CFTC publishes first prediction markets rulemaking proposal as legal battles continue

The US Commodity Futures Trading Commission released its first notice of proposed rulemaking regarding prediction markets Wednesday, which represents a preliminary but significant step forward in the regulator’s relationship with the fast-growing and controversial derivative exchanges.

Stakeholders and interested parties will have a 45-day public comment window to respond to the proposal, which is narrower in scope than a broader prediction market rulemaking notice that was announced in March. The comment window will begin once the proposal is published in the Federal Register, which hasn’t happened as of writing.

In a statement announcing the release, the CFTC said this rulemaking pertains specifically to “amendments to CFTC Regulation 40.11 and the addition of Appendix F to part 40”. The proposal would “establish a structured framework for evaluating whether such contracts involve an activity enumerated in Section 5c(c)(5)(C) of the Commodity Exchange Act —activity that involves terrorism, assassination, war, gaming, or conduct that is unlawful under federal or state law—and, if so, whether that contract is contrary to the public interest”.

While not all-encompassing, this particular aspect of prediction market regulation is of great interest to the gaming industry. Many of the lawsuits involving prediction markets centre around the existing language of the CEA and whether sports event contracts constitute “gaming”, which would preclude those contracts from being listed and traded.

CFTC Chairman Michael Selig has become a very public figure in recent months, as the financial regulator has defended its jurisdiction over prediction markets both in the media and in court. Selig said in the CFTC statement that the proposal “gives the Commission a durable, transparent framework to identify the contracts Congress directed us to scrutinize while letting legitimate markets move forward.”          

What is gaming?

The 267-page proposal published Wednesday features the word “gaming” a total of 222 times. Perhaps the most notable allusion comes on page 161, where the CFTC offers a new definition for the term:

“The proposed rulemaking defines “gaming” as activity typically engaged in for recreation or to entertain others, governed by rules, with measurable occurrences or outcomes dependent on participants’ luck, skill, or athletic ability during the activity,” the text reads. The Proposal also clarifies that elections and awards “are contests, not gaming.”

The proposal asserts that contracts currently listed “already reflect elements of this shift away from the Commission’s prior view”, and these markets “include underlying events focused on aggregate performance in sports events (final scores, point differentials, season long statistics, tournament advancement)”.

This interpretation is a stark change from the CFTC’s previous position, which is acknowledged in the rulemaking. In previous litigation in DC federal court, the commission had asserted that gaming is synonymous with gambling, but this was referred to as a “previous error” in the new text. The court rejected that interpretation, and the commission agrees, because all contract trading could be considered gambling and that would mean all event contracts could be subject to review, which would be unrealistic.

“Ordinary definitions of “gambling” include “the act of risking something of value, especially money, for a chance to win a prize,” the proposal says. “If this definition of gaming built around wagering were implemented, some could argue that the definition should apply to all event contracts and render the Special Rule’s “gaming” category limitless. Therefore, that definition of gaming is incompatible with the Special Rule’s structure.”

Analysing the Special Rule

Much of the proposal, including the gaming definition, relates to the CFTC’s “Special Rule”, or CEA section 5c(c)(5)(C). That rule was enacted via the Dodd-Frank Act in 2010, and gives the commission the authority to disallow contracts that involve terrorism, war, assassination, gaming, illegal activities under state or federal law or any other activity the regulator deems to be contrary to public interest.

Detractors of prediction markets have criticised the CFTC for what they view as a refusal to enforce the Special Rule in light of recent expansion. However, this hesitancy to invoke the review seems to predate the current boom — previous CFTC chair Caroline Pham held a meeting with tribal gaming leaders last May and said she was not aware of the commission ever disallowing or taking action against a contract.

Regardless, the new proposal seems to indicate that the commission itself views the Special Rule as a steep and onerous requirement that it is loathe to meet. The CFTC “preliminarily interprets the Special Rule to require the Commission to engage in a three-step inquiry before it may determine an event contract is prohibited thereunder”, the text reads.

In order to take action or disallow a contract, the CFTC has to:

• Determine that it the underlying event is actually an event that occurs or does not occur;
• Determine that the contract involves one of the enumerated categories above; and
• Conduct a public interest analysis to conclude whether the contract is “affirmatively against the public interest”.

Notably, this process applies to individual contracts; prediction markets are constantly self-certifying whole swaths of contract markets — disallowing one specific contract, such as a player’s performance in the Super Bowl, would not ban NFL contracts as a whole, for example.

Only 300 ‘detailed’ submissions

After the CFTC first announced the advanced notice of proposed rulemaking for prediction markets in March, more than 3,500 comments were submitted in response. Under the Administrative Procedure Act, federal agencies like the CFTC are required to review all submissions during rulemaking processes, which could stretch for months or even years for high-visibility rule changes.

In February, former CFTC special counsel Carl Kennedy told iGB he’d “never seen” the agency “take their [rulemaking] responsibility lightly”. He gave an example from 2012, when the CFTC and Securities and Exchange Commission adopted new swap product definitions. That rulemaking processes garnered many comments and took two years to get from start to finish.

Just 41 days have passed since the portal closed and the first prediction markets proposal was published. In the new proposal, the CFTC said less than 10% (300) of the 3,500 submissions “provided detailed comments and recommendations”.

“The remaining submissions were either duplicative of points made in other submissions or non substantive,” the text reads. “The comments came from individuals, prediction markets and firms applying for designation as a prediction market, firms using event contracts, trade associations, public advocacy organizations, academics and researchers, members of Congress, federal agencies, tribal governments, state governments and others. Relevant commenter feedback is interwoven throughout this proposed rule.”

Fierce industry opposition

As expected, gaming and financial advocacy groups were opposed to the rulemaking, and the swath of lawsuits involving prediction markets is only continuing to grow.

As of writing, the CFTC has sued six states — Arizona, Connecticut, Illinois, New York, Wisconsin and Minnesota — for what it views as infringement on its regulatory jurisdiction. There are more than 10 states currently in litigation with prediction markets themselves, including major gaming states Nevada and New Jersey.

“This is a remarkable attempt to redefine what constitutes sports betting,” Bill Miller, president and CEO of the American Gaming Association, said in a statement. “It makes a mockery of Congressional intent while going against a bipartisan coalition of 41 Attorneys General, countless legislators across the country, and the 81% of voters who recognize that the so-called ‘prediction markets’ are backdoor sportsbooks evading state and tribal law.”

Differing takes

Conversely, the Coalition of Prediction Markets a lobbying group for the industry, lauded the CFTC for its  “commitment to protecting consumers,” and “empowering American markets.”

“The CFTC is the right cop on the beat, and we look forward to continuing to work with the agency to support fair, transparent exchanges,” the coalition wrote in a statement.

Meanwhile, an anti-prediction market political advocacy group headed by a former director of the Office of Management and Budget also decried the release of the proposed rules. Gambling is Not Investing, which counts the Family Business Fund and the Hispanic Leadership Fund as members, is headed by Mick Mulvaney, a former White House Chief of Staff under US President Donald Trump.

“This proposal deserves serious scrutiny from lawmakers, state officials, tribes, sports leagues, and anyone concerned about preserving the integrity of our gambling laws,” Mulvaney said in a statement. “A sports bet doesn’t stop being a sports bet just because you call it a contract. If it quacks like a duck, it’s sports gambling.”