Meteoric rise of daily fantasy sports causes lawmakers to consider regulation, perhaps taxation
Oct. 26, 2015
Inside a banquet hall at the Bellagio casino in January, a record turnout at the Fantasy Sports Trade Association’s Winter Conference in Las Vegas listened intently as Tom Walls, a lobbyist from mega-firm Dentons, offered up a message of caution in a room teeming with optimism about the sudden rise of daily fantasy sports.
He warned that a “public perception” problem might soon be at hand, if the burgeoning industry and its two giants, FanDuel and DraftKings, were to provoke lawmakers who struggled to distinguish between daily fantasy sports (DFS) and traditional sports betting. Another lobbyist on the panel, Ryan Brennan of Advantage Capital Partners, cautioned that “a tremendous” amount of lawmakers at the state level were “new and uneducated,” when it came to understanding fantasy sports.
Even while all indications seemed to suggest states were trending toward liberalization, those in the room needed to be mindful of appearances, Walls urged. The nascent industry was still vulnerable.
“Everybody needs to really think about who’s listening when you speak,” he said.
Ten months later, after daily fantasy’s meteoric rise into a billion-dollar industry far outpaced expectations, bludgeoning its way into the public consciousness with multi-million-dollar ad blitzes and high-powered corporate sponsorships, the perception problem attendees were warned of that day has become a grim reality. A data leak at DraftKings in early October – characterized as “insider trading” in the initial New York Times report – has turned the industry on its head, galvanizing lawmakers across the country, at every level of government, to launch investigations and jump-start regulatory legislation.
An independent law firm commissioned by DraftKings ultimately found that employee Ethan Haskell, who accidentally published ownership data and then subsequently won $350,000 on rival site FanDuel, could not have seen the data in question prior to his entry locking. But the public relations damage already had been done.
Class-action lawsuits have since piled up. The FBI began probing the industry. A U.S. Attorney’s office in Florida has delivered subpoenas to the FSTA among others, and another U.S. Attorney in New York, known most for bringing down the online poker industry, is also looking into the industry. Last week, the Nevada Gaming Commission took the harshest step yet, deeming DFS as gambling, which requires an expensive license to operate in the state. Before the dark clouds subside, other states might join Nevada.
“It’s difficult to imagine a tougher test of the viability of DFS than what we’re seeing right now,” LegalSportsReport.com publisher Chris Grove said.
Negative attention has been unending, with the industry’s two giants at the center of it all, patiently calculating their next move. The widely held assumption is that any penance will include extensive – and ultimately expensive – regulatory measures, at which the industry has mostly bristled since its inception.
That tune has changed, however, in the midst of intense scrutiny. Daily fantasy insiders say the FSTA plans to break its silence to release its own plans for regulation. NBA commissioner Adam Silver, whose league has a partnership with FanDuel, has voiced his hopes for regulatory measures. Even DraftKings CEO Jason Robins has said publicly that his company is “open” to the idea. Concerns, though, persist that hopes of a moderate regulatory response might now be for naught. Extensive regulation, some contend, could cripple the industry. Others wonder if a shutdown is on the horizon.
What measures should be taken will be debated in the coming months. But among legal experts and industry insiders, there is almost universal agreement that the precipitous rise of daily fantasy could have been executed far more carefully by its two industry leaders, who ignored warnings and bypassed oversight as their start-ups grew into a billion-dollar duopoly.
PERCEPTION PROBLEMS
Tommy Gelati was at his local barbershop in New York last week when conversation turned to daily fantasy and the DraftKings data leak. As his barber understood it, an employee had cheated by changing his lineup after results were available. Others in the barbershop seemed to agree.
“That’s what an uninformed mind thinks when they hear ‘insider trading,’” said Gelati, who is one of the more visible, high-stakes players in the DFS industry. “People are looking at this as gambling and betting with fixed results.”
This misrepresentation has Gelati fuming at what he feels have been sensationalist media accounts of what’s going on in the industry. He worries that misinformation could unnecessarily damage the industry. And as the attacks pile up, Gelati has been increasingly tempted to lash out and speak on behalf of the industry – the leaders of which have been mostly silent over the past few weeks.
“You just can’t trust anything you see right now,” he said.
Industry players have come to daily fantasy’s defense, in hopes of staving off more scrutiny. Some have even expressed sympathy for DraftKings and FanDuel, characterizing their missteps as growing pains of start-ups that grew unprecedentedly fast. Others, Gelati included, assign at least some blame to the industry’s two leaders for perpetuating an ego-driven competition that saw the public overwhelmed with advertisements and ultimately led to that dangerously eager growth.
The industry does seem to be in agreement on welcoming regulation. The widespread concern now is whether those open arms might be too late.
“Had a lot of the companies taken the right steps to regulate it initially, it could’ve been regulated by competent people,” Gelati said. “My fear now is that it’s going to be regulated by the government or the states, who don’t have the first idea about how any of this stuff works. They’re going to take it from the far right to the far left. Different problems, but the same issues.”
The FSTA, which declined comment for this story, is expected to introduce a plan for self-regulation this week, which might include a third-party regulatory board. But multiple legal experts who spoke with the Register agreed that, while it is an adequate starting point, it would not be enough.
“A day late and a dollar short,” LegalSportsReport.com’s Grove said.
Many of the issues now under the microscope, Gelati said, were brought up by daily fantasy players in the past, but ignored. Several players openly questioned whether DFS employees should be prohibited from playing on other sites – a rule that has been put in place since the data leak. Concerns were also brought up by some about the sheer amount of entries high-stakes players could play, as well the algorithms many top players use to maximize efficiency. In some cases, up to 1,000 entries were allowed in single contests, which gives an implicit advantage to those playing a high volume.
“When you thought about it, just a little bit, they probably all would’ve agreed that these were bad ideas,” said Kevin Braig, an Ohio attorney who specializes in government regulation. “The daily fantasy industry has been astoundingly immature in its approach to this. It’s like children. You let children just go out and run the gambling world. It was pretty predictable there were going to be problems.”
Tension and mud-slinging among executives at both FanDuel and DraftKings have long been apparent to those within the industry. In separate August interviews with the Register, Robins boasted about surpassing FanDuel in market share, while FanDuel co-founder Tom Griffiths asserted that DraftKings was “pushing the legal envelope aggressively.”
At a recent FSTA meeting in New York, FanDuel CEO Nigel Eccles went as far as to publicly challenge Robins on his choice to include legally questionable daily fantasy offerings in golf and NASCAR on DraftKings, to the surprise of many in attendance.
Players had expressed concern before that the competition-fueled animosity between FanDuel and DraftKings would get in the way of the long-term health of the industry. Now, some agree it has played a part in the controversy the industry is facing.
“DraftKings and FanDuel never looked at this as, ‘We can be Pepsi and Coke,’” Gelati said. “They always looked at it as one of us is going to win and one of us is going to lose. … It just became such a pissing match that they lost sight of the actual goal, which is to keep this industry solvent and fun for everyone.”
Insiders say the two companies are finally presenting a united front. But players remain universally concerned about what’s to come. They wonder about a future in which small DFS operators shut down, unable to afford regulatory fees, while the industry giants drop prize pools, slowed by bureaucracy. For the moment, though, most agree that future doesn’t include a full-scale tear down, such as what happened with the online poker industry.
“Some regulation could be very useful,” said Jeff Mans, who hosts “Fantasy Alarm” on SiriusXM radio and is a high-profile player. “None of us, not even the guys running these companies, really expected daily fantasy to become this multi-billion-dollar industry, especially this quickly. Sometimes, you need help. We need to look at this in a positive way.”
THE REGULATION DEBATE
When asked about the potential for regulation in August, Paul Charchian, the president of the FSTA, didn’t mince his words.
“Regulation and taxation would severely damage the industry,” he told the Register. “The daily fantasy providers are not profitable. Pushing a significant level of bureaucracy and taxation into the fold could severely damage the ability for those companies to do business like they are now.”
Of course, the industry will likely never return to how it operated before the current firestorm of controversy. But the question of how daily fantasy might be regulated does have serious implications for its survival. And at this point, it remains mostly uncertain.
Assuming federal investigations don’t freeze the industry, how daily fantasy is defined will almost certainly be decided on the state level. Even as daily fantasy proponents have held up the sanctity of a fantasy sports carve-out in the Unlawful Internet Gambling Enforcement Act of 2006, legal experts agree that it will offer little safe harbor from states that determine DFS to be gambling and not “a game of skill.”
Twelve state legislatures already have introduced bills that pertain directly to fantasy sports, including California, where a bill fromAssemblyman Adam Gray(D-Merced) would require licensing by the Department of Justice and a tax on gross income, but does not define DFS as gambling. Gray, who introduced the Internet Fantasy Sports Game Protection Act in September before controversy arose, said he simply wanted to “start the discussion” but that parameters were clearly needed within the industry. California legislators will hold an informational hearing in December to gather facts on the issue.
“When you have this kind of gaming and this kind of money, there’s a reason we regulate this stuff,” Gray said. “In California, church fundraisers for bingo are regulated. There’s a reason for that. You want to make sure that these games are being conducted fairly and that there are consumer and legal protections and restrictions on age participation for kids. All of those things are very important.”
Challenging daily fantasy’s definition on a state-by-state basis would be “extremely expensive and time-consuming,” explained I. Nelson Rose, a gaming law expert and professor at Whittier College.
But avoiding that process, according to Rose, likely would mean the industry throwing itself on the sword by accepting taxation.
“A targeted group like this could and should come out and say, ‘We want to be regulated, and we want to be taxed. We want that revenue to go to the states,’” Rose said. “What happens is the state governments are then no longer an enemy. They’re an ally.”
But could the industry stay afloat under the weight of those costs?
Smaller DFS companies, such as Orange County-based operator Fantasy Aces, could find themselves in financial trouble with taxes and licensing fees. In Nevada, an internet gambling license costs a first-time fee of $500,000, and $250,000 annually to renew. Taxation, depending on how it was implemented, could be even more onerous.
“This is a business model that is already under tremendous strain,” Grove said. “If you add a tax on turnover, not on profit, but on amount wagered – which is not an atypical way to tax gambling – that would be fundamentally challenging for the industry.”
While there’s no easy way to institute blanket regulation nationwide, the attorney Braig argued that it could greatly benefit the industry in the long term. He suggested to regulate through state casino control commissions – with a licensing process, a significant licensing fee and required cash reserves similar to casinos, which help safeguard customers. That process, however, likely would mean the commercial casino industry would wield significant power in regulation, which could fundamentally change DFS.
“I don’t think there can be credible regulation unless they face up to the fact that it’s gambling,” Braig said.
The industry, however, is unlikely to cross that line willingly.
Instead, its most likely approach is to focus on lobbying, in order to fight its perception problem. In 2014, the FSTA, which claimed $458,146 in revenue, spent $72,561 on lobbying, according to documents filed with the Internal Revenue Service. That number assuredly will multiply this year.
A more thorough response likely will be mounted soon, perhaps beginning this week with the FSTA’s regulatory plans. But the next steps the industry’s leaders take will be crucially important for daily fantasy’s survival, as investigators continue digging and states further question how to label and regulate the industry.
Until then, Gelati and others who have cashed in on the rise of daily fantasy will wait with a mix of optimism and anticipation, crossing their fingers that its public perception can be salvaged.
“In the long run,” Gelati said, “this will be a very good thing for the industry. As long as we weather this storm and get through it, I think it’ll be a nice little check to a lot of the people from CEOs all the way down to players that we’re not invincible.
“Now, this is big business. This isn’t a little fantasy game anymore.”http://www.ocregister.com/articles/industry-689093-fantasy-daily.html
