By: Christopher Hughes*
“What a man does not know and cannot find out is chance as to him, and is recognized as chance by the law.” Justice Oliver Wendell Holmes, Dillingham v. McLaughlin, 264 U.S. 370, 373 (1924).
It is late Saturday evening and you see a television commercial: for a small fee, you can potentially be $1 million richer within 24 hours based on your “fantasy team.” How can you turn down the opportunity of making a huge return on such a small investment? What you may not see is the fine print at the bottom of the screen saying average winnings are only $22 and the number of winners is a small percentage of total entrants. While many participants see this as an innocent game, a debate is playing out across the nation, from whether these games are legal, to if they are, how they should be regulated, as well as, what consumer protections need to be established while appropriately regulating a new technology industry.
I. What is Daily Fantasy Sports?
Fantasy sports are games where the participants, acting as “owners,” draft rosters of simulated teams composed of actual players. The owners compete against each other based on the statistical performances of the actual players in actual games, which are then calculated to fantasy points. Fantasy sports are generally divided into two types: (1) traditional fantasy sports, which track player performance through the majority of a season (with the concluding weeks usually comprising the fantasy league’s playoffs); and (2) daily fantasy sports (DFS), which track player performance for a single game (i.e. one Sunday of the NFL schedule). Rather than playing individual head to head match ups through a season as traditional fantasy sports operate, DFS sites collect fees from owners to compete against dozens if not hundreds of opponents at once, with prize pools of $2 million.
In 2014, 1.5 million Americans paid more than $1 billion in DFS tournament entry fees. The two largest DFS operators are DraftKings and FanDuel, with the two companies receiving 7.1 million entries to their guaranteed prize pool tournaments for NFL games played on October 11, 2015, generating $43.6 million in entry fees.
Recent events have led to increasing scrutiny by lawmakers, regulators and the public of DFS sites as a result of advertising large potential payouts, and reports of DFS operators’ employees winning large sums by using information not generally available to the public.
II. Federal Law’s Prohibitions on Financial Transactions Related to Illegal Wagering and the Exclusion for Fantasy Sports
The Unlawful Internet Gambling Enforcement Act (UIGEA) of 2006 prohibits the acceptance of any financial instrument in connection with unlawful gambling. The primary purpose of UIEGA is to supplement “traditional [gambling] law enforcement mechanisms” and to facilitate the regulating of “gambling prohibitions or regulations on the Internet, especially where such gambling crosses State or national borders.” However, UIEGA specifically excludes participation in fantasy sports leagues where the teams are not based on the current membership of an actual team and meets certain conditions as wagers. While some argue this legalizes fantasy sports, it simply means the financial transactions related to fantasy sports are not criminalized.
III. Daily Fantasy Sports on the Front Page
Daily fantasy sports operators have found themselves in a brighter spotlight in recent weeks, and not just because of their prevalent advertising, but also a result of numerous reports of what resembled insider trading and regulatory bans.
A. Use of Insider Information
In early October 2015, reports emerged of an employee of DraftKings who won $350,000 on FanDuel the previous week. The same employee posted online “player owned percentages” only available to company employees while games were still being played. Owners with access to this data could hypothetically use this information to make tactical decisions to matchup better against players without it. Employees of both companies have been regularly ranked among the most consistent winners of DFS contests. Following these revelations, both companies, as well as the Fantasy Sports Trade Association (FSTA), issued statements regarding employee integrity, while banning employees from playing any DFS games on any site for money.
Subsequently, DraftKings hired Greenberg Traurig, LLP, to conduct an internal investigation of the allegations the employee at issue improperly utilized information. The law firm concluded the employee could not have possibly entered the winning lineup based upon receipt of the player owned percentages since the lineup was submitted nearly ten hours before he received the information, and the information was provided forty minutes after lineups were locked. However, the report did not address any other instances where employees may have utilized proprietary data to their advantage.
B. Regulatory Activity
Before considering how New Jersey should approach the question of regulating DFS operators, it is appropriate to consider ongoing regulatory and legislative activity from other jurisdictions.
New York Attorney General
Following the reports of DFS operators’ employees’ potential usage of insider information, the New York Attorney General asked DraftKings and FanDuel for internal data and details on how they prevent fraud. On November 10, 2015, New York Attorney General Eric Schneiderman issued cease-and-desist letters to both DraftKings and FanDuel. In letters to the CEOs for both companies, the Office of the Attorney General explained the wagers met the New York definition of gambling since “bettors make bets (styled as “fees”) that necessarily depend on the real-world performance of athletes and on numerous elements of chance” with winning bettors receiving large cash prizes while the company takes a cut, or “rake” from each wager. While both companies sought injunctions and a temporary restraining order on the Attorney General from taking action, the court initially denied these motions. However, an appellate court judge later ruled the companies would be irreparably harmed and granted them a temporary stay.
Massachusetts Attorney General
The Attorney General of Massachusetts has indicated DFS are legal and criminal charges would not be pursued, and subsequently proposed regulations designed for the purpose of consumer protection.
United States Senator Bob Menendez and Congressman Frank Pallone, both from New Jersey, requested the Federal Trade Commission (FTC) “explore and implement safeguards to ensure a fair playing field for fantasy sports enthusiasts who participate in daily or weekly games.” Their letter to FTC Chairwoman Edith Ramirez asked whether the FTC has jurisdiction to promulgate additional regulations in line with UIGEA to include safeguards against potential insider use of information by employees or whether additional legislation would be necessary. The legislators also inquired whether DFS operators’ employees with access to nonpublic information would give those individuals advantages and if so, whether this constituted an “unfair or deceptive practice” pursuant to federal law.
The Wall Street Journal also reported the United States Department of Justice (DOJ) and the Federal Bureau of Investigation (FBI) have begun contacting customers of DraftKings to examine whether their experiences resembled a form of gambling outside the purview of the fantasy sports exemption contained in UIGEA.
Nevada Gaming Control Board Ban
On October 16, 2015, the Nevada Office of the Attorney General issued a memorandum opining on the legality of DFS: specifically, do DFS constitute gambling games, sports pools, and/or lotteries pursuant to the Nevada Gaming Control Act and Gaming Commission Regulations? Ultimately, the Attorney General advised the Nevada Gaming Control Board that DFS constituted both gambling games and sports pools under Nevada law and required licensure.
Nevada’s broad definition of gambling games and sports wagering make no distinction between games of skill and games of chance, thus the level of skill or chance is not relevant in determining whether DFS constitutes a gambling game or sports wager. The Nevada opinion relies on wagers by players are present in some form, fitting the statutory construct, to play a game (or sports wager), for the possibility of receiving any representative of value.
Following Nevada’s actions, the Illinois Gaming Board announced it was seeking the opinion of the Illinois’ Attorney General whether DFS websites violated state law. Subsequently, Illinois Rep. Michael Zalewski announced his proposal to introduce legislation to establish rules governing the DFS operators. The legislation defines what constitutes a “fantasy contest,” requires DFS operators to implement certain policies and procedures, and exempts these type of contests from the criminal definition of gambling. However, no specific provision is included subjecting any portion of funds retained by the operators to taxation. On December 23, 2015, Illinois Attorney General Lisa Madigan determined daily fantasy sports constituted illegal gambling pursuant to Illinois law “absent legislation specifically exempting daily fantasy sports contest from the gambling provisions….”
Daily fantasy sports operators comprising the membership of the FTSA recently announced the creation of a self-regulatory body called the Fantasy Sports Control Agency (FSCA). The organization’s head described the entity as a “freestanding ethics and integrity agency.” The FTSA empowered the FSCA to: (1) develop a set of standards; (2) establish a system of company control, processes and leadership for compliance; (3) implement auditing policies and principles; and (4) establish a system of enforcement which penalizes failures and incentivizes compliance.
IV. New Jersey Law: What Should Daily Fantasy Sports be Classified As?
A. What is Gambling in New Jersey?
The Supreme Court of New Jersey has articulated the standard by which an act is defined as gambling, which is based on the “playing for money or other valuable thing.” The three essential elements of gambling are: (1) consideration; (2) chance; and (3) prize. The Court has held games played for stakes and involved the hazarding of money on uncertain events constitutes gambling, regardless of whether skill or chance predominated, and are thus illegal.
Current criminal code defines “gambling” as “staking or risking something of value upon the outcome of a contest of chance or a future contingent event not under the actor’s control or influence, upon an agreement or understanding he will receive something of value in the event of a certain outcome.” Included is “the formation of pools…in which monies are divided based upon the results of the tournament.” This fits the current civil definition of unlawful gaming transaction in New Jersey which includes “all wagers, bets or stakes made to depend upon any race or game, or upon any gaming by lot or chance, or upon any lot, chance, casualty or unknown or contingent event….” The Casino Control Act also defines “gaming” or “gambling” as “the dealing, operating, carrying on, conducting, maintaining or exposing for pay of any game.”
However, when the New Jersey Division of Gaming Enforcement (DGE) permitted fantasy sports tournaments in Atlantic City casinos it specifically exempted conducting fantasy sports tournaments from the definition of “gaming” or “gambling” as well as excluded any entry fee, management fee or any other revenue generated from conducting a fantasy sports tournament from the definition of gross revenue for taxation purposes. Thus, while all other types of wagers are considered gaming or gambling by statute or judicial case law, fantasy sports wagering is not via administrative regulation. While DGE adopted regulations more than two and a half years ago, as of today, no Atlantic City casino has offered fantasy sports.
B. Is Daily Fantasy Sports a Contest of Chance or a Contest of Skill?
Operators of DFS sites argue their games are skill competitions, rather than games of chance; thus, they should not be subject to gaming laws. To determine whether fantasy sports are games of skill or a game of chance, one must consider a number of factors.
Academic research has shown seasonal and perennial fantasy sports leagues which initially allocate players via a traditional auction or draft are driven primarily by skill.
Conversely, fantasy leagues lasting for less than a full professional season, involve substantially greater levels of chance than full season leagues, because there is not a sufficient period of time for participants to utilize strategic skills. The unanticipated loss of a player due to injury or other circumstance preventing their usage is the most significant chance element placing a team at a disadvantage and cannot be addressed once a DFS contest begins. This appears no different than the flip of a card in a poker game or a horse injuring itself out of a starting gate; both of which are contests of chance, not skill. DFS games appear to fit into this type of scenario as games of chance, since the shorter the season, the unpredictability increases.
While Nevada’s analysis declaring DFS constitute gambling games and sports pools is not determinative of whether the same finding exists pursuant to New Jersey law, it does provide analogous situations. Nevada applies the “dominant factor test,” which determines whether a game is one of chance or skill. The test does not rely on whether the game contains an element of chance or an element of skill, but which is the predominating element. New Jersey’s test of determining which factor dominates focuses on whether a player possessing average skill would be successful more often than not, which is a lower standard.
New Jersey statute only formally defined “contest of skill” in 2014. The statute defines it as:
[A]ny baking or photography contest, and any similar contest that is approved as a “contest of skill” by the Attorney General, provided that the winner or winners are selected solely on the quality of an entry in the contest as determined by a panel of judges using uniform criteria to assess the quality of entries.
Excluded from the definition of “contest of skill” is “any contest, game, pool, gaming scheme or gaming device in which the outcome depends in a material degree upon an element of chance” and “any casino game, any sports wager or sports wagering scheme, or any Internet gaming of any kind.”
This exclusion comports with the New Jersey statutory definition of a “contest of chance” as “any contest, game, pool, gaming scheme or gaming device in which the outcome depends in a material degree upon an element of chance, notwithstanding that skill of the contestants or some other persons may also be a factor therein.” The courts have clarified the skill factor involved in a game is not determinative of the issue of whether chance plays a material role in the outcome of the activity for purposes of determining whether something constitutes gambling. The court further rejected the inclusion of a dominant element standard, or the “dominant factors test”, into the statute for determining whether an activity is gambling. In fact, the court stated the proper focus is not the level of skill, but whether any element of chance is a factor to the final result.
Even applying a “dominant factors test” requires a DFS operator to demonstrate unskilled contestants may enjoy a rare victory, while the contestants’ skills normally determine winners; however, the number of contests must be accounted for. Along these lines, some DFS operators point out they “have consistent winners”; however, consistent winners alone are not necessarily enough to prove a contest is skill-based. While during the first half of the 2015 Major League Baseball Season, 91% of all DFS profits were won by just 1.3% of players, this data actually places DFS into the New Jersey definition of a “game of chance” since the average or novice player in the long run would end up losing more than he could gain.
While DGE regulations require the winning outcome of a fantasy sports tournament to reflect the relative skill of the participating patrons, the New Jersey statutory definitions and case law remain. The current statutory requirements defining a “contest of skill” are so narrowly tailored, DFS cannot be classified as one as they rely on other individuals’ performances, which could be affected by any number of unpredictable elements.
Similarly, the expansive definitions of “contest of chance” and “gaming” or “gambling” appear to include DFS games, thus subjecting them to regulatory oversight.
V. Impact on Marketplace
As no casino in New Jersey currently offers fantasy sports or sports wagering, it is difficult to estimate the actual impact daily fantasy sports would have on the State’s gaming marketplace. The best approximation can be based on Nevada’s gaming activity prior to the decision requiring DFS operators to be licensed.
According to the American Gaming Association, since DraftKings and FanDuel were founded, wagering at Nevada sports books has increased annually, from $2.55 billion in 2009 to $3.9 billion in 2014. 2015 wagers are estimated to increase by 14.6% from 2014, bringing total sports wagering in Nevada to almost $4.5 billion.
However, unique differences must be recognized when comparing the gaming marketplaces of Nevada and New Jersey. Nevada has an operating sport book; while New Jersey does not. The only available data showing economic gains tied to DFS are related to sports wagering. Individuals who either travel to Atlantic City to participate in onsite DFS wagering or conduct it through the Internet may be induced to wager on other gambling games, which would benefit the Atlantic City marketplace. This impact could be more pronounced if New Jersey is successful with its current legal challenge to permit unregulated sports wagering at casinos and horse tracks.
The week following the scandal, FanDuel earned a 16% profit, while DraftKings earned a 10.6% profit. Averaging the figures together and applying it to the $43.6 million in entry fees paid, equates to approximately $5.8 million in profits. This amount is the equivalent of New Jersey’s definition of “gross revenue.”
If these gross profits were taxed like other casino revenues in New Jersey are, this amount would either be subject to a 8% gross revenue tax along with a 1.25% investment alternative for bets placed in person, or a 15% gross revenue tax and 2.5% alternative investment for bets placed through the Internet totaling $536,500 or $1.015 million in tax revenue, respectively (this assumes all betting was processed through a New Jersey casino and thus the wager originated in New Jersey). If one considers the proportion of New Jersey residents to total population nationwide (2.8%), the total weekly tax revenue would be between $15,022 and $28,420, which translates to at least between $781,144 and $1.48 million in annual tax revenue to New Jersey.
VI. Potential Remedies
A. Regulate and Realize Revenue
Regulations currently dictate how poker revenue is calculated in New Jersey. This is important, since poker games between players, hosted by a casino, appear to be the most analogous casino game to a fantasy sports pool. Poker revenue is calculated by extracting a commission known as the “rake,” which is the subject to the gross revenues taxes. Poker games, which rely on both skill and chance, thus provide a model to how DFS should be regulated and taxed.
Any taxes on gross revenues of these operations would provide “funding for reductions in property taxes, rental, telephone, gas, electric, and municipal utilities charges of eligible senior citizens and disabled residents of the State, and for additional or expanded health services or benefits or transportation services or benefits to eligible senior citizens and disabled residents….” Thus, the amount above (or any other amount derived from DFS wagering) could be applied these types of programs.
B. Regulate and Lose Potential Revenue
Legislation to regulate daily fantasy sports has been proposed in New Jersey. The proposal allows a casino licensee or a DFS provider to operate a DFS game, while setting certain parameters. The requirements include: (1) the outcome must be determined by statistics generated by actual individuals participating in real professional or collegiate athletic events; (2) all prizes offered must be established and disclosed in advance to all participants; and (3) the outcome cannot be solely based on the performance of one athlete or of a single team or combination of real teams. The proposal classifies DFS games as a game of skill, not a game of chance, and resembles the current regulations excluding any entry fee, management fee, or other revenue generated from a game from gross revenue. Such a proposal treats DFS different than any other game offered by casinos in New Jersey and essentially ignores almost all current law on the matter. Furthermore, such an approach deprives the State of potential revenue which could be dedicated to senior citizens and disabled residents as described above. This anticipated legislation appears to be what the DFS industry supports: a semi-regulated industry subject to no gaming taxes.
C. Declare DFS as Unregulated
A final option would be the most complex and potentially involves repealing all statutes related to games of chance and skill, thus nullifying any gambling prohibitions, thus legalizing DFS. This represents the least feasible option as it would then allow gambling outside of currently regulated facilities in New Jersey by unlicensed entities. This could also run afoul of the state constitutional limitations on how gaming is regulated by leaving no regulatory structures in place.
New Jersey, home to the second largest gaming marketplace in the nation, has an opportunity to protect consumers, while fostering a vibrant growing marketplace. At the same time, the appropriate classification of DFS as gambling should occur. While some may fear this will result in residents not being able to play these games, which is far from the truth. Simultaneously, the State should take the opportunity to design a regulatory framework, applying existing standards for regulating gaming and taxing gross revenues, whether from an in-person or Internet wager, and apply it to DFS operators, allowing the State to protect consumers, while also realizing revenue for valuable programs supporting vulnerable populations, all while not permitting a gambling enterprise to operate in a regulatory vacuum.
*Christopher Hughes received his J.D. from Rutgers School of Law - Camden in 2015. He served as Managing Notes Editor for the Rutgers Journal of Law and Public Policy from 2014-2015.