Will regulators sideline fantasy stock-trading games?
Stock Battle – one of the first to allow real-money stock-picking games modeled on daily fantasy sports services – received a cease-and-desist letter from the Securities and Exchange Commission, Yahoo Finance has learned.
According to an email from Stock Battle co-founder Lee Lowden to customers on Monday, the SEC letter said the firm’s games amounted to dealing in “unregulated security based swaps.”
“Unfortunately, we do not have the capital, time, or resources to be ‘regulated.’ As a result, we have decided that it is best to close our operations,” Lowden wrote.
Lowden did not reply to requests for comment. An SEC spokeswoman declined to comment.
Stock Battle was among a group of firms hustling to capitalize on the boom in daily-fantasy sports competitions that have driven private-market valuations of leaders DraftKings and FanDuel above $1 billion, according to recent reports.
A Yahoo Finance article this month detailing this emerging trend noted: “The vague fear that regulators might turn hostile on this area continues to hang over the business.” That fear has become a not-so-vague reality in the past two weeks.
These services were set up to allow individuals to compete for cash prizes based on the performance of a virtual stock portfolio.
As noted in the earlier piece, anyone can speculate in stocks every day in the actual stock market. So why would anyone need a virtual version of the generally losing game of day trading? The short answer is that fantasy investing games charge only skimpy entry fees, far lower even than discount-broker trading commissions.
Representatives of some other firms that have entered this arena, including Jacana Trading and the World Series of Trading, say they have not yet received any communication from the SEC seeking to restrict their activities.
Fantasy sports vs. fantasy trades
All these firms have relied on being granted the same legal treatment afforded those daily fantasy sports games, in which players compete for cash prizes based on the performance of a virtual team of real athletes.
Yet fantasy sports leagues were explicitly exempted from the Unlawful Internet Gambling Enforcement Act (UIGEA) of 2006, which targeted online poker and other casino-style games that operated beyond states’ supervisory reach. Fantasy leagues were deemed “games of skill” rather than chance, for the purposes of the law, and terms of the contests were reqiured to fulfill certain specific criteria to pass muster. The fantasy trading entrepreneurs were assuming they would likewise qualify as a skill-based competition.
Even if it did demonstrably take skill to select a basket of stocks that does better than others in a contest on a given day, for fantasy investing sites, the online gaming law could be superseded by the explicit powers granted to the SEC and Commodity Futures Trading Commission by the Dodd-Frank financial-reform act of 2010.
David Klein is a partner with the New York law firm Klein Moynihan Turco, specializing in fantasy sports, sweepstakes and gaming issues. He says, “I get calls every day” from people looking to start fantasy-trading sites. “I consistently advise against it,” because in his view “it doesn’t comport with the UIGEA ‘carve-out’ for fantasy sports.”
Klein concedes that he’s somewhat conservative in his interpretation of the law, and others who are pursuing “aggressive twists on fantasy” might see things otherwise.
But among the many objectives of the Dodd-Frank act was to spell out detailed regulatory oversight rules for various over-the-counter instruments that exist adjacent to the public securities markets. Among these are “security-based swaps,” or financial agreements between two parties whose payoff terms are based on the value of a security or “narrow-based index” of securities. A commentary on the Dodd-Frank rules by the law firm Skadden Arps Slate Meagher & Flom says a narrow-based index is generally viewed as one that includes fewer than nine securities.
Regulatory jurisdiction over security-based swaps was handed to the SEC, while the CFTC was assigned oversight of standard swaps based on interest rates, currencies and such.
Even a conservative interpretation of the law won’t necessarily sink the nascent fantasy trading business. Perhaps explicit compliance standards will be formulated. Maybe some sites will even opt to undertake the costly and cumbersome process of registering with the SEC.
Until it all gets sorted out, though, the mock stock trading business might have a hard time gaining momentum. Perhaps small-time traders will have to resort to the actual stock market to day-trade themselves into the red.
Source: Yahoo! Finance