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