The fantasy sports industry nearly imploded in 2015. While several factors fueled that near detonation, chief among them was a belief that fantasy sports games are actually illegal lotteries or illegal gambling games.
Since the 2015 implosion, eight states, including New York, have adopted laws legalizing (and, in most cases, heavily regulating) fantasy sports. Although daily fantasy sports remains banned or legally uncertain in about ¼ of the states, the industry seems to be recovering from its near-death experience. In fact, the fantasy sports industry’s experiences offer helpful lessons for companies and counsel in other industries. I discuss those lessons in the article, “What In-house Counsel Can Learn From the Fantasy Sports Industry”, co-written with my colleague, Ellen Zavian, and appearing in the September 2016 issue of the Association of Corporate Counsel’s Docket Magazine.
This blog posting explains why state regulators and others viewed (or continue to view) fantasy sports as illegal.
What Are Fantasy Sports?
Fantasy sports competitions are games in which participants simulate the role of an owner or manager of a professional sports team. Other names for this type of promotion include rotisserie, roto, and owner simulation. There are fantasy sports leagues for many sports including football, baseball, basketball, hockey, NASCAR races, soccer, and golf. Currently, fantasy games based on the National Football League are by far the most popular in the United States, with games based on soccer being the most popular globally. The simulation game genre has even gone beyond sports and exists for politics, movies, and reality television programs.
In a fantasy sports competition, each participant selects a roster of athletes to play on that participant’s simulated team. The selected athletes are real people who actually belong to professional sports teams. A roster assembled by a fantasy sports team player typically consists of players from several teams. The participant gets points based on the real-life statistical performance in actual games by the athletes on his roster. The winner of the fantasy sports competition is the participant with the most points.
Fantasy sports can be divided into two broad categories: the more traditional season fantasy sports (SFS) and the newer daily fantasy sports (DFS). As the name implies, SFS games track athletes’ performance over the majority of a season. In contrast, DFS games track athletes’ performance over a single game or single week. The surge in DFS competitions sparked many of the industry’s recent woes.
Impact of Federal Unlawful Internet Gambling and Enforcement Act
In arguing their legality, fantasy sports companies relied heavily on the Unlawful Internet Gambling and Enforcement Act of 2006, 31 U.S.C. §§ 5361-5367 (UIGEA). The UIGEA is a federal law that prohibits funds transfers to businesses engaged in unlawful internet gambling. The act defines “unlawful internet gambling” as transmitting a bet or wager via the internet where the bet or wager violates the gambling laws of any state in which the bet is initiated, received, or otherwise made. The UIGEA specifically excludes from the definition of “bet” or “wager” money paid for participation in a fantasy or simulation sports game as long as the fantasy sports game satisfies the following conditions:
- The sponsor establishes the prizes to be awarded and makes all participants aware of that information prior to the start of the promotion.
- Neither the number of participants nor the amount of fees paid by participants determines the value of the prizes.
- Winning outcomes are determined predominately by accumulated statistical results of the performance of individuals (athletes in the case of sports events) in multiple real-world sporting or other events.
- No winning outcome is based on the score, point-spread, or any performance or performances of any one or more real-world teams.
- No winning outcome is based solely on any single performance of an individual athlete in any single real-world sporting or other event.
Daily fantasy sports providers inaccurately cited the UIGEA's fantasy sports exemption as authority for the legality of their business model. As state regulators highlighted, the exemption in the UIGEA for fantasy sports does not mean that fantasy sports are lawful in all states. The federal exemption means only that fantasy sports are not criminalized under the UIGEA.
Instead, whether or not a fantasy sports league comprises gambling within a particular state is state specific. It depends on the individual state’s gambling laws and how the state evaluates the structure of the particular fantasy sports game.
Impact of State Gambling Laws
For the most part, gambling is illegal in the United States. States that do allow gambling tend to regulate it heavily. In response to government scrutiny, fantasy sports companies describe their fantasy game offerings as skill-based contests, and, thus, not a gambling game or lottery.
Is a Fantasy Sports Competition a Skill-Based or Chance-Based Game?
Like many games, fantasy sports games combine elements of skill and chance. Skill comes from the fantasy sports participants’ use of their knowledge of athletes, statistics and strategy to pick a winning team. Chance exists because external factors that are beyond the fantasy sports participants’ control influence the outcome. These external factors injecting chance include the future performance, injury status, and time at play of athletes on the participants’ roster as well as the overall game plan.
The more direct impact participants have on the selection of their rosters, the more one can argue that skill rather than chance determines the game winner. The greater extent to which participants can trade, cut, and add players, and decide which players start or are benched for each game, the more opportunities participants have to use their knowledge and strategic thinking to influence the outcome of the competition.
Many state investigations into daily fantasy sports have focused on the fact that once a player places a wager and picks a lineup for a DFS promotion, those choices are locked in as soon as the real-world competition begins. This structure contrasts with that of a SFS game in which a participant can make changes to his roster over the course of a season.
How States Make the Chance-Skill Determination
The approach to a skill-chance determination is state specific. Most states apply the dominant factor doctrine or the material element test to determine whether chance or skill prevails in a game that combines elements of both. Variations in the states’ evaluations of fantasy sports illustrate the challenge to operators when offering fantasy sports competitions nationwide.
As an example, in his conclusions that DFS games such as FanDuel and DraftKings’ are illegal gambling in his state, Hawaii Attorney General Kevin Takata, applying the material element test, stated that chance is a material element for the vast majority of players and that skill made a difference in the outcome for only a tiny minority of top-performing players. The Hawaii opinion also cited sources from litigation between the State of New York and DraftKings indicating that the typical participant playing DraftKings' Major League Baseball-Fifty-Fifty game had a win ratio slightly worse than random chance (i.e., about 45%).
In a contrasting example, Rhode Island Attorney General Peter F. Kilmartin, applying the dominant factor doctrine, concluded chance does not dominate the outcome of DFS games and that therefore, DFS does not constitute a game of chance and is not an illegal gambling game or lottery in Rhode Island.
Existence of Chance Is Not the Whole Story
Some states have one set of laws for lotteries and a different set of laws for the broader category of gambling. While every lottery is a form of gambling, the converse is not true. Every gambling game is not a lottery. Offering a fantasy sports game viewed as either a gambling game or as a lottery creates problems with state regulators.
One major distinction between the two is the elements required to constitute a lottery versus the elements required to constitute gambling. With very few exceptions, each state requires a finding of prize, consideration, and chance before categorizing a game as a lottery. In contrast, as the fantasy sports industry has learned, some states designate a game as gambling even if it does not contain the element of chance.
In opining that fantasy sports is illegal in Nevada, Nevada regulators explained that “ . . . while a determination that an activity is a game of skill is relevant to determining whether that activity is a lottery, it is not relevant to determining whether that activity constitutes a gambling game”. In the Hawaii opinion letter discussed above, even had the attorney general concluded that daily fantasy sports games did not contain a material element of chance, the games would still be illegal gambling in Hawaii since they meet another prong of the Hawaii anti-gambling laws in that winning depends on future contingent events (i.e., performance by athletes in sporting events) that are outside the control of participants.