An Overview of the NY AG's Demands On FanDuel and DraftKings
Anyone who has turned on their television in the past year is likely familiar with the business model of DraftKings, Inc. (“DraftKings”) and FanDuel Inc. (“FanDuel”). In case you have missed the numerous advertisements, both FanDuel and DraftKings run daily fantasy sports (“DFS”) promotions where contestants pay varying entry fees for the opportunity to receive cash prizes based upon the performance of their fantasy team in a given day. DFS promotions have exploded in popularity in the blink of an eye. FanDuel was founded in 2009 and, according to the FanDuel web site, it now has over one million registered users, has paid out $560 million in 2014 alone, and has received over $350 million in venture funding. Its junior, DraftKings, founded in 2012, promises over $1 billion in payouts this year according to its web site. Both companies have brokered partnerships with professional sports leagues and teams as well as other industry leaders. Recently, however, DFS companies, including, most prominently, FanDuel and DraftKings, have come under fire due to allegations (among other reasons not discussed in this post) that DFS constitute illegal gambling under certain state lottery and gambling laws and, also, the federal Unlawful Internet Gambling Enforcement Act of 2006 (“UIGEA”).[i] DraftKings asserts on its website that it is “100% legal” because 45 of 50 states[ii] and the federal government consider one-day daily fantasy sports a legal game of skill, but both federal and state regulators and enforcement agencies are beginning to question this assertion. Most recently, on November 10, 2015, the New York State Attorney General (“NY AG”) issued cease and desist letters to DraftKings and FanDuel demanding that both parties stop accepting entry fees (or “wagers”, according the NY AG) from New York residents. The NY AG’s action follows closely behind an October 15, 2015 Nevada Gaming Control Board (“NGCB”) notice which asserted that DFS constitute gambling under Nevada law and, therefore, must be licensed by the NGCB. Further, according to a recent Wall Street Journal report, both companies are under investigation by the FBI and Department of Justice to determine whether DFS violate the UIGEA.
WHAT MAKES A PROMOTION ILLEGAL GAMBLING?
As background, a promotion will be found to be an illegal lottery, i.e., illegal gambling, if all of the following three elements are present:
- Mandatory consideration (g., payment of money, purchase of a product, etc.); and
A private sector company that wants to offer a prize promotion must remove one of the three lottery elements to avoid violating state lottery and gambling statutes. Determining the presence of prize and consideration are usually relatively straightforward whereas it may be more difficult to ascertain whether chance is present. In part, this is because states take a wide range of approaches to determine what constitutes a skill contest versus a game of chance. The tests used by states generally fall into one of the following four categories: “pure chance”, “predominant element”, “material element”, and “any chance” taints. Each test can be summarized as follows:
- Pure Chance Test. A minority approach is the “pure chance” doctrine under which a promotion must be solely based on chance to be an illegal lottery. The exercise of any skill by a participant removes the promotion from within the definition of a lottery and it will instead be viewed as a game of skill.
- Predominant Element Test. The majority of jurisdictions apply the “predominant element” test. This test evaluates the relative degree of skill and chance present in the game; if the element of skill predominates over chance, then the game is likely permitted.
- Material Element Test. In several jurisdictions, a promotion will be prohibited if chance plays a “material” role in the outcome. A jurisdiction using this test would prohibit wagering on the game if chance has more than a mere incidental effect on the game, even if skill primarily influences the outcome of the game. This is a stricter standard than the “predominant element” test and makes it more difficult to offer skilled-based gaming if the games in question resort to a chance component in determining the outcome. New York adheres to the material element test.
- Any Chance Test. A small number of jurisdictions apply the “any chance” test. In other words, if any chance is present in the promotion and there is a charge to play, then the promotion becomes an illegal lottery. Certain (but not all) of the Excluded States adhere to the “any chance” test.
Further, certain states (e.g., Montana) explicitly prohibit fantasy sports or, more generally, pay to play contests by statute.
With respect to federal law, the UIGEA generally prohibits online gambling but makes an exception for online fantasy sports where (among other requirements) the “winning outcomes reflect the relative knowledge and skill of the participants and are determined predominantly by accumulated statistical results of the performance of individuals (athletes in the case of sports events) in multiple real-world sporting or other events.”[iii]
ON WHAT BASIS DOES THE NY AG ALLEGE THAT DFS ARE ILLEGAL GAMBLING?
In the cease and desist letters, the NY AG concluded that both FanDuel and DraftKings run gambling operations that are illegal under NY law (pursuant to N.Y. Penal Law § 225.000 et seq. and N.Y. Const. Art. I, § 9) and demanded that both cease and desist from accepting “wagers” from NY residents. Under NY law, “a person engages in gambling when he stakes or risks something of value upon the outcome of a contest of chance or a future contingent event not under his control or influence” and a “contest of chance” exists where winning or losing depends on elements of chance to a “material degree” (i.e., NY adheres to the “material element” test discussed above) (N.Y. Penal Law § 225.00(2), see also N.Y. Gen. Bus. Law § 369-ee). Under NY law, those who operate illegal gambling enterprises are subject to criminal prosecution, but the individual gamblers are not.
The NY AG distinguished DFS from traditional fantasy sports stating: “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.” The letters allege that, unlike traditional fantasy sports, FanDuel and DraftKings are engaged in illegal gambling because the fees paid by participants are actually bets that “depend on the real-world performance of athletes and numerous elements of chance” and because each party in its respective business controls the prize amounts, sets the variables (e.g., player “salaries”), advertises easy game play with big payoffs, stresses the lack of long term strategy needed, and profits directly from the wagers (i.e., by taking a cut of the entry fees paid by participants). Also for these reasons and because “a small number of professional gamblers profit at the expense of casual players”, the letters assert that DFS are more akin to (and, therefore, pose the same public health and economic risks as) poker and traditional gambling.
Notably, the letters point out that Washington state’s definition of gambling is substantially the same. Like NY, Washington adheres to the “material element” test. As noted herein, Washington is (and always has been) one of the Excluded States for both companies and Washington state regulators and its Attorney General’s office have consistently challenged the legality of all fantasy sports (traditional and DFS).
Finally, the NY AG letters lay the ground work for bringing a lawsuit against each company for their advertising campaigns, which the letters allege deceive and mislead consumers as to the prospects of winning large sums of money.
Both parties vehemently deny that their activities constitute illegal gambling and each quickly stated their opposition to the NY AG's position. On Friday morning, both FanDuel and DraftKings filed actions seeking declaratory and injunctive relief in the New York County Supreme Court.[iv] At least for the time being, however, FanDuel has stopped accepting deposits from NY residents.
Given the high level of market exposure that FanDuel and DraftKings have experienced recently, it is not surprising that they are the subject of multiple enforcement investigations. It remains to be seen whether DFS companies will be able to persuade regulators and enforcement agencies that DFS are in fact games of skill that do not constitute illegal lotteries. This is something that we will continue to watch.
[i] Generally speaking, the provisions of the UIGEA are applicable only to payment processors.
[iii] A bill recently introduced in Illinois (HB 4323 and SB 2193) that aims to exempt fantasy contests from the state’s criminalization of gambling contains nearly identical language.
[iv] DraftKings’ filing also includes numerous other causes of action based on, among other things, violations of the U.S. and NY Constitutions.