Tottenham Report: Caveat Emptor By Andrew Tottenham, Managing Director, Tottenham & Co March 17, 2021 at 10:00 pm Last week, Football Index, the fantasy sports share-trading business, called in the administrators, a process similar to the United States’ Chapter 11, and the UK Gambling Commission (GC) suspended its operating license, resulting in the closure of the business. The GC put out a statement: “The suspension follows an ongoing section 116 review into the operator, as we had concerns activities may have been carried on in purported reliance on the licence, but not in accordance with a condition of the licence, and that Football Index may not be suitable to carry on with licensed activities.” This left their customers in a very difficult position, essentially holding the equivalent of open bets, but without any hope of getting paid for winners or even having their stakes returned. It is not even clear whether money held in customers’ accounts will be returned. A quick check of the website reveals conflicting results. On the one hand, the FAQs say that funds held in customer accounts are “medium protection”, according to the GC standards, and “will be returned in the event of insolvency.” But, on the other hand, the company’s terms and conditions state that there are “no guarantees that all funds will be repaid in the event of insolvency”. The GC has three levels of protection for customer funds. “Not protected” means customer funds are comingled with the company’s operating capital. “Medium protection” indicates customer funds are in a separate account and there is some mechanism to protect them, i.e., insurance. “High protection” refers to the funds being held in a trust account or administered by a third party. In light of what has happened, it looks to me that these definitions are inadequate and the Gambling Commission needs a better early-warning system for potential company failures. In the UK, company administrators have wide-ranging powers and can seize the funds of unsecured creditors to pay the secured creditors. In this case, it appears that Football Index’s clients would rate as unsecured creditors. Reading some of the comments on the Football Index blogs, I don’t think their customers understood this provision. How did Football Index work? It was a clever idea, but I am not sure it was one which could ever be monetised successfully. It would have needed to gain significant traction and accept losses for many years, while it built up a large customer base—and, given the business model, that seems unlikely. Their product worked similar to fantasy sports, but with a difference. The language was that of investment, but essentially it was a bet. There were two ways a customer could make money. Football Index sold “shares” in players, up to fifty thousand per player in the “initial offering,” and its customers bought and traded those shares amongst themselves. Customers received dividends from Football Index for each share owned. Among a number of different types of dividend, the most important was the “performance dividend”. If the performance of that player improved relative to the other players on the platform, the dividend rate went up. If it decreased, the dividend rate went down. Secondly, customers could sell shares at any time, provided someone wanted to buy them at the price set or at a price that someone on the platform was offering. As long as they sold it for more than it was originally bought for, the customer made money. As mentioned previously, the owner of the shares received dividends, with a maximum of 14p, and averaged somewhere between 10% to 12% of the cost of the original share per annum. However, and it is a big “however”, according to the rules, each share was valid for only three years from when it was originally purchased; after that, it expired. In other words, a buyer held an asset that was intrinsically worth 30% to 40% of its original value, with that depreciating rapidly. Even if the offer price went up, who would buy a share if it had only a few months left before expiry? After three years, there were no more dividends. The share expired and was valueless. The terms and conditions gave the company wide latitude to make unilateral changes, some of which could be incredibly detrimental to the customers’ interests. For example, the company had the right to issue more shares, up to a maximum of one million in any player, at any time. Perhaps more problematically, the company could change the basis for calculating the dividend rate twice a year or at any time in exceptional circumstances. In January of this year and again earlier this month, the company reduced the maximum dividend — with catastrophic results. How did the company obtain its revenues? There was a 2% commission on buying shares, and the company originated and sold shares at the time of the initial offering of the player to the market. Probably of greater importance was the revenue it obtained from selling additional shares into the market when a player’s share price was high, i.e., when demand for those shares was high. So what went wrong? With hindsight, it looks like the company was running out of cash. The revenues from the sales of new shares plus commissions was not covering the payment of dividends plus running costs. The company cut costs by paring back the dividend rate. As a consequence, the share prices plummeted, which exacerbated the problems; instead of selling shares into the market for sometimes as much as £15, the same shares could be sold for only 15p or not at all. I believe the company was advised to tell the GC of their predicament and in response were told that in view of the cash shortage, the operating license was being suspended. Essentially, Football Index’s customers bought the possibility of getting 45p, paid out over three years for £1, and with the risk that if Football Index went bust, all their shares and maybe the money in their accounts would become valueless. I scratch my head wondering why anyone would buy shares on their platform. It is not the same as buying shares in a company. If the company goes bust, your shares may be worthless. But if the exchange goes bust, you still own the shares and the company can list them elsewhere. With Football Index, when the exchange went bust, all of the shares were valueless. The GC’s CEO, Neil McArthur, has resigned abruptly and there is speculation that the bad publicity around the closure of Football Index was to blame. My personal view is that for the DCMS, it was the last straw; there had been a number of missteps on his watch and the DCMS and the Government were not happy that he had ploughed ahead with significant changes to regulations, even after the review of the Gambling Act was announced. Football Index forced their hands.