Kyle Stanford December 11, 2015
On Friday, New York Supreme Court Justice Manuel J. Mendez ruled against daily fantasy sports (DFS) sites, upholding an order for them to cease taking bets, entry fees and wagers from users within the state. DraftKings and FanDuel immediately appealed the ruling, however, and won an emergency stay that allows them to continue operating for the moment.
The industry could see wide-ranging affects from the initial ruling, which may cause more states to investigate the legality of these sites. If DFS sites are required to shutdown in more states—currently six states have deemed DFS sites illegal—it could spell the end of the services.
It may be time for DraftKings and FanDuel to spend a large amount of money on political lobbying in order to convince states to, rather than shut down the sites completely, create rules and regulations for the industry. Massachusetts is the first U.S. state to announce certain rules pertaining to DFS, a move that should help the state through taxes, but also may put a crimp in DFS company revenues.
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(Original post: November 25)
It may not be The Hunger Games, but the legal fight between daily fantasy sports (DFS) sites and the U.S. government may be catching fire.
DFS has become part of the norm in the U.S., as ads urging people to sign up for the one-day fantasy sports leagues have been appearing everywhere. Much of the growth in advertising over the past few months has been aided by the near $800 million that the two largest sites, FanDuel and DraftKings, have combined to raise in venture funding, mostly over the past two years. Each company is valued at over $1 billion, and they have combined to draw investment from names such as KKR, Atlas Venture, Redpoint Ventures and Wellington Management.
The DFS industry has begun to run into roadblocks, however, as questions of its legality have been raised after several scathing investigative reports and a mounting number of lawsuits.
On Wednesday, DFS companies—more specifically FanDuel, DraftKings and Yahoo—are set for a showdown in court with New York Attorney General Eric Schneiderman. Two weeks ago, FanDuel and DraftKings were issued cease-and-desist letters by the NY AG, stating that an investigation had found that “unlike traditional fantasy sports, daily fantasy sports companies are engaged in illegal gambling under New York law, causing the same kinds of social and economic harms as other forms of illegal gambling.” FanDuel and DraftKings immediately challenged the cease-and-desists letters by seeking a temporary restraining order against the NY AG, though it was denied pending Wednesday’s hearing—DraftKings has refused to close shop and is still taking online bets and new clients, while FanDuel has halted operations in the state.
The letters were another major hit to an industry that has already been banned by the de facto gambling capital of the world, Nevada, along with five other U.S. states. FanDuel and DraftKings together control more than 90% of the DFS activity, and each sees almost 10% of its customer base come from New York. So no matter your take on fantasy sports, or gambling in general, Wednesday's ruling is big. A loss in court could snowball and bring down the sites in other states, or even in a worst-case-scenario, lead to them being banned throughout the U.S.
Much of the legal background on the issue stems from the Unlawful Internet Gambling Enforcement Act of 2006 (UIGEA), which has been used by both sides to convey either the legality or illegality of DFS. The act, which lays out the nature of illegal online gambling, says that “participation in any fantasy or simulation sports game” is exempt from being considered illegal IF “all prizes and awards offered to winning participants are established and made known to the participants in advance of the game or contest and their value is not determined by the number of participants or the amount of any fees paid by those participants,” AND,“all winning outcomes reflect the relative knowledge and skill of the participants and are determined predominantly by accumulated statistical results of the performance of individuals,” as long as the winner is not determined by a final score, point spread or performance of real-world teams, or solely on the performance of a single individual athlete.
Though it seems at least somewhat straightforward, the act was written prior to either FanDuel or DraftKings being founded, at a time when fantasy sports leagues almost always took place over an entire season and champions were generally accepted as needing some degree of skill to win. Further complicating the matter, the act, based on certain language, defers much of the responsibility for determining the legality of fantasy sports to the states, which create their own interpretation of skill vs. chance, #facepalm.
Of the sites’ legal stances, the fact that they have operated within New York—and other states—for years without being the target of a probe or state lawsuit may be what is front and center in Wednesday’s emergency hearing. (For what it’s worth, DFS was not even high on the radar of the U.S. government until an insider trading-like scandal in October; the FBI and U.S. Justice Department announced a preliminary investigation soon after.) Ultimately, the opinion that is under the highest scrutiny is whether or not DFS is a game of chance or a game of skill.
Under the UIGEA, if “winning outcomes reflect the relative knowledge and skill of the participants,” then fantasy sports can be legally run if states decide, according to federal laws. FanDuel and DraftKings argue almost to exhaustion that their leagues are skill-based, and to their defense, many people would probably agree to an extent. The problem with that argument is that again the determination as to how much skill needs to be involved for betting to be legal resides with the states. Some states ban betting and wagering on anything affected by chance in the slightest, while others conclude that outcomes cannot be “materially affected” by chance. The future of DFS will hinge on the ability of the companies and their lawyers to prove that their games are not a game of chance, something that online poker companies and proponents were unable to do in the past.
The ruling Wednesday will not be the end, not by a long shot. The losing side will undoubtedly appeal the ruling and the end-game may take months or longer. Several states have begun to look at legislation that could make DFS sites legal, with restrictions, which would be a major win for the industry. The Massachusetts Attorney General has already proposed regulations, including capped monthly spending by users, a 21+ age restriction and blocking advertising and promotional events on college campuses, among others. Though the restrictions may hamper DFS revenues, they were welcomed with open arms by the companies. If DraftKings and FanDuel are able to delay the final ruling by New York, and push out a federal ruling (if there ever is one), it may give some states enough time to put in place regulations on the industry that would allow them to stay open for business..
DFS does have some powerful players at its back to help it through the legal challenges. FanDuel and DraftKings have partnered with major sports leagues in the U.S., including the NHL, MLB and MLS, and also secured huge advertising deals with corporations such as ESPN, Verizon and Time Warner (also an investor FanDuel). But with issues mounting—several states are waiting on the New York ruling; several NFL athletes have sued the companies over use of their names and likenesses; a DFS customer has filed a class-action lawsuit in Florida that includes several investors and sports leagues as defendants—the costs of fighting to become 100% legal (which is stated prominently on DFS websites) may just be too much to overcome.
But until then, FanDuel's slogan seems fitting: ”Think you know fantasy sports? Prove it.”
If you'd like to see trends of venture investment in fantasy sports, or want info on the VC financing histories of FanDuel and DraftKings, contact us today.
[Related: It’s no fantasy: VCs wagering heavily on FanDuel, DraftKings—PitchBook]
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