Welcome to Fantasy Island

Sports gambling in the United States is an enormous and lucrative business; it’s also mostly illegal. In 2012 the National Gambling Impact Study Commission estimated that $3.45 billion was legally wagered in Nevada sports betting facilities, but this is just a pittance compared to illegal sports betting, which cashes in at around $380 billion annually in the U.S., and more than $2.5 billion of that comes from annual betting on just the NCAA Men’s Basketball Tournament. 
While Congress and federal prosecutors have launched aggressive attacks on Internet gambling and sports betting in the United States, more people play the odds through online fantasy sports. What was once a seasonal hobby among friends and co-workers has blossomed into a $4 billion to $5 billion per year industry, with nearly 35 million adults in the United States participating in some form of fantasy sports in 2014. 
This meteoric success has led entrepreneurs, investors, sports leagues and media companies to pour hundreds of millions of dollars into online fantasy sports businesses without fully evaluating the legal risks posed by existing federal and state laws.
Under traditional fantasy sports models, players manage a roster of real-world professional athletes and, based on the statistical results of the athletes over the course of an entire season, compete for pride and relatively small prizes awarded on a one-time basis at the end of the season. Daily leagues, however, typically include a cash entry fee, the selection of players, and a payout of large cash prizes based on the performance of athletes in a single day. 
Both traditional fantasy sports leagues and daily leagues rely on statistical results of real athletes, but daily leagues entice participants with elements of exchange wagers, daily market action, and sports betting. This complex and cutting-edge structure will likely fuel the growth of the fantasy sports industry, increasing the risk that sponsors will be targeted in an enforcement action. To lessen these risks, and to lawfully tap the multi-billion dollar fantasy sports market, key stakeholders must ensure that their games and platforms comply with applicable federal and state laws.
Internet gambling, and sports betting in particular, is generally regarded as illegal under most states’ laws, and has long been in the crosshairs of Congress and federal prosecutors. Over the past 12 years, the United States has taken aggressive measures to prevent states and tribes from implementing new sports betting schemes and to otherwise prohibit all forms of Internet gambling.  

Legislation Has Spawned Opportunity, Huge Confusion and Under Appreciated Risk
In 1992, the Professional and Amateur Sports Protection Act (“PASPA”) became law in the United States, effectively banning sports betting outside of Nevada and grandfathering-in limited sports betting operations in three other states (Delaware, Montana and Oregon). In 2006 – a time when the Internet gambling market was expected to reach $15 billion worldwide – Congress passed the Unlawful Internet Gambling Enforcement Act (“UIGEA”), aimed at prohibiting the transfer of payments in connection with “unlawful Internet gambling within the United States.” In 2011 and 2012, relying in part on the UIGEA, the U.S. Department of Justice shut down PokerStars, Full Tilt Poker, Absolute Poker/Ultimatebet and Bodog, four of the largest Internet poker and sports betting sites operating in the United States, and indicted the companies’ principals.
While the passage of the UIGEA was popularly viewed as a Congressional attempt to squash Internet gambling and sports betting in the United States, as a result of successful lobbying efforts by the professional sports leagues, the UIGEA explicitly protected fantasy sports. Specifically, the UIGEA exempted fantasy sports games from the definition of “bets or wagers” under the UIGEA if:

The fantasy team is not based on the current membership of an actual amateur or professional sports team;
All prizes and awards are established and made known before the start of the contest, and their value is not determined by the number of participants or the amount of any fees paid by those participants; and
All winning outcomes reflect the relative knowledge and skill of the participants and are determined predominantly by accumulated statistical results of individual performances of athletes in multiple real-world sporting events, and not on the score, point-spread, or performance of any single sports team (or combination of such teams), or any single performance of an individual athlete in any single real-world sporting event.

This so-called “fantasy sports exemption” of the UIGEA does not make fantasy sports legal. Rather, it looks to other federal and state laws to define “unlawful Internet gambling,” and does not otherwise alter, limit, or extend any federal or state law prohibiting, permitting, or regulating gambling within the United States, including gambling in connection with fantasy sports. 
Even though the UIGEA did not legalize fantasy sports, its “fantasy sports exemption” appears to have spawned a new business model and form of sports wagering – daily league fantasy sports. These daily games did not exist when the UIGEA was debated or enacted. According to the Fantasy Sports Trade Association (“FSTA”), the first daily league fantasy site was launched by Fantasy Day Sports Corporation at FantasySportsLive.com in mid-2007, nearly a year after the passage of the UIGEA. And with the birth of daily fantasy sports games has come exponential growth of fantasy sports, from 12.6 million U.S. participants in 2005 to nearly 35 million in 2014. 
Regardless of whether a website offers traditional fantasy sports or daily leagues, it is only legal if it falls within the exemption of the UIGEA and complies with all other applicable federal and state laws. Most states have laws prohibiting paid-entry games of chance, as well as betting on the outcome of future contingent events outside the player’s control. In addition, most states prohibit “gambling,” which is generally defined as a scheme involving the payment of consideration (e.g., cash) for an opportunity to win a prize in a game of chance. Based on this common definition, games of skill are generally legal in most states, but not all states have adopted the same language or analysis for determining what constitutes a game of chance as opposed to a game of skill. Notwithstanding the UIGEA carve-out for fantasy sports, there is no question that fantasy sports games and contests run afoul of many state laws.
Because laws vary from state-to-state, and the tests for games of skill versus games of chance can be somewhat subjective, it is important for fantasy sports site developers, operators and investors to carefully review their proposed games, platforms, entry fee and prize structures to determine in which states their games and contests can be offered. 
We have reviewed the legal terms and conditions of the paid-entry fantasy sports websites of 40 members of the FSTA. Based on our review, most, but not all, of the 40 sites exclude players from four states (Arizona (38), Iowa (36), Louisiana (38), and Montana (38)).  But while the FSTA member sites appear to be in general consensus on these four states, the sites are wildly inconsistent with regard to their assessment of the law in virtually all other states. One site prohibits play in zero states, while another site prohibits play in 25 states, and half of the 40 surveyed FSTA sites prohibit play in anywhere from six to thirteen states.
Fantasy Sports Operators and Investors Must Do Their Homework Up Front
In order to reliably determine where any particular fantasy sports game or contest is legal, stakeholders should consider the degree to which chance influences the outcomes of their games and contests, and what each state’s law defines as unlawful gambling. In addition, to avoid trouble, fantasy games should be structured so that the winning outcomes are determined as much as possible by each participant’s own skill and knowledge, not the skill and knowledge of the other players or of the athletes. 
Prudent fantasy sports site operators and investors should consider engaging legal counsel to conduct a 50-state survey of the laws, statutes and attorney general opinions of each of the fifty states to aid in determining whether their proposed fantasy sports game, platform, entry fee and prize structure are legal. 
In order to avoid legal pitfalls, it is not enough for fantasy sports sites to simply post legal terms and conditions. Site operators must also develop and implement internal processes and technical safeguards to effectively exclude players from the states they and their counsel determine to be prohibited. While all of this can be a daunting and costly exercise to perform prior to launch, it can help operators and investors lesson the legal risks and costs associated with defending against enforcement actions and related scrutiny and controversy. In the end, putting the time and money to get it right up front will pay huge dividends, including protecting an individual’s liberty. The UIGEA fantasy sports exemption has lulled many into a false sense of complacency. But jail and multi-million dollar fines are no fantasy. Rather, they are real possibilities for fantasy sports operators and investors in many states, including states where many fantasy sports sites are up and running.