CFTC Wants to Answer the Tough Questions on Prediction Markets

Corporations, investors, and retail traders hoping for regulatory guidance on prediction markets may soon get their wish.

The Commodity Futures Trading Commission on March 12 issued an advanced notice of proposed rulemaking, formally kicking off an effort to update its regulations to address prediction markets.

The agency’s Division of Market Oversight also issued a new staff advisory clarifying expectations for how designated contract markets—meaning derivatives exchanges—should design and monitor event contracts.

The CFTC is accepting comments through April 30. There are four fundamental issues that we expect the rulemaking will address.

Fraud and Abuse

Prediction markets pose unique opportunities for fraud and abuse, and the application of the Commodity Exchange Act’s antifraud provisions to event contracts isn’t always clear.

Kalshi revealed two disciplinary actions in February associated with event contract trading recently addressed by the exchange, describing the cases as involving “insider trading.” In one, a gubernatorial candidate traded contracts relating to his own race; in the other, an editor for the popular “Mr. Beast” YouTube channel traded contracts relating to the content of videos posted to the channel.

The CFTC issued a release of its own, reaffirming that the agency has authority to prosecute insider trading, fraud, and manipulation in prediction markets.

While these examples may seem like easy calls, applying traditional insider trading rules—which in the US generally require a trade while in possession of material non-public information in breach of a legal duty—isn’t always so simple in prediction markets.

The questions of non-public information and confidentiality obligations are particularly challenging. Consider the example of a star baseball player who grasps painfully at his hamstring during pre-game batting practice—a clear injury that will eliminate him from the game and shift the odds associated with the game or the player’s performance.

Does the player have an obligation to keep his injury confidential? What about the manager who sees it from the dugout? A groundskeeper on the field? Does the information become public only if general admission fans are already in the stadium? These lines aren’t always easy to draw, and the CFTC may issue rules or guidance to address them.

Susceptibility to Manipulation

Under the Commodity Exchange Act, designated contract markets may only list event contracts that aren’t “readily susceptible to manipulation.” The March 12 staff advisory identified one factor that the CFTC will consider in assessing this standard: Sports event contracts are less susceptible to manipulation if they depend on “aggregate performance of multiple participants over an extended period of play.”

In contrast, markets involving “individual sports participants” or “officiating actions” are likely to carry a heightened risk of distortion because they’re dependent on the actions of a single individual or small group of people.

The CFTC may issue additional rules or guidance addressing this issue, including whether this factor may also apply to non-sports event contracts. One type of contract under this rubric is “mention markets,” which are based on what a single person or small group of people will say.

Because mention markets may be easily influenced by the people who are the subject of the contract, they may be more susceptible to manipulation and insider trading than many other forms of event contracts.

The commission also may consider whether the market depth of certain event contracts, many of which are thinly traded, affect their susceptibility to manipulation.

Public Interest

The March 12 release cites the agency’s authority to bar certain event contracts as “contrary to the public interest,” including for assassination, war, and terrorism. Yet many other contracts that could be considered ethically fraught fall outside these predefined categories.

For example, CFTC regulations don’t prohibit event contracts based on a person’s injury or death (outside the context of assassination and war), nor do they prohibit contacts involving minors or other vulnerable individuals.

New CFTC regulations may clearly prohibit them, as such contracts could create financial incentives for violence and other harm.

‘Swap’ Definition

One question that will have a major impact on prediction markets is the extent to which event contracts qualify as “swaps” subject to the CFTC’s jurisdiction pursuant to the Commodity Exchange Act. While the CFTC has argued that many event contracts, including those based on sporting events, are swaps, it has declined to offer guidance on types of event contracts that don’t meet this definition.

In an amicus brief filed in the US Court of Appeals for the Ninth Circuit in connection with a lawsuit challenging prediction markets’ ability to operate in Nevada, the CFTC asked the court not to “resolve the outer limits of the definition of a swap or engage in line drawing between a swap and a wager.” It’s up to the CFTC to define these limits if the courts don’t.

For example, a swap must be associated with a potential financial, economic, or commercial consequence. The CFTC has argued that sporting events generate economic activity, but this rationale arguably doesn’t apply to many types of event contracts.

While the fact that a sporting event takes place may have an economic impact, can the same be said about which team wins? Does the margin of victory have an economic impact? The total points scored by both teams combined, or the number of points scored by a specific player?

Many non-sports event contracts pose similar issues. What is the economic impact associated with a mention market, or the winner of a reality television show? Future CFTC rulemaking and guidance may answer these questions.

Looking Ahead

As prediction markets grow from a fringe curiosity to an established financial sector, the CFTC is seeking to keep pace. It’s asking similar questions regarding fraud and abuse, manipulability, public interest, and regulatory authority.

Future rulemaking by the CFTC will likely strive to provide clear answers to give participants confidence in prediction markets.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Jack Murphy is a white collar defense & government investigations senior counsel at Akin.

William Fowkes is an associate in Akin’s litigation practice.

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