In wake of latest allegations, a look at the legality of daily fantasy sports

After the latest insider trading allegations against FanDuel and DraftKings, here's a deeper look at the legality of Daily Fantasy Sports.

If you don’t play daily fantasy sports—sometimes called DFS—you’re missing out on an increasingly popular and largely unregulated form of the fantasy sphere. While there is little to suggest that the popularity of DFS will recede anytime soon, recent allegations of insider trading and skepticism about the distinction between DFS and sports betting could spur governmental intervention. Any such intervention would be unwanted by the two largest DFS companies: DraftKings and FanDuel.

How insider trading and related legal problems could arise in the DFS industry

By now, you’ve seen the TV ads during NFL games, probably much more often than you’d like. FanDuel. DraftKings. DraftKings. FanDuel. Ad after ad. It almost seems as if every commercial break relays the same message: you too can win money by playing daily fantasy sports!

Daily fantasy employees accused of misusing insider information

Like fantasy sports games in general, DFS involves assembling a team of players and accumulating points based on how well those players statistically perform over a period of time. DFS games depart from the traditional model of fantasy sports games by occurring over a relatively short time period, often just a day or week. If you have the most points at the end of the day or week, you win your DFS game.

And, as the TV ads enthusiastically tell us, you can win a lot of money by playing DFS, even thousands of dollars. Unsurprisingly, the ads are quieter about another possible consequence of playing DFS: you can lose money, perhaps a good amount of money, if you play DFS often and keep losing. This is because various types of DFS games require you to pay an “entry fee” of as much as $1,000 in order to play. As a result, if you win, you take home substantially more money than you paid out, but if you lose, you don’t recoup what you paid to play. You thus might conclude that when you play DFS, you are “betting” money on a sports outcome: namely, that your players will perform statistically better than the players assigned to other DFS participants. Unfortunately for most DFS participants, they tend to lose that bet. A July 2015 study by Ed Miller and Daniel Singer published in the Sports Business Journal found that the majority of DFS participants lose money.

Some DFS participants, however, clearly excel at selecting or drafting players based on those players’ projected statistical performances. While anyone can get “lucky” picking a player who happens to succeed beyond expectations, successful DFS participants normally invest substantial time and energy researching players and strategizing how these players are likely to perform. Further, DFS participants typically operate within a salary cap where they, like real-life general managers, must adroitly select players of varying salaries. This is necessary in order to stay within a maximum dollar figure for a DFS team’s combined player salaries. For many DFS participants, this data analysis is ongoing, requiring a substantial amount of time on a daily or near-daily basis. So if DFS sounds like investing in stocks, it’s because DFS is like investing in stocks.

What the appeals court ruling means for O'Bannon's ongoing NCAA lawsuit

Therein lies the foundation for an insider trading concern. This concern is made more problematic because DFS is mainly controlled by only two companies, DraftKings and FanDuel, and both companies employ similar DFS games. As originally reported by Chris Grove of Legal Sports Report, DraftKings writer Ethan Haskell allegedly used information about which players DraftKings participants drafted to turn a $25 entry fee on FanDuel into a $350,000 prize. In short, Haskell allegedly possessed “insider” knowledge about the draft results of thousands of DraftKings participants in DraftKings' “Millionaire Maker” game. He apparently knew, for instance, which players had been overlooked at relatively high statistical rates. This knowledge could aid a DFS participant to better understand market inefficiencies and thus that person would enjoy a higher chance at winning his or her DFS game. Haskell was barred from playing in the DraftKings game because DraftKings (and FanDuel) bar their employees from playing in DFS games. That didn’t stop Haskell from allegedly utilizing his knowledge to play in a similar FanDuel game.

Haskell’s suspected conduct likely does not constitute “insider trading” from a legal standpoint. Under federal securities law, insider trading generally refers to the trading of a security—which includes any note, stock, security future, bond and other financial instruments—while possessing nonpublic information. A person in the DFS industry would not be trading a “security instrument” unless a DFS game could be construed as counting as such an instrument. Although there is always a chance of a first-time holding, there is no precedent for a court interpreting a DFS game as a security instrument.

NFL looks for resolution with expedited appeal of Brady decision

Still, other areas of law could pose concerns for DraftKings and FanDuel. To the extent these two competitors knowingly fail to police their own employees from profiting off of knowledge, other DFS participants might contend that DraftKings and FanDuel are engaged in anti-competitive conduct that violates antitrust law. There are also consumer protection laws in such states as New York and Massachusetts that are fairly aggressive at stopping what might be portrayed as “deceptive practices.” Along those lines, it would not be surprising if the Federal Trade Commission explored whether insider knowledge in the DFS industry poses an anticompetitive, consumer-harmful practice in violation of federal trade regulations. In fairness to DraftKings and FanDuel, the companies insist that they have adopted practices to ensure the “integrity of the games we offer.” It remains to be seen whether those practices are sufficient to prevent potential legal exposure.

The legal framework for DFS

While DFS sounds like investing in stocks, it also sounds like sports gambling. Yet federal law treats DFS much more kindly than it does gambling. This disparity traces back to 1992, when Congress passed and President George H.W. Bush signed the Professional and Amateur Sports Prohibition Act (PASPA). PASPA, which professional sports leagues aggressively sought, bans 46 states' ability to license, sponsor or authorize sports betting. Four states—Oregon, Delaware, Montana and, most notably, Nevada—were grandfathered out of this prohibition.

What a new college course devoted to the topic of Deflategate looks like

Fourteen years later, Congress passed and President George W. Bush signed the Unlawful Internet Gambling Enforcement Act (UIGEA). The UIGEA constitutes a sweeping ban on Internet gambling—particularly online poker—but carves out an important exemption for certain kinds of fantasy sports: those that reflect the skill and knowledge of the participants, as opposed to luck, chance or randomness, and that do not link cash prizes to the amount of fees necessary to play.

Why DFS supporters insist that it is a lawful form of fantasy sports

Most legal observers have concluded that DFS, like other types of fantasy sports, is lawful under the UIGEA. They stress that no DFS company has ever been criminally prosecuted as engaging in an illegal sports betting practice. This is not surprising, since DFS clearly requires some degree of skill. Advocates of DFS, in fact, would insist that a considerable amount of expertise is essential for success in playing DFS games.

Professional sports leagues and players’ associations, including the NFL, NBA and NFLPA, clearly view DFS as a lawful exercise of fantasy sports. These leagues have sold ads to DraftKings and FanDuel, and the NBA has invested in FanDuel. Just last week, the NFLPA joined the DFS bandwagon by reaching a deal with DraftKings to allow for NFL players to appear in promotional campaigns. If these leagues and players’ associations were worried about the continued legality of DFS, it is unlikely that they would so aggressively embrace DFS.

Why DFS critics assert that DFS raises legal concerns

But not everyone views DFS as necessarily lawful. Keep in mind, DFS was not marketable in 2006, and thus Congress and President Bush would likely not have contemplated DFS when assessing the merits and weaknesses of exempting fantasy sports from a federal prohibition. This timing circumstance by no means proves that DFS is unlawful. It does, however, raise the question of whether DFS ought to fall within the scope of the UIGEA when DFS was not in the relevant economic marketplace envisioned by Congress and President Bush.

Analyzing the future of New Jersey sports betting after denied appeal

The UIGEA also allows states to impose limitations on fantasy sports. Although most states permit DFS companies to operate without added restrictions, a small group of states view DFS with more suspicion and have adopted restrictions on DFS practices. These states have taken this approach for the same reasons that motivated Congress to ban sports betting in 1992: concern that wagering money on sports outcomes might lead to gambling addictions, human hardships and the fixing of games. Arizona, Iowa, Louisiana, Montana and Washington have adopted stiff restrictions on DFS, while Delaware and Tennessee have adopted lesser but still meaningful restrictions. Massachusetts might soon join this list, as its Attorney General, Maura Healey, is reviewing the legality of DFS under state law.

There is also movement afoot to rethink how the federal government regulates sports betting and to reconsider whether sports betting and fantasy sports, including DFS, should be treated so differently under the law. Consider that a sports bettor would have an incentive to conduct similar kinds of statistical analyses conducted by a DFS participant. Imagine you are going to bet money on whether the St. Louis Rams will upset the Green Bay Packers this Sunday at Lambeau Field. You would probably conduct research on relevant player data and trends, such as how well Nick Foles has fared against the Packers defense and how well Eddie Lacy has historically run against the Rams. You might also research weather reports for Sunday in Green Bay, and how Rams and Packers players typically play under those conditions. In other words, when money is on the line, you probably wouldn’t rely solely on luck or gut reaction: you’d do your homework and utilize your brain. Yet betting on this Sunday’s Jets-Dolphins game would be illegal unless you are in one of the four states that permits it.

Watch for Congress to soon explore the differing legal treatments of DFS and sports betting

Former NBA commissioner David Stern supports sports betting

Congressman Frank Pallone, Jr. has called for Congress to hold hearings on the continued legality of fantasy sports and to consider whether the federal government ought to legalize sports betting in all 50 states. Pallone hails from the state of New Jersey, which has waged litigation that has thus far been unsuccessful against the NCAA and the major professional leagues in an effort to carry out a law that would repeal the state’s prohibition against sports betting. New Jersey insists that PASPA unlawfully treats Nevada better than other states in regards to the capacity to sponsor sports betting. To date, this legal argument has failed, with a three-judge panel on the U.S. Court of Appeals for the Third Circuit recently ruling that the U.S. Constitution’s “Commerce Clause” protects PASPA. The Commerce Clause allows the federal government to limit state autonomy in regards to economic activities that extend into other states. The economic impact of proposed sports betting in New Jersey—where people would visit New Jersey to place bets and then travel home with winnings or, if they lose, without some of the money they brought into New Jersey—is viewed as certain to extend into other states.

• Silver hopes to continue CBA talks|Future of New Jersey sports betting

If Congress holds hearings on sports betting and fantasy sports, don’t be surprised if NBA commissioner Adam Silver and former NBA commissioner David Stern are called to testify. Both have expressed firm support for Congress to legalize sports betting, albeit in a regulated manner. Therein lies some concern for DFS companies: if Congress rethinks its ban on sports betting, could any resulting changes to federal law adversely impact DFS? It is certainly possible, since a comprehensive new sports betting law would likely address DFS. Even if DFS is not touched in a federal legalization of sports betting, DFS companies could lose the market advantage they enjoy over sports betting should sports betting become legal in all 50 states.

The bottom line: DFS appears legal under federal law because it is mainly about skill, but there’s a good argument that this same logic should lead to the federal legalization of sports betting. DFS may also attract legal and political attention over insider trading allegations. So don’t place your bet—or entry fee—on laws that regulate sports betting and fantasy sports staying the same.

Michael McCann is a Massachusetts attorney and the founding director of the Sports and Entertainment Law Institute at the University of New Hampshire School of Law. This fall he is teaching an undergraduate course at UNH titled “Deflategate.” McCann is also the distinguished visiting Hall of Fame Professor of Law at Mississippi College School of Law and he teaches “Intellectual Property Law in Sports” in the Oregon Law Sports Law Institute.