Tuesday, October 13, 2015

Why Fantasy Sports Makes 'Insider Trading' Legal

A recent Washington Post headline reads, "Insider-trading scandal rocks daily fantasy sports industry." There is one problem with that headline; there is no such thing as "insider trading" in fantasy sports. It is unregulated. Insider trading activities are illegal when laws make them illegal. For example, trading a public company's stock when you have access to non-public information about the company is illegal because the Securities Exchange Act of 1934 outlaws it. There is no such law in fantasy sports. Therefore, a DraftKings or FanDuel employee can draft a team based on information that gives him or her a competitive advantage. Is it moral? You decide. Is it legal? Yes. This is just one of the risks that players assume when signing up. There are no legal protections for players. There is a trade association that supposedly monitors the fantasy sports world, but it answers to no one.

In fact, when it comes to fantasy sports, the law is on its side. The industry is set to rake in over a billion dollars in 2015. Google it and you will see various headlines asking if is it legal. The simple answer is: Yes! Many may not agree with that legality and many may feel that fantasy sports is just a masqueraded form of gambling. However, there is a specific law legalizing it. Not only does the law legalize it, the law broadly defines it. This leaves plenty of gray area for interpretation. In other words, there are plenty of "loopholes" that companies like DraftKings and FanDuel can and do exploit.

The law that makes fantasy sports legal is the same law that makes online gambling illegal. The Unlawful Internet Gambling Enforcement Act of 2006 (UIGEA) creates a specific exemption for fantasy sports. In fact, the congressman who wrote the bill has publicly said that he couldn't get the bill passed by fellow lawmakers without creating an exception for fantasy sports. The UIGEA prohibits online gambling but says that the prohibition "does not include... participation in any fantasy or simulation sports game." This exception has a few requirements. Each fantasy sports team cannot be based on the membership of one real-world team, it has to include several players from different teams. The winning outcomes must be determined by the performances of individuals playing in multiple sporting events. No winning outcome can be based on the score, point-spread or performance of a single team or a single individual performance from a single sporting event. Lastly, the prizes and awards have to be announced ahead of time and can't be based on the number of participants or fees paid for that contest.

Traditionally, fantasy sports is a role-playing game that allows you to pretend you own and manage your own NBA, NFL, MLB or NHL team. Contestants draft a team made up of individual athletes from different real-world teams. The team racks up points every time its athletes play in a game and those points are tallied up over the course of a season to determine a winner. Along the way, there may be injuries and trades; the contestant may bench some players, while others may play better than expected. The idea is that contestants are exercising a degree of knowledge and skill in choosing players for a team, arranging lineups and making changes along the way. Now, there are plenty of people who say that in the end the outcome is left to chance and for that reason, fantasy sports amounts to gambling. While that argument can be made, the lawmakers who wrote the exception for fantasy sports defined it as a game of knowledge and skill.

One reason fantasy sports has exploded into big business and drawn skepticism is because fantasy sports companies added a twist by providing fantasy sports contests on a daily basis. Because the game isn't played on an ongoing basis, players exercise less skill and there is a higher level of chance. Many of the legislators who pushed for the law admit they never envisioned that their exemption would enable companies to provide daily fantasy sports contests. They assumed these contests would happen over weeks or months. Because the legislators never envisioned this, they never addressed it in the bill. There is no clause containing a time limit. Therefore, nothing outlaws daily contests even though they are arguably more similar to gambling bets than season-long contests. They are legal. You snooze, you lose.

There is one tricky aspect to the law. The language of the UIGEA states that the outcome must be based on the statistical "performance of individuals (athletes in the case of sports events) in multiple real-world sporting or other events." This can be read in two ways. It can mean that the same individuals must accumulate points over the course of multiple sporting events or that points can be racked up from multiple sporting events featuring different individuals. DraftKings and FanDuel rely on the latter interpretation. Therefore, they can tally points from individual playing in multiple sporting events on the same day. Nothing in the law clarifies how points may be accumulated, so companies can score games however they want. Since the law is overly broad but plainly written, almost anything goes as long as the requirements are met.

Some argue that daily fantasy sports is illegal under state law, but federal law trumps state law.

So, why all the negative attention recently? It picked up momentum when DraftKings and FanDuel started a bombastic advertising blitz. The success of companies like DraftKings and FanDuel has attracted people who want to bring the business down. In fact, if you look closely at the history of sports betting in America you will see a strong theme, the battle hasn't been over whether or not to legalize sports betting, fantasy or otherwise. It also hasn't been about whether sports betting will corrupt the moral fiber of the country. It is predominantly a battle over the tremendous amount of revenue inherent within. Every year millions of dollars slips into the hands of illegal sports betting operations. Finally, states like New Jersey wanted in on the action, to help its struggling casinos. When New Jersey tried to legalize sports betting, the NBA, NFL, MLB and NCAA sued to stop it, claiming it would hurt the integrity of the game. Yet, with little hesitation, most of those very same professional organizations simultaneously partnered with DraftKings and FanDuel to share in the lucrative profits of daily fantasy sports bets.

So what did New Jersey do? It retaliated. One of its legislators asked congress to examine the legality of fantasy sports. Take that NBA, NFL, MLB and NHL! If Jersey can't get sports betting money than you can't either. After all, why should corporations make big money and not states? And that's the prevailing theme, states vs. corporations. Many states, such as Iowa, are passing bills to formally legalize fantasy sports and those states are going to want in on the action. And, that's where regulation comes in. The New York Attorney General's inquiry into fantasy sports and the congressional scrutiny will likely lead lawmakers to regulate the industry. The amount of regulation and whether it is done at the state level or federal level will determine how much money is made and whose pocket it falls into. Where does moral fiber fit into all of this? What about all those people who spend their life savings feeding their sports betting addictions? Well, that remains to be seen. And, will there be an insider trading provision to protect players? It's a possibility. For now though, the field and the cash cow legitimately belong to DraftKings and FanDuel because quite simply, they figured it out first.

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