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New York Moves to Shut Down DraftKings and FanDuel as Illegal Gambling Operations

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Since Week One of the 2015 NFL season there has been a lot of discussion about the meteoric rise of daily fantasy sports. Daily fantasy sports, and specifically fantasy football, have quickly transformed from friendly diversions played for “bragging-rights” into a multi billion dollar industry dominated by two entities, DraftKings and FanDuel.  What’s interesting is that before the start of the 2015 NFL season, few were familiar with DraftKings, FanDuel, or their budding economic empire.  But after spending hundreds of millions of dollars flooding every conceivable marketing platform with advertisements promising million dollar payouts, it’s hard to find anyone unfamiliar with these businesses.

The ad blitz by DraftKings and FanDuel succeeded in getting everyone’s attention and bringing in new business. But in retrospect, that may not have been a good idea.  The sheer size of the media campaign had two unintended consequences that are now threatening the continued existence of DraftKings and FanDuel.  First, by saturating the market with incessant advertisements, DraftKings and FanDuel succeeded in growing their customer base and in angering non-fantasy football players tired of watching their commercials and seeing their billboards. Second, and more significantly, DraftKings and FanDuel drew unwanted attention from regulators, lawmakers and the casino industry.

When regulators and lawmakers started looking closely at the business models of DraftKings and FanDuel, they quickly realized that it was very difficult to distinguish daily fantasy sports from gambling. By “very difficult to distinguish,” I mean impossible.  Daily fantasy sports clearly qualifies as “gambling” under most, if not all state laws.  Here’s the thing though – unlike all other forms of gambling, daily fantasy sports are unregulated on the federal level and have been operating freely throughout most of the union. Why, you may ask?  Primarily because when Congress passed the Internet Gambling Enforcement Act of 2006, it declined to classify daily fantasy sports as “gambling,” essentially exempting DraftKings and FanDuel from federal regulation.

The federal loophole for fantasy sports has tied the hands of federal regulators. Unless Congress steps in to eliminate the loophole, the federal government can’t do much to reign in fantasy sports gambling.  But although the feds may be hamstrung, the states are not.  And it is the states that pose an imminent threat to DraftKings and FanDuel.

Last month, Nevada regulators determined that daily fantasy sports qualify as “gambling.”  And, because DraftKings and FanDuel were allowing Nevada residents to play daily fantasy football (i.e. “gamble”) without having the proper licenses, they were engaged in illegal activity.  In short, regulators booted DraftKings and FanDuel out of Nevada.  To be fair, Nevada regulators were likely under pressure from the casino industry, which has long enjoyed a national monopoly on sports betting. The casinos are clearly unhappy with DraftKings and FanDuel taking away potentially lucrative business opportunities and have been lobbying state regulators to shut these businesses down.

Politics aside, Nevada’s move to classify daily fantasy sports as “gambling” was clearly warranted. It was also a serious economic blow to DraftKings and FanDuel.  It now appears to be the start of a trend.  On Tuesday of this week, the New York Attorney General’s Office followed Nevada’s example, sending a sternly worded cease and desist letter to DraftKings. A very similar letter was sent to FanDuel.

The November 10, 2015 letter is from Kathleen McGee, the Chief of the Attorney General’s “Internet Bureau,” and it is addressed to DraftKing’s CEO, Jason Robins.  The letter begins by informing Mr. Robins that the Attorney General’s office completed a review of DraftKing’s business operations and concluded “that DraftKings’ operations constitute illegal gambling under New York law.”  Explicitly rejecting Congress’ ludicrous determination that daily fantasy sports are games of “skill,” Ms. McGee wrote that “DraftKing’s customers are clearly placing bets on events outside of their control or influence, specifically on the real-game performance of professional athletes.”

Interestingly, the Attorney General’s letter carefully distinguish the “daily fantasy” business being run by DraftKings and FanDuel from the more “traditional” fantasy games that have been largely unregulated for years.  The point here is to justify why the New York Attorney General is taking action against DraftKings and FanDuel, and not all fantasy sports websites:

We believe there is a critical distinction between DFS and traditional fantasy sports, which, since their rise to popularity in the 1980s, have been enjoyed and legally played by millions of New York residents. Typically, participants in traditional fantasy sports conduct a competitive draft, compete over the course of a long season, and repeatedly adjust their teams. They play for bragging rights or side wagers, and the Internet sites that host traditional fantasy sports receive most of their revenue from administrative fees and advertising, rather than profiting principally from gambling. For those reasons among others, the legality of traditional fantasy sports has never been seriously questioned in New York.

Unlike traditional fantasy sports, the sites hosting DFS are in active and full control of the wagering: DraftKings and similar sites set the prizes, control relevant variables (such as athlete “salaries”), and profit directly from the wagering. DraftKings has clear knowledge and ongoing active supervision of the DFS wagering it offers. Moreover, unlike traditional fantasy sports, DFS is designed for instant gratification, stressing easy game play and no long-term strategy. For these and other reasons, DFS functions in significantly different ways from sites that host traditional fantasy sports.

Having concluded that “daily fantasy sports” is really gambling, McGee’s letter alleges that DraftKings ongoing operation in the State violates New York law and the State Constitution.  Thus, the Attorney General concludes its letter by demanding that DraftKing’s immediately prohibit New York residents from playing online daily fantasy sports, stating:

[W]e demand that DraftKings case and desist from illegally accepting wagers in New York State as part of its [daily fantasy sports] contests. 

McGee certainly recognized that the Attorney General’s distinction between “daily fantasy sports” and “traditional” fantasy sports is on shaky legal ground.  As sort of a “backup” legal argument, she also alleged that DraftKings’ advertisements violate state consumer protection laws because they are misleading.  McGee alleged that DraftKings fantasy competitions are rigged in favor of a select few who reap most of the winnings:

Further, DraftKings has promoted, and continues to promote DFS like a lottery, representing the game to New Yorkers as a path to easy riches that anyone can win. The DraftKings ads promise: “It’s the simplest way of winning life-changing piles of cash”; “The giant check is no myth. . . BECOME A MILLIONAIRE!” and similar enticements. Like most gambling operations, DraftKings’ own numbers reveal a far different reality. In practice, DFS is far closer to poker in this respect: a small number of professional gamblers profit at the expense of casual players. To date, our investigation has shown that the top one percent of DraftKings’ winners receive the vast majority of the winnings.

Finally, McGee’s letter advances a public policy argument for shutting down DraftKings, contending that its gambling operations has a negative impact on public health:

DraftKings DFS contests are neither harmless nor victimless. Daily Fantasy Sports are creating the same public health and economic concerns as other forms of gambling, including addiction.

The decision by the New York Attorney General to threaten DraftKings and FanDuel is monumental and is a clear and present danger to their ongoing existence.  From a legal perspective, McGee’s attempt to distinguish “daily fantasy sports” from “traditional” fantasy games is questionable.  There is no real legal precedent for such a distinction and you can bet that the Attorney General’s interpretation will be the subject of litigation.  DraftKings and FanDuel really have no choice but to fight the Attorney General in court – New York is too big and too lucrative a market to walk away from without a fight.  And if DraftKings and FanDuel don’t make a stand now, you can be sure that more states will follow the lead of Nevada and New York.

Photo credit: FreeImages.com Nikki Johnson

Class Actions

DraftKings and FanDuel Accused of Systemic Fraud and Civil Conspiracy in Class Action Lawsuit

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As I have written on a few occasions, DraftKings and FanDuel, the two heavy hitters in the multi-billion dollar fantasy sports industry, are facing increasing pressure from lawmakers who are finally realizing that these daily fantasy leagues are really unregulated, government sanctioned gambling. But now they also have to worry about the lawyers. And the lawyers are coming in waves.

A number of lawsuits have recently been filed in response to allegations that a DraftKings employee used insider information to win a $350,000 playing fantasy football on the rival FanDuel website.  Each of these lawsuits alleges that executive level employees at DraftKings’ and FanDuel’s exploit their access to confidential customer information to win large sums playing fantasy football for their own account.  Put simply, the lawsuits allege that DraftKings and FanDuel employees are lining their own pockets at the expense of their paying (and quite gullible) customers.

In a recent proposed class action filed in federal court in the Southern District of New York, class representative Adam Johnson made some pretty heavy handed allegations against DraftKings and FanDuel.  The Complaint starts off by alleging that the two daily fantasy giants spent more than $100,000,000 million this year alone to advertise their fantasy platforms.  Although this is not a necessarily a relevant fact (and probably not shocking considering you can’t visit a website or turn on a TV without seeing a fantasy football advertisement), it does highlight just how massive and profitable the fantasy football industry has become.

After briefly describing how DraftKings and FanDuel make money (customers pay a fee to play and the businesses pay out in winnings less than they take in . . . sounds suspiciously like a casino), the Complaint quickly gets down to the brass tacks.   The attorneys for Johnson smartly led off with a strong salvo meant to drive home the theme of the lawsuit – that DraftKings and FanDuel exploit the naiveté of the vast majority of their customers to make money for themselves and few of their best and most favored customers.

The Complaint alleges that DraftKings refers to its new fee paying users as “fish” and “relies on these new users who lack skill to keep its most active users – and therefore profitable” customers happy.  In other words, daily fantasy leagues entice the unsuspecting and unskilled masses to essentially fork over money to play a rigged game they can’t win and that money is split between DraftKings and FanDuels and a few of their top players.  To buttress this claim, the Complaint cites to fantasy baseball statistics and uses these statistics to insinuate that 91% of the profits made playing daily fantasy football are won by just the top 1.3% of players.

Building on its allegations that the vast majority of daily fantasy players are being snookered, the Complaint then turns to the recent scandal involving a DraftKings employee who is alleged to have used inside customer information to win large sums playing fantasy football at rival FanDuel.

The Complaint notes that “Because the goal is to beat other players, a player with statistical data about ownership percentages of competitors would have an edge over players without this data.”  It then points out that in Week 4 of the NFL season, a DraftKings employee “accidentally” released confidential player ownership information and, as it would happen, that very same week another DraftKings employee beat out 229,883 other competitors and won $350,000 playing fantasy football with FanDuel.

Again, the theme being insinuated here is that these daily fantasy leagues are a fraud and employees are given a huge advantage over paying customers by exploiting inside information.  To give some additional meat to this allegation, the Complaint alleges that the daily fantasy performance of the employee who won $350,000 improved dramatically after he took a job at DraftKings, specifically stating: “An analysis of this employee’s previous [daily fantasy] history shows a remarkable increase in winnings since moving from a job with rotogrinders.com . . . to . . . DraftKings.”  In fairness to the employee, the Complaint did not divulge the purported source or methodology underlying the “analysis.”

Ultimately, the Class Action Complaint alleges that the proposed class representative never would have spent money playing fantasy football if he had known he couldn’t win.  If he had known DraftKings and FanDuel operate and exist for the sole purpose of exploiting the gullibility (and pocketbook) of the little guy.  In essence, the Complaint alleges that DraftKings and FanDuel are fraudulent enterprises that use a rigged game to make a few select people a lot of money while taking everyone else for a ride.

It’s not clear if the Johnson Complaint will ever survive a motion to dismiss.  It looks like DraftKings and FanDuel were smart enough to make their users sign mandatory arbitration provision, essentially waiving their right to access the court system.  The Complaint tries to avoid this issue by claiming that it would be unconscionable to allow DraftKings and FanDuel to enforce the arbitration agreement considering the agreement was premised on a fraud.  But, federal courts have been extremely aggressive in enforcing arbitration agreements and it seems like a longshot that District Court judge ruling on the Johnson Complaint would make an exception here.

Even so, DraftKings and FanDuel are now facing mounting pressure on all fronts.  How they navigate these challenges will likely determine if they can continue to operate as independent enterprises, or whether by legislative edict they will be swallowed up by Las Vegas casinos. Either way, change is coming and coming soon.

Photo credit: FreeImages.com Nikki Johnson