DraftKings, FanDuel Follow Uber’s Playbook As Legal Battles Loom

Xconomy Boston — 

Like other immensely popular but controversial tech startups in recent years, DraftKings and FanDuel have reached the critical juncture where, having already won over millions of users, they must now do the same with regulators.

The open question is which way the pendulum swings: Will fantasy-sports companies emerge mostly victorious, as sharing-economy stars Uber and Airbnb have so far? Or will they end up like Aereo, which was dealt a fatal blow when the U.S. Supreme Court ruled that its antenna-based live TV streaming service was illegal?

The operations of Boston-based DraftKings and New York-based FanDuel rely on an exemption in a 2006 federal law that banned online poker but allowed fantasy sports, which were categorized as games of skill and not chance, and therefore don’t fall under the purview of gambling laws. DraftKings and FanDuel are currently operating in more than 40 states.

Their websites allow users to pay a fee to play short-term fantasy contests against millions of opponents and potentially win large sums of money. Users draft a lineup of players and earn points based on how well those players perform.

Critics question the legality of the industry, saying the games are basically the same as sports gambling, which is illegal in most states. If legislators or the courts settle that debate, and the final call goes against DraftKings and FanDuel, it could mean a knockout punch for their businesses.

But even if the companies prevail on that question, they won’t be out of the woods, says Charles Whitehead, a Cornell Law School professor overseeing a new program there that pairs attorneys and recent law grads with entrepreneurial students who might need help navigating legal questions.

If the leaders of DraftKings and FanDuel are smart, Whitehead says, they’re studying the chessboard and planning two or three moves ahead.

“The point is, I’ve got to be careful even if I win,” Whitehead says of DraftKings and FanDuel. “Regulators and others might still try to change the rules in a way that makes it impossible to continue with my business model.”

Relying on the exemption in the 2006 federal law “may work for some period of time at the federal level,” Whitehead says. “But it overlooks the fact that you have to consider state law issues.”

And that seems to be where the debate is headed now.

On Tuesday, the New York attorney general sent a cease-and-desist order to the companies, claiming their sites are illegal gambling operations under state law. The companies disagree with that view, of course, and are weighing their legal options during the five-day window they have to respond to the letter. But both have made it clear they intend to fight to keep operating in New York.

The New York attorney general’s action followed last month’s decision by the Nevada Gaming Control Board that forced daily fantasy sports websites to shut down there until they get a gambling license. DraftKings and FanDuel instead opted to cease operations in Nevada, at least temporarily.

“This decision stymies innovation and ignores the fact that fantasy sports is a skill-based entertainment product loved and played by millions of sports fans,” FanDuel said in a prepared statement after the Nevada agency’s ruling.

DraftKings and FanDuel have been impossible to ignore this fall, even for those who don’t give a rip about sports. The two competitors have spent heavily to run advertisements (giving new meaning to ad nauseam) since the start of the NFL season in September, thanks to war chests of more than $350 million in venture capital each.

They attracted unwanted attention when word broke in early October that an employee of DraftKings, Ethan Haskell, won $350,000 playing fantasy sports on FanDuel’s site. The incident was the industry’s version of an insider trading scandal that raised questions about whether Haskell had created his winning player lineup using internal DraftKings data unavailable to the public.

Two weeks later, DraftKings said an investigation conducted by an outside firm concluded that Haskell did not win the money using an unfair advantage, because his lineup was set and locked in before he received the internal data. In light of the situation, the companies instituted policies forbidding employees from playing on daily fantasy sports websites.

Nevertheless, the incident prompted investigations by the FBI and the U.S. Department of Justice, and it has intensified the scrutiny from regulators around the country. At least 16 states have considered legislation this year that would regulate daily fantasy sports sites, according to Legal Sports Report, a website that covers the daily fantasy sports and sports betting industries.

Thus far, those legislative efforts have brought mixed results for the companies.

Kansas’s law was passed in May and … Next Page »

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