DRI-102 for week of 11-22-15: Fantasy Regulation Trumps Fantasy Sports in New York

DRI: 102 (Brought to you by Access Advertising)A few days ago, New York Attorney General Eric Schneiderman announced that he was issuing a “cease and desist” order against the two titans of daily fantasy sports, Draft Kings and Fan Duel. The order prohibited the companies from accepting wagers from residents of New YorkState. This amounted to an elimination of roughly 10% of their business. Ironically, both firms have large administrative offices in the state, and these would be unaffected by the order.

AG Schneiderman purported to have discovered that daily fantasy sports constituted illegal gambling under New York state law. He also claimed to have consulted experts in health, human behavior and economics, on the basis of which he deplored the “economic and social harm” done by the companies.

The cease-and-desist order allowed five days for the companies to show why their operations should be allowed to continue. Both companies took issue with the AG’s actions and predicted they would be vindicated in court.

Although opponents of fantasy sports commonly depict the issue in moral terms, habitués of this space will not be surprised to learn that it is better understood in economic terms.

The Background: A Brief History of Fantasy Sports

Two somewhat different kinds of activity have fallen under the heading of fantasy sports. Both of them cater to sports fans who gain satisfaction from activity involving sports without literally playing the sport themselves. In the first type, the fan simulates games by using statistical data on actual players as well as actuating mechanisms such as spinning dials or rolling dice. Although the idea for this type of fantasy sport goes back to the immediate post-World War II era, it was executed by companies such as Strat-O-Matic and Negameco starting in the early 1960s. (The most successful, Strat-O-Matic, still operates today.) It was first applied to baseball and spread to football, basketball and hockey. While this type of fantasy sport tests the fan’s sports knowledge and mental acuity to a limited degree, its pleasure is really observational rather than participatory. The success of the game derives from the company’s skill in accurately reproducing the skills of the players in the statistical categorizations it provides. The more accurate its depictions, the more representative will be the simulated games and the more pleasure the fan will gain. Indeed, hard-core players of tabletop games like Strat-O-Matic have sometimes spoken reverently of the greater appreciation of the sport given them by the game.

The second type of fantasy sport is participatory rather than observational and tests the player’s mental acuity to a much higher degree. Like the first type, though, the fan does not actually play the game – the proper analogue would be to the manager or coach rather than to a player. The fan chooses (or “drafts”) a team of players from the roster of actual players. The performance of this “team” in actual games provides the raw material for calculating its performance on behalf of the fan. Fan-performance is calculated according to certain pre-selected metrics than correlate closely with sporting success in individual and team terms. (For example, a baseball fantasy sport might award a certain number of points for a player’s home run or a run batted in; a football fantasy sport might award points for a player’s touchdown scored by running, passed for or received.) The number of players is limited by the rules, as is the duration of the contest. At the end, the fan whose team scores the most points wins.

This second type of fantasy sports contest also began in the early 1960s. An Oakland businessman named Wilfred “Bill” Winkelbach, who later became part-owner of the Oakland Raiders, is credited as its originator. An early version of this type of league met at a New York City restaurant called La Rotisserie Francaise, giving the sport the nickname “rotisserie sports.”

In the beginning, the metrics rewarded were simple and basic enough to allow one individual to compile and compute them. This person came to be called the “commissioner” of the fantasy “league.” Over time, though, two factors combined to replace the commissioner with a computer. First was the work of legendary sports statistician Bill James, whose BaseballAbstract was first widely published in 1982. James himself was not a fantasy participant, but his book became the veritable bible of fantasy sports. James revealed the hidden meaning behind baseball statistics, devaluing some of the most revered ones and raising the stock of other hitherto-unappreciated data. His work was just the thing fantasy gamers needed to prosper in their esoteric pastime. Before long, James’s insights provided grist for the metrics governing success in fantasy baseball, thereby complicating the calculations required to determine winners and losers. Second, the improvements in and omnipresence of computer technology came along just in time to serve the needs of fantasy sports. The fantasy-league commissioner became more of a figurehead than a prime mover.

It was in the 1990s that fantasy sports took off like the proverbial rocket. By 1988, USA Today estimated that 500,000 people participated in fantasy sports in the US. The rise of the Internet and proliferation of desktop computers in the 1990s drove the fantasy market through the roof. Successful websites were created to facilitate the creation of teams and leagues. Two of these were Commissioner.com and Roto News.com. In 1999, a year in which Commissioner.com was sold to Sports Line for $31 million, a survey estimated that 29 million people 18 and over played fantasy sports in the US. This figure was questioned when it became known that it may have included those choosing brackets in NCAA Final Four office pools. Still, a subsequent survey in 2003 estimated 15 million US participants in fantasy football alone. More recently, the Fantasy Sports Trade Association estimated in Sept., 2015 that 56.5 million people 12 and over played fantasy sports in the US and Canada, 33.5 million of those in the US alone.

Law and Legalism

It is a sign of the times that many – perhaps most – Americans are confident about the legality of fantasy-sports wagering whereas the subject is actually shrouded in mystery. The interpretation of the 2006 Unlawful Internet Gambling Enforcement Act (hereinafter, UIGEA) illustrates this confusion beautifully. The operative word in its title is “enforcement.” The provisions of the act relate to money and banking, not to delineations of which online activities are and aren’t illegal. Because the UIGEA contains a provision exempting fantasy sports, the belief was fostered that fantasy sports – including the daily fantasy games sponsored by Fan Duel and Draft Kings – had been ruled legal. In fact, the legislation does not even define the concept of sports gambling; it deals only with money transfers for the purpose of defining illegal money laundering.

The definition of gambling is up to individual state law. And this definition hinges mostly on the concept of a “game of chance.” Some states introduce the element of “skill” to differentiate between games of chance and skill. Other states prefer to differentiate between “substantial” and insubstantial degrees of chance. AG Schneiderman bases his accusation of daily-fantasy-sports’ illegality on dual grounds – the fact that the outcome of real sports contests lies outside the sphere of fantasy participants’ control and the fact that wagers are a “contest of chance.”

By any rational standard, participation in fantasy sports is a game of skill rather than chance. In statistics, a chance occurrence is a random event. Textbooks often use a coin flip to exemplify this, but this would be a theoretical coin flip, in which the flipper makes no conscious effort to influence the result (or the coin if flipped by a random mechanical device). The lack of control exerted by participants over sports events is irrelevant, since the wager is not over the outcome of the sports events themselves but over the skill with which participants can gauge the skills being applied in the sporting events. Another way to view this is to realize that fantasy-sports wagering is a game of skill for the same reason that the sports being wagered upon are games of skill. This holds true even more for the kinds of “daily” contests that particularly trigger the ire of AG Schneiderman than it does for the allegedly innocuous seasonal, or “intramural,” contests in which participants follow the fortunes of their chosen team for an entire season. After all, participants were originally attracted to the game in the first place because it played to their fantasy of stepping into managerial/executive shoes and picking winning lineups. Would Schneiderman et al really pretend that the originary sports – baseball, football, basketball, and hockey – are not games of skill and real-life field managers and general managers are merely engaged in blind, random choice? If actual managers of sports teams are skillful to a greater or lesser degree, how can this not also apply to the derivative fantasy sports? The information available to both groups of people is of exactly the same type, albeit not exactly the same quantity. (Real-life managers have the advantage of seeing and talking with the participants while fantasy players don’t – but these two groups don’t compete against each other so this differential doesn’t affect the relevant sets of results, which are teams versus each other and fantasy-sports participants versus each other.)

Schneiderman wants to parse the definition of terms like “material element of chance” to make a legal case that daily fantasy sports are gambling. But this is legalism rather than law. Apart from the issue of skill, there are other longstanding principles of common law that tell against New York’s AG. One is the principle that a plaintiff cannot sit on his rights indefinitely; that is, he cannot neglect to pursue a valid claim for so long a time that a defendant’s rights are compromised. In this case, many millions of Americans have pursued daily fantasy sports for years, building up substantial emotional and – in some cases – financial investments in this form of entertainment. If the New York government had a valid claim against daily fantasy sports on principle, it should have been able to state it without waiting a decade or more. “Silence gives assent” is a common-law principle dating back many centuries. Fantasy-sports fans had every right to believe that the silence of government betokened assent toward their avocation.

The distinction between law and legalism may be lost on most New Yorkers, but they have no trouble grasping the surrealism of AG Schneiderman’s declaration. All they have to do is look around them. New YorkState plays host to legal gambling in the form of state-licensed casino games, state-sanctioned pari-mutual betting at horse tracks and a state-run lottery. The misnamed “social losses” stemming from these forms of betting are far more pronounced, simply because the odds favoring the house are so much steeper. The glaring contradiction between allowing – and, in the case of the lottery, promoting – these state-sanctioned forms of wagering and prohibiting daily fantasy sports is so obvious that even Democrats can’t miss it.

What’s In It for AG Schneiderman?

What new sunburst of enlightenment motivated this sudden action by AG Schneiderman? What counterweight does he offer to the sound arguments marshaled above? Actually, it is clear that AG Schneiderman’s motives are anything but lofty and uplifting. Rather, they are as base and ignoble as those of any politician.

As a practical matter, we can assume that the $350,000 won by a Fan Duel employee in a rival Draft Kings contest was the precipitating factor in the AG’s decision to go after the two companies. True, an independent investigation uncovered no wrongdoing by the employee – that is, no use of proprietary information that conferred undue advantage to the winner. But the episode somehow sounded illicit, like a widow marrying her deceased husband’s best friend. It gave the AG a visceral pretext for launching an “investigation” that – lo and behold! – revealed a heretofore unsuspected conspiracy of immense proportions that was fleecing an unsuspecting public.

Of course, it is purely a coincidence that this shocking discovery follows in short order the equally shocking discovery that led the AG to sue Exxon: Exxon’s purported conspiracy to defraud its shareholders by hiding the fact that it has known all along that man-caused global warming is settled scientific fact. And this follows still another coincidence: the AG’s discovery of the shocking on-call policies followed by some retail sales companies operating within New YorkState. Thanks to AG Schneiderman, New York will henceforth be known as the State of Serendipity.

A cynical observer, such as an economist, might suspect AG Schneiderman of following the same strategy that elevated former New York AG Eliot Spitzer to the governor’s office; namely, terrorizing corporate targets for the delectation of the political left wing. (Those not yet singled out for indictment may choose to contribute to the AG’s future political campaigns in hopes of avoiding that fate.) Observe the tell-tale signs of vainglory in Schneiderman’s rhetoric: “Our investigation shows…Today we have sent a clear message: not in New York and not on my watch.” The incautious variation between the royal we and the self-absorbed first person is not merely bad writing but a dead give-away as to Schneiderman’s obsession with his career.

There is a variation on the theme that Schneiderman’s motives are political and self-seeking rather than noble and altruistic. In October, 2015, the state government of Nevada announced that it had suddenly discovered that daily fantasy sports constituted “sports gambling” under its state law. This did not make them illegal in Nevada, but it did mean that operators like Fan Duel and Draft Kings would have to obtain state licenses, just as the state’s casinos do. In other words, the state was forcing the fantasy-sports companies to split their takings with state government. Speculation is rampant that Schneiderman may be angling for this sort of negotiated outcome with the fantasy-sports companies. The AG’s pointed refusal to blackball their business operations in New York City points to this.

Public Reaction to AG Schneiderman’s Actions

AG Schneiderman’s actions may provoke cynicism, but the public’s reactions provoke dismay. Nobody really believes the AG’s central contention that the two companies have operated a conspiracy to fleece their customers. If they did, the reaction from over 30 million Americans would be widespread shock and outrage. Instead, people have reacted with surprise. They are surprised that even a state attorney general would peddle such blatant falsehoods. The other emotion they express is resignation – because most people think there is nothing they can do to stop him.

The only part of his indictment they are prepared to accept is his claim that the fantasy-sports industry produces “social” losses in the form of gambling addiction and misdirected expenditures. Here, AG Schneiderman himself has tapped into one of America’s favorite fantasy sports – the spectator sport of telling the other guy how to live his life. The admittance fee to this pastime is zero and nearly everybody is a player. Thus, people who do not participate in fantasy sports themselves are quite willing to look down on those who do. What a waste of time and money! There oughta be a law!

The large segment of the public that is simply resigned to getting pushed around by big government, combined with the segment that secretly longs to tell other people how to run their lives, is enough to more than counterbalance the 30-million-plus fantasy sports participants who are mad as hell at AG Schneiderman. Why 30-million-plus when only 3 million or so actually live in New York? Because the rest are beginning to see handwriting on the wall and they don’t like what it says.

If New York joins Nevada in extorting money from the fantasy-sports companies, other states will not be long in following suit. At best, this will drive up the cost markedly to participants. At worst, the AG may be able to make a ban stick.

To appreciate the fears of fantasy-sports fans, we need only cast our minds back a few years to recall the history of online poker. In 2003, a participant in the World Series of Poker, Chris Moneymaker, qualified for the live final round via an online tournament. He won the lucrative title, triggering not only a huge boom in popularity for the sport but also a tremendous surge in online poker participation. Dozens of websites sprang up offering money gambling. In the decade since then, several states (beginning with Washington) have ruled online poker illegal. Three states (Nevada, New Jersey and Delaware) have ruled it legal – but only if licensed and regulated. A former U.S. senator (Alphonse D’Amato) signed on as lobbyist for poker interests. And the legal ambiguity in the other states has pretty much squelched the online poker boom in the U.S. Notice that it wasn’t necessary for every single state, a majority of states or even a plurality of states to literally pass laws declaring online money poker illegal. A combination of bans in one or two states, the imposition of higher costs of licensure in a few key states and threatening rhetoric and continuing legal uncertainty elsewhere was sufficient.

This is the specter haunting fantasy-sports fans today.

Government Gone Wild

Economists are familiar with the atmosphere of an economic boom, when the animal spirits of businessmen run high, optimism prevails, employment grows like weeds and income spirals upwards. What we have experienced under the Obama administration is best described as a “government boom.” While this government boom lacks the proliferation of agencies and growth of government employment associated with the late Kennedy, Johnson and early Nixon administrations, it has exhibited a frenzy of administrative regulation and control exceeding any seen heretofore. That frenzy has affected not just government administrative agencies, but also federal and state prosecutors. Regulators at every level have sensed blood in the water and have reacted like schools of piranha.

Among those targeted in this government boom have been: bankers, truck drivers, stockbrokers, car dealers, nail-salon operators, bakers, insurance-company owners and employees, financial planners, doctors and innovators in the so-called “sharing economy.” Since the end-in-view behind all economic activity is consumption, consumers have been harmed indirectly by all of the adverse actions referred to above. AG Schneiderman’s latest foray is only one more in a punishing series of body blows to the abdomen, kidneys and solar plexus of the body economic.

Why should there be an ebb and flow of government regulatory activity? What accounts for a cyclical pattern of government advance and retreat? If nothing else, regime change probably signals an end to the incumbent philosophy and a return of old ways. In any event, that has been the pattern ever since big government became a fixture in our lives. (In this context, “regime” denotes ideological rather than political identity; “Kennedy/Johnson/Nixon” was liberal, “Reagan” was conservative and George H. W. Bush was somewhere in between.)

In our case, the regime change was a gradual shift leftward after Ronald Reagan left office, culminating with a sharp left turn coinciding with Barack Obama’s ascension to the White House. It has become more and more apparent over the seven years of the Obama administration that it represented a golden opportunity to centralize power in the hands of the regulatory and administrative state. Moreover, this opportunity came with a probable expiration date – either November, 2016, or the date of U.S. economic collapse. Any bureaucrat wishing to stake a claim had better file it soon.

That is why the juridical Klondike is overrun with prospectors like AG Schneiderman, forehead damp with gold fever and eyes wide with dreams of power.

They Call It Fantasy Sports For a Reason

Both contending parties to the debate over daily fantasy sports should spend a little more time thinking about the logic underlying the pastime. The word “fantasy” denotes something ardently wished for but not realistic and hence likely unattainable. It stands to reason, then, that the pleasure gained from it will probably derive from the pursuit rather than the actual achievement.

Fantasy sports play on the fantasy of the sports fan that he or she can be a big-league manager. Fantasy management combines the managerial and general-managerial functions of a real-life sports team while leaving out what may be the most difficult part of both jobs – managing people. As with almost any job or pastime, it involves an element of luck as well as a high degree of skill. There are very few highly successful real-life managers and general managers, just as there are relatively few highly successful fantasy-sports participants. In both, luck can produce success in the short run.

Fantasy sports is no different than any other avocation. Most hobbies entail pecuniary costs and some are very costly. Fantasy sports offer the possibility that the hobby may pay for itself or – in a few cases – turn an avocation into a vocation. The attempt by government to distort the true nature of fantasy sports and profit from the distortion is both typical and despicable.
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