The biggest insider trading scandal of the month isn't unfolding in Congress or on Wall Street, and it doesn't involve the Galleon Group or a London Whale. Instead, it's the burgeoning industry of fantasy sports that's getting a taste of organized corruption.
The New York Times reported yesterday that employees at online fantasy sports betting sites DraftKings and FanDuel face allegations of using insider information to rake in major winnings at rival sites. One mid-level DraftKings employee reportedly won $350,000 on FanDuel just one week after "accidentally" releasing sensitive data ahead of NFL gameplay, a coincidence that raised alarm among observers. "The incident has raised questions about who at daily fantasy companies has access to valuable data," the Times reported, "how it is protected and whether the industry can—or wants—to police itself."
Fantasy sports has been something of a Wild West, and this scandal may finally give authorities the incentive to tame it—for the better.
This isn't the same as throwing down your bonus to a bookie who's got better odds than you: These allegations are the equivalent of fraud, a crime "akin to insider trading in the stock market," according to the Times. Fantasy sports leagues have always been big business: Consider Dial Sports, an early pay-per-call service run by Mickey Charles out of his Philadelphia garage that, at its peak in the 1980s, was "receiving 20 million phone calls a month and generating millions of dollars in revenue," according to this fascinating ESPN profile. While sports betting is technically illegal in the United States (with some local exceptions), fantasy sports—"games of skill," rather than games of chance, like poker—aren't, making them an attractive market. But until now, fantasy sports has been something of a Wild West, and this scandal may finally give authorities the incentive to tame it—for the better.
Modern sports betting has grown into a massive beast thanks to the Internet. DraftKings netted a $300 million round of funding this year, bringing the company's total haul to $426 million. Not to be outdone, FanDuel has raised some $363 million in capital since the company's inception in 2009. Each company is valued at $1 billion. But even those fantasy behemoths are ultimately small potatoes: The global sports betting market yields some $202 billion in revenue each year, according to IBISWorld's Global Sports Betting and Lotteries research report.
The massive valuations for the two companies have already raised questions about the structural fairness of these sprawling fantasy leagues. When some 57 million Americans are throwing down money on fantasy sports leagues, are they really getting a fair game? Considering that Americans spent around $11 billion on fantasy betting last year, one would hope the odds are, somehow, in their favor.
Critics believe that DraftKings and FanDuel have exploited the 2006 federal law offering them refuge as "games of skill."
But the sheer scale required for these companies to earn their ridiculous valuations creates a massively complex betting pool, and that complexity tips the balance to those who figure out how to game the system. "To get to the size their investors are expecting requires a continuous stream of new players lured by ever-increasing prize pools with the help of muscular advertising campaigns," Joshua Brustein and Ira Boudway explain in Bloomberg. "These ads never spell out a simple truth about daily fantasy competitions: While any player might get lucky on the back of a handful of entries, over time nearly all of the prize money flows to a tiny elite equipped with elaborate statistical modeling and automated tools that can manage hundreds of entries at once and identify the weakest opponents."
Then again, this sort of corruption and collusion shouldn't necessarily seem surprising: Fantasy betting has been the Wild West of gambling for years. "Gambling law pre-dates the introduction not only of fantasy sports but of the Internet in general," LegalSportsReport.com editor Chris Grove told the Washington Post in September. "A lot of gambling law was written around the time of pinball machines and crane games. It becomes far more difficult to apply those tests to modern gambling products."
Critics of online fantasy betting believe that DraftKings and FanDuel have exploited the 2006 federal law offering them refuge as "games of skill." Those days are likely coming to a close. In mid-September, New Jersey Representative Frank Pallone requested a hearing to examine the legal relationship between fantasy sports and gambling. "These sites are enormously popular, arguably central to the fans' experience, and professional leagues are seeing the enormous profits as a result," he said in a statement. "Despite how mainstream these sites have become, the legal landscape governing these activities remains murky and should be reviewed."
The insider trading scandal isn't merely a bump in the road for red-hot start-ups like FanDuel and DraftKings, but a legal moment of reckoning for the burgeoning fantasy sports economy. Through selfish, idiotic recklessness, the employees of these companies have opened their beloved and profitable enterprises to regulatory scrutiny, which could have devastating consequences for their rapidly growing businesses. But while fantasy sports devotees may look upon snoops like Pallone as threats to their beloved games, perhaps the time is right for a regulatory regime that actually works to protect fans.