A few have begun pouring gambling proceeds into noncasino operations like banks, property, even bottled-water companies (see “Reservations Not Required” at the end of this article). “We need to diversify our revenue sources,” acknowledges Debra Croswell, deputy executive director of the Confederated Tribes of the Umatilla Reservation, which has financed the construction of a new technology park on its reservation near Pendleton, Oregon. She pauses, then adds, “Gaming may not be around forever.”

Based on past performance, that would seem to be a pretty safe bet. If so, consider it one more broken promise, one more accommodation on a long trail of disappointments. “You know, if there is one lesson to be learned from American history,” says attorney Hamilton, “it’s that when Native Americans have something non-Indians want, they take it from them.”

John Goff is technology editor at CFO.

Reservations Not Required

As their casino operations face pressure, some tribes are exploring new business ventures.

Most companies do everything they can to help customers find their places of business. And then there’s the Mohican North Star Casino and Bingo. This Native American house of cards (and slots) is located on County Road A, a backwoods trail that twists through corn and cattle country in north central Wisconsin. Few billboards point the way to the casino, which is owned by the Stockbridge-Munsee Band of Mohican Indians. Take a wrong turn at the junction of Road A and Road U and you end up driving into and out of Gresham, a detour that will cost you at least six seconds.

Most Indian-owned casinos, in fact, sit on remote reservation lands in places like Kamiah, Idaho (Nez Perce); Lame Deer, Montana (Northern Cheyenne); and Mescalero, New Mexico (Apache). Rural casinos do scant business compared with better-located rivals. Indeed, 40 percent of tribal casinos account for barely 2 percent of total Native American gaming revenues.

Not surprisingly, a number of tribes are keen to set up gambling operations nearer to town. The strategy, known derisively as “reservation shopping,” has met with stiff resistance from state and federal officials. In July, a bill was introduced in Congress by Rep. Richard Pombo (R-Calif.) that would all but kill the practice.

While Pombo’s bill was defeated, a growing number of Native Americans fear an antigaming (read: anti-Indian) backlash. Thus, many are leveraging casino money to diversify their business portfolios — often off the reservation. The Stockbridge-Munsee have already acquired a golf course and properties outside the 17,000 acres currently held in trust for the tribe by the federal government. The San Manuel Band of Mission Indians, whose small reservation mostly sits atop mountains in Highland, California, has partnered with three other tribes to build a hotel in Washington, D.C. Perhaps the most intriguing project in Indian country, however, is Cayuse Technologies. Founded in the fall of 2006 by the Confederated Tribes of the Umatilla Reservation, the information-technology specialist will operate in the tribes’ newly built industrial park near Pendleton, Oregon.

Cayuse is working with consulting firm Accenture Ltd. to establish a 40,000-square-foot business-process outsourcing and support center. Set to open in the summer of 2007, Cayuse will help Accenture serve government and other clients that choose not to offshore back-office work.

“Cayuse won’t be cheaper than India,” acknowledges Randall Willis, a Lakota Sioux and senior executive at Accenture. Still, given the low costs of labor on the reservation, the center will likely be 30 to 40 percent cheaper than back-office operations in urban centers like Boston or New York. Sometimes, being in the middle of nowhere has its advantages. — J.G.

Gaming the System

The Indian Gaming Regulatory Act, which authorizes states to bill tribes for regulatory oversight, prohibits them from assessing a charge on gaming revenues. It hasn’t worked out that way.*

Regulatory fees

$22.1 million

Local revenue sharing

$87.5 million**

State revenue sharing

$987.2 million

*2005 figures.
**Based on incomplete data.
Source: Alan Meister, “Indian Gaming Industry Report”

Six Sigma? How about Seven Generations?

In the corporate world, long-term planning typically involves a 5-year forecast. In the Indian world, it covers a slightly longer stretch. Generally speaking, tribes plan for seven generations. That’s 140 years.

Indeed, despite endless variables, tribal decisions must be based on how they will affect descendants seven generations down the line. Not surprisingly, the idea lost much of its relevance when tribes were forcibly pushed onto reservations and left to live off handouts from government agencies. Even in recent times, seven-generation planning was mostly a pointless pursuit. Says Robert Chicks, president of the Stockbridge-Munsee Band of Mohican Indians: “We used to plan a year at a time because federal funds come in a year at a time.”

Tribal gaming has changed all that. Buoyed by casino cash, officials of Native American nations are again looking ahead. “Gaming has given us the ability to take control of our destiny,” Chicks says of the Wisconsin tribe, a band that recorded unemployment levels of 70 percent just 25 years ago. “We now think about our long-term future.”

Part of that thinking is based on hard lessons learned from the past. After 200 years of government-sanctioned maltreatment, it’s hardly surprising that many tribal leaders focus on risk management when putting together tribal plans. Indeed, most gaming tribes funnel a portion of their casino revenues into bond funds and other money-market instruments — vehicles designed to generate interest income in perpetuity. “We set up a foundation to help secure the future,” says Vincent Duro, vice chairman of the San Manuel Band of Mission Indians. “If we do lose gaming, the tribe will be able to last.”

A number of tribes, including the San Manuel, have also begun investing in long-term assets such as real estate. In eastern Washington, the Confederated Tribes of the Colville Indian Reservation used some of its casino money to purchase 20,000 acres of timberland — forests that once made up part of the tribes’ original homelands. The acquisition of those vast tracts, says Michael Marchand, chairman of the group’s business council, squares nicely with the tribe’s investment horizon. Says Marchand: “We’re going to be here forever.” — J.G.