The Only Color in Gambling is Green-Why Staking is a Security

The Securities Act of 1933's catchall for defining a security is the "investment contract." The landmark case, SEC v Howey, explained that "an investment contract for the purposes of the Securities Act means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely form the efforts of the promoter or a third party …" Here, the Howey Court held that selling shares in a citrus farm managed by the promoter was an investment contract. Under the Howey test, staking sports, poker, or fantasy sports gamblers (or a related fund) is also likely an investment contract.

Staking is a common financial relationship between professional gamblers and investors. The gambler sells shares of his or her action to investors. The player then incorporates the investors' money into a bankroll that is used to enter tournaments, play cash games, or make bets. The terms are typically described in a staking contract or verbally with handshake. If the gambler is profitable, then investors get a percentage of the winnings commensurate with their piece of the gambler's action. Top gamblers are compensated similar to their hedge fund counterparts-they receive a large percentage of the profits while floating very little of the risk.

Increasingly, staking arrangements have become more complex with millions of dollars on the line. Gamblers are forming LLC's to conduct their staking business. Third party sites like ChipMeUp and YouStake operate as platforms to connect players and gamblers. Here, gamblers upload their stats and staking terms while investors back gamblers while benefiting from the security of investing through the site. Additionally, aggressive fund managers, who want high altitude returns, are now investing in gamblers. While most operate below the radar, funds like thepokerbackers and vip-grinders advertise staking poker players for investors. In 2016, the first legal sports betting fund, Bettor Investments, LLC, opened for business in Nevada after the passage of Nevada Senate Bill 443, which allows entities to place sports bets. Finally, rumors have swirled for years about the existence fantasy sports hedge funds. These funds source profitable gamblers and manage the staking contracts for the pool of investors.

This author is not aware of a court case in context of staking, but with the explosion of online fantasy sports (which is legal and a multibillion dollar business), it is only a matter of time before the SEC targets fantasy sport funds that solicit investors. The argument for game-of-skill legalization like poker or fantasy sports could be the very argument for classifying staking agreements as an investment contract. For example, each poker hand is at least one trade up to a series of trades. In short, poker players trade hand ranges and distributions, and over time those with an edge show a profit. Thus, poker advocates argue that poker is the same in theory as option day trading rather than a form of "entertainment."

If a day trader formed an LLC, raised money by selling shares to investors, then traded the investors' money to return a profit to the investors, the scheme would undoubtedly be an investment contract. Similarly, if sports betting, poker, and fantasy sports are games of skill, then investors are not playing a game for entertainment. They are: (1) investing their money with a promoter that has special knowledge and abilities; and (2) pooling money into a common scheme for one purpose-to make a profit.

Sounds awfully like an investment contract.

Posted in: Stacking
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