The insider trading scandals could bring down DraftKings and FanDuel.

Why the Insider Trading Scandals Could Bring Down DraftKings and FanDuel

Why the Insider Trading Scandals Could Bring Down DraftKings and FanDuel

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Oct. 13 2015 4:47 PM

The DraftKings Crash

Insider trading scandals could bring down daily fantasy sports.

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DraftKings’ party might be coming to a crashing end.

Screenshot via Draftkings

It was a banner week for daily fantasy sports. FanDuel and DraftKings, the two companies that tower over the DFS landscape, set records for number of entries (7.52 million) and entry fees ($45.6 million) in the fifth week of the NFL season.* That news was just the latest in a run of explosive growth for the enterprises. The two companies’ ads have dominated the airwaves since pro football started back up again last month. And most teams in the NFL are taking in big sponsorship money from the two DFS kingpins. But recent revelations, and facts likely to spill out over the next few months and possibly years, threaten to bring the party to a crashing end. At the very least, increased federal and state oversight seems a good bet in the wake of what amounts to damaging allegations of insider trading. Despite the lack of current regulations on the industry, the legal case against DFS appears to be a strong one.

The event precipitating the most serious accusations against the two companies centers around one Ethan Haskell, a DraftKings employee. On Sept. 27, he accidentally posted information about how many people selected specific NFL players for their teams in the DraftKings game that week—DFS players plunk down money to select a squad of athletes and then win or lose depending on how those athletes do—and then stated that he was “the only person with this data.” The data in question would offer anyone who had it a significant edge, because the way the game works makes it incredibly beneficial for a player to differentiate himself from the rest of the field by taking advantage of market inefficiencies and picking undervalued athletes.

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Haskell tried to reassure anyone who might be concerned about this potential edge, reminding everyone that, as a DraftKings employee, he was forbidden from playing on his own site. What he failed to state, though, is that he was allowed to play on FanDuel’s site. Despite Haskell’s claims that he didn’t have the data in time to benefit from it (and DraftKings’ statement that an internal investigation found no insider trading), his stratospheric success since going to work for DraftKings is hard for some to ignore. For the week of this incident alone, he raked in $350,000 on FanDuel. But he’s been killing it for some time now—at least ever since he started working at the company. This site breaks down his track record before and after June 2014, when he began with DraftKings. His ascent is startling. If this is indeed a coincidence, it’s a big one.

While this level of success might make Haskell an outlier, a DraftKings founder stated last month that some of his employees made more money from playing on their competitor’s site than they took home in salary. And the New York Times reported on Sunday another allegation of an employee sharing insider information. The initial scandal led DraftKings and FanDuel to ban their employees from playing on any DFS site. But that might be too little too late.

Last Tuesday, the New York attorney general’s office opened an investigation into the matter, and on Thursday, a penny-ante participant filed a class-action lawsuit in federal court, also in New York. The complaint is a complex stew of facts and legal theories, but if allowed to proceed, it could result in a huge financial hit for both DraftKings and FanDuel. And any documents unearthed during the course of the litigation could reveal facts that the companies would prefer not become public.

Johnson v. FanDuel alleges that the two companies violated the laws of three states—Kentucky, where Johnson resides; Massachusetts, where DraftKings maintains its principal place of business; and New York, FanDuel’s corporate headquarters. Federal law doesn't regulate DFS—it’s considered a game of skill rather than gambling and therefore isn’t covered by the Unlawful Internet Gambling Enforcement Act of 2006. But, as the complaint illustrates, there’s no shortage of other legal principles designed to prevent unfairness to consumers that could be applicable in this case. Even though Johnson deposited money only with DraftKings, the complaint refers to the two companies as acting in concert, notably by following the same rules about employee participation and “issuing numerous joint and/or identical statements on their websites.”

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The centerpiece of the lawsuit is the allegation that employees of both companies had access to the “biggest edge” to success in DFS—data and information that wasn’t public. The Haskell story provides the chief piece of specific evidence in support of this allegation, and the complaint ridicules the “coincidence” explanation by pointing out that he “beat 229,883 people the same week it was clear he had access to ownership data.” Johnson also accuses the defendants of failing to disclose that their employees were permitted to play on the other’s site and states that, had he known that this practice was allowed, he wouldn’t have played the game. His losses amounted to only $100, but he’s only the first class-action plaintiff.

The allegations, if proven, are the ingredients of a successful claim for fraud. To win on that legal theory, a plaintiff needs to show that the defendant knowingly made a misrepresentation of an important fact or, as in this case, failed to disclose facts that it owed its customers a duty to disclose. If Johnson can prove that the company knew of insider trading, he could recover his money by showing that he wouldn’t have plunked down $100 to play the game if he’d known it was rigged.

Even if the company didn’t know of insider trading, there’s also a related claim of negligence, alleging that the companies failed to take reasonable steps to prevent insiders from competing against members of the proposed class of plaintiffs. And for good measure, violations of the Kentucky consumer protection statute and the New York false advertising law are thrown in.

It’s impossible to know whether the suit will succeed. If it moves forward and the class becomes large enough—as seems likely—refunding all the money paid out by duped participants would be a big hit to DraftKings and FanDuel. In a worst-case scenario, the plaintiffs would be able to convince a jury that the conduct was evil enough to justify punitive damages. It’s hard to say what would happen next to the two companies—valued at more than $1 billion each, but yet to turn profits.

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Either way, the publicity over insider trading might cause even broader problems for DFS. With increased attention on the possible cheaters comes greater focus on the undeniable fact that, for all but the most sophisticated players, daily fantasy really is a kind of gambling—with the house having a huge advantage. As Ed Miller and Daniel Singer pointed out in a very smart column this past summer, the game rewards only the most highly skilled players—the rest are really just their financial fodder. During the first half of 2015, for example, a little more than 1 percent of the players raked in 91 percent of the winnings.

Perhaps enough people just enjoy the emotional investment in fantasy sports for DFS to survive, but losing gets old after a while. And if Congress or some of the states get interested in regulating the activity—as now seems quite likely—DraftKings and FanDuel could be the biggest losers of all. 

Correction, Oct. 15, 2015: Due to an editing error, this post misstated that FanDuel and DraftKings had a record revenue week. They had a record entry-fee week. (Return.)

John Culhane is the H. Albert Young Fellow in Constitutional Law at Delaware Law School, and Co-Director of the Family Health Law & Policy Institute. He is a frequent contributor to Slate, and is working on a book about the legal recognition of relationships other than marriage. Following him on Twitter is possible, but not necessarily wise.