CFTC Affirms Enforcement Authority Over Prediction Markets
Commentary by Steven Lofchie
The CFTC Division of Enforcement warned market participants that federal anti-fraud and anti-manipulation provisions apply to event-based contracts traded on registered exchanges.
In a Prediction Markets Advisory issued after the public release of two internal enforcement matters brought by Kalshi (see related coverage), the Division addressed the CFTC’s own enforcement authority. The Division warned against misuse of material non-public information in connection with those markets. Although Kalshi handled the disciplinary actions through its own compliance program, the Division emphasized that exchange-level enforcement does not preclude federal action.
The Division emphasized that the CFTC retains independent authority under the CEA to investigate and prosecute the following improper practices:
- Insider Trading. Misappropriation of confidential information in breach of a pre-existing duty of trust and confidence, in violation of CEA Section 6(c)(1) ("Prohibition regarding manipulation and false information") and Regulation 180.1 ("Prohibition on the employment, or attempted employment, of manipulative and deceptive devices").
- Wash Sales and Noncompetitive Trading. Engaging in pre-arranged, noncompetitive trading and wash sales in violation of CEA Section 4c(a)(1) ("Prohibited transactions") and Regulation 1.38(a) ("Execution of Transactions").
- Disruptive Trading Practices. Engaging in disruptive trading practices prohibited under CEA Section 4c(a)(5).
- Fraud and Manipulation. Committing fraud and market manipulation in violation of Section 6(c)(1) and other applicable provisions of the CEA.
The Division stated that the advisory reflects the rapid growth and unique characteristics of prediction markets and reiterates that Designated Contract Markets have an independent duty under the CEA’s core principles to maintain surveillance, audit trails, and enforce rules against prohibited practices. The Division warned that it will investigate and prosecute violations in appropriate cases and will continue coordinating with DCMs regarding enforcement matters and referrals.
Commentary
When Dodd-Frank was adopted, Congress imported to the CEA language that was used in the Securities Exchange Act to prohibit insider trading. Although this importation was well meaning, it is not so clear how this works in practice. An issuer cannot trade in its own securities when it is in possession of material nonpublic information because it will disadvantage holders of its securities to whom the issuer owes a duty. The same logic does not apply to a producer of physical commodities, as the producer does not owe a comparable duty to persons who happen to own that physical commodity (who likely have no relationship with the producer). Defining what constitutes insider trading, or what duty is owed to whom, will become even more difficult as applied to prediction markets.
The "Langford" matter, discussed in a related news story, is a good example of a case that does not readily fit into traditional insider trading law. While Langford clearly had inside information, it does not appear that, under traditional law, he owed a duty to any third party with respect to such information. This is not to say that Langford did not violate the exchange's rules; only that it is not obvious that the CFTC would also have had authority to bring an enforcement action against Langford.
Related Articles
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Kalshi, a regulated prediction market exchange, suspended two traders in unrelated enforcement actions for engaging in prohibited transactions involving influence over event outcomes and the use of material non-public information.
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In an amicus brief filed by the CFTC in an appeal before the Ninth Circuit, the agency urged the Court to reverse a lower court decision that would allow Nevada to apply state gambling laws to "event contracts" traded on federally regulated exchanges.