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Entertainment, Media & Sports Alert >> Daily Fantasy Sports — The Specter of Gambling Threatens an Industry

October 27, 2015

Just a year ago, FanDuel and DraftKings were earning plaudits for exploiting a loophole in federal gambling regulations, raising hundreds of millions of dollars from major sports and media investors, and building billion dollar businesses by taking fantasy sports into the mainstream.

But the entire daily fantasy sports industry is attracting a different type of attention which threatens its long term existence. Nevada has deemed unlicensed daily fantasy sports games to be illegal, and representatives from numerous states have called for Congressional hearings. The Attorneys General in New York and Massachusetts have both opened investigations. Insider betting allegations have led to class action lawsuits, and new stories are questioning the security of fantasy sports systems and the Federal Trade Commission (FTC) may get involved. Much of this activity focuses on the overriding question which hangs over the daily fantasy sports industry: Does it amount to illegal gambling, or is it a game of skill?

Background
As discussed in our previous alert (to read more, click here) daily fantasy sports have condensed the season long activity of traditional fantasy sports leagues into a single day or week’s worth of games, allowing users to rebuild teams and compete daily or weekly. While users can compete in some games for free, the explosive growth in daily fantasy sports over the past year has been in the paid games, where operators require entry fees and allow users to compete for cash prizes.

To be legal, daily fantasy sports must comply with various federal laws. For example, the Professional and Amateur Sports Protection Act of 1992 (PASPA) prohibits sports betting nationally, except in states in which sports betting was legal prior to passage of the law. Online sports betting and online gambling also are prohibited under federal law. The Interstate Wire Act of 1961 prohibits sports betting through the use of “wire communication facilities,” including telephones and the Internet, except for betting transactions between states in which this activity is legal.

Online gambling of other kinds is prohibited under the Unlawful Internet Gambling Enforcement Act (UIGEA). The law defines unlawful online gambling as placing, receiving, or otherwise knowingly transmitting a bet by means that use the Internet “where such bet or wager is unlawful under any applicable federal or state law.”

There is a fantasy sports “carve-out” in the UIGEA, applicable to fantasy sports games that meet three criteria:

  1. The value of prizes are not determined by the number of participants or the amount of fees paid by participants;
  2. Winning outcomes must be based on skill, not chance; and
  3. Outcomes must not be based on the score or statistics of an individual athlete in a single event.

A New Jersey court in 2007 supported the notion that fantasy sports is not gambling, in a case where the plaintiff sought to recover various amounts under the state’s gambling-loss recovery statutes. Notably, that court did not reach the question of whether fantasy sports are games of skill or chance. Instead, it held that money paid qualifies as an entry fee and not a bet or wage when those entry fees are paid unconditionally, when prizes offered are for guaranteed amounts and when the fantasy sports entity does not itself compete for the prize. The court further distinguished fantasy sports from gambling because the sports sites at issue do not “win” as the house does in gambling because the sites themselves do not participate in the contests. Instead, all of the competition takes place between individual entrants.

Hearings and Investigations
In September, Frank Pallone, Jr. (D-NJ), the ranking member of the House of Representatives Energy and Commerce Committee, requested that the committee hold a hearing to examine the relationship between professional sports and fantasy sports “to review the legal status of fantasy sports and sports betting.” Rep. Pallone’s letter called the federal law governing fantasy sports “murky.”

Following this month’s reports of the alleged use of nonpublic information by employees of two daily fantasy sports websites - DraftKings.com and FanDuel.com - to place bets at each other’s website, Rep. Pallone and U.S. Senator Bob Menendez (D-NJ) sent a letter to the FTC’s Chairwoman urging the FTC to explore and implement safeguards to ensure a fair playing field in daily or weekly games. The letter said that these reports “raise serious questions about the integrity of these online fantasy sports websites” and about “whether there are sufficient consumer and competition safeguards to protect the integrity of these online games.”

New York Attorney General Eric Schneiderman recently initiated an investigation into DraftKings and FanDuel on similar grounds, investigating whether company employees or agents “may have gained an unfair, financial advantage…by exploiting their access to nonpublic data.” And the Massachusetts Attorney General already is investigating, too. She told a reporter last month, “The point is this: This is a new industry. It’s something that we’re reviewing, and we’ll learn more about it.”

Most significantly, Nevada gambling regulators recently ruled that fantasy sports is gambling, and all fantasy sports sites must obtain state licenses. Nevada’s definitive statement that daily fantasy is gambling puts other states in a difficult position – by allowing daily fantasy sites to operate, those states are allowing illegal gambling operations in violation of federal law. Instead of obtaining a gambling license, FanDuel retreated from operating in Nevada. DraftKings also strongly disagreed with the decision, but it is not immediately clear if DraftKings will seek a Nevada gambling license.

In addition to action by state regulators, the first private cause of action was filed earlier this month against both FanDuel and DraftKings. A Kentucky man filed a class action lawsuit against both companies in New York, accusing them of fraud, false advertising and negligence. He alleges that, because the companies each perform complex analytics on player drafting patterns and return on investment of various strategies, any game in which employees of the companies participated was unfairly weighted against average players.

Gambling or Skill?
The daily fantasy sports sites will soon have to address issues relating to their security, fairness, and integrity. Ultimately, however, the big issue to be resolved is whether fantasy leagues that last as little as one day amount to gambling or contests of skill.

Did a user’s team of hand-picked players lose tonight? The player can buy in again the next day, draft a different roster, and watch to see if he or she fares better. Some claim that this new rubric looks too much like gambling. Others, however, have pointed out that most daily fantasy games currently on the market are much more complicated, mirroring the intricacy and required skill of traditional fantasy games but compressing it in a more “Twitter-friendly” timeframe.

Courts have not yet weighed in on the issue. In 2013, a suit against FanDuel seeking to have the site’s operating profits disgorged as an illegal gambling operation was dismissed by an Illinois federal court, but the court did not address the question of whether daily fantasy is a game of skill or unlawful online gambling and instead made its decision on unrelated legal grounds – portions of which mirrored the 2007 case in New Jersey.

One longstanding case from the Alaska Supreme Court may provide guidance as this question heats up. That decision elaborated on the difference between a game of skill and chance. The court held that for something to qualify as a contest of skill, participants must have a distinct possibility of exercising their skill, the general class of participants (an average citizen, if the contest is aimed at the general public) must have the skill necessary to compete, and skill, not luck, must control the final result. Of course, that analysis was not applied to fantasy sports (which did not meaningfully exist in 1973), and how courts and legislatures do so in the coming months could be central to the evolution of this matter.

Bottom Line

There has been an exponential growth in fantasy sports, and it now is a multi-billion dollar industry. As Rep. Pallone has observed, anyone who watches a professional football game is “inundated by commercials for fantasy sports websites.” It is not yet clear, however, that it is safe for media outlets, media planners and buyers, and marketers to get involved with daily fantasy games – or whether daily fantasy sports games are legal. Right now, the odds are grim but the stakes are high. Stay tuned.