Gambling on private-equity firms

By Liz Benston

Thursday, Oct. 12, 2006 | 7:23 a.m.

A bid by a pair of private-equity firms to buy Harrah's Entertainment, if approved, will offer the latest evidence of a flourishing symbiotic relationship between Nevada regulators and the casino industry.

A vital role of regulators is to set the bar for who is allowed to operate casinos in Nevada, and to conduct background investigations into their character. Reputation, honesty and credibility are everything in an industry that is based on the tracking and handling of cash.

That oversight is all the more important in Nevada, because nearly half of the state's general fund revenue comes from gambling taxes.

For that same reason, Nevada gaming regulators have a second vital role: to encourage investment in the casino industry. And for decades, the state's regulators have had to roll with the industry to accommodate different kinds of companies that want to operate casinos. After all, what's good for the industry is good for Nevada.

Now, regulators may be asked to review the newest flavor of Strip capitalists - a group of private investors, including some who prize their privacy. The state won't want to stand in the investors' way, but at the same time it will need to make sure that the relevant managers are up to running a huge casino company.

In Las Vegas' early days, when casinos were owned by individuals or small groups of investors, the regulator's job was relatively simple: Make sure each investor was qualified to operate the joint.

Beginning in 1967 with billionaire Howard Hughes' purchase of several casinos from their mob-controlled owners, regulators began to shift their sights from the few people who owned casinos to major corporations with tens of thousands of shareholders.

By then, casinos had become a vital contributor to state tax coffers, forcing regulators to wrestle with the problem of how to exert control over an industry upon which the state depended.

Thanks to legislation to facilitate Hughes' purchases, regulators effectively removed the mob from its controlling position in the casino industry. But disclosure rules and restrictions on trading stock still kept major corporations out of Nevada until 1969, when the state passed additional rules allowing public companies to own gaming subsidiaries without submitting all of their shareholders to background investigations.

Under Nevada's licensing rules that apply to publicly traded companies, regulators reserve background investigations for key decision-makers such as executives and directors as well as shareholders owning more than 10 percent of company stock.

Ordinary stockholders, funds and institutions that own casino stocks aren't required to be licensed under the premise that they are passive investors who don't influence how Nevada's casinos are run.

The corporate gaming rules changed the state forever by fueling unprecedented investment in Nevada. The first major corporations with many shareholders began to flood into the state after Hughes, acquiring single-owner properties, building new casinos and generating the vast majority of the state's gambling revenue.

Wall Street has done well on Las Vegas Boulevard: Today, a pair of publicly traded companies - MGM Mirage and Harrah's - are collectively worth more than $25 billion.

And now, Las Vegas is seeing yet a third kind of casino ownership proposal: private equity companies such as the ones vying for Harrah's. If consummated, the bid could fuel another sea change by attracting a host of privately held investment companies that want to own more than just a partial stake in Las Vegas casinos. And still - even as they promote industry growth - state regulators will have to subject newcomers to background checks unheard of in other sectors of American business.

Like corporations with public stock, private equity funds have hundreds, even thousands of investors. Unlike retail mutual funds, they accept individual investments in the millions of dollars from pensions, endowments and wealthy individuals who include prominent businesspeople and politicians.

While casinos had been eyed for years as stable and lucrative investments, private equity funds avoided them, unwilling to fill out license applications more than 70 pages long in which regulators probe managers' relationships with business associates and even ex-wives.

Indeed, an agency that both promotes gaming and regulates the industry may seem to be working at cross purposes: The same licensing requirements that are designed to keep out unscrupulous people such as mob associates and tax dodgers have also kept out squeaky-clean investment firms with money to burn but who desire to keep financial details and investors out of the public eye.

But these groups didn't want to walk away from Las Vegas, so they found a creative way to use Nevada's corporate licensing rules to pass regulatory muster - by structuring their deals so that only a few decision-makers are investigated.

It is their strategy to clump the vast majority of shareholders into separate entities whose members hold nonvoting shares. Because they are ostensibly passive investors, regulators don't need to license them, and instead focus on the few people who direct the funds and who hold voting shares.

The dual voting structure, while fairly new, has allowed these funds to invest in Nevada casinos without the state needing to change its regulations.

With investment banks and fund managers investing millions and even billions in casinos, regulators don't harbor the same concerns about mob influence or shady business practices that they did years ago.

Each private equity deal is structured slightly differently and has been examined to ensure that the key managers making investment decisions are licensed rather than front men cherry-picked by management to undergo background checks, Gaming Control Board member Mark Clayton said.

The bid for Harrah's would not only be the biggest deal in history but the first in years to allow private equity firms to acquire 100 percent of a Nevada gaming company. Other recent deals have involved partial ownership of casinos that are still run and operated by experienced Nevada operators.

Regulators still retain the right to investigate any shareholder of a casino investment - big or small - at any time.

"That's a huge caveat," said Ellen Whittemore, a gaming attorney with Lionel Sawyer & Collins and former deputy attorney general. "These are great investment vehicles for Nevada, but the bottom line is that if you have any investment in a casino you always have the potential that you'll be required to submit an application.

"The licensing structure has ensured that companies don't just come to make a quick dollar and leave," Whittemore said. "It's a commitment.