Regulatory Categorization and Arbitrage: How Daily Fantasy Sports Companies Navigated Regulatory Categories Before and After Legalized Gambling

• Date: 01 March 2020
• Author: Christopher M. McLeod,Marc Edelman,John T. Holden
• DOI: http://doi.org/10.1111/ablj.12156
• Published date: 01 March 2020

American Business Law Journal

Volume 57, Issue 1, 113–167, Spring 2020

Regulatory Categorization and

Arbitrage: How Daily Fantasy Sports

Companies Navigated Regulatory

Categories Before and After

Legalized Gambling

John T. Holden,*Christopher M. McLeod,** and Marc Edelman***

This article uses the context of daily fantasy sports (DFS) to analyze how compa-

nies use strategic categorization in regulatory arbitrage. Recent actions by two

leaders in the DFS industry, DraftKings and FanDuel, provide an ideal context to

study this issue. DraftKings and FanDuel categorized themselves differently to dif-

ferent audiences at different times in a manner that evaded categorization as an

illegal gambling activity, only to then dominate the sports betting market after the

Supreme Court’s decision in Murphy v. NCAA. We examine how this type of stra-

tegic categorization, which we call “fluid categorization,” raises important ques-

tions for regulators and others concerned with regulatory arbitrage. We also

explore how fluid categorization provides lessons for other businesses. While this

article has broad implications for the sports gambling marketplace, it also contrib-

utes to meaningful discourse for the broader business community, as its findings

are relevant to industries beyond DFS that offer gray market products and seek to

fight categorical labels until there is a reclassification event.

*John T. Holden, J.D., Ph.D., Assistant Professor, Spears School of Business, Oklahoma

State University. He can be contacted at john.holden@okstate.edu.

** Christopher M. McLeod, Ph.D., Assistant Professor, Department of Kinesiology & Sport

Management, Texas Tech University. He can be contacted at christopher.m.

mcleod@ttu.edu.

*** Marc Edelman, J.D., Professor, Zicklin School of Business, Baruch College, City Univer-

sity of New York. Hecan be contacted at marc@marcedelman.com.

©2020 The Authors

American Business Law Journal ©2020 Academy of Legal Studies in Business

113

INTRODUCTION

On May 14, 2018, the U.S. Supreme Court declared the Professional

and Amateur Sports Protection Act (PASPA)

1

unconstitutional, opening

the doors for states to legalize sports wagering across the country.

2

FanDuel and DraftKings, two companies that established the quasi-

gambling Daily Fantasy Sports (DFS) industry, quickly emerged as indus-

try leaders in the newly legal sports betting markets.

3

The transition for

FanDuel and DraftKings from quasi-gambling companies to full-fledged

gambling companies was nearly seamless, despite the companies having

spent the better part of the previous five years arguing that DFS was not

gambling (although sharing nearly all of the legal characteristics of gam-

bling).

4

These two companies, which dominated the DFS market before

the end of PASPA, managed to effectively flip a switch and turn on their

sports betting apparatus within weeks of the Supreme Court’s decision,

1

Pub. L. No. 102-559, 106 Stat. 4227 (codified at 28 U.S.C. §§ 3701–3704 (2012)).

2

Murphy v. NCAA, 584 U.S. ___, 138 S. Ct. 1461, 1481 (2018) (holding that “the PASPA

provision prohibiting state authorization of sports gambling is not a preemption provision

because there is no way in which this provision can be understood as a regulation of private

actors. It certainly does not confer any federal rights on private actors interested in con-

ducting sports gambling operations. (It does not give them a federal right to engage in

sports gambling.) Nor does it impose any federal restrictions on private actors. If a private

citizen or company started a sports gambling operation, either with or without state autho-

rization, §3702(1) would not be violated and would not provide any ground for a civil

action by the Attorney General or any other party. Thus, there is simply no way to under-

stand the provision prohibiting state authorization as anything other than a direct com-

mand to the States. And that is exactly what the anticommandeering rule does not allow.”).

3

DraftKings was the first company to launch mobile sports betting in New Jersey after the

Supreme Court struck down PASPA. See Grant Lucas, DraftKings Sportsbook Goes Live State-

wide, Get First Place in Race to Launch in New Jersey,NJG

AMBLING SITES (updated July

18, 2019), https://www.njgamblingsites.com/14498/draftkings-sportsbook-new-jersey-launch/

. FanDuel and DraftKings are the top two companies in the new legal market outside of

Nevada with regard to revenue. See Jacob Feldman, FanDuel, DraftKings Set to Compete for the

American Sports Gambling in 2019,S

PORTS ILLUSTRATED (Dec. 20, 2018), https://www.si.com/

tech-media/2018/12/20/future-sports-gambling-technology-apps-fanduel-draftkings.

4

See Kurt Wagner, DraftKings, Which Has Long Argued Its Business Isn’t Gambling, Wants to

Build a Sports Gambling Business,R

ECODE (Feb. 2, 2018, 12:04PM), https://www.recode.net/

2018/2/2/16964742/draftkings-sports-gambling-product-jason-robins. Gambling games con-

tain three essential elements: a prize, some degree of chance, and consideration. John

T.Holden, Trifling and Gambling with Virtual Money, 25 UCLA ENT.L.REV.41, 91-92 (2018).

114 Vol. 57 / American Business Law Journal

taking their electronic customer lists with them.

5

In all likelihood, they

were preparing for this outcome prior to the Supreme Court’s May

14, 2018 ruling.

6

In transitioning seamlessly into full-blown sports gambling companies,

it seems FanDuel and DraftKings aligned themselves in different regula-

tory categories several times over the course of their short lifespans with-

out fundamentally changing their underlying service.

7

This

categorization strategy enabled the companies to avoid regulation and

become two of the most recognized brands in U.S. legal sports betting.

8

Regulatory arbitrage takes advantage of generally applicable laws that

imperfectly cover all transaction types.

9

It manipulates the structure of a

deal to exploit “the gap between the economic substance of a transaction

and its legal regulatory treatment, taking advantage of the legal system’s

intrinsically limited ability to attach formal labels that track the economics

of transactions with sufficient precision.”

10

This behavior is common in

finance and tax law.

11

Examples of regulatory arbitrage include the offer-

ing of zero-coupon bonds in the 1980s,

12

Bill Veeck’s depreciation of

5

While not yet sharing the same virtual wallet between sports betting and DFS players,

the interface used by DraftKings and FanDuel for DFS and sports betting would have

been familiar to consumers who already used the product. Bill King, DraftKings, FanDuel

Taking the Lead in States’ New Sports Gambling,B

IZ J. (Nov. 7, 2018, 1:46 PM), https://www.

bizjournals.com/newyork/news/2018/11/07/draftkings-fanduel-taking-the-lead-in-

gambling.html.

6

Polina Marinova, DraftKings Is Getting into Real Sports Betting,FORTUNE (Aug. 1, 2018),

http://fortune.com/2018/08/01/draftkings-sportsbook-betting/.

7

See infra Part IV.

8

Rey Mashayekhi, Inside the Battle for the Future of Sports Betting,FORTUNE (Apr. 10, 2019),

http://fortune.com/longform/sports-betting-battle/.

9

Victor Fleischer,Regulatory Arbitrage,89TEX.L.REV. 227, 229 (2010).

10

Id.

11

Id.

12

Id at 250–51. A zero-coupon bond is a security that is issued at a discounted price but

does not pay interest. The inflow of capital enables companies to take the money received

and purchase Treasury bonds (or other security) that would mature at the same time as the

company-issued bond, but the Treasury bonds would pay sufficient interest to cover the

zero-coupon notes at maturity. See John D. Finnerty, Zero Coupon Bond Arbitrage: An Illustra-

tion of the Regulatory Dialectic at Work,14F

IN.MGMT. 13, 14 (1985); James Chen, Zero-Coupon

Bond,I

NVESTOPEDIA (July 7, 2019), https://www.investopedia.com/terms/z/zero-

couponbond.asp.

2020 / Regulatory Categorization and Arbitrage 115