By Liana B. Baker
(Reuters) - The world of fantasy sports is having to grow up fast.
Everything seemed to be going great for rapidly growing companies whose customers, after paying an entry fee, draft fantasy player lineups from a range of sports for periods as short as a day in the hope of winning big cash prizes. Investors poured money into the top two U.S. companies, DraftKings and FanDuel, ahead of the current National Football League season, the busiest time of the year for fantasy sports.
But in the past few weeks the nascent industry has attracted the attention of lawmakers and government officials, and that will mean probes and hearings that could eventually lead to restrictions on how the companies operate. The companies are scrambling to respond by taking on external advisers and law firms, tightening policies and ordering their own investigations.
The companies may have painted big targets on their backs through aggressive advertising and relaxed internal policies that allowed employees to bet on rival sites and become some of the biggest cash winners. That triggered concerns among supporters and critics of the companies that the employees may have unfair advantages over other players because they may had access to non-public decisions by the best-performers.
On Tuesday, New York's Attorney General Eric Schneiderman opened a probe into DraftKings and FanDuel after the companies disclosed that a DraftKings employee recently won $350,000 from a $25 bet in fantasy football contest and had other major winnings on rival website FanDuel. A FanDuel spokesman has also confirmed that a FanDuel employee has won significant cash prizes on DraftKings.
Both companies have since announced permanent bans on its employees playing on rival sites, and will try to prevent staff at other fantasy sports companies from playing on their sites.
But the week's events caught Washington's attention. The top Democrat in the U.S. Senate, Harry Reid, on Tuesday called on Congress to scrutinize the business, saying there was "scandalous conduct" in fantasy sports. Separately, Representative Frank Pallone and Senator Bob Menendez, both New Jersey Democrats, asked the Federal Trade Commission to look into the employee issue. Pallone also said the House of
Representatives could hold hearings this fall about the industry.
DraftKings may also be facing blowback from its own investors. Major League Baseball, a two-time investor in the company, sought an explanation from DraftKings on Tuesday about employees being allowed to participate in games.
"We're battling the public perception here. The over-saturation of advertising has made daily fantasy a target. The companies need to come out saying we will do everything in our power to say our games are fair," said Dan Back, co-host of the daily RotoGrinders show on SiriusXM Fantasy Sports Radio.
FanDuel said on Wednesday it had asked former U.S. Attorney General Michael Mukasey, and his team at law firm Debevoise & Plimpton, to evaluate the company's internal controls and find weak points in standards and practices. DraftKings said it has hired a team from law firm Greenberg Traurig, led by former U.S. Attorney John Pappalardo, to conduct an investigation into the allegations against its employees.
As for other industry participants, a spokesman for Yahoo! Sports, which has offered fantasy sports with monetary prizes since July, said it is also evaluating the question of whether employees play on other fantasy sports websites. CBS Corp which also runs contests for money did not yet have a comment on the matter.
The Fantasy Trade Sports Association, the trade group representing the industry, hired public relations firm Finsbury about three weeks ago to handle industry policy and public affairs.
The risk is that the wake up call has come too late for the companies and that major damage has already been done to their market positions.
Andrew Lowenthal, a former financial services lobbyist, said the issues revealed this week exposed a potential weakness in the system, not that different from when brokers "front run" trades, or act with advance knowledge of another investor's upcoming transaction.
"The industry is exposing not only itself and its investors and partners to a lot of potential scrutiny and risk. This is more fuel for the fire," he said, adding he has spoken in the past with daily fantasy sports companies but does not currently have any clients in the sector.
IPOs AT RISK
The listing ambitions of DraftKings and FanDuel could also be on the line if the scrutiny builds. FanDuel CEO Nigel Eccles said last month that the company was waiting until January, when it will review its financial performance following the NFL season and decide if it wants to raise another private funding round or hire banks for an IPO. DraftKings also has IPO plans or wants to pursue a merger with FanDuel, CEO Jason Robins said last month.
Gaming sector investor Jason Ader, who runs investment firm SpringOwl and is one of the largest shareholders in British gambling firm Bwin.Party Digital Entertainment PLC, is skeptical either company could go public without a regulatory framework in place.
"There's a lot of variables that go into an IPO but at the very least they need to resolve this regulatory uncertainty and game integrity issue to get the highest possible valuation for their venture investors," Ader said.
(The story was refiled to corrects to say SpringOwl is one of the largest shareholders in Bwin, not the largest. Also corrects the spelling of Dan Back's name)
(Reporting by Liana B. Baker; Additional reporting by Steve Ginsburg in New York and Andy Sullivan and Diane Bartz in Washington; Editing by Martin Howell)