Insider Trading in Prediction Markets Poses Compliance Risks

There has been a massive rise over the past year in prediction markets—online platforms that let users place wagers on event outcomes through contracts that pay out based on whether that event occurs. But this rapid expansion comes with increased risk.

Companies and their employees with inside information could face civil or criminal liability for insider trading or the misuse of material nonpublic information, or MNPI, similar to traditional securities markets. With the increased regulatory focus on these markets, whose platforms are known by names such as Polymarket and Kalshi, companies should consider reviewing their existing policies and procedures to ensure they address potential insider trading and the misuse of MNPI in prediction markets.

Regulatory Authority

Imagine any of the following scenarios:

• an investment bank employee using confidential deal-related information betting on a transaction’s outcome or the stock price of an adjacent company
• a prime brokerage employee who has knowledge of upcoming large institutional trades betting on short-term price movements or volatility events before those trades are executed
• a mutual fund analyst betting on a credit rating change after learning, through confidential bondholder meetings, that a downgrade is imminent

To guard against these types of risks, companies should consider reviewing existing insider trading policies, surveillance tools that monitor compliance with those policies, and training programs to determine whether they adequately address trading that might occur in prediction markets.

The Commodity Futures Trading Commission has asserted primary regulatory authority over prediction markets, identifying event contracts as “swaps” or “derivatives” that fall within the CFTC’s exclusive jurisdiction under the Commodity Exchange Act. The CFTC prohibits trading on MNPI in derivatives markets, including futures and swaps, under CEA Section 6(c)(1) and Regulation 180.1.

While the CFTC has yet to bring an enforcement action involving insider trading in prediction markets, it recently reaffirmed that it “has full authority to police illegal trading practices occurring” on any prediction market platform and “will investigate and prosecute violations.”

The Securities and Exchange Commission may also play a significant role in the regulation and enforcement of prediction markets. The SEC and CFTC recently announced that they will be meeting regularly to coordinate on overlapping issues. And SEC Chairman Paul Atkins in February stated that “[p]rediction markets are exactly one thing where there’s overlapping jurisdiction potentially” between the CFTC and SEC, and specifically noted that prediction markets may fall under the SEC’s oversight if the contracts are structured in ways that resemble securities.

The Department of Justice may become more active in investigating and prosecuting insider trading and manipulation in prediction markets. The DOJ has authority to bring criminal charges for violations of the CEA and Rule 180.1 under 7 U.S.C. Section 13(a)(5) and could also prosecute insider trading in prediction markets under the criminal wire fraud statute.

The DOJ has yet to bring any cases alleging insider trading in prediction markets, but it recently brought two cases alleging the misuse of MNPI in placing “prop bets”—bets on occurrences within an event other than the event’s final outcome (who wins or loses). And Jay Clayton, the US Attorney for the Southern District of New York, said his office expects to bring prediction-market-related fraud cases, warning that “just because it’s a prediction market doesn’t insulate you from fraud.”

States including Arizona, Connecticut, Illinois, Maryland, Massachusetts, Nevada, New Jersey, and Ohio have also taken steps to regulate prediction markets. CFTC Chairman Michael Selig has responded by urging states to curtail their enforcement efforts in deference to the CFTC’s jurisdiction. In a recent case, the CFTC filed an amicus brief arguing that it has exclusive federal jurisdiction over prediction markets.

And on April 2, the CFTC filed suit against Arizona, Connecticut, and Illinois, seeking to bar the states from relying on state gaming laws to regulate prediction markets and asserting that the CFTC’s exclusive jurisdiction over prediction markets preempts such laws. In addition, on April 6, a federal appellate court affirmed a preliminary injunction barring New Jersey from enforcing state gambling laws against Kalshi on the basis that such laws are likely preempted by the CFTC’s exclusive jurisdiction over prediction markets.

Some platforms have taken steps to self-police MNPI misuse. Kalshi in February announced two internal enforcement cases it closed: one involving a California gubernatorial candidate who traded on his own candidacy, and another involving an insider employed by a popular YouTube streamer who bet on that YouTuber’s content.

Kalshi reported these cases to the CFTC, suspended the violators from its platform, and imposed fines payable to a nonprofit providing consumer education on derivatives markets. Last month, Polymarket announced it was barring trades on stolen confidential information, illegal tips, or by those who can “influence the outcome” of a prediction market.

Implications and Risks

If employees trade on MNPI in placing bets, they may expose themselves to liability for insider trading, market manipulation, and the misuse of MNPI. Entities could also face regulatory scrutiny because of such conduct.

For example, under CFTC Rule 166.3, institutions have a duty to diligently supervise their employees’ handling of commodity interests. CEA Section 2(a)(1)(B) also provides for vicarious liability for violations of Section 6(c)(1) and Rule 180.1 by employees committed within the scope of their employment.

Key Takeaways

Addressing the risk associated with the potential misuse of MNPI in prediction markets has no one-size-fits-all solution. Companies should stay apprised of enforcement trends in this area and consider steps to reinforce existing policies and procedures to guard against insider trading and misuse of MNPI. Companies should also consider what additional training and surveillance may make sense given their specific operations and capabilities to address this growing compliance risk.

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

Amy Jane Longo is a litigation and enforcement partner and Los Angeles office managing partner at Ropes & Gray who focuses on SEC enforcement matters and the defense of securities and other class action cases.

Lisa H. Bebchick is a litigation and enforcement partner at Ropes & Gray, focused on complex commercial and securities litigation and white collar criminal defense and regulatory matters.

Devon Applegate Caton is litigation and enforcement counsel at Ropes & Gray and represents clients in securities enforcement actions, federal securities litigation, and complex commercial disputes.

Ashley Stamegna contributed to this article.

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