Are DraftKings and FanDuel legal?

September 24, 2015, 1:01 PM UTC

DraftKings and FanDuel are both flooding the airwaves with commercials this month, and in those commercials, regular folks boast about the money they’ve won competing in the daily fantasy “contests” that these companies offer.

So: are these contests legal?

For now they are, in 44 states—and thanks to partnerships with major sports leagues (Major League Baseball, the National Basketball Association) and large corporations (Disney (DIS), Fox (FOX)), there is enough momentum that fantasy sports are probably here to stay. Federal law also allows them. But the line often used by executives to explain the legality of the business—it’s a game of skill, not chance—is in fact a ­simplification.

Laws differ in each state for how the skill requirement must be met. In Kansas, for example, a contest must prove only that it involves more skill than chance. New York is far tougher: The contest must have no “material amount” of chance. The bar is even higher in Tennessee and Arkansas, where a game of skill must involve no chance whatsoever.

DraftKings and FanDuel currently operate in all those states. Marc Edelman, a law professor at Baruch College, believes that courts there could potentially find that the companies are operating illegally. Edelman also believes some of the single-day contests DraftKings already offers, like those for single PGA golf tournaments, are in fact illegal in all of the states where they are operating, because federal law seems to require a fantasy sports contest to contain multiple contests. (FanDuel does not offer golf contests.)

In four of the five states where DraftKings and FanDuel do not operate—Washington, Louisiana, Iowa, and Arizona—it isn’t that they are expressly illegal in those states; the companies choose not to offer service there because it is clear the law is unfriendly. The only state to have a statutory ban on some fantasy sports games is Montana. In Nevada, the Gaming Control Board ruled in October that daily fantasy companies are gambling operators, and thus cannot offer service unless and until they obtain a gambling operator license.

The “game of skill” argument rests on the idea that it takes talent—a deep understanding of the sport and the rosters, perhaps with the aid of statistics-filled spreadsheets—to consistently win money doing this, rather than chance, which would make it gambling. Some see that as a loophole. After all, customers are plunking down money on athletes they believe will perform well. Using their argument, doesn’t betting at the horse track also take skill? You could research the horses: learn which one does best in the rain, which one has a delicate left hoof.

In explaining why daily fantasy requires skill, Jason Robins (40 Under 40, No. 8), co-founder and CEO of DraftKings, compares it to stock picking. Daily fantasy players conduct extensive research, considering a wide range of factors, to assemble the team they believe will have the highest number of points. But doesn’t that very argument contradict the ability these apps have to lure casual new users?

Even Edelman doesn’t believe these companies are suddenly going to be shut down entirely. They have too much momentum. And he points out that legalized sports betting could pad state and federal tax coffers. “My expectation,” Edelman says, “is that we will move in the direction of England and have all-out legalized sports betting in the U.S.”

That will create an interesting scenario for daily ­fantasy-sports firms that have operated in the limbo of legal uncertainty. Their advantage for the last few years has been that the larger companies engaged in season-long fantasy sports have waited to jump into the “daily” market. Can DraftKings and FanDuel withstand the competition that would result from clear legality? That’s the billion-dollar question.

A shorter version of this story appeared in the October 1, 2015 issue of Fortune. To read the feature story it accompanied, see “This man is blowing up fantasy sports.”

Note: This article was updated on October 18 to reflect new developments.

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