States Zero in on FanDuel, DraftKings, With Eye Toward Regulation

FanDuel logo© The Associated Press

North Carolina State guard Anthony Barber dribbles across the FanDuel logo during an NCAA basketball game sponsored by the daily fantasy sports website. States are trying to figure out how to regulate and tax such sites.

If you have been near a TV set in the last three months, you are almost guaranteed to have seen ads from daily fantasy sports websites like DraftKings and FanDuel about how “easy” it is to make money. Now, states are trying to figure out how to regulate and possibly raise revenue off the exploding industry.

New York and Nevada have banned the sites, labeling the games illegal gambling — rulings that the sites are challenging. But many more states are working on legislation for upcoming sessions that would subject the games to oversight or licensing. Pennsylvania and California are leading the way. But other states, such as Colorado, Delaware, Georgia and Illinois, are interested, too.

The daily sites, an Internet outgrowth of the rotisserie sports leagues of the 1980s, emerged in the last few years and took off this year amid massive ad campaigns. Players will spend more than $3 billion this year in entry fees, said Chris Grove of Eilers Research, a gaming-industry market research firm. Of that, the sites will keep roughly 10 percent; the rest will be paid out as winnings.

“The uptick in state examination of the issue coincided with the beginning of football season when the ads became nonstop,” said Jonathan Griffin, a gambling specialist for the National Conference of State Legislatures. “I expect this [coming] year we’re going to see a significant number of states that are going to try to regulate it, which is directly related to the fact that they have become so well-known in the past months.”

The daily sports sites work much like fantasy sports games in general: A player picks out a fantasy team of athletes from real sports teams (they don’t have to play for the same team in real life). Each athlete has a salary number attached to him, and the cost of an entire team must fit under a certain salary cap. That prevents a daily player from picking a team of only all-stars.

Fantasy players score points if their selected athletes perform well by scoring touchdowns or rolling up yardage in football, accumulating hits in baseball or making baskets in basketball. The difference between daily fantasy sports and the old-fashioned, group-of-friends fantasy play is the winning payouts that can occur each day. Another big difference: As the sites stress in their ads, players can win hundreds of thousands of dollars every day.

For the states, the basic question is whether the daily contests are gambling, i.e., “games of chance,” or not gambling, i.e., “games of skill.” The fantasy companies contend the games are based on skill — that players need to know a lot about a sport and how athletes compete if they are to win. Nevada and New York contend the daily fantasy contests are gambling — that luck plays a big role in who wins. For example, they say, it’s bad luck when the star quarterback fractures his ribs and is out for the game, diminishing his value to the daily fantasy sports player.

In October, the Nevada Gaming Control Board issued a ruling calling for all daily fantasy sports websites to “cease and desist” operations in the state. But the board’s long-term intent, according to many analysts, is to bring the fantasy games under the umbrella of state regulation and require participants to go to casinos to play.

“Nevada, deep down inside, would like to have it and regulate it. It’s another profit center,” said Alan Silver, a professor at Ohio University who used to work for and is widely consulted by the gaming industry.

“Fantasy sports appeal to the younger demographic,” he said, noting that millennials are less likely than previous generations to go to casinos to play traditional table games, which are Nevada’s gambling bread and butter. “If it were put into play and if it was regulated by Nevada, that’s going to be another way to get millennials into the casinos.”

Legalities

In New York, DraftKings and FanDuel went to court in November, after Democratic Attorney General Eric Schneiderman moved to shut them down. At a State Supreme Court hearing, lawyers for the two companies argued their activities were not gambling and were permitted under a 2006 federal law that had exempted fantasy sports from a ban on processing online financial wagering. But lawyers in Schneiderman’s office maintained that the games were based on luck — not skill — and were prohibited as gambling. A decision is expected this month.

DraftKings operates out of Boston, where Democratic Attorney General Maura Healey decided to regulate the industry, not ban it. The proposed Massachusetts regulations aim to protect consumers. They prohibit anyone under 21 from playing, require age verification, and ban betting on college sports, which makes up a fraction of the daily business, according to Eilers Research. The proposed rules would officially take effect Jan. 22, but Healey called on the industry to start obeying them now, and the industry has been mostly receptive.

As the legal controversy over Internet fantasy games heated up, FanDuel CEO Nigel Eccles called for “strong, common sense, enforceable consumer protection requirements” from states, to include age requirements, protection of personal information, individual player accounts and third-party audits.

The company, however, said daily fantasy sites didn’t want to be lumped in with casinos by regulators. “We … welcome the opportunity to work with attorneys general in all states, along with other lawmakers, to implement fair regulations that benefit both consumers and sports tech innovators,” a spokeswoman said.

DraftKings did not respond to repeated requests for comment. Earlier, it called the New York attorney general’s decision “hasty,” and said it would be willing to work with states and other “relevant authorities to ensure that our industry operates in a manner that is transparent and fair for all consumers.”

Billions of dollars are at stake in courts and statehouses for the sites and their high-profile investors. Fox Sports and NBC Sports, MLB and the NHL, Time Warner and the Kraft Group, which owns the New England Patriots, have invested in FanDuel and DraftKings. Forbes reported that FanDuel had raised an estimated $361 million from media companies, while DraftKings had raised $375 million total.

Legislation Looming

In Pennsylvania, legislators have begun studying how to regulate and tax fantasy sports sites. The House Gaming Oversight Committee held a hearing in November, and Republican Rep. George Dunbar is readying a bill.

“The industry needs regulation,” Dunbar said in an interview. “The issue is who regulates them. In my opinion, it is gaming and it should fall under our Gaming Control Board.”

But, he said, he is considering an “Internet gaming act” that would allow casinos already in the state to have websites at those locations that could run Internet poker and other games. “This could force Internet fantasy daily sports to run through our casino sites,” he said.

He said the legislation, still being drafted, would include a one-time $1 million casino fee to be paid by the sites and a $5 million fee paid by the casinos to include the games as part of their operations. The profit margin that a casino makes off the sites would be subject to state taxes. Pennsylvania has one of the highest casino tax rates in the country at 55 percent.

For that type of bill to become law, the state would first need to legalize Internet gambling altogether, he said.

In California, the Assembly’s Committee on Governmental Organization has scheduled a hearing this month, to which representatives of the big daily fantasy sites, consumer groups and other interested parties have been invited. Committee Chairman Adam Gray, a Democrat, has a bill that would license and regulate the sites through the California Gambling Control Commission.

Gray said the emergence of daily fantasy sports this fall was hard to miss. “For a sports fan as I am, I didn’t miss the barrage of commercials. It seemed clear to me that we were quickly going to get to a place where regulatory oversight was needed.”

He said there seems to be both an element of skill in the games, as well as an element of chance. California law has a “predominant purpose test,” which determines an activity to be gambling if greater than 50 percent of the outcome is derived from luck.

In New York, the state has something called the “material element test,” which determines that the activity is one of chance, as long as chance plays a “material role” in the outcome.

The differing standards may influence each state’s rules on daily fantasy sports.

Gray said his bill would include a revenue element, probably a licensing fee, to help pay for the costs of administering the regulations.

Daniel Wallach is a sports and gaming attorney with Becker & Poliakoff in Florida, where he said lawmakers are considering regulations that Wallach characterized as “friendly” to the daily fantasy industry.

He said many lawmakers in Florida and in some other states think the sites should be legal, but unavailable to minors, and the public should be protected from insider gambling.

Insider trading was raised this fall when allegations surfaced that site employees were placing bets using secret information. A DraftKings employee won $350,000 at FanDuel in a week. Employees of the two sites have now been banned from playing on either site.

Protecting the public from scams and insider trading factored into the regulations from the Massachusetts attorney general, and other states are considering similar rules.

Wallach, who does not represent fantasy sites, predicted that a year from now, there will be “more legislative clarity, but it will be a hodgepodge.”

“It will be legal, but how it’s regulated will vary state to state,” he said.

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