United States: Draft Kings Class Action Argues Data Leak Revealed "Insider Trading" – But Can Case Survive Arbitration Clause?

Last Updated: October 20 2015
Article by Andrew G. Phillips

Draft Kings and Fan Duel, competing daily fantasy sports (DFS) sites, have been vying for attention by flooding the airwaves with a reported 60,000 commercials this year. However, a recent data leak has resulted in less desirable attention from lawmakers, regulators and – most recently – the class action plaintiffs' bar. ( Read more about the class action and related issues after the break.)

Daily Fantasy Sports – A Brief Primer

Before getting to the lawsuit, it's helpful to understand how DFS work. We'll use NFL football for our example. Like traditional auction league fantasy football, team "owners" work within a pre-set salary cap to draft the team of NFL players they expect to put up the gaudiest stats. At the end of the contest (typically an NFL weekend), the highest score wins the grand prize, but, depending on the number of participants in the pool and payment structure, many more might also win cash prizes. Contest entry fees range from 25 cents to over $5,000 and prizes can reach seven figures. If this sounds like gambling, it isn't – legally. At the urging of the NFL, MLB and others, who understood that fantasy sports drove interest in their products, fantasy sports were expressly exempted from the Unlawful Internet Gambling Enforcement Act of 2006 as "games of skill."

A crucial difference between DFS and traditional fantasy is that in DFS many different teams can own the same player(s). In other words, having Gronk at tight end in week one didn't separate you from the pack because thousands of other teams also had Gronk. Thus, the key to success in DFS, as explained by a source familiar with the game, is "to differentiate your lineup from the competition with players that have good value but low ownership."

The Data Leak and the Big Score

Because of the proprietary and valuable nature of the data, DFS sites do not release stats on player popularity until after lineups are "locked." Thus, managers are left to their own devices to determine player value – with casual owners relying on ESPN and intuition while more sophisticated players employ custom algorithms to set thousands of complementary lineups. However, entering week three of the NFL season, a Draft Kings employee privy to proprietary roster statistics posted that data online before it was supposed to be publicly available – information that could help owners identify potential value players in multimillion-dollar contests. The employee and Draft Kings maintain that the leak was inadvertent.

While the leak alone might not have caused much of a stir, that same week, the same employee came in 2nd in a Fan Duel contest, winning $350,000 – raising skepticism regarding the security and use of valuable and proprietary data. Although Draft Kings and Fan Duel promptly issued a joint press release stating that the employee did not have access to the leaked data at the time he set his Fan Duel lineup, the confluence of events was a wake-up call to consumers and lawmakers that (1) DFS employees were playing on competitors' sites, (2) DFS employees had access to data that could be used to create an unfair advantage, and (3) this valuable data may not be adequately protected.

The Class Action Lawsuit

On October 8, 2015, Adam Johnson filed the first class action lawsuit against Fan Duel and Draft Kings alleging that, although the games are advertised as contests of skill and knowledge, insiders were using non-public information regarding winning strategies and lineup data to obtain an unfair advantage. As Johnson alleges, Draft Kings and Fan Duel have sophisticated systems in place to monitor their games, including IP addresses of players from competing DFS companies. Moreover, Draft Kings and Fan Duel were aware of, and even discussed, whether their employees should be permitted to play competitor sites, yet allowed the practice to continue despite the potential for abuse of insider information. In fact, the complaint alleges, DFS employees from CEOs on down played and profited on competing sites – sometimes winning as much or more than their salaries. Based on these allegations, Johnson asserts claims including negligence, fraud, conspiracy and violations of various consumer protection and false advertising statutes. The suit seeks certification of a nationwide class to recover compensatory and punitive damages, attorneys' fees and declaratory relief.

Is Class Adjudication Barred by Draft Kings Arbitration Provision?

While there are many hurdles between the filing of Johnson's Complaint, class certification and any recovery, the most immediate is Draft Kings' Terms of Use, to which all players must agree. Notably, the Terms of Use include a mandatory arbitration clause, titled "ARBITRATION, CONSENT TO JURISDICTION IN MASSACHUSETTS, ATTORNEY'S FEES," which, in pertinent part, states:

[All claims] except for claims filed in a small claims court that proceed on an individual (non-class, non-representative) basis, shall be settled by binding arbitration ....

....

Any and all claims shall be arbitrated on an individual basis only, and shall not be consolidated or joined with or in any arbitration or other proceeding involving a Claim of any other party. You and Draft Kings agree that the arbitrator shall have no authority to arbitrate any Claim as a class action or in any other form other than on an individual basis.

The Draft Kings arbitration clause further provides that "[t]he arbitrator shall not have authority to award punitive damages." The Fan Duel Terms of Use contain a similar provision, titled "Binding arbitration and class action waiver" – though, as a Draft Kings customer, there is no reason to believe Johnson ever agreed to the Fan Duel terms.

So, do Draft Kings' Terms of Use put Johnson's class action on the permanent DL? Johnson doesn't think so. Tackling the issue head-on, Johnson argues that Draft Kings' terms are unenforceable because (1) he was fraudulently induced into entering the contract by the promise of a fair game; (2) the terms are illusory because they purport to bind Johnson but do not bind Draft Kings; and (3) the clause is unconscionable.

While these arguments are all well and good offensive attacks on the facial validity of a contract, Draft Kings has a ringer on D: Harvard standout and the J.J. Watt of Justices, Antonin Scalia, who in American Express Co. v. Italian Colors Restaurant interpreted the Federal Arbitration Act to find arbitration provisions in similar adhesion contracts binding and enforceable even where, as here, they make the pursuit of small claims economically unviable by eliminating class or collective actions.

That said, while the DFS companies appear to be the Vegas favorites, the victory formation would be premature. First, the court could be convinced by one of Johnson's contractual defenses – particularly if it negates contract formation. Or, it might find that one or more causes of action (perhaps false advertising or conspiracy) are not claims within the ambit of the Terms of Use. The inclusion of Fan Duel as a defendant, with which Johnson did not contract and which therefore does not have an arbitration agreement, is another interesting wrinkle. Finally, this case has generated a lot of heat and interest – ranging from the New York Attorney General's Office to Capitol Hill – and the parallels to insider trading in an unregulated consumer marketplace shape a troubling narrative. More generally, just last week, the Consumer Financial Protection Bureau, an agency known for taking an expansive view of its jurisdiction, announced that it is exploring a rulemaking to eliminate the use of arbitration agreements in consumer contracts that bar class action lawsuits. So even if the DFS companies prevail here, the championship game may be against prosecutors, regulators and Congress.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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