Prediction Markets Can’t Go on Without Legal Enforcement in Place

Prediction markets have increased the risks of government officials engaging insider trading and corruption, leaving states and the federal government scrambling to stop it. Yet there are few mechanisms to prevent it right now. States and federal government must act quickly to develop rigorous and effective frameworks beyond merely banning officials from insider trading.

Some states are already moving to address the problem. In April, New York Gov. Kathy Hochul (D) issued Executive Order No. 60, which prohibits state employees from using nonpublic information to trade on prediction markets.

Gov. Wes Moore (D) in Maryland quickly followed, while other states have proposed or signed executive and legislative measures. And the US Senate voted unanimously late last month on a resolution that bans its members and staff participating in prediction markets. Lawmakers of both parties are proposing similar legislation that would go a step further and bar executive branch trading as well.

But how effective will these measures be? Insider trading on prediction markets may seem like easy money to unscrupulous officials because profits are almost guaranteed for someone who can enter binary yes/no wagers on the outcome of events that they know will take place.

Real events exemplify this potential. Last month, a US Army soldier was charged with making $400,000 on Polymarket’s prediction market by using insider information about a raid he helped plan against then-Venezuelan President Nicolás Maduro.

Prediction markets also vastly expand the types and volume of events on which one can gamble, including obscure events that have no material effect on the world or corporate share prices—such as, for example, the attire a public official will wear at an event. An unscrupulous official doesn’t need to place large wagers on big events to get rich but instead can enter several smaller wagers with insider knowledge of government minutiae.

Prediction markets also make it much more difficult to detect insider trading because users can contract anonymously or pseudonymously on the platforms, and the volume of trading is astronomical, potentially hiding illicit trades. There are an estimated 43 million prediction market transactions per month, involving multiple billion dollars changing hands. On days with major sporting events, such as the Masters Tournament or the Super Bowl, prediction market trading volume can reach $1 billion.

With traditional insider trading, the purchase and sales of stocks on legitimate exchanges are recorded and the taxable events transmitted to the IRS via Form 1099-Bs. Those formalities made insider trading at least somewhat more detectable. But the IRS and Department of the Treasury haven’t yet issued formal guidance on how to treat prediction market transactions, either gambling losses or capital assets.

Prediction markets’ nature is also being debated as either regulated future contracts or straightforward gambling regulated by state gambling authorities. That dispute is still percolating in lower state and federal courts, with courts going in both directions.

Kalshi, for example, is making its second trip to the Ninth Circuit in decisions out of Nevada and Arizona federal courts. The US Court of Appeals for the Third Circuit recently issued a ruling affirming federal court’s decision to block New Jersey regulators from exercising jurisdiction over Kalshi’s sports offerings. And the Supreme Court of Massachusetts held oral arguments in which it appeared skeptical of Kalshi’s argument that the CFTC has exclusive jurisdiction over prediction markets.

While Hochul’s order prohibits government employees from using nonpublic information on prediction markets, it doesn’t set forth any specific penalty other than possible “dismissal” and the “appropriate sanction” to be determined by the state agency where the official works. So how does the state plan to monitor prediction market trading by its officials (or their friends and family) when there are millions of trades daily, made anonymously and pseudonymously?

Given prediction markets’ rapid ascent, state and federal regulators are scrambling to address new problems—gambling addictions and threats to government ethics and national security from insider trading. The nature of prediction markets and the sheer volume of trading make that regulatory task difficult, and recent executive orders, including the one out of New York, are likely only the beginning.

The real question is what other means are available to prevent insider trading and whether they can be effective. Legal rulings that classify prediction markets as commodities within the exclusive jurisdiction of the Commodity Futures Trading Commission could limit states’ options and put more pressure on the federal government to resolve these issues nationwide. Notwithstanding the possible hurdles, states will have to do more to prevent insider trading and ensure public trust in government.

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

Mark Pinkert is a litigation and appellate partner at Holzman Vogel, and the managing partner of its Miami office.

Akiva Shapiro is a litigator at Holzman Vogel, managing partner of its New York office, and chair of its New York administrative law and regulatory practice group.

Brandon Smith is a government investigations and litigation partner at Holtzman Vogel, managing partner of its Nashville office, and co-chair of the firm’s state attorneys general practice group.

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