The Tip of the Iceberg: Daily Fantasy Sports as a Harbinger of Future Regulatory Challenges

mchugh_jamesstempeck_justinby Hon. James F. McHugh (Ret.) and Justin G. Stempeck

Legal Analysis  

In the fall of 2015, as professional football fans drew up their chairs, turned on their television sets and began another season with their favorite sport, they witnessed a sustained barrage of advertisements promising them the opportunity to win enormous cash prizes for playing daily fantasy football.  The advertisers were two Internet companies, DraftKings, based in Boston, and FanDuel, headquartered in New York, its chief competitor.  Both were young companies, but by that fall they had captured about 85% of the national daily fantasy sports (DFS) market.

In one form or another, fantasy sports have been with us for decades.  In the original model, groups of baseball fans formed a fantasy baseball league, paid an agreed entry fee and then created fantasy teams composed of active major league baseball players.  The success of the fantasy teams depended on the performance of the real players in real games played throughout the season.  The success of those players – the number of hits they made, the number of strikeouts they threw, the number of runs they drove in, etc. – translated into points earned by the fantasy team on which they also “played.”  At the end of the season, the owner of the fantasy team that had the most points collected a cash reward composed of the entry fees all team owners paid when the league was formed.

Available only through the Internet, DFS is built on the same concept but the entry fees are paid to DraftKings or FanDuel and the winners are determined on the basis of player performance on a single day.  The concept has spread far beyond baseball and now includes football, hockey, basketball and a variety of other sports. Indeed, major league sports have embraced the idea and major league baseball has created fantasy programs of its own.

Until the fall of 2015, DraftKings and FanDuel offered their products in a relatively quiet fashion to a relatively small market.  The explosion of advertising in which they began to engage at the opening of the 2015 football season was a dramatic departure from their previous business model and it provoked an immediate reaction that continues today.  That reaction was amplified by published reports that an employee of one of the companies had won over $300,000 using insider information to form and enter a fantasy team on the other company’s website.  Though the reports were vigorously denied, they added to the intensity of the reaction the advertising had provoked.

The reaction produced probing questions about the nature of DFS contests, their legality, fairness and similarity to other forms of regulated gambling.  Previously the industry had relied on certain provisions of the federal Unlawful Internet Gambling and Enforcement Act (UIGEA) to assert that DFS was “100% legal.”  A careful reading of UIGEA demonstrated that, while it did include a carve-out for fantasy sports, it ultimately deferred questions of legality to state law.  As a result, numerous attorneys general began examinations of DFS and concluded that it constitutes illegal gambling under their respective state’s law.[1]  Additional state attorneys general are still reviewing the industry and have yet to render formal opinions on its legality.

The attention on the DFS industry also spurred myriad legislative efforts to legalize the activity although no uniform approach to legalization has yet crystalized.  Proposed legislation is extremely varied in both scope and depth, ranging from simply decriminalizing the activity in a state’s criminal code to creating a detailed licensing scheme for the industry.  A number of gaming commissions also have investigated the topic through hearings and public discussions.  Nevertheless, the main focus of inquiries over the past eight months has been on the legality of the contests as viewed by attorneys general pursuant to state law.

Just as significant as the attorney general opinions has been the reaction of online payment processors.  Because DFS is available exclusively on the Internet, both DraftKings and FanDuel rely on those processors to direct payments made by DFS players to the issuers of the credit cards on which the payments were charged.  Thus, the processors are the foundation for the DFS platforms.  One of the largest processors is a company called Vantiv.  After the New York Attorney General concluded that DFS was illegal under New York law and issued a cease and desist letter to both companies, Vantiv, undoubtedly concerned about the UIGEA’s penalties for processing illegal gambling debts and charges, told its DFS clients that it could not accept payments from players in New York.  In December, the New York State Supreme Court granted the Attorney General’s request for a preliminary injunction stopping DFS operators from doing business in the state; however, later that same day, an appellate judge stayed the decision, allowing the businesses to continue their operations while the appeal was considered.  Concurrently, DraftKings obtained an order from a Massachusetts Superior Court judge obligating Vantiv to continue to process New York player payments.  Vantiv has since initiated its own lawsuit in New York State Supreme Court challenging the conflicting rulings in New York and Massachusetts on its ability to process DFS payments.

The reaction in Massachusetts has been significantly different.  Massachusetts has a long history with gambling, legal and illegal.  On the legal side, from the lottery, now in its fifth decade, to the more recent passage of the 2011 Expanded Gaming Act, M.G.L. c. 23K, Massachusetts has recognized and benefited from regulated gambling.  Despite a familiarity with gambling, Massachusetts, like the nation, was caught flatfooted by the meteoric rise of DFS and its associated legal questions.  During the initial flurry of official responses to DFS, Attorney General Maura Healey opined that the games did not run afoul of any state or federal laws but did constitute gambling.  Her office has since promulgated first-of-their-kind consumer protection regulations specifically applicable to DFS.  The regulations address age and deposit limits, segregation of experienced and novice players and contain a ban on automated computer “scripts,” amongst other topics.

In parallel to General Healey’s development of regulations, the Massachusetts Gaming Commission, at the behest of state legislators, researched and drafted a white paper on DFS.  This white paper addressed the history of DFS, the questions surrounding its legality (both state and federal), the universe of consumer protection issues involved and concluded by positing a regulatory framework flexible enough to address not only the challenges of DFS but also future challenges posed by other online/mobile gaming products.[2]

General Healey’s approach to DFS and the white paper both highlighted gaps in Massachusetts law that produce difficulties when one attempts to determine whether a novel gambling-like activity is legal or illegal.  While Massachusetts does have a statutory definition of “illegal gaming,” the statute, M.G.L. c. 4, § 7(tenth), is definitional only, lacking provisions for criminal or civil consequences.  Instead, those consequences are primarily found in statutes and judicial decisions concerning lotteries and betting pools.

Lotteries, as defined in numerous judicial decisions, encompass a wide range of activities sharing three common elements: “(1) the payment of a price for (2) the possibility of winning a prize, depending upon (3) hazard or chance.”  See Com. v. Stewart-Johnson, 78 Mass. App. Ct. 592, 594 (2011), quoting, Com. v. Lake, 317 Mass. 264, 267 (1944).  Numerous activities have been found to constitute lotteries, including: operation of a toy crane to win prizes, the playing of a version of “Beano” that included a combination of darts and bingo, video poker and the operation of a slot machine that solely awarded free plays.  Further complicating matters is the fact that merely because an activity includes these three elements does not immediately make it an illegal lottery.  Instead the balance of chance versus skill must be weighed by a fact-finder prior to determining whether the activity is legal or illegal.

While nearly every competitive activity includes some element of chance, the issue is highlighted in DFS contests where the DFS players cannot control the performance of the athletes that they “draft.”  DFS has never been evaluated under the skill-versus-chance test but even if it passed such an analysis it still could become entangled in the Massachusetts lottery or betting pool statutes.

A pool has been defined as “a combination of stakes the money derived from which was to go to the winner.  . . .  This does not mean, however, that all the money derived from the combination of stakes must go to the winner.  Commonly the man who runs the pool makes something out of the transaction.”  Com. v. Sullivan, 218 Mass. 281, 283 (1914) (citing the definition articulated by Oliver Wendell Holmes in Com. v. Ferry, 146 Mass. 203, 208 (1888)).  Sullivan further defines a “bet” as “the hazard of money or property upon an incident by which one or both parties stand to lose or win by chance.”  Id.  “For one to have placed a ‘bet,’ he must have taken a risk on the uncertain outcome of a particular event and, depending on the outcome, he must be entitled to receive payment from another.”  Com. v. Sousa, 33 Mass. App. Ct. 433, 437 (1992).  M.G.L. c. 271, § 17 provides that it is a felony for one to possess an “apparatus, books or any device . . . for buying or selling pools, upon the result of a trial or contest of skill, speed or endurance of man, beast, bird or machine, or upon the result of a game. . . .”  Section 16A of the same chapter makes it similarly illegal for one who “organizes, supervises, manages or finances . . . the illegal buying or selling of [such] pools.”

The typical DFS contest involves numerous participants paying their entry fees to a company, the company taking a percentage of the total entry fees and the winner being paid from the company’s coffers.  Such contests bear more than passing resemblance to the betting pools found to be illegal in Sullivan and thus have potential application to DFS operators.  But that conclusion is not certain nor is it certain that either the lottery or pool statutes that originated in the 18th and 19th centuries apply.

The complexities, gaps and uneasy fits just described are largely the product of a regulatory scheme created for a different era and never updated.  In that era, bookmakers kept books, or at least paper records, on which accounts, wagers and payoffs were recorded by hand.  Lotteries were mainly paper affairs in which the winner was determined by drawing a paper ticket out of some sort of container.  Pools typically were tangible collections of cash and chits kept in some identifiable place within the Commonwealth’s borders.

The Internet has changed much of that, just as it has changed so much else.  Now horseracing fans in the United States can place real-time bets on races that occur throughout the nation and the world.  Outside the United States, legalized sports betting over the Internet is a huge business.  It is a huge business inside the United States, too, though most of it is illegal and therefore clandestine.  This year, sports fans will be able to watch live eSports events on ESPN, in the process joining the estimated 100 million international monthly viewers who now watch, and often bet on, Internet broadcasts of those video game contests that are complete with play-by-play announcers and color commentators.  Social gaming, i.e., gambling and other Internet games in which the prizes theoretically cannot be redeemed for tangible benefits, is an industry that now produces annual revenues in the vicinity of $30 billion.  It is likely that those revenues will continue to grow as new games and game concepts are added.  It is also likely that questions about whether the games do or do not produce tangible benefits for the players will become increasingly complex.  Prediction markets, increasingly popular as the election season proceeds, essentially allow participants to bet on the outcome of future events.  Those events are mainly, though not exclusively political in nature, but there is no reason why their reach cannot expand.

Any list of gambling-like activities available on the Internet is likely to require quick revisions, for the Internet environment is highly dynamic.  The rewards for successful innovation can be enormous and launching a new concept requires only a laptop and a new idea.  The low barriers to entry and the speed with which new activities can and will be launched pose significant challenges.  Indeed, under the current regulatory framework, it is entirely possible that gambling or gambling-like activities can be deployed and operating for substantial periods before they attract any regulatory attention.  Moreover, as the current national examination of DFS reveals, many such activities will inevitably raise one or more of a series of questions.  Among them is whether the activity amounts to “gambling” and, if so, whether the activity is illegal.  If it is illegal, why should it be, particularly in Massachusetts, where residents annually spend $700 per capita gambling on the state-sponsored Lottery?  If the activity is not gambling or if it is but it is not illegal, is some form of regulation nevertheless necessary or is the activity so transparent or low risk that no regulation is required?  If regulation is required, what form should the regulation take?

Perhaps the most important question, though, concerns who should answer those questions.  The Legislature is the obvious candidate but the Legislature typically is engaged in deliberative policy-making that by its very nature takes time. There is a real question whether a legislative determination, particularly on an activity-by-activity basis, can keep pace with the issues that will likely require exploration.  State and local law-enforcement agencies could answer at least some of the questions through application of the criminal law, though that approach uses a blunt instrument to deal with what are likely to be nuanced issues.  Moreover, inaction by law enforcement presents at best an ambiguous answer to questions about whether an activity is or should be legal.  The Attorney General and other existing agencies with responsibility for consumer protection could deal with consumer safety through issuance of regulations, as General Healey has done in the case of DFS in Massachusetts, but that process is reactive and may be insufficiently nimble to keep up with the pace of change.  The Massachusetts Gaming Commission has observed that the dynamic nature of the Internet, the desirability of a comprehensive approach to Internet gaming-like activity and the need for right-sized regulations that protect the public without stifling creativity suggest the desirability of a single regulatory body charged with oversight of all such activity.

However those questions are answered, one thing is certain: The issues recently raised by the advent of DFS are going to recur, perhaps at an increasing pace, as we move forward in the Internet age.  With that certainty in mind, now is an opportune time to create a framework for rapid and thoughtful exploration of the questions each new type of activity will inevitably raise.  To be successful, that framework must provide for prompt decisions about whether the activity is legal.  It must also provide for prompt decisions about whether specific regulations are needed to deal with unique issues the activity presents or whether existing regulations of general applicability will suffice.  If specific regulations are needed, the scheme must also provide for prompt deployment of right-sized regulations to deal with unique issues of concern while not unduly discouraging the creative entrepreneurial spirit the Internet demonstrably produces.

James F. McHugh is a retired Massachusetts judge and a retired member of the Massachusetts Gaming Commission.

Justin G. Stempeck is a former civil litigator and current staff attorney with the Massachusetts Gaming Commission.

[1] To date attorneys general in Georgia, Alabama, Tennessee, Michigan, Mississippi, New York, Hawaii, Texas, Vermont, Illinois and South Dakota have all opined that DFS is illegal under their respective state’s law.  Nevada’s attorney general also opined that DFS was gambling under state law, but, like any other gambling, would be legal with the appropriate gaming license.  In contrast, the attorneys general in Rhode Island and Massachusetts have opined that DFS is legal under the law of their respective states.

[2] The full whitepaper is available at: http://massgaming.com/blog-post/blog-post-the-massachusetts-gaming-commission-submits-daily-fantasy-sports-white-paper-to-the-legislature/.

 

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