DraftKings and FanDuel could be shut down in New York. Here's what you need to know.

If you follow sports, you've likely seen dozens of advertisements for DraftKings and FanDuel, two companies that have pioneered a relatively new type of online gambling known as daily fantasy sports. A few weeks ago, the sports world was rocked by revelations that a DraftKings employee with access to proprietary DraftKings data had won $350,000 in a FanDuel contest. That naturally led to speculation that his access to DraftKings data had given him an edge at FanDuel.

Since then, federal and state regulators have been subjecting the two companies to greater scrutiny.

In October, the Wall Street Journal reported that DraftKings received a subpoena from US prosecutor Preet Bharara, who was probing whether a DraftKing employee misused proprietary information and whether the business models of DraftKings and its major competitor, FanDuel, are running afoul of federal gambling laws.

Now the companies are facing unwanted attention from New York's powerful attorney general too. According to the New York Times, Attorney General Eric Schneiderman has ordered DraftKings and FanDuel to stop taking bets in the state of New York, where DraftKings has 500,000 users.

The companies deny their services are illegal gambling, and they could still fight the order in court. But the fact that multiple public officials are raising concerns about the legality of daily fantasy sites is an ominous sign for both companies.

Daily fantasy sports look a lot like online gambling

Fantasy sports have been around for decades; the concept first became popular for baseball before spreading to other sports. And in the early days, fantasy baseball wasn't such a big business.

The concept caught on first in baseball thanks to the wealth of statistics available about baseball games

It worked like this: At the beginning of the season, you would assemble an imaginary team — a pitcher, catcher, shortstop, and so forth — using the names of real, active players. Then, over the course of the season, your fantasy team would rack up points based on the real-world performance of the players you've chosen. You might also be able to trade players in your lineup with others in your fantasy league midway through the season. At the end of the season, the contestant whose imaginary team earns the most points wins the league.

The concept caught on first in baseball thanks to the wealth of statistics available about baseball games. As the internet made it easier to find information about other sports, the concept spread beyond baseball — especially to football.

In the past five years, a variant called daily fantasy sports has become popular. The basic concept — choosing fantasy teams and racking up points based on players' real-world performance — is the same. But whereas conventional fantasy sports provided fun, low-stakes entertainment for a group of friends (albeit often with some money at stake), daily fantasy leagues look a lot more like conventional sports gambling.

The daily fantasy market is dominated by two relatively new companies: FanDuel (which has a partnership with Vox Media's sports site SB Nation) and DraftKings. Players might pay $5, $25, or $100 to enter a contest, and they can win prizes as large as $1 million. Rather than just competing against a few friends, people compete with thousands of strangers from across the country. Both companies have raised millions of dollars in venture capital, and they say they'll pay out more than a billion dollars in prizes in 2015.

Fantasy sports sites enjoy a special loophole in federal law

Major sports leagues lobbied for the ban on internet gambling Congress passed in 2006 that shut down internet poker and other online gaming. But they also convinced Congress to carve out an exception for fantasy sports leagues because they boost fan interest in watching sports. As a result, fantasy leagues are the only form of sports betting that's legally available to most Americans.

Companies like FanDuel and DraftKings have taken full advantage of the loophole. Today's daily fantasy sites feel more like professional gambling operations than a friendly office pool. And at least one legal expert believes these sites are bumping up against the legal limit under federal law.

In the process, these companies have created an awkward situation for the NFL. In the past, it was easy for the NFL to argue that it should be in a different legal category from conventional sports betting. But daily fantasy leagues are blurring this line.

A DraftKings employee's big win on FanDuel created a PR headache for the industry

A few weeks ago, we learned that DraftKings employee Ethan Haskell did two things on Sunday, September 27:

• He released data earlier than usual on how many people had chosen each athlete for an upcoming fantasy contest. With thousands of contestants competing in each round, leagues allow many people to choose the same fantasy athlete. DraftKings normally keeps this information confidential until fantasy players have finished choosing their players for a particular game.
• He won second place in a fantasy contest hosted by DraftKings competitor FanDuel, winning $350,000.

Naturally, a lot of people wondered if these events were connected. Because the payouts in daily fantasy games go disproportionately to the top players, data about which athletes are most and least popular among other fantasy players can help a contestant boost the odds of winning. And while Haskell didn't have access to any data about FanDuel users, the DraftKings and FanDuel contests are similar enough that data about DraftKings players' bets should have provided a lot of insight about both sites.

However, DraftKings insists that nothing of the sort happened. The company says FanDuel's deadline for choosing players was 1 pm, while Haskell didn't get access to the DraftKings data until 1:40 pm — so data from DraftKings couldn't have helped him assemble his winning FanDuel roster.

Knowing how other users have bet can help a user stand out from the crowd

And to be clear, the data Haskell released was not sufficient, on its own, to win money. Far from it. Winning requires choosing a roster of players who perform well in a particular set of games. No one can know that in advance. So even someone who has data about other players' rosters will only be able to win a small percentage of the time.

But daily fantasy sports, like most betting, is a game of averages. Knowing how other users have bet can help a user stand out from the crowd. And even modest improvements in the odds of winning can add up over the course of many bets.

The controversy is increasing public scrutiny of fantasy sports

In a brief joint statement released in early October, DraftKings and FanDuel insisted that they have strict policies in place to prevent employees from cheating on fantasy games. They also temporarily banned employees from playing on competing sites (employees were already banned from playing on their own sites).

The big worry for DraftKings and FanDuel is that the controversy over Haskell's winnings — whether or not they were based on inside informaiton — will cause policymakers to reconsider whether daily fantasy sports sites are, or should be, legal under federal law. Bharara might conclude that critics of DraftKings and FanDuel are right, and the sites don't actually qualify for the fantasy sports exemption. If he does, that could lead to a big legal battle that could force the sites to radically change their services or shut down altogether.

It's also possible that Congress could become involved. Congress exempted fantasy sports from its online gambling ban at a time when fantasy leagues looked very different from conventional online gambling. But Congress could revisit that decision and impose new restrictions — restrictions that could make these fantasy sites much less profitable. At least one member of Congress has questioned whether the line drawn between fantasy sports and other forms of sports betting makes any sense.

Of course, that line of reasoning could lead in one of two directions. One option would be to narrow the fantasy sports exemption and more strictly regulate — or ban altogether — sites like DraftKings and FanDuel. Or Congress could decide that online gambling really doesn't pose a threat to the republic and opt to open up the market to other forms of internet betting.

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