Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street

Prologue: The Wire Service

THE STORY STARTS with a corrupt telegraph operator. His name was John Payne, and he worked for Western Union’s Cincinnati office in the early 1900s. At the urging of one of its largest stockholders, Western Union took a moral stand against the evils of gambling. It adopted a policy of refusing to transmit messages reporting horse race results. Payne quit his job and started his own Payne Telegraph Service of Cincinnati. The new service’s sole purpose was to report racetrack results to bookies.

Payne stationed an employee at the local racetrack. The instant a horse crossed the finish line, the employee used a hand mirror to flash the winner, in code, to another employee in a nearby tall building. This employee telegraphed the results to pool halls all over Cincinnati, on leased wires.

In our age of omnipresent live sports coverage, the value of Payne’s service may not be apparent. Without the telegraphed results, it could take minutes for news of winning horses to reach bookies. All sorts of shifty practices exploited this delay. A customer who learned the winner before the bookmakers did could place bets on a horse that had already won.

Payne’s service ensured that the bookies had the advantage. When a customer tried to place a bet on a horse that had already won, the bookie would know it and refuse the bet. When a bettor unknowingly tried to place a bet on a horse that had already lost…naturally, the bookie accepted that bet.

It is the American dream to invent a useful new product or service that makes a fortune. Within a few years, the Payne wire service was reporting results for tracks from Saratoga to the Midwest. Local crackdowns on gambling only boosted business. It is my intention to witness the sport of kings without the vice of kings, decreed Chicago mayor Carter Harrison II, who banned all racetrack betting in the city. Track attendance plummeted, and illegal bookmaking flourished.

In 1907 a particularly violent Chicago gangster named Mont Tennes acquired the Illinois franchise for Payne’s wire service. Tennes discreetly named his own operation the General News Bureau. The franchise cost Tennes $300 a day. He made that back many times over. There were more than seven hundred bookie joints in Chicago alone, and Tennes demanded that Illinois bookies pay him half their daily receipts.

Those profits were the envy of other Chicago gangsters. In July through September of 1907, six bombs exploded at Tennes’s home or places of business. Tennes survived every one of the blasts. The reporter who informed Tennes of the sixth bomb asked whether he had any idea who was behind it. Yes, of course I do, Tennes answered, but I am not going to tell anyone about it, am I? That would be poor for business.

Tennes eventually decided he didn’t need Payne and squeezed him out of business. Tennes’s General News Bureau expanded south to New Orleans and west to San Francisco.

This prosperity drew the attention of federal judge Kenesaw Mountain Landis. In 1916 Judge Landis launched a probe into General News Bureau. Clarence Darrow represented Tennes. He advised his client to take the Fifth Amendment. Judge Landis ultimately ruled that a federal judge had no jurisdiction over local antigambling statutes.

In 1927 Tennes decided it was time to retire. He issued 100 shares of stock in General News Bureau and sold them all. Tennes died peacefully in 1941. He bequeathed part of his fortune to Camp Honor, a character-building summer camp for wayward boys.

General News Bureau’s largest stockholder, of 48 shares, was Moses (Moe) Annenberg, publisher of the Racing Form. Annenberg was unapologetic about the social benefits of quick and accurate race results. If people wager at a racetrack why should they be deprived of the right to do so away from a track? he asked. How many people can take time off from their jobs to go to a track?

Annenberg hired a crony named James Ragan to run the wire service. By that time, there were scores of competitors. Annenberg and Ragan expanded by buying up the smaller wire services or running them out of business.

One man with the guts to stand up to Annenberg and Ragan was Irving Wexler, a bootlegger and owner of the Greater New York News Service. After Ragan started a price war with Greater New York News, Wexler sent a team of thugs to vandalize Annenberg’s New York headquarters.

Annenberg knew that Wexler was tapping into General News’s lines to get race results. It was cheaper than paying his own employees to report from each racetrack. So one day Annenberg delayed the race results on the portion of line that Wexler was tapping. Annenberg had the timely results phoned to a bunch of his own men, who placed big bets on the winning horses with Wexler’s subscribers. Wexler’s bookies, getting the delayed results, did not know that the horses had already won. By day’s end, they had suffered crippling losses.

Annenberg’s men went to each of Wexler’s subscribers and explained what had happened. They refunded the day’s losses, advising the bookies that it would be wise to switch to General News Bureau.

With such tactics, Annenberg’s service—also known as the Trust or the Wire—expanded coast-to-coast, to Canada, Mexico, and Cuba. In 1934 Annenberg ditched his partners much as Tennes had done. Annenberg established a new, rival wire service called Nationwide News Service. Bookies were told to switch carriers or else.

The growth of General News Bureau paralleled that of the American Telephone and Telegraph Company. In 1894 Alexander Graham Bell’s telephone patents expired. Within a few years, over 6,000 local telephone companies were competing for the U.S. market. AT&T acquired or drove most of them out of business. Though AT&T’s techniques were more gentlemanly than Annenberg’s, the result was about the same. The government stepped in with an antitrust suit. The legal action was settled in 1913 with an agreement that AT&T permit competing phone companies to connect to its long-distance network. In 1915 the first coast-to-coast telephone line went into operation. The following year, AT&T was added to the Dow Jones average. With its now-legal monopoly and reliable dividend, AT&T was reputed to be a favorite stock of widows and orphans.

Few of those widows and orphans realized how closely the phone company’s business was connected to bookmaking. General News Bureau did not own the wires connecting every racetrack and bookie joint. It leased lines and equipment from AT&T, much as today’s Internet services lease cables and routers. Both telegraph and voice lines were used. As the system grew more sophisticated, voice lines provided live track commentary.

AT&T’s attorneys worried about this side of the business. An in-house legal opinion from 1924 read: These applicants [the racing wire services] must know that a majority of their customers are bound to be owners of poolrooms and bookmakers. They cannot willfully blind themselves to these facts and, in fact, set up their ignorance of what everybody knows in order to cooperate with lawbreakers.

On legal advice, AT&T put an escape clause in its contract with the wire lessees. The clause gave the phone company the right to cancel service should authorities judge the lessee’s business illegal. AT&T continued to do business with bookies—while officially it could claim to be shocked that gambling was going on in its network. By the mid-1930s, Moe Annenberg was AT&T’s fifth largest customer.

Annenberg’s takeover of the wire service business infuriated the other stockholders of General News Bureau, who now owned shares in a company with practically no customers. One stockholder, Chicago mobster John Lynch, took Annenberg to court. Annenberg attorney Weymouth Kirkland argued that, because the wire service was patently illegal, the court had no jurisdiction. He cited a 1725 precedent in which an English judge had refused to divide the loot of two disputing highwaymen. The court accepted Kirkland’s bold defense.

Lynch appealed to Al Capone’s mob. He felt he might get a sympathetic ear as Capone (then in prison for tax evasion) had already made unsuccessful overtures to Annenberg about acquiring the wire service. Capone’s enforcer, Frank Nitti, told James Ragan that if he’d ally himself with the Capone mob, Annenberg would be dead in twenty-four hours.

Ragan said no. Annenberg skipped town for Miami. Negotiations between Annenberg and Capone’s people dragged on for a couple of years. It was eventually agreed that Annenberg would pay Capone’s people $1 million a year in protection money, but Annenberg would retain ownership of the wire service.

Then, in 1939, Annenberg was up on tax evasion charges. In order to prove he was a reformed man, he did the unthinkable. He walked away from the wire service.

The vacuum created did not last long. The wire service was quickly reconstituted under the name of Continental Press Service. James Ragan remained at the helm.

Again the Chicago mob approached Ragan about taking over. Ragan still wasn’t interested. To protect himself, he prepared affidavits implicating Frank Nitti in the attempted murder of Annenberg. He let it be known that should anything happen to him, the affidavits would go to the FBI.

The most powerful Italian and Jewish mobsters of the time were allied in a national organization cryptically called the Combination. The Combination decided it didn’t need Ragan. It founded its own wire service, Trans-American Publishing and News Service, with the intention of putting Continental out of business.

Trans-American was run by Ben Siegel. Better known as Bugsy, a name he hated, Siegel was a New Yorker who had moved to the West Coast. Trans-American’s territory included Nevada—a special case, since gambling was legal there. Siegel decided that Nevada bookies should pay more, not less. He reasoned that casino bookmaking operations are a way to draw people into the casinos so that they will play the other games. Siegel therefore charged the casino bookies the usual subscription price plus a cut of their income—in some cases, as much as 100 percent of the bookmaking income.

On June 24, 1946, James Ragan stopped his car at a Chicago intersection. A banana truck full of crates pulled up next to him. Someone on the truck pulled up a tarpaulin. Two shots rang out. One mangled Ragan’s arm and shoulder. Ragan spent the next six weeks under police guard in a Chicago hospital. Despite that, someone apparently poisoned Ragan by putting mercury in his Coca-Colas, or his catheter, according to various accounts. With Ragan dead, the mob seized Continental Press.

The synergy of merging Continental Press and Trans-American did not escape anyone. It didn’t escape Los Angeles bookies, who were compelled to subscribe to both wire services at $150 a week each. But Siegel decided that Trans-American was really his own business, not the Combination’s. Siegel was building the Flamingo hotel and casino in Las Vegas. It had cost far more than projected, and Siegel owed the construction company $2 million. Siegel told the Combination’s board of directors in New York that they could have the Trans-American wire service back for only $2 million. The board’s response was cool.

Siegel later got word that the Combination had called another board of directors meeting without inviting him. That was a bad sign. Siegel was concerned enough to track down the exiled Lucky Luciano in Havana. Siegel insisted he needed to keep the wire service and its profits one more year. Luciano, still one of the most powerful men in the Combination, advised Siegel to give the wire service back immediately.

One implausibly verbatim contemporary account records Siegel’s reply as: Go to hell and take the rest of those bastards along with you. I’ll keep the goddamn wire as long as I want.

There had been a rule that no board member got the death sentence. The Combination broke that rule for the first time with Siegel. On June 20, 1947, an unknown gunman took aim at Siegel through the trellis of a rose arbor in Beverly Hills. He fired a full clip of steel-jacketed bullets from a .30 caliber army carbine. Most missed. The four that didn’t were more than enough to do the job. Siegel’s right eyeball came to rest fifteen feet away, on the tile of a dining room floor.

A half hour before the murder, four toughs assembled in the lobby of the Flamingo. At the appointed time, they walked over to the manager and announced that they were taking over. The Combination took over Siegel’s wire service, too.

The murder of Ben Siegel was a costly mistake. A high-profile execution in a wealthy California suburb showed that organized crime had reached all the way to the Pacific. It raised interest in the wire service that the mob was so intent on possessing.

Tennessee senator Carey Estes Kefauver branded Continental Press Public Enemy Number One. In my opinion, the senator said, the wire service keeps alive the illegal gambling empire which in turn bankrolls a variety of other criminal activities in America.

Kefauver, a folksy man who liked to be photographed in a coon-skin cap, organized a Special Committee to Investigate Organized Crime in Interstate Commerce. The Kefauver committee’s hearings were televised and ran for fifteen months starting in 1950. The Senate committee traveled the nation, subpoenaing most of the country’s major organized crime figures. Many of them managed to be on vacation when the committee hit town. Many invoked the Fifth Amendment. The committee sometimes got more interesting testimony from corrupt cops and prosecutors. A Chicago police captain admitted allowing a bookie joint to operate while he himself amassed a fortune betting on sports, elections, and the stock market. Louisiana police explained that they didn’t have the heart to close down illegal casinos that employed the underprivileged.

The high point of the investigation came in March 1951, when the committee grilled the powerful crime families of New York. How can we curb gambling in this country? Senator Kefauver asked New York mobster Frank Costello.

Senator, Costello answered, if you want to cut out gambling there’s just two things you need to do. Burn the stables and shoot the horses.

Kefauver demanded to know where Costello got the money to buy three buildings on Wall Street. Costello said he borrowed it from gamblers.

Costello had gotten his start making counterfeit Kewpie dolls for carnival prizes. From that he had built a gambling empire that extended south to Tropical Park, Miami. The dapper Costello agreed to testify on the condition that his face not be televised. When he spoke, the TV cameras cut to his carefully manicured hands. Costello sounded ill at ease, and his graceful gestures, described as a hand ballet, were surreally disconnected from his status as a major crime boss.

Possibly the real mastermind behind the Combination was New Jersey gangster Longy Zwillman. Interviewed in Washington, Zwillman presented himself as a legitimate businessman who was baffled as to why he had been brought before this particular committee. He addressed his interrogators as sir and politely requested that the photographers stop using flashbulbs. I feel like I’m getting shot, he told Senator Kefauver. The line got a big laugh.

The senators were attempting to establish that an interconnected social network of career criminals ran a wire service for bookies, as well as gambling, prostitution, loan-sharking, and rackets throughout the country. As much as possible, the mobsters denied knowing each other. Zwillman admitted knowing Costello, slightly. In the old days, I met everybody, Zwillman said. Every place you went, you met somebody.

Zwillman’s business associate in New Jersey was Willie Moretti. Moretti was as short (just over five feet) and loud as Zwillman was tall and quiet. Moretti dressed like a gangster, down to the omnipresent diamond stickpin. He was a great lover of women, the darker their skin the better. Long ago, Moretti had contracted syphilis. He never had it treated and was entering the disease’s terminal stages.

At first this hadn’t been a problem for Zwillman. His business was built on intimidation. It was not such a bad thing to have a partner who was not only violent and impulsive but also losing his mind.

Moretti became a problem in the Kefauver hearings. Testifying before the committee, Moretti freely admitted knowing Frank Costello. He said he knew every other big-name mob figure in the whole country. They were well-charactered men he had met at racetracks.

Moretti described himself as a professional gambler. He had made $25,000 by betting on a race—the 1948 presidential race. He picked Truman to win.

The senators put it to Moretti that his business interests were mob-infiltrated rackets. Everything is a racket today, Moretti replied. As he left the stand, he invited the senators to come visit him at his home on the Jersey shore. Moretti quickly became one of the first celebrities of reality TV. He prolonged his fifteen minutes of fame by giving off-the-cuff interviews to reporters.

This was too much for Vito Genovese. From 1949 Genovese had been the leader of the Cosa Nostra. Genovese began spreading rumors of Moretti’s mental deterioration. If Moretti was mouthing off now, what would he say as the rest of his brain rotted away? Genovese called a meeting of the Combination. They decided that it was, regrettably, time to kill another board member. On October 4, 1951, Moretti was shot twice in the forehead at his hangout, Joe’s Elbow Room in Cliffside, New Jersey.

In its final report, Kefauver’s committee traced much American organized crime to the age-old Sicilian criminal brotherhood, the Mafia. However, Kefauver concluded that the most powerful crime figure in America was not Italian. He was Longy Zwillman, a Jew. The Kefauver hearings were, all things considered, effective. Through them America learned of the extent of organized crime and was galvanized into action. Public sentiment turned against gambling. The Senate hearings were credited with the defeat of proposals to legalize gambling in California, Massachusetts, Arizona, and Montana. Kefauver recommended a ban on the transmission of interstate gambling results. Congress quickly passed the legislation.

The surprising thing is that it worked. The legal pressure put the mob’s wire service out of business. Maybe the crackdown worked because, at the dawn of the television age, the wire service was already technologically obsolescent. After fifty years, Payne’s profitable idea came to an abrupt end.

This book is about a curious legacy of that long-ago wire service. Twelve miles to the southwest of the West Orange, New Jersey, mansion that Zwillman bought with mob money, American Telephone and Telegraph built a scientific think tank with its own monopolistic riches. In 1956 a young scientist pondering his employer’s ambivalent relationship with bookmaking devised the most successful gambling system of all time.

PART ONE

Entropy

Claude Shannon

LIFE IS A GAMBLE. There are few sure things, least of all in the competitive world of academic recruitment. Claude Shannon was as close to a sure thing as existed. That is why the Massachusetts Institute of Technology was prepared to do what was necessary to lure Shannon away from AT&T’s Bell Labs, and why the institute was delighted when Shannon became a visiting professor in 1956.

Shannon had done what practically no one else had done since the Renaissance. He had single-handedly invented an important new science. Shannon’s information theory is an abstract science of communication that lies behind computers, the Internet, and all digital media. It’s said that it is one of the few times in history where somebody founded the field, asked all the right questions, and proved most of them and answered them all at once, noted Cornell’s Toby Berger.

The moment I met him, Shannon became my model for what a scientist should be, said MIT’s Marvin Minsky. Whatever came up, he engaged it with joy, and attacked it with some surprising resource—which might be some new kind of technical concept—or a hammer and saw with some scraps of wood.

There were many at Bell Labs and MIT who compared Shannon’s insight to Einstein’s. Others found that comparison unfair—unfair to Shannon. Einstein’s work had had virtually no effect on the life of the average human being. The consequences of Shannon’s work were already being felt in the 1950s. In our digital age, people asked to characterize Shannon’s achievement are apt to be at a loss for words. It’s like saying how much influence the inventor of the alphabet has had on literature, protested USC’s Solomon W. Golomb.

It was Shannon who had the idea that computers should compute using the now-familiar binary digits, 0’s and 1’s. He described how these binary numbers could be represented in electric circuits. A wire with an electrical impulse represents 1, and a wire without an impulse represents 0. This minimal code may convey words, pictures, audio, video, or any other information. Shannon may be counted among the two or three primary inventors of the electronic digital computer. But this was not Shannon’s greatest accomplishment.

Shannon’s supreme opus, information theory, turned out to be one of those all-encompassing ideas that sweep up everything in history’s path. In the 1960s, 1970s, and 1980s, scarcely a year went by without a digital trend that made Claude Shannon more relevant than ever. The transistor, the integrated circuit, mainframe computers, satellite communications, personal computers, fiber-optic cable, HDTV, mobile phones, virtual reality, DNA sequencing: In the nuts-and-bolts sense, Shannon had little or nothing to do with these inventions. From a broader perspective, the whole wired, and wireless, world was Shannon’s legacy.

It was this expansive view that was adopted by the army of journalists and pundits trying to make sense of the digital juggernaut. Shannon’s reputation burgeoned. Largely on the strength of his groundbreaking 1948 paper establishing information theory, Shannon collected honorary degrees for the rest of his life. He kept the gowns on a revolving dry cleaner’s rack he built in his house. Shannon was a hero to the space age and to the cyberpunk age. The digital revolution made Shannon’s once-arcane bits and bytes as familiar to any household as watts and calories.

But if a journalist or visitor asked what Shannon had been up to lately, answers were often elusive. He wrote beautiful papers—when he wrote, explained MIT’s Robert Fano, a longtime friend. And he gave beautiful talks—when he gave a talk. But he hated to do it.

In 1958 Shannon accepted a permanent appointment as professor of communication sciences and mathematics at MIT. Almost from his arrival, Shannon became less active in appearances and in announcing new results, recalled MIT’s famed economist Paul Samuelson. In fact Shannon taught at MIT for only a few semesters. Claude’s vision of teaching was to give a series of talks on research that no one else knew about, explained MIT information theorist Peter Elias. But that pace was very demanding; in effect, he was coming up with a research paper every week.

So after a few semesters Shannon informed the university that he didn’t want to teach anymore. MIT had no problem with that. The university is one of the world’s great research institutions.

Shannon wasn’t publishing much research, though. While his Bell Labs colleague John Nash may have had a beautiful mind, Shannon had a very peculiar sort of mind, said David Slepian. Shannon’s genius was like Leonardo’s, skipping restlessly from one project to another, leaving few finished. Shannon was a perfectionist who did not like to publish unless every question had been answered and even the prose was flawless.

Before he’d moved to MIT, Shannon had published seventy-eight scientific articles. From 1958 through 1974, he published only nine articles. In the following decade, before Alzheimer’s disease ended his career all too decisively, the total published output of Claude Shannon consisted of a single article. It was on juggling. Shannon also worked on an article, never published, on Rubik’s cube.

The open secret at MIT was that one of the greatest minds of the twentieth century had all but stopped doing research—to play with toys. Some wondered whether he was depressed, said Paul Samuelson. Others saw it as part of an almost pathologically self-effacing personality.

One unfamiliar with the man might easily assume that anyone who had made such an enormous impact must have been a promoter with a supersalesman-like personality, said mathematician Elwyn Berlekamp. But such was not the case.

Shannon was a shy, courteous man, seemingly without envy, spite, or ambition. Just about everyone who knew Shannon at all liked him. He was five feet ten, of thinnish good looks and natty dress. In late middle age he grew a neat beard that made him look even more distinguished.

Shannon enjoyed Dixieland music. He could juggle four balls at once. He regretted that his hands were slightly smaller than average; otherwise he might have managed five. Shannon described himself as an atheist and was outwardly apolitical. The only evidence of political sentiment I found in his papers, aside from the fact of his defense work, was a humorous poem he wrote on the Watergate scandal.

Shannon spent much of his time with pencil in hand. He filled sheets of paper with mathematical equations, circuit diagrams, drafts of speeches he would give or papers he would never publish, possible rhymes for humorous verse, and eccentric memoranda to himself. One of the memos is a list of Sometime Passions. It includes chess, unicycles, juggling, the stock market, genealogy, running, musical instruments, jazz, and Descent to the demi-monde. The latter is tantalizingly unexplained. In one interview, Shannon spoke affectionately of seeing the dancers in the burlesque theater as a young man.

At Bell Labs Shannon had been famous for riding a unicycle down the corridors. Characteristically, Claude was not content just to ride the unicycle. He had to master it with the cerebrum as well as the cerebellum, to devise a theory of unicycle riding. He wondered how small a unicycle could be and still be rideable. To find out, he constructed a succession of ever-tinier unicycles. The smallest was about eighteen inches high. No one could ride it. He built another unicycle whose wheel was purposely unbalanced to provide an extra challenge. An accomplishment that Shannon spoke of with satisfaction was riding a unicycle down the halls of Bell Labs while juggling.

Shannon was born in Petoskey, Michigan, on April 30, 1916. He grew up in nearby Gaylord, then a town of barely 3,000 people near the upper tip of Michigan’s mitten. It was small enough that walking a few blocks would take the stroller out into the country. Shannon’s father, also named Claude Elwood Shannon, had been a traveling salesman, furniture dealer, and undertaker before becoming a probate judge. He dabbled in real estate, building the Shannon Block of office buildings on Gaylord’s Main Street. In 1909 the elder Shannon married the town’s high school principal, Mabel Wolf. Judge Shannon turned fifty-four the year his son was born. He was a remote father who dutifully supplied his son with Erector sets and radio kits.

There was inventing in the family blood. Thomas Edison was a distant relation. Shannon’s grandfather was a farmer-inventor who designed an automatic washing machine. Claude built things with his hands, almost compulsively, from youth to old age.

One project was a telegraph set to tap out messages to a boyhood friend. The friend’s house was half a mile away. Shannon couldn’t afford that length of wire. Then one day he realized that there were fences marking the property lines. The fences were made of barbed wire.

Shannon connected telegraph keys to each end of the wire fence. It worked. This ability to see clean and elegant solutions to complex problems distinguished Shannon throughout his life.

Shannon earned money as a messenger boy for Western Union. In 1936 he completed his bachelor of science at the University of Michigan. He had little notion of what he wanted to do next. He happened to see a postcard on the wall saying that the Massachusetts Institute of Technology needed someone to maintain its new computer, the Differential Analyzer. Shannon applied for the job.

He met with the machine’s designer, Vannevar Bush. Bush was the head of MIT’s engineering department, a bespectacled visionary rarely seen without a pipe. Bush advised presidents on the glorious future of technology. One of his favorite epigrams was It is earlier than we think.

Bush’s Differential Analyzer was the most famous computer of its time. It was about the size of a two-car garage. Electrically powered, it was fundamentally mechanical, a maze of gears, motors, drive belts, and shafts. The positions of gears and shafts represented numbers. Whenever a new problem was to be solved, mechanical linkages had to be disassembled and rebuilt by hand. Gears had to be lubricated, and their ratios adjusted to precise values. This was Shannon’s job. It was several days of grunt work to set up an equation and several more for the machine to solve it. When finished, the machine plotted a graph by dragging a pen across a sheet of paper fixed to a drafting board.

Shannon understood that the Differential Analyzer was two machines in one. It was a mechanical computer regulated by an electrical computer. Thinking about the machine convinced Shannon that electrical circuits could compute more efficiently than mechanical linkages. Shannon envisioned an ideal computer in which numbers would be represented by states of electrical circuits. There would be nothing to lubricate and a lot less to