Legal analysis of the risks facing the daily fantasy sports industry

A legal analysis of the risks facing the daily fantasy sports industry, including DraftKings and FanDuel.

Editor’s note: FanDuel is a sponsor of Sports Illustrated. This piece was pursued and executed independent of that business relationship. Sports Illustrated also has a partnership with DailyMVP, another daily fantasy sports provider.

It was only a few weeks ago when the daily fantasy sports industry was flying high. Through an aggressive—if not excessive—advertising campaign, DraftKings and FanDuel had become almost fixtures of NFL television broadcasts. These two companies had also negotiated strategic partnerships with major pro sports leagues and global media companies that gave powerful interests a stake in DFS’s continued success. The law, it seemed, also worked in the favor of DraftKings and FanDuel: the Unlawful Internet Gambling Enforcement Act of 2006 (UIGEA) exempted fantasy sports from a federal ban on Internet gambling so long as the fantasy games required skill and knowledge rather than luck. To be sure, DFS was not marketable in 2006—and thus DFS was likely not contemplated by Congress and President George W. Bush when they considered UIGEA legislation. Also, a handful of states have since restricted DFS games, which is permissible under the UIGEA. Still, as of a few weeks ago, the law mostly painted a favorable landscape for DraftKings and FanDuel to thrive.

• Report: FBI, Justice Department investigating daily fantasy sports

Times sometimes change fast. In the case of DFS, times seem to be changing at warp speed. In a stunning sequence of events, allegations that a DraftKings employee, Ethan Haskell, used information unavailable to other DFS participants to turn a $25 entry fee on FanDuel into a $350,000 prize have spawned a fast-moving reconsideration of whether DFS constitutes illegal gambling. This reconsideration is playing out in multiple legal forums, each of which poses different risks for DraftKings, FanDuel and the future of the DFS industry.

Risk of criminal law exposure

By far, the most troubling legal worry for those who work at DraftKings and FanDuel is the possibility that they could be charged with crimes. While various civil challenges might be brought that threaten DFS companies and their employees with monetary damages and business disruption, there is nothing more threatening than the risk of incarceration.

What a federal grand jury could mean for daily fantasy sports companies

As analyzed on SI.com, the U.S. Attorney’s Office in Tampa is investigating whether DFS operators violated the Illegal Gambling Business Act of 1970 (“IGBA”). This law, which was passed with mafia-funded gambling operations in mind, carries potential penalties that include imprisonment, forfeiture of profits and assets and fines. In order for DFS operators to be convicted under the IGBA in Florida, there would need to be a showing that these operators violated a Florida law that prohibits betting money on certain games of skill.

The Florida investigation has led to a federal grand jury, which will review evidence and testimony related to relevant targets. Those targets most likely include those who actively operate DFS companies in Florida. On Friday, the Wall Street Journalreported that the Fantasy Sports Trade Association has been subpoenaed by the U.S. Attorney's Office in Tampa for records, including board-meeting minutes, that might relate to allegations of anti-competitive collaboration between DFS companies. The grand jury might be impaneled for as long as the next 18 months, during which time the grand jury could find probable cause, meaning it is more likely than not that a crime occurred. The finding of probable cause would set in motion the issuance of indictments against operators of DFS companies. Those indicted could eventually face trial and be convicted or found not guilty, or they could reach plea deals along the way. To be clear, a grand jury investigation does not mean that the grand jury will find probable cause. It is quite possible that the grand jury will instead return “no bill” of indictment, which would likely end the investigation.

In addition to the Florida grand jury, DFS companies also face potential criminal repercussions from the Justice Department and the Federal Bureau of Investigations expanding an ongoing probe into the legality of fantasy sports into one that more closely scrutinizes the DFS industry. This probe reportedly includes interviews with employees at DFS companies, DFS participants and others connected to the industry. Like the Florida grand jury, there is no certainty that the probe will lead to any criminal charges. Yet the mere involvement of the Justice Department and FBI is nonetheless troubling. After all, the range of potential criminal laws that fall within the scope of an FBI investigation is extensive. Those laws include the Racketeer Influenced and Corrupt Organizations (RICO) Act, which has been used to prosecute illegal gambling as a criminal enterprise. There are also civil penalties that could be used to wreck serious havoc on the DFS industry.

Even if criminal law ultimately fails to stick to DFS companies, the very possibility of criminal law playing a role could significantly damage those businesses. Sponsors, for instance, will be less inclined to strike business partnerships with DFS companies if those companies are under a cloud of legal uncertainty. DFS companies could also experience a “brain drain” where talented employees, spooked by seeing FBI agents at the workplace, seek employment elsewhere. Perhaps most significantly, consumers will be less inclined to spend money on DFS games if they believe—fairly or not—that DFS games are somehow illegal or could become illegal.

Risk of civil judgments that require millions of dollars in damages

More than one half-dozen lawsuits have been brought against DraftKings and FanDuel in federal district courts since the insider trading scandal surfaced. Expect many more civil complaints to be filed in the weeks ahead. The lawsuits, which have been filed in such states as New York and Louisiana, are constructed in similar ways. Each hopes to become a class action and each essentially contends that FanDuel and DraftKings have deceived consumers through advertisements and public assurances into believing that they can win at DFS by being “smarter than the average fan.” The plaintiffs insist that winning at DFS is not based on intelligence or wisdom, but rather on being the beneficiary of a fixed game where DFS employees have access to information unavailable to other DFS participants. The lawsuits demand monetary damages, which could become considerable if a federal court certifies any of the lawsuits as a class action.

What impact will the lawsuit filed against DraftKings, FanDuel have?

While the DFS lawsuits are mostly the same, some have unique qualities that raise particular questions about the DFS industry. For instance, in John Weaver v. FanDuel and DraftKings, the plaintiff argues that he started winning at DFS once DraftKings and FanDuel announced that they were no longer allowing employees to play the other companies’ DFS games. This claim, if true, creates the impression that alleged insider trading had a meaningful impact on probability of winning. Alternatively, in Artem Genchanok v. FanDuel and DraftKings, the plaintiff was apparently able to play DFS in a Louisiana, a state where DFS is prohibited by law as illegal gambling. This assertion (if true) implies that the DFS companies failed to adequately police where DFS games are played.

Do not expect swift resolution with any of these lawsuits. The litigation process is slow and will take months, if not years, to play out. In the near future, DraftKings and FanDuel will file motions to dismiss these lawsuits. These companies will contend that as a contractual condition of playing DFS games, the plaintiffs willingly assented to an “arbitration clause.” This clause states, in so many words, that regardless of the merits of any legal claims a DFS participant might have against DraftKings and FanDuel, the participant agreed to resolve any disputes in private arbitration and thus out-of-court. Case law varies by state and by circumstance on the enforceability of arbitration clauses, but these clauses are often enforced due to a federal law—the Federal Arbitration Act—that generally encourages judges to dismiss lawsuits brought by those who agreed to arbitration clauses. However, DFS lawsuits brought in states that exhibit more skepticism towards arbitration clauses could be at an advantage.

If the DFS lawsuits advance past motions to dismiss, federal judges would then turn their attention to whether to certify the lawsuits as class actions. These judges would also evaluate how to best construct appropriate boundaries for pretrial discovery. Class certification is a complex process that itself takes months and sometimes years. In assessing certification, judges would determine if the plaintiff in the lawsuits adequately represent other DFS participants. It is also possible that multiple DFS lawsuits could be consolidated into one larger case (as has occurred in recent sports litigations, including the concussion lawsuits brought by retired NFL players).

Whether in the form of multiple cases or one consolidated case, pretrial discovery would likely enter the story and become worrisome for DFS companies. During pretrial discovery, DFS companies and their executives would be required to share information—likely including computer data, gaming algorithms, security protocols and emails—that might present a host of public relations woes and legal problems. Pretrial discovery could also lead to the disclosure of sensitive business strategies.

Risk that additional states ban DFS

As noted above, although the UIGEA makes fantasy sports games lawful under certain conditions, this same law permits states to impose additional regulations and even prohibitions on fantasy sports games. Five states—Arizona, Iowa, Louisiana, Montana and Washington—generally ban DFS games, while several other states, including Delaware and Tennessee, impose lesser restrictions.

A new state can be added to this list and it is a very meaningful one: on Thursday, the Nevada Gaming Control Board ruled that DFS counts as a form of sports betting under Nevada law. In 46 states, the classification of a business practice as “sports betting” would mean the practice is unlawful, but that is not the case in Nevada. The Professional and Amateur Sports Prohibition Act of 1992 (PASPA) exempts four states (Nevada, Oregon, Delaware and Montana) out of a federal ban of the licensing, sponsoring or authorizing by states of sports betting. While the classification of DFS as gambling does not make it automatically unlawful in Nevada, it means that DFS companies will need to apply and obtain a license from the Nevada Gaming Control Board in order to lawfully operate in Nevada. In the meantime, DFS will essentially be banned in Nevada, with criminal sanctions a possibility for DFS companies who ignore the ban.

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

The temporary fall of DFS in Nevada might be taken with a grain of salt. The interests of DFS companies and traditional gaming companies are often not aligned since they are, to some extent, competing industries. While DFS is focused mainly on player performance and gambling is focused more on team performance, DFS and sports betting operate in the same overarching space. With that in mind, a gaming company would obviously rather you place a bet in Nevada than play a DFS game in Nevada. Given that gambling companies exert significant political influence in Nevada, the state banning DFS could be seen as having more to do with politics gamesmanship than legal reasoning.

On the other hand, states that have not paid significant thought to the legality of DFS under their laws could be tempted to follow the lead of Nevada. In fact, given the structure of its economy and regulatory framework, Nevada likely has a more informed sense of what counts as “gambling” than any other state. With this in mind, may be noteworthy that on Friday, the Illinois Gaming Board concluded that DFS appears to be illegal under Illinois law. The Board will seek a formal opinion by Illinois Attorney General Lisa Madigan. Attorney General Madigan’s involvement would follow that of New York Attorney General Eric Schneiderman and Massachusetts Attorney General Maura Healy, who have both expressed concerns towards the lawfulness of DFS under their states’ laws.

Keep in mind, even if federal laws on sports betting and DFS remain constant, the banning of DFS in individual states, one-by-one, could dramatically reduce the value of DraftKings (which is reportedly has interest in conducting an initial public offering in 2016) and FanDuel. Their customer bases would shrink and their opportunity for further growth would be curtailed.

Risk that Congress or federal courts alter the legal landscape for sports betting and DFS

While Congress has often struggled in recent years to pass legislation on divisive topics, there is the possibility that Congress could soon revisit the legal framework for sports betting and DFS. The UIGEA and PASPA are both capable of being altered in ways that could dramatically change how sports betting companies and DFS companies conduct business in the United States. Congressman Frank Pallone, Jr. (D., N.J.), for instance, has called for Congress hearings on sports betting and DFS. U.S. Senator Robert Menendez (D., N.J.) has also called for further discussion on this topic. Some believe it is inevitable that the federal government will weigh in. “The days of DFS operating without governmental regulation are over,” opines Florida gaming attorney Daniel Wallach. “The recent events highlight the need for regulation in order to protect consumers. And that will undoubtedly happen in the coming months.”

Reports: Fantasy Sports Trade Association facing subpoena

If Congress schedules hearings on sports betting and DFS, we can be sure lobbyists would play a pivotal and well-financed role in shaping those hearings. The gaming and DFS industries would have a great deal of money to spend on those lobbyists and an even greater deal of money to lose or gain if Congress tries to change the law. These industries would also be interested parties if the Federal Trade Commission evaluates whether the DFS industry engages in consumer-harmful practice that run afoul of federal trade regulations.

As to the White House, it is unclear whether President Obama would sign legislation that legalizes sports betting in all 50 states (thereby amending or nullifying PASPA). Similarly, it is unknown if he would sign legislation that restricts DFS practices in all 50 states (thereby amending or nullifying UIGEA). Perhaps President Obama and the candidates for the 2016 presidential race will be asked about this subject area.

The federal legal landscape of sports betting and DFS could also be altered in court. New Jersey and its governor, Chris Christie, have for several years been in court battling the NCAA and the major pro sports leagues over the constitutionality of PASPA and whether New Jersey can repeal the state’s prohibition against sports betting. While this litigation has yet to succeed, New Jersey received encouraging news earlier this week when the U.S. Court of Appeals for the Third Circuit announced it would hold an “en banc” hearing on the case. I describe the mechanics of the hearing in another SI.com article, but it could lead to legal sports betting in New Jersey—which would likely permit other states to follow suit—as well as an opportunity for the U.S. Supreme Court to weigh in.

As sports bettors and DFS participants know all too well, there aren’t many “safe bets” in this world. Well, I have one for them: You can bet on the legal framework for sports betting and DFS only becoming more dizzying in the months ahead.

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. As a disclosure, one of McCann’s family members is represented in a personal matter by an attorney who represents a plaintiff in John Weaver v. FanDuel and DraftKings.