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Everything you ever wanted to know about daily fantasy sports and why they're getting sued

The legal fight around daily fantasy sports sites DraftKings and FanDuel is heating up. Here's a primer on the biggest controversy in sports this year.

This Wednesday, the New York Supreme Court will hold a hearing to determine whether daily fantasy sports sites FanDuel and DraftKings constitute gambling as defined by state penal law. You've likely seen their advertisements by now, promising riches just a few finger taps away. Those ads have contributed to an explosion of business that has made FanDuel and DraftKings targets of law enforcement.

The court's decision will either be a buoy or a sizable blow to what have become near-billion dollar companies. New York residents comprise a significant portion of the DFS user base, and New York City houses the headquarters to the major American professional sports league, as well as media companies that have partnered with DFS sites (Note: FanDuel is a partner of SB Nation).

Thus far, discussion has centered on whether daily fantasy is a game of chance or skill, the latter designation giving it some protection under federal law. Arguments at Wednesday's hearing will go even deeper. Both sides have a wealth of precedent at their disposal.

The ensuing battle has the potential to be long and complex -- even more so than it already is. To properly set it up, better to start with the basics.

What is Daily Fantasy Sports?

DFS is a compacted offshoot of traditional fantasy sports, essentially. Both FanDuel and DraftKings work roughly the same way. Users select a lineup of players each week and score points based on how well they perform. How a lineup gets constructed depends on how a user manages his in-game budget.

From the FanDuel website

The best players have higher salaries, thus eating into more of the budget. The key to success is finding players who are undervalued by the service. For example, Devonta Freeman likely came cheap in Week 3 after totaling 106 yards in his first two games. He then exploded for 193 total yards and three touchdowns against the Dallas Cowboys and went on to establish himself as a prized, and expensive, commodity.

So what's wrong with that?

Well, nothing about how the game itself is played.

It's what it takes to play that's the issue. The crux of the New York attorney general's concern with FanDuel and DraftKings is that users pay "fees" to enter games that pay out a range of prizes. "Fees" is in quotation marks because the AG would rather use other terms like "bet" or "wager." Users can pay as little as $0.25 on DraftKings and $1 on FanDuel to play their games, and both services offer games with entry fees of $10,600 for much, much larger payouts.

You pay money in hopes of winning more money. If you don't, you're out. By a rudimentary definition of the term, that's "gambling." Even Joe Namath knows it.

So that's it then, DFS is gambling?

Except it's not, at least under federal law. The reason daily fantasy sports sites are as big as they are is because of an exemption in the Unlawful Internet Gambling Enforcement Act passed in 2006 for "fantasy or simulation sports" games. UIGEA's passage was itself controversial. It was a rider to an act that otherwise regulated port security, and it went through on the day before congress adjourned for the 2006 elections.

UIGEA prohibits "gambling businesses" from accepting electronic payments in connection with a "bet or wager." Fantasy sports games are exempted under UIGEA, however, as long as the games meet certain criteria. FanDuel and DraftKings believe their games satisfy the three-fold requirement:

  1. Payouts are made clear to users before the game takes place, and the number of users does not determine the payout.
  2. Winning reflects "the relative knowledge and skill of the participants and are determined predominantly" by the accumulated statistics of individuals across "multiple" sporting events.
  3. Users can't win prizes as a result of the performance of a team as a whole (say, the entire San Diego Chargers), the outcome of a game or the performance of a "single" individual athlete.

The second point is contentious. The phrase "winning outcomes reflect the relative knowledge and skill of the participants" is difficult to judge. Generally speaking, better players tend to win daily fantasy sports contests more often, maybe enough to satisfy that bullet point.

So that's it then, DFS is perfectly legal and fine?

Well, maybe not. While UIGEA doesn't say that daily fantasy sports are gambling, it doesn't really pass judgment either way. The law simply says that sending payment over the Internet to play fantasy sports does not run afoul of the law, even when it would be considered an illegal bet or wager in the state it was sent from or received.

That didn't stop the New York attorney general from sending cease-and-desist letters to both companies stating that their games constitute illegal gambling under New York penal law.

The attorney general's memorandum of law argues that DFS games rely on chance to a "material degree." New York state law thus recognizes that a game can consist of skill elements and still be considered "gambling." Moreover, the relative balance of skill may not matter all that much.

In many instances, it may be virtually impossible to determine whether chance or skill dominates; it should be sufficient that, despite the importance of skill in any given game, ‘the outcome depends in a material degree upon an element of chance.’"

To prove that daily fantasy sports relies on chance, the memorandum cited an instance when Jay Cutler inadvertently cost a DraftKings user $20,000.

In a common strategic move, Quarterback Jay Cutler took a knee to run out the clock and assure victory. This play cost the Bears one yard, and reduced Cutler’s total fantasy production by one-tenth of one point—and reportedly cost one unlucky FanDuel player $20,000; he had apparently picked Cutler and the one-tenth of a point reduction spelled the difference between winning $50,000 in first place and $30,000 in second place.

Performance can also be dictated by seemingly random occurrences like an unexpected weather pattern or freak injury. Few users likely put Steelers quarterback Ben Roethlisberger in their lineups in Week 10 when the quarterback was announced to be sitting with a knee injury. When starter Landry Jones got injured in the first quarter, however, Roethlisberger stepped in and had a great game, throwing for 379 yards, three touchdowns and one interception.

According to the attorney general, such instances make up the "material degree" of chance that define daily fantasy sports as illegal gambling in New York.

So is DFS actually a game of skill or a game of chance?

It's both, really. The attorney general hasn't said that there is no skill involved in daily fantasy sports, only that the presence of skill doesn't negate the element of chance. Likewise, users at a protest rally organized by FanDuel didn't shy away from the gambling designation, and in a Reddit AMA from 2012 the founders of DraftKings used gambling terms to describe the game.

There are other real money games as well, but you put a wager down on them as your bet, and if you win, you get the pot.

Whether daily fantasy sports are legal or illegal may be a matter of semantics. The attorney general's memorandum points out that, according to a FanDuel skills analysis, the top 10 percent of players beat the bottom 90 percent roughly 59 percent of the time. Based on that, one could argue that daily fantasy sports satisfy the UIGEA stipulation that "winning outcomes reflect the relative knowledge and skill of the participants." It also suggests that chance, too, may be present to the "material degree" standard set by New York.

It'll be up to the courts will decide which neat category DFS falls into for legal purposes.

Why is New York important?

New York is an important source of revenue for daily fantasy sports sites. New York residents make up roughly 7 percent of DraftKings' and 5 percent of FanDuel's active user bases, according to the attorney general's complaints. More than 150,000 individual New York residents played DraftKings games from April 25 to Oct. 25 in 2015. More than 250,000 New York residents were registered with FanDuel as of September.

But besides the short-term impact on those companies' ledgers, a defeat in New York's State Supreme Court could be the first battle of a protracted conflict. DraftKings and FanDuel could appeal through the state's court system, and eventually make their way to the federal level where a strict interpretation of UIGEA's muddy phrasing might take place.

New York is saying that daily fantasy sports isn't "fantasy sports" by UIGEA's definition, but unlawful gambling. If courts agree it could dismantle the industry.

Why is this a big deal now?

FanDuel has existed since 2009, and DraftKings since 2012. However, the attorney general began investigating FanDuel and DraftKings after Ethan Haskell, a DraftKings employee, won $350,000 in a FanDuel game while potentially having access to information that had not yet been made available to the public.

Nothing has come out of the attorney general's inquiry into whether employees have inside information -- Haskell purportedly had access to the information after lineups had to be locked in. Both companies no longer allow employees to play their competitors' games and they were never allowed to play their own. The inquiry did raise questions about the the companies' business model within the attorney general's office, however.

Coupled with the pervasiveness of the advertising and the rapid growth of both businesses, daily fantasy sports became a target.

Does it differ from other gambling businesses?

Online poker has been brought up often over the past few weeks. Once upon time, online poker was also a thriving business, but UIGEA significantly hindered it. It was also a near-billion dollar industry, and as it grew, it too was challenged in New York courts. In April 2011, several online poker domains were seized by the government for violating UIGEA. They seemingly fell under the legislation's definition of a "bet or wager."

The fact that poker was struck down as a game dictated by luck may not bode well for daily fantasy sports. As with DFS, one can get good enough to win at poker relatively consistently. Via Bloomberg:

During the 2010 World Series of Poker, 720 players identified beforehand as high-skilled earned an average return on investment of 30.5 percent, an average profit of more than $1,200 per player per event. The average return of all other players was minus 15.6 percent, a loss of more than $400 per event.

Of course, no one can ever truly be insulated from a bad beat.

So can I actually win at daily fantasy sports?

Of course! Just don't count on it. The attorney general found that, according to DraftKings data, 89.3 percent of daily fantasy sports players had an overall negative return on investment in 2013 and 2014.

In addition to the companies' 10 percent cut of entry fees, users also have to contend with "sharks" -- users who largely have strong grasps of mathematics and have the means to enter hundreds of contests a day.

They are Saahil Sud, and they prey on "minnows."

The first step is scraping data from various public resources online and plugging the numbers into his custom-built predictive models, which generate hundreds of lineups based on his forecasts. There are publicly available tools that do some of this work for daily fantasy players, but Sud created bespoke software to make sure no one else can access his data. He also has a technique for identifying athletes who aren’t going to end up on a lot of other team’s rosters, which is important, because there’s a particular advantage in choosing players no one else has noticed.

Why is Internet gambling illegal?

Though winning at daily fantasy sports is difficult, it's not because anyone is cheating (at least, one hopes). Sharks use uncommon knowledge and ingenuity to win, which may be disconcerting to the average user but doesn't violate any rules.

More insidious, however, is the dangers of gambling addiction. Last year, the National Council on Problem Gambling estimated that 2.2 percent of the United States population qualified as problem gamblers, and there's evidence that daily fantasy sports invokes addiction in some users.

The attorney general looked at messages received by customer service representatives at DraftKings with subject lines reading "Gambling Addict do not reopen," "Please cancel account. I have a gambling problem" and "Gambling Addiction needing disabled account." The attorney general's memorandum cited mental health professionals who took issue with daily fantasy sports advertising, which they say implied that users would improve their odds of winning if they played more often.

There are a lot of things that are legal that can also be bad for you, of course, but gambling addiction is certainly serious and, with the high stakes often involved, capable of destroying lives.

Is there a middle ground?

There's a chance that daily fantasy sports can persist in a regulated form. The Fantasy Sports Trade Association announced this past October the formation of the Fantasy Sports Control Agency, which it hopes can be an independent regulatory body over fantasy sports. The FSTA tabbed Seth Harris, former U.S. secretary of labor under Barack Obama, as the FSCA's chair.

However, the Haskell incident -- although no egregious wrongdoing was found -- illustrated how little oversight there is over daily fantasy sports. The FSTA's purpose, by its own admission, is the advancement of fantasy sports, and its board of directors is a who's-who of industry leaders including Nigel Eccles and Jason Robins, founders and CEOs of FanDuel and DraftKings, respectively.

The FSCA, in its current form, likely won't placate government officials eager to rein in the industry.