Daily Fantasy Sports Debate: Self-Regulatory Panel Faces Doubts Amid Federal, State Probes

The fantasy sports industry's preemptive strike this week to avoid strict regulation with a self-regulatory body is unlikely to stop federal and state officials from examining the business practices of companies such as DraftKings and FanDuel. Experts say regulation of the daily fantasy sports industry is inevitable -- especially given that the head of the self-regulatory panel has strong ties to the industry he will monitor.

The Fantasy Sports Trade Association has announced the formation of the Fantasy Sports Control Agency. Dubbed an “independent authority,” it will establish industrywide standards to protect against consumer fraud and audit how companies like FanDuel and DraftKings conduct their business. The panel was formed weeks after a DraftKings employee accidentally leaked sensitive information on fantasy football lineups the same week he won $350,000 playing in one of rival FanDuel’s paid NFL contests.

Self-reform will help reassure fantasy sports fans that they aren’t getting scammed out of their money -- a necessity for FanDuel and DraftKings, both valued at more than $1 billion, whose future growth is predicated on building up their customer bases. But experts say the self-regulatory group has some clear weaknesses. Seth Harris, the former acting U.S. secretary of labor tapped to lead the panel, is an attorney at Dentons US LLP -- the same firm that acts as outside counsel to the FSTA and has lobbied on its behalf. The panel’s creation was a savvy attempt to control the debate over fantasy sports regulation, but it won’t be enough to deter legislators from taking a closer look.

“To the outside world, the appointment of Seth Harris may look impressive, the same way the appointment of Kenesaw Mountain Landis as the first commissioner of Major League Baseball [in 1921] looked impressive,” said Marc Edelman, an associate professor of law at Baruch College’s Zicklin School of Business in New York. “But Landis was always an agent of Major League Baseball, paid by the teams, and Seth Harris is an agent of the Fantasy Sports Trade Association, paid by its members. This is not external oversight. This is more of the same.”

While the Fantasy Sports Control Agency is supposed to oversee the entire industry, formal regulation would have the biggest impact on daily fantasy sports operators like FanDuel and DraftKings. Both companies expect to give away more than $1 billion prizes in 2015. As a whole, the daily fantasy sports industry is projected to generate $3.7 billion in entry fees with this year, with that number expected to reach nearly $18 billion by 2020, Eilers Research, which tracks the industry, told the Los Angeles Times.

Despite that growth, the daily fantasy sports industry remains largely unregulated at present, free to operate without formal oversight at the federal level. Daily fantasy sports companies operate in this manner due to a 2006 federal statute that excluded fantasy games from federal bans on more traditional forms of online gambling. Daily fantasy operators argue that their contests are based on skill, not chance, and are thus different from regulated games like blackjack.

With the industry’s rapid growth, several lawmakers have called for hearings on whether daily fantasy sports contests are legal under the 2006 federal carve-out. Those calls escalated to formal inquiries earlier this month after the inside information leak and rising concerns about how these fledgling companies guard consumer data and protect users against fraud.

The FBI and U.S. Department of Justice each launched inquiries into the industry’s internal business practices. Federal lawmakers, including Sen. Harry Reid, D-Nev., have called for formal regulation of the industry, as has NBA Commissioner Adam Silver. On the state level, Nevada gaming regulators formally classified daily fantasy contests as a form of gambling earlier this month and ordered operators to cease business until they obtain proper licenses. Illinois is considering similar forms of oversight. Five states have banned daily fantasy games entirely.

The fantasy sports industry’s creation of a self-regulatory panel was a “brilliant attempt” to address the growing debate, said Edelman, the Baruch College professor. State regulation would create a financial logjam for the industry, as daily fantasy operators would have to apply for costly licenses and deal with heavy taxation -- and to alter their business practices on a case-by-case basis.

The FTSA said the panel will be fully independent, with the ability to penalize companies that fail to comply with its standards.

“Secretary Harris is an independent expert of unimpeachable credibility who has dedicated his career to ensuring fairness and a level playing field,” FSTA President Paul Charchian said in a statement. “The FSTA Board of Directors, which represents our 300 member companies, will give Secretary Harris and the FSCA the autonomy and control to evaluate our industry and create an effective and transparent monitoring and enforcement program.”

But self-reform in the form of internal consumer safeguards won’t stop the federal investigations into the daily fantasy sports industry, nor will it end questions about whether the contests are legal in the first place. That’s especially true if the FSTA is paying for the review.

“I really don’t believe that some prosecutor somewhere is going to say ‘great, they’re regulating themselves now, we don’t have to look any further.’ They would not be discharging their duties under the law,” said Pat Madamba, an attorney who specializes in gaming law at Fox Rothschild LLP in New Jersey.

Self-regulatory bodies are typically seen as a complement to formal oversight, not a substitute, Madamba said. In the United States, the Financial Industry Regulatory Authority polices brokerage firms that operate on the New York Stock Exchange, but those firms are still subject to oversight from the government-controlled Securities and Exchange Commission.

Formal regulation of the fantasy sports industry would come with some growing pains, but it could end up a net positive. The United States’ casino gaming companies have benefited from strict regulation since 1978, when New Jersey became the first state outside Nevada to legalize casinos. Regulation restored public confidence in an industry that had long been associated with shady dealings.

“All of the major gaming companies are listed – they’re either New York Stock Exchange companies or Nasdaq companies. It became a legitimate industry,” said Madamba. “And as a result of becoming a legitimate industry, it not only had consumer confidence, but it had investors’ confidence. It was a result of that strict regulatory scheme that casino gaming has proliferated across the United States.”