Internet Raises Questions About States Rights

By: - January 18, 2000 12:00 am

With the growth of the Internet, states face the most serious threat to their ability to enforce their laws since the rise of catalog sales and the repeal of Prohibition.

The states have just begun to grapple with the loss of tax revenue to Internet transactions — an Advisory Commission on Electronic Commerce, chaired by Virginia Gov. Jim Gilmore, is supposed to recommend a solution to Congress by April 21.

On the horizon are additional fights over regulating doctors who consult with patients by computer, pharmacies and wineries that ship across state lines and on-line casinos.

The Supreme Court has barred states from collecting sales taxes from businesses that are physically located elsewhere. But the states have long controlled who practices medicine, who sells booze and who operates gambling halls.

Under the popular banner of consumer protection, state regulators have tightly exercised these controls, aided by the fact that almost all of these businesses existed within their borders. In turn, licensees have benefited from the reduced competition created by strict state regulation.

With the Internet that familiar landscape is rapidly changing.

Hesitant to hamstring what they view as an economic dynamo as revolutionary as the assembly line, state legislators and Congress have been slow to revamp old laws to suit the Internet. But, they are now coming face to face with what may be the World Wide Web’s most daunting challenge.

By allowing buyers and sellers anywhere to link up more quickly and efficiently than ever before, the Internet has spawned a billion international marketplace in just six years. The World Wide Web is already home to more than 1100 virtual gambling sites and drugstores, expert say.

In a market without geographical boundaries, what laws apply and who enforces them? And, are there enough cops on the beat?

“The implications for state sovereignty are enormous,” said Temple University law professor David Post, an expert on cyberlaw.

The arguments pit state against state, states against the federal government, and traditional brick-and-mortar businesses against on-line pioneers.

With lawmakers slow to act, states have gone to court to enforce existing laws against Internet scofflaws — resulting in a rising tide of lawsuits brought by attorneys general against companies based in other states and even in other countries.

Internet enthusiasts and some lower court judges are calling for states to relinquish their authority in these areas to the federal government or even international regulators. Libertarians and adamant free-traders urge the states to give up all together.

Many in the business community, however, prefer state regulation to federal. The American Medical Association, California vineyard owners, and many on-line pharmacies say they are committed to working with the states and are pushing for easier, more uniform rules.

In the U.S. Congress, bills introduced in the last session would strengthen state powers over gambling and alcohol, but pre-empt them on taxes and the licensing of pharmacies.

  • With the strong support of liquor wholesalers, both houses of Congress voted in 1999 to allow states to pursue in federal court alcohol shippers who violate state liquor laws. The session ended, however, before the bills received final votes.
  • In November, the Senate passed a bill sponsored by Senator Jon Kyl, a Republican from Arizona that would extend current federal anti-gambling prohibitions to Internet casinos.
  • A third bill, by Rep. Ron Klink, a Pennsylvania Democrat, would allow the federal Food and Drug Administration to police on-line pharmacies that fail to post their locations and licenses. Last month, President Clinton went even further with his proposal that the FDA assume regulation of Internet drugstores, a vast increase of federal power at the expense of the states.
  • In his campaign for the Republican nomination for President, Senator John McCain of Arizona is touting his plan to ban all Internet sales taxes, even on transactions made within a single state. The National Governors’ Association has called the idea “clearly” unconstitutional because it strips states “of the power to decide what happens entirely within their borders.”

“There has clearly been a lot of legislation introduced that is pre-emptory in nature. That is going to continue,” said Bret Hester of the NGA. “There is going to be a realization among states that Congress is moving in that direction and that states have to act.”

A Crackdown On Internet Pharmacies

In 1999, four states, Kansas, Illinois, Michigan and Missouri, filed lawsuits against Internet pharmacies for violating state laws that govern the prescribing and dispensing of medicine.

State medical boards in at least another 13 states, Arizona, California, Colorado, Connecticut, Illinois, Kansas, Nevada, New Jersey, Maryland, Ohio, Texas, Washington and Wyoming, have investigated, and sometimes disciplined, doctors who prescribed medication to patients solely over the World Wide Web.

From the surface, the underlying issues appear relatively straightforward. For their cases, Kansas Attorney General Carla Stovall and Michigan’s Jennifer Granholm are relying on existing laws that require all pharmacies ‘doing business’ in Michigan or Kansas to be licensed by the state.

Stovall filed suit in June against eight on-line pharmacies and six doctors for violating the Kansas Consumer Protection Act. Granholm filed a notice of intent to sue 10 Internet drugstores in mid-December.

“These on-line pharmacies are, in many ways, no better than the street corner drug pushers. All they are interested in is the money,” Granholm said when she announced the action. “You might as well put prescription drugs on store shelves along with the candy.”

In both states, investigators bought Viagra and other prescription-only medicine after completing a questionnaire, but without undergoing a physical examination.

“I don’t know of anyone in the medical profession who thinks a prescription should be issued based on an anonymous form. How do you know they are not lying? How is that doctor or pharmacist going to know that what they are getting is the truth?” said Granholm’s spokesman Chris DeWitt.

Viagra, a treatment for impotence, can kill a man with a heart condition who also takes nitrates. According to the American Medical Association, more than 100 people have died from mixing Viagra with heart medication. But in only one of those cases, an Illinois man who suffered a heart attack last March, has a death been linked to an Internet purchase.

In their lawsuits both Michigan and Kansas named the Seattle pharmacy Confimed, L.L.C. According to Confimed attorney Margaret Fitzpatrick, both the pharmacy and the prescribing physician, Dr. Howard Levine, are licensed in Washington.

“We do not intend to violate any laws,” Fitzpatrick said. But the laws governing this new brand of medicine just don’t exist, she said. “It has happened so fast, how can anybody have caught up?”

“There aren’t many states that can point to a line that says ‘Thou shall not prescribe drugs via the Internet,'” said Dale L. Austin of the Federation of State Medical Boards. If they do write such laws, “they are looking at requiring face-to-face interaction.”

A face-to-face meeting “is not required, nor is it common practice, nor do we necessarily want it to be,” said Susan Winckler of the American Pharmaceutical Association.

Many patients have relied on a phone call to a doctor, whom they may or may not know, for allergy, flu or other medications.

In fact, the AMA, the Federation of State Medical Boards, the American Pharmaceutical Association and the National Association of Boards of Pharmacy (NABP) all support telemedicine, or the ability of doctors to consult with, and sometimes prescribe medication, for patients by computer.

They do not, however, endorse prescribing drugs based solely on the questionnaires many on-line drugstores are now using.

“It needs to be regulated effectively by the state boards,” Winckler said. “They either have to pass laws or, at a minimum, they need to look at their law and see how it applies.”

For most doctors and pharmacists, obtaining licenses in all 50 states is nearly impossible. Each state subjects medical practitioners to a time-consuming and expensive vetting process.

As a partial solution, the NABP last spring unveiled a process by which Internet pharmacies could apply for and receive a ‘seal of approval.’ They must prove they follow widely accepted procedures for selling prescription drugs.

Only four sites have so far received the certification:, Merck-Medco Rx Services, and

The Federation of State Medical Boards has proposed a universal, limited license that doctors could obtain from the states where they plan to practice telemedicine. Both the AMA and the FSMB are currently reviewing their policies on telemedicine and plan to release guidelines in the spring.

Whose Laws?

In its fight against Michigan and Kansas, Confimed’s attorneys will argue those states have no right to hold an out-of-state pharmacy accountable under their laws.

Under the ‘commerce clause’ of the Constitution, the power to regulate trade “among the several states” resides with the U.S. Congress. Many argue that transactions over the Internet, because of its national not to mention global reach, clearly constitute interstate commerce, and therefore fall outside the jurisdiction of the states.

As it stands now, however, Confimed will have trouble prevailing with that argument. Many lower court judges have already ruled states can haul into their courts out-of-state companies that use web sites to take orders from their residents in violation of state law.

The American Civil Liberties Union, however, has successfully used the commerce clause, as well as the First Amendment, to defeat Internet anti-pornography laws in Michigan and New York.

In the New York case, American Library Association v. Pataki, Judge Loretta Preska decided regulation of the internet should be left to Congress. “The Internet,” she wrote, “must be marked off as a national preserve to protect users from inconsistent legislation that, taken to its most extreme, could paralyze development of the Internet altogether. …Only Congress can legislate in this area.”


States’ rights to regulate business may be greatest when it comes to alcohol. That power is embodied in the 21st Amendment, which prohibits the shipment of intoxicating beverages in violation of state laws.

To keep tabs on sales and to prevent bootlegging, most states have established a so-called three-tier system to control alcohol distribution. A licensed brewery, distillery or vineyard sells to a licensed wholesaler who in turn sells to a licensed retailer. States reap significant sales and excise taxes through this system, while wholesalers enjoy the benefits of sharply curtailed competition.

According to the Wine Institute, a wine-industry lobbying group, 30 states prohibit the shipment of alcohol directly to a consumer. Seven of them Florida, Georgia, Indiana, Kentucky, Maryland, North Carolina and Tennessee have made the offense a felony.

Twenty states allow direct shipment with restrictions.

California vineyard owners argue that the three tiers effectively shut out small wineries. States are using the 21st Amendment more as a tool to protect the monopolies of licensed liquor wholesalers than to protect the public, says Wine Institute attorney Wendell Lee.

The Supreme Court has ruled that states may not restrict alcohol sales for purely economic reasons.

Wholesalers “were operating behind a curtain no one bothered to look through,” Lee said. “If the Internet were a dog, it would be Toto… Alcohol distribution, just from a profit point of view, is so inefficient, and the Internet takes that curtain away.”

Barry McCahill of Americans for Responsible Alcohol Access, a lobbying group funded by liquor wholesalers, argues it’s the vineyards that are profit-driven. “They want to charge top dollar and the best way they can make top dollar is to ship to you directly.

“It’s a major issue with the states because they are aware their systems are being violated and they are losing tax revenue.

“We can’t compete with [direct shippers]. We are paying taxes,” he said.

“We are eager to participate. We want to help collect these taxes,” said Peter Granoff, the founder of the on-line retailer Virtual Vineyards. “We are willing to work with wholesalers in the states.

“This is a revenue opportunity for the states. They should embrace it.”

Using an argument even experts at the National Conference of State Legislatures call a red herring, wholesalers argue that direct shipment and the Internet easily allow teenagers to buy beer and wine. Granoff also dismisses this. The minimum price for a bottle of wine from his web site,, would cost , including shipping, and would take days to arrive, he says. Teenagers, he says, have faster and less costly ways to buy wine.

“There are a lot of things that are possible. That doesn’t mean they are going to happen,” he said.

Both sides expect the debate to percolate up to the U.S. Supreme Court, where justices will likely have to weigh the power of the 21st Amendment vis a vis the commerce clause.

In an unusual decision last month, a federal judge cited the commerce clause when he overturned Indiana’s strict prohibitions on shipping alcohol. Thirteen connoisseurs had sued the state because they could not find the wines they wanted in local stores and Indiana law prohibited them from receiving it by mail. Indiana is a ‘felony state’ and it had granted no shipping permits to out-of-state distributors.

Judge Allen Sharp found Indiana’s law too restrictive. “[T]hese statutes on their face discriminate against out-of-state commerce… This clearly violates the Commerce Clause of the Federal Constitution,” he wrote.

In other cases brought by Missouri and Utah, however, judges have ruled those states can prosecute unlicensed, out-of-state distributors who shipped alcohol across their borders.


Much as they do over alcohol sales, the states have deeply embedded powers to legalize or outlaw gambling. No state explicitly allows wagering over the Internet and three states — Nevada, Louisiana and Illinois — have banned on-line casinos. Using their existing laws, Attorneys General of Missouri, Minnesota, New York and Wisconsin have successfully quashed the few sites based in the United States.

The largest threat now comes from abroad. According to Sue Schneider of the Interactive Gaming Council, which represents on-line gambling operators, all 700 of the casinos and lotteries on the Internet are physically located off-shore, many of them in the Caribbean. Some of these sites are owned by American companies, she said.

Most experts doubt the states or the federal government can ever keep these foreign casinos from taking bets from Americans. In fact, despite prohibition in the U.S., internet gambling sites have been multiplying, Schneider says.

Most states have shied away from trying to sue the operators. But, New York’s Attorney General, Eliot Spitzer, did, and this summer a judge of New York State Supreme Court — which, in New York, is a lower court — agreed with him.

Judge Charles Edward Ramos ruled that an Antigua casino violated New York’s gambling laws by creating virtual betting parlors on the computers of users in the state. World Interactive Gaming Corporation’s web site blocked bettors who said they lived in states that prohibit casino gambling. But, it allowed a gambler in New York, who claimed to live in Nevada, to place bets. The bettor was an investigator in Spitzer’s office.

Although a corporation based in New York owns the Antigua company, law professor David Post argues that the state has overstepped it bounds. A state that has outlawed Internet gambling cannot “reach out and apply” its law in a place where on-line wagering is legal. “I don’t think they can say web sites in Antigua have to abide by New York law,” he said.

“If upheld, the court’s decision will mean that when a company does business on the Internet, it will have to be prepared to defend itself in every court in the country,” the IGC said in a press release after the decision.

To deter on-line gambling, some lawmakers, including the National Association of Attorneys General, have proposed prosecuting bettors, not just web sites. An early version of Senator Kyl’s Internet Gambling Prohibition Act would have criminalized placing a bet over the Internet.

The Justice Department called that idea completely unenforceable and it was dropped.

The American Gaming Association, which represents the nation’s largest casino owners, says its members have no plans to launch online roulette or blackjack games. One prominent sticking point is how to design and operate games that can fit within the tight regulations states demand. All states that allow casino gambling require the games meet verifiable standards of fairness.

Some at the IGC expect America’s casino owners may change their minds as the Internet grows more sophisticated and attracts more gamblers. According to the IGC, one company has already filed a patent to cybercast live games from casinos.

Michigan Attorney General Jennifer Granholm has called the Internet the “wild, wild west without a sheriff.” As the proliferation of web pharmacies and gambling halls illustrates, states face a very steep challenge in policing all of the potential law-breakers.

Even the well-known internet music and book retailer has had trouble tracking violators of its own rules, let alone those set by state and federal authorities. Amazon runs a vast cyber-auction, as well as a department store. In October, reporters for CNet, an internet computer news service, found martial arts weapons — illegal in many states — available on the site.

Amazon spokeswoman Sharon Greenspan told CNet the company has “total control” over its auctions, but “no system is absolutely effective.”

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