The deal comes at a time when a number of governments both in Europe and the United States are relaxing the rules on online gambling, hoping to tax the activity and use the revenue to reduce gaping budget shortfalls.

“We will immediately be a leader in these markets as they open up,” the chief executive of PartyGaming, Jim Ryan, said Thursday during a conference call.

PartyGaming, whose shares are traded in London, was once the world’s largest Internet poker site, but it was hit hard by a crackdown in the United States on online gambling that was passed into law in 2006. The company immediately withdrew from the country, costing it more than three-quarters of its business and ceding the market to privately held companies based in offshore locations, including PokerStars and Full Tilt.

On Wednesday, the Financial Services Committee of the House of Representatives approved a bill that would overturn the 2006 law.  Supporters say taxes on Internet betting could yield as much as $42 billion for the government over 10 years.

In Europe, Italy and France recently began allowing privately owned gambling sites to operate in competition with state-controlled monopolies. Other countries are considering similar moves, allowing them to tax Internet betting, a business worth nearly $30 billion globally, according to H2 Gambling Capital, a consulting firm.

Until now, online gambling has operated in a legal limbo across much of Europe, with governments neither officially allowing it nor able to tax it. The changes could provide opportunities for online gambling companies like PartyGaming and Bwin to expand their business, analysts say, but could also create new financial pressure.

“They’re going from a no-tax environment to a high-tax environment, and that’s challenging,” said Warwick Bartlett, chief executive of Global Betting & Gaming Consultants. “This is a deal that’s being made out of necessity rather than choice.”

The merger would bring together companies that in 2009 generated gambling revenue of 682 million euros, or $893 million, and earnings before interest, taxes, depreciation and amortization of 196 million euros. Under the merger agreement, Mr. Ryan of PartyGaming would share the chief executive role with Norbert Teufelberger, who is currently co-chief executive of Bwin, along with Manfred Bodner. Mr. Bodner would become a nonexecutive director.

Analysts say the companies are a good fit because Bwin has a big presence in sports betting while PartyGaming is stronger in online poker and casino games. The deal would allow them to cut costs and to cross-promote each other’s sites, potentially reaching new customers.

The shares of both companies surged Thursday on news of the deal, which follows months of speculation that Bwin and PartyGaming might merge. Now, analysts say, further consolidation is likely in the industry.

“The bill introduction should happen in the next month,” a spokesman for House of Representatives Financial Services Committee Chairman Barney Frank said.

On Thursday, Reuters reported the EU could file a complaint about U.S. enforcement of the gambling ban at the World Trade Organization.

“Mr. Frank will bring back legislation to repeal the UIGEA (Unlawful Internet Gambling Enforcement Act),” the spokesman said, referring to a Republican-crafted bill passed in 2006 when the party controlled Congress and the White House.

Supporters of the ban argued offshore Internet gambling websites take billions of dollars out the U.S. economy, damage families and serve as vehicles for money laundering.

The law cost Europe’s online gambling companies billions in lost market value as they were forced to retreat from one of their most lucrative markets. It barred businesses from knowingly accepting payments in connection with unlawful Internet gambling, including payments made through credit cards, electronic fund transfers and checks.

Against Frank’s advice, the Bush administration finalized regulations late last year to implement the ban and gave companies until December 1 to comply.

Frank said the rules would burden the financial service industry at a time of economic crisis.

Many publicly traded European companies, including PartyGaming and 888.com, withdrew from the United States after Congress passed the ban, but they face possible criminal prosecution for activities before then.

Anurag Dikshit, a founder of PartyGaming, pleaded guilty in December to Internet gambling charges and agreed to pay $300 million in fines. He still faces possible jail time under a deferred sentencing arrangement. Other PartyGaming founders have not settled with the U.S. Justice Department.

EU industry officials said the pressure on Dikshit to make a deal showed the Justice Department had crossed a major line in its prosecution of cases.

The European Commission, acting on industry petition, began a formal investigation in March into whether Washington was singling out EU companies for enforcement actions while allowing U.S. online firms to operate freely.

Sources familiar with that investigation told Reuters in Brussels on Thursday they expect the investigators’ report, initially due last year, to recommend action at the WTO when it is released next month.

Rather than move immediately to litigation, EU officials would use the report as leverage to seek a negotiated solution with the United States, they said.

Observers say it’s a landmark moment for online gambling.

Growing hostility of the US authorities to online gaming led in February last year to internet payment processing giant Neteller withdrawing from the States after a nationwide crackdown saw the FBI freeze funds held in customer account.

Funds were subsequently released under a deal reached with the US Attorney’s office.

The guilty plea of the co-founder of PartyGaming in New York’s federal court last week is a move that doesn’t directly affect e-gaming businesses that have set up here, many of whom are targeting the European and Asian rather than the US markets.

For them, it’s business as usual although they are monitoring developments closely.

Paul Telford, head of legal services at Poker Stars, insisted: ‘As far as we are concerned it’s biggest as usual.

‘It doesn’t affect the company. This doesn’t change the law, no precedents have been set.

‘But it will give us food for thought as to the bigger impact. The situation is very fluid so there is little point in commenting further.’

Garth Kimber, head of e-gaming development at the Department of Trade and Industry, said: ‘We are monitoring the situation closely to look at any potential impact.’

Meanwhile, delegates to a seminar held in Douglas heard that e-gaming is well-placed to ride out global recession.

Thirty people attended the event organised by Global Betting and Gaming Consultants Ltd on December 3 at the Claremont Hotel in Douglas, including representatives from the Department of Trade and Industry.

Chief executive Warwick Bartlett told delegates: ‘GBGC is constantly being asked how the recession was likely to affect e-gaming. A question difficult to answer as there is no comparable data.

‘Gambling benefits from not being a big ticket item, whereas people will stop spending on cars and moving house they will continue to have a pint and have a bet.

‘The global roll out of broadband is also assisting the growth of internet gambling. So it is far more resilient than the traditional land-based betting shop or casino.’

He emphasised that while the Isle of Man had done well from financial services, it was not beneficial to be too reliant on one business sector and it was in everyone’s interest to promote the Island as an e-gaming centre.

GBGC was instrumental in setting up Malta as an e-gaming centre.

Trying to overturn a 2006 U.S. ban on online poker, gamblers have started a lobbying group, established a political action committee, and promoted their effort to politicians by holding poker tournaments at the Republican and Democratic nominating conventions.

“Up until this point, the minority of the public that is anti-gambling has yelled louder,” professional poker player Andy Bloch said.  “We’re trying to change that.”

The Poker Players Alliance, which claims 1 million members, has invited lawmakers and celebrities to a charity tournament Sept. 3 in Minneapolis, across the Mississippi River from St. Paul, where Republicans are meeting to formally nominate John McCain for president.

Before President George W. Bush signed the Republican- backed gambling ban in October 2006, the U.S. accounted for about half the market on Internet gambling sites operated from countries where betting is legal. Inserted into unrelated port- security legislation by then-Senate Majority Leader Bill Frist, a Tennessee Republican, the law forbids credit-card companies to process online-wagering transactions.

The ban hammered Internet gambling stocks in London; PartyGaming Plc fell 58 percent, and Sportingbet Plc plunged 64 percent, on the first trading day after Congress passed the measure. At the time, Gibraltar-based PartyGaming alone said it had 900,000 American players. PartyGaming and Sportingbet still trade for 80 percent less than their prices before Congress passed the ban.

Internet Gambling
House Financial Services Committee Chairman Barney Frank has sponsored legislation to allow and regulate online gambling, including poker. Frank, a Massachusetts Democrat, said he expects the measure to pass next year in a Democratic-controlled Congress.

Frank, Bloch, and actor Ben Affleck were among almost 200 participants during last week’s Democratic National Convention at a tournament benefiting the Paralyzed Veterans of America.

The Washington-based lobbying group set up 20 tables with cards, chips and professional dealers in a second-floor room at Coors Field, home of the Colorado Rockies baseball team. Players got buttons reading: “Reduce your carbon footprint. Play online poker.”

Larger Political Force
“We’re trying to make this a larger political force,” said Toby Moffett, a lobbyist and former Connecticut Democratic congressman who represents the poker group and urged it to sponsor the convention events. “It shows our supporters we’re not going away.”

Gamblers say the law violates individual rights. “It’s a bad idea for legislators to tell people what they can and cannot do in the privacy of their own homes,” said poker pro Chris “Jesus” Ferguson during a lobbying trip to Washington last fall.

Online poker also is a potential source of tax revenue. “We’re facing this really horrific financial situation,” said Annie Duke, another poker pro.

The poker players face opposition from other political forces, including Christian conservatives.

“You can’t make public policy out of a group of individuals’ desires,” said Chad Hills, an analyst for gambling research and policy at Focus on the Family, the Colorado Springs-based group founded by Dr. James Dobson. “You have to say, `How is this impacting our culture? How is this impacting our children?”’

Alfonse D’Amato
The poker alliance, headed by former New York Republican Senator Alfonse D’Amato, spent $729,750 on lobbying during the first half of 2008, after spending $900,000 in all of 2007. Its political action committee, PokerPAC, began April 11 and raised $43,226 through Aug. 12.

In the presidential race, the Republican platform supports the ban on Internet gambling.

Hills, saying the Internet functions like the public library of previous generations, said gambling shouldn’t be allowed. “Some activities are not appropriate in the public library,” Hills said. “This is one of those things.”

The poker players may benefit from growing celebrity, as popular televised contests make stars of professionals like Bloch, Ferguson, Duke, and Duke’s brother Howard Lederer.

“People sitting in their homes, watching top professionals playing a game of skill, allows us to have this conversation,” Lederer said. “If I can use my celebrity to help further the cause I truly believe in, I will do it.”

Bloch and Lederer are among those who’ve given the maximum individual contribution, $5,000, to PokerPAC. “We realized we had to have a voice in Congress,” Bloch said.

“It always helps when you have someone who’s very well known,” said Representative Steve Israel, a New York Democrat and one of 48 co-sponsors of Frank’s bill. “When I’m at home, it always give me a thrill when someone approaches me and says, `I read about what you’re doing on Internet poker.’ That tells me how effective this cause has become.”

The lawsuit filed in U.S. District Court in Manhattan said “these unlawful investments suffered significant losses when the government began arresting principals of the gambling enterprises,” but it did not provide a specific amount.

A spokeswoman for Vanguard Group in Malvern, Pennsylvania said the investment fund management firm had not yet been served with the lawsuit and she could not comment.

An attorney for the two plaintiffs, Tom Sheridan, said the exact amounts would be revealed in the discovery process, but he estimated Vanguard’s losses exceeded $10 million.

“The investments by the plaintiffs are not worthless, but they are less than they would have been if the money had not been invested in offshore gambling companies,” Sheridan said.

The U.S. cracked down on offshore betting companies in 2006 that included the arrests of executives from British online companies such as Sportingbet and BetOnSports Plc.

Large public companies lost billions of dollars in market value and millions of customers when they shut down their Web sites for sports betting, poker and other games in the United States.

Friday’s class action lawsuit brought by Deanna McBrearty of New York, New York, and Marylynn Hartsel of Boca Raton, Florida, makes claims under the Racketeer Influenced and Corrupt Organizations Act (RICO) and seeks a jury trial, compensatory and punitive damages.

A similar lawsuit was filed in U.S. District Court in San Francisco on Thursday against American Century Companies Inc.

The funds named as defendants in the New York lawsuit include Vanguard International Equity Index Funds, Vanguard European Stock Index Fund, Vanguard Horizon Funds and the Vanguard Global Equity Fund.

McBrearty first purchased shares in Vanguard European through her individual retirement account in May 2005, the lawsuit said. It said Hartsel bought shares before July 1, 2006 for investment purposes.

The lawsuit does not name any of the online sites. The largest sites such as PartyGaming and Sportingbet earned most of their money from the United States. PartyGaming suspended its U.S. business after President George W. Bush signed the Unlawful Internet Gambling Enforcement Act on Oct. 13, 2006.

Other defendants named in the lawsuit are Alliance Bernstein LP, Acadian Asset Management LLC, Marathon Asset Management LLP.