Looking the other way

By Liz Benston, Jeff German, Michael Mishak

Sunday, March 9, 2008 | 3 a.m.

Casino companies should have known about the huge amounts of cash washing through nightclubs on their properties long before the Internal Revenue Service began investigations of two of Las Vegas’ most popular clubs, say former gaming executives and others familiar with the industry.

The casino companies, MGM Mirage and Harrah’s Entertainment, had reason to keep an eye on the lucrative clubs because the large sums of cash created a potential for abuse just steps away from the casino floors. If abuses were to occur, the state Gaming Control Board could fault a casino company for failure to prevent conduct that reflects poorly on the gaming industry — even if that conduct did not directly involve gaming.

Another reason for diligent casino oversight is that Pure Management Group, which operates the two clubs, has revenue-sharing agreements for the five nightclubs and one restaurant it operates at MGM Mirage properties. Harrah’s would not disclose the financial relationship it has with the five clubs at its properties operated by Pure Management.

A casino company that has a revenue-sharing agreement with a nightclub has a fiduciary responsibility to shareholders or other investors to know how much money comes through the club each night. But unless the money flowing into Pure Management’s nightclubs were strictly managed, the amount of revenue available for sharing could not be determined.

“It’s a very precarious situation,” a former Las Vegas casino executive said. “You have the possibility that your employees are going into business for themselves,” especially if transactions aren’t generating receipts and if pricey alcohol, table service and other services are being paid for with cash and not by credit card.

He and a second former Las Vegas casino executive said that if they had been running the casinos involved, they would have audited the clubs and employed “secret shoppers” to go inside and observe. The two former executives would not speak for attribution, expressing reluctance to criticize others in the close-knit gaming community.

Reviewing practices

The two Pure Management nightclubs under investigation by the IRS are Pure in Caesars Palace, owned by Harrah’s, and LAX inside Luxor, owned by MGM Mirage. The IRS has said it is investigating possible schemes among employees and managers aimed at concealing income from the federal government.

MGM Mirage and Harrah’s aren’t commenting on what they knew about the money flowing through the Pure Management clubs. The companies are, however, promising reviews of their nightclub partners’ operations.

MGM Mirage, the Strip’s largest gaming company, is conducting a broad review of the nightclubs operating on its premises, from tipping procedures to the accounting of tips and other cash payments, said spokesman Alan Feldman.

“Everything is open to review,” Feldman said. The company has the authority to remove any business partner or third-party operator that puts its gaming licenses at risk.

Harrah’s spokesman Gary Thompson said his company is reviewing nightclub procedures.

On a typical night, club operators say, tens to hundreds of thousands of dollars above and beyond register receipts can move through popular nightclubs. That money comes in the form of cash payments to doormen, VIP hosts, servers and bartenders, as well as payments for bottle service. Nightclub employees have said the money was pooled and shared, in some instances with managers all the way up the Pure Management chain.

Huge amounts of cash

As partners, should the casino companies have been aware of the cash flowing through the clubs?

A third former casino executive familiar with the major gaming companies said casino managers did know that large amounts of cash came into the clubs, but was surprised to learn of its magnitude.

“Everyone knew these places were awash with money, but they were stunned at the astronomical amounts that these employees were receiving,” said the former executive, who also spoke on condition that he would not be identified. “There’s been an absolute avalanche of money.”

Bryan Bass, a former Strip beverage manager who teaches nightclub management at UNLV, said that casinos took an unusual hands-off approach as they contracted with outside companies, such as Pure Management, to run nightclubs on their properties.

“In their rush to do it they may have given nightclubs a little bit more wiggle room to operate than they traditionally would a restaurant or a show,” Bass said. “The IRS investigation will change the way deals are structured in the future. It raised concerns that corporate Vegas didn’t really realize before — and to some extent they didn’t need to realize them because of how much money they were making.”

Keith Copher, former chief of enforcement at the state Gaming Control Board, said state gaming regulators give less scrutiny to nightclubs inside casinos that are operated by business partners and not by the casinos themselves. If wrongful practices occur inside a nightclub operated by a gaming company, the company itself is liable in the eyes of regulators. But if those practices are the fault of an outside operator, the casino company might be shielded from any blame — unless it knew or wasn’t diligent about trying to find out what was going on inside the club. If either of those occurred, regulators could fault the casino company for poor conduct that reflected on the industry.

Casino ownership

Some Nevada casino executives did foresee the issues involved, including Wynn Resorts Chairman Steve Wynn.

“We recognized the exposure this had from the day we opened,” Wynn said. The two nightclubs at Wynn Las Vegas, Blush and Tryst, are owned by the casino, which imposes strict internal controls over their operations. Victor Drai, who runs Tryst for the casino, is paid a percentage of the profits and does not control the club’s revenue stream.

Wynn described the arrangement as a “separation of powers.” Drai and his management team are confined to running the door, hiring waitresses and promoting the club. Although the club’s employees are allowed to pool their tips, Wynn said, they do not have control over the club’s liquor and inventory, which are monitored closely by the casino’s accounting department. The accounting department also hires all employees who handle financial transactions, including cashiers.

“The different lines of reporting are the heart of any kind of control system for a company,” Wynn said.

Station Casinos last year bought out the company’s two major nightclubs, the Lobby Bar at Green Valley Ranch Station Casino and Cherry at Red Rock Resort, from operator Rande Gerber’s Midnight Oil chain of clubs and lounges. Station did so, in part, to maximize profit.

The nightclubs were folded into Station’s food and beverage department, which uses software to account for entry fees and bottle service and other drink purchases.

“We have a lot of checks and balances in the system to account for everything going in and everything coming out,” spokeswoman Lori Nelson said.

Tips vs. revenue

An issue that cuts to the heart of the alleged cash abuses involves whether the cash handed out in the Pure Management clubs should be considered tips. Some argue that money handed to doormen, the tacked-on prices for bottles of liquor and similar payouts should be considered tips — not revenue subject to sharing with casino partners or managers of the clubs.

Others argue that a large percentage of the money could be counted as revenue.

For instance, the practice of setting a door price and then charging many times that amount through a doorman for access to the club is a classic case of what economists call “underpricing,” said Russell Roberts, an economist at George Mason University. The practice allows club management to set a door charge well below what the market will bear, which creates an atmosphere conducive to black-market activity, Roberts said.

“It’s a system that allows management to avoid the tax collector and the shareholder,” he said. “In this case, the fact that the money was shared with management makes it much more problematic and much more likely that it was a form of revenue. But it’s still a gray area.”