Because regulators want to ensure that player funds are safeguarded in the event of corporate financial difficulties, such as bankruptcy, and may not be used to repay corporate debts, several states require Fantasy Sports operators (either daily, or both daily and season-long) to segregate player funds from their own operating funds. Like many components of the evolving regulatory framework surrounding fantasy sports, this requirement can appear intimidating at first. Fortunately, properly setting up segregated accounts can be relatively straightforward – as long as you follow a few basic steps.
Which States Require Segregated Accounts?
Out of the 10 states that have formally passed legislation related to fantasy sports, all but Kansas require companies to segregate their operational funds from their customers’ funds. Thus, if you are operating daily fantasy sports games in Colorado, Indiana, Maryland, Massachusetts, Missouri, Mississippi, New York, Tennessee, and/or Virginia, you need to establish a mechanism to ensure that sufficient funds are maintained to cover all player funds and that those same funds may not be used to cover operational costs. (Note: Not all the states listed above apply their fantasy sports regulations to operators of season-long games.)
What to Do?
The guidelines established by Massachusetts are the most extensive and therefore following these guidelines will permit you to take a single approach to compliance. Even if your company does not currently operate daily games in Massachusetts, adopting this approach may position you to 1) expand more easily into other regulated states, 2) show less demanding states that you have satisfied, and potentially even exceeded, their protections; 3) begin offering daily games if you choose to do so at a later time.
How to Do It?
Massachusetts provides two methods for protecting player funds: 1) you can either hold them in a trust or 2) in a special purpose segregated account, which is maintained and controlled apart from your company (also called a “Special Purpose Entity”). The SPE method has been deemed by some operators to be less burdensome, because the use of a trust presents unique complications related to player participation across states and the ability to enter into contracts with certain vendors who either do not offer trust accounts, or charge more for entering into contracts related to trust accounts.
However, at this juncture, the New York Gaming Commission has not indicated whether it will allow operators to use SPEs as a method of complying with their regulations or whether such regulations will require the use of Trust Accounts. Thus, if doing business in New York is integral to your business, you may want to wait and see.
To set up the SPE, you can follow the three steps set forth below. In addition to these key steps, you will need to set up a separate bank account for your customers’ funds and notify payment processors that customer deposits should be placed in the SPE’s account going forward.
- Form your Special Purpose Entity (SPE) as an LLC. The SPE must have a governing board that includes at least one independent member who is unaffiliated with your company and is essentially responsible for representing your customers and protecting their funds from unauthorized uses.
- Draft an LLC Agreement for the SPE between your company and the independent member of the SPE’s board. This Agreement must contain a number of provisions to satisfy the requirements. Foremost, it should prohibit the co-mingling of player funds and your own operational funds except as necessary to reconcile debts owed by the player to your company. This Agreement should also ensure that a unanimous vote is required to declare bankruptcy so that player funds are not vulnerable to creditors. The requirement of a unanimous vote ensures that the independent member of the board supports the bankruptcy declaration. The SPE must also be prohibited from incurring debts other than to players as laid out by the rules that govern their accounts as customers. Finally, this Agreement must prohibit the SPE from dissolving, merging, or consolidating with another company while there are any amounts owed to customers, unless the new or merged company maintains an SPE in compliance with Massachusetts law. As with any corporation, it is also important to include provisions concerning necessary corporate formalities, such as board meetings and the keeping of minutes.
- Draft an Intercompany Service Agreement between your company and the SPE. This Service Agreement should primarily address account reconciliation services, which will be used to settle-up accounts regularly and guarantee that your users get paid.
We hope this blog has helped demystify the process of segregating customer funds in a manner that complies with state laws and regulations. Of course, each situation may present unique issues and nothing in this post constitutes legal advice upon which you should solely rely.