In addition to a joint comment with a score of signers, I also responded to the Commodity Futures Trading Commission (CFTC)’s Concept Release on the Appropriate Regulatory Treatment of Event Contracts by firing off a solo comment. I there focused soley on question 14, in which the CFTC asked, “Should certain underlying events or measures–such as those based on assassinations or terrorist activities—be prohibited altogether due to the social perception and impact of such events? What statutory or other legal basis would support this treatment?”

Much of my comment tracked the answer I posted here earlier. Long story short: such claims would not materially promote wrongful acts, so the CFTC has no legal basis to ban them. To that argument, however, I added a First Amendment analysis; to wit:

Could you fault claims about assassinations or other terrorist events for giving incentives for wrongful acts? Not very plausibly; as I explain above, it is very unlikely that anyone would find it profitable or prudent to try to use an event market to cash in on wrongdoing. Furthermore, all sorts of investment instruments offer the same incentives. Thus, for instance, a would-be terrorist might go long on oil futures prior to pulling off an attack on a refinery. Indeed, that sort of scenario seems much, much more likely than one involving event markets.

At root, concern about unseemly event market claims boils down to concern about violating a taboo about what sorts of things people discuss openly in a polite society. Those norms merit our concern, granted. They do not, however, justify imposing a speech restriction on event markets. And make no mistake about it; to bar such claims would constitute a restriction on speech.

Specifically, if the CFTC banned certain sorts of event market claims relating to assassinations, terrorist activities, or criminal acts, it would thereby impose a content-based restriction on speech. That would, under present First Amendment jurisprudence, trigger the highest level of judicial review: strict scrutiny. The ban would almost certainly fail to survive that scrutiny, as it would be too broad (stopping not just the bad guys but also the good ones), too narrow (since it would fail to forbid the use of other financial instruments, such as generic futures, from like uses), and not narrowly tailored (since there are other, better ways to discourage bad acts). Those sorts of claims would, moreover, fall within the core of the sort of speech protected by the First Amendment, as they would concern political events.

Our freedoms of speech and expression include the right to ask troubling questions. The CFTC has no good reason to ban event market claims about assassinations or other illegal acts. Nor can it do so constitutionally.

Suppose that my argument leads the CFTC to doubt that it can ban event markets from hosting claims about assassinations or terrorist activities. Suppose further, as seems likely, that the CFTC has some discretion in deciding whether its jurisdiction encompasses event markets; suppose, that is, that extant law does not command one answer to that question. What result?

I predict that the CFTC would tend to deny that it has jurisdiction over event markets because it would not want to take the blame for encouraging distasteful claims. Indeed, I not only predict that result, I intend it. I don’t trust the CFTC to do a very good job regulating event markets, so I want it to know why it does not even want to try.

[Crossposted at Agoraphilia and Midas Oracle.]

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• Let Prediction Markets Fight Terrorism.
• A draft response to the CFTC
• What public interests are served by event contracts?
• A second look at HedgeStreet’s comment to the CFTC about “event markets”
• Chris Masse’s first comment to the CFTC on “event markets” (prediction markets)

The Commodity Futures Trading Commission (CFTC)’s Concept Release on the Appropriate Regulatory Treatment of Event Contracts says, “Comments must be received by July 7, 2008.” What deadline does that impose? I played it safe, and assumed that I had to send mine in before midnight, this morning. Today, I learned from Bruce Fekrat, Special Counsel to the Office of the Director of the CFTC, that in fact I had up until this coming midnight to email my comments.

Any lawyer worth his or her salt knows better than to use the ambiguous “by” when specifying a deadline. The CFTC should have said, “Comments must be received before July 8, 2008.” Thanks to its poor drafting, I rushed my comment out the door, missed the chance to get lots of new signatures, and wasted time swapping emails with various people equally confounded about what the CFTC meant.

Sigh. And to think that some people hope the CFTC will assert jurisdiction over prediction markets and clarify their legality under U.S. law! If the CFTC cannot get even something so routine as specifying a deadline right, I shudder to think what sort of confusion it might impose on prediction markets.

[Crossposted at Agoraphilia and Midas Oracle.]

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• The CFTC is going to close the comments in 4 days. We have 4 days left to convince the CFTC to accept FOR-PROFIT prediction exchanges (e.g., InTrade USA or BetFair USA), and counter the puritan and sterile petition organized by the American Enterprise Institute (which has on its payroll Paul Wolfowitz, the bright masterminder of the Iraq war).
• The CFTC is going to close the comments in 3 days. We have 3 days left to convince the CFTC to accept FOR-PROFIT prediction exchanges (e.g., InTrade USA or BetFair USA), and counter the puritan and sterile petition organized by the American Enterprise Institute (which has on its payroll Paul Wolfowitz, the bright masterminder of the Iraq war).
• COALITION OF REGULATED EXCHANGES SUBMIT A JOINT COMMENT TO THE CFTC ON “EVENT MARKETS” —ONE DAY AFTER THE DEADLINE.
• The CFTC takes a necessary step toward sorting out its role with respect to prediction markets.
• Chris Masse’s first comment to the CFTC on “event markets” (prediction markets)

Update: I’ve extended the deadline for signing up until 7 p.m. Pacific, Sunday, July 6. Also, I fixed a typo in paragraph 3, changing “denying” to “giving.” (Thanks, Gil!)>

The deadline looms for interested parties to respond to the Commodity Futures Trading Commission’s request for comments about regulating prediction markets (”event markets” in the CFTC’s usage). I may or may not get around to a detailed, point-by-point response to the CFTC’s many questions. In the meantime, though, I’ve drafted a general statement that many of you might agree with. I invite you to sign it with me, so that together we might tell the CFTC where to go. Please see below for details on how to sign on. Here is the draft statement:

What regulatory treatment should the Commodities Futures Trading Commission (”CFTC”) apply to event markets? We the undersigned, who represent a wide range of viewpoints, agree on three general observations. First and foremost, the CFTC should do no harm. Second, at a minimum, the CFTC should make more general the sort of “no action” status enjoyed by the Iowa Electronic Markets (”IEM”). Third, if the CFTC decides to regulate event markets more substantively, it should adopt clear and limited jurisdictional boundaries and allow affected parties to step outside of them.

First, do no harm: Many sorts of event markets—including public ones, private ones, ones that offer only play-money trading, and ones that offer real-money trading—already thrive in the U.S. They have provided a rich array of benefits without evidently harming anyone. The CFTC could help event markets achieve still greater success by clarifying their legality. Instituting the wrong sort of regulations could suffocate event markets in their cradle, however. The CFTC should exercise a light hand, taking care to do no more than offer qualifying event markets the shelter of federal preemption and freeing them to continue operating under the extant legal regime.

Second, open up the “no action” option: Thanks in part to the “no action” letters that the CFTC has issued to it, the IEM has for many years benefited the public by offering real-money event markets. No sound reason precludes the CFTC from giving similar treatment to other institutions that, like the IEM, offer event markets solely for academic and experimental purposes and without imposing trading commissions.

Although the CFTC’s “no action” letters do not specify the exact criteria the IEM had to satisfy, they took favorable note of the IEM’s account limits. Those account limits effectively prevent the IEM from supporting significant hedging functions. If the CFTC builds a similar requirement into any general “no action” guidelines, it should adopt limits considerably more generous than the meager $500/trader limit adopted decades ago by the IEM. Even a limit ten times that amount would still effectively preclude hedging.

The CFTC should not limit “no action” status to markets run by tax-exempt organizations. The no-action letters that the CFTC issued to the IEM emphasized not the nature of the hosting institution, the University of Iowa, but rather the business model adopted by the IEM itself. Profitability could not have mattered, as tax-exempt organizations can and do earn profits (indeed, as their burgeoning endowments demonstrate, many universities earn immense profits). The CFTC apparently cared only that the IEM did not plan to profit from charging traders commissions. A tax-paying organization could satisfy that condition just as easily as a tax-exempt organization could. In either event, price discovery would flourish and consumers would win a safeguard against getting fleeced.

Third, preserve regulatory exit options: If the CFTC decides to write substantive regulations for event markets, it should recognize and guard against the risk of overregulation. Even well-intentioned and well-informed regulators remain human and, thus, all too apt to make mistakes. They run an especially large risk of making mistakes when they first attempt to regulate new institutions, such as event markets. To make matters worse, regulators typically lack reliable signals to determine when they have gone too far. Industries wither away for many reasons, after all.

The CFTC’s approach to regulating event markets should accommodate these policy considerations by establishing clear jurisdictional boundaries and opening exit options. Thus, for instance, the CFTC might specify that it has no jurisdiction over event markets that offer trading only to members of a particular firm, over markets that offer only spot trading in negotiable conditional notes, or over markets that do not support significant hedging functions. Then, if the CFTC enacts unduly burdensome regulations, an event market could opt out of them by changing its business model. So long as markets publicly announce that they operate outside the CFTC’s purview, allowing them that freedom of exit would harm nobody. To the contrary, it would help the CFTC gauge the suitability of its regulations and serve the public by protecting the continued viability of event markets.

Interested in signing on? Please drop me a private email (tbell at chapman dot edu) with your name, institutional affiliation, and snailmail address. I welcome your comments—I’m sure a typo or two persists in my draft—but I of course cannot revamp the entire statement without mucking up the entire process. To leave me time to get everything together and out the door before the July 7 deadline, you’ll have to contact me before noon Pacific time on Sunday, July 6.

[Crossposted at Agoraphilia and Midas Oracle.]

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• Tom W. Bell rebuts the puritan and sterile petition organized by the American Enterprise Institute (which has on its payroll Paul Wolfowitz, the bright masterminder of the Iraq war).
• The CFTC is going to close the comments in 12 days. We have 12 days left to convince the CFTC to accept FOR-PROFIT prediction exchanges, and counter the evil petition organized by the American Enterprise Institute (which has on its payroll Paul Wolfowitz, the bright masterminder of the Iraq war).
• The CFTC is going to close the comments in 4 days. We have 4 days left to convince the CFTC to accept FOR-PROFIT prediction exchanges (e.g., InTrade USA or BetFair USA), and counter the puritan and sterile petition organized by the American Enterprise Institute (which has on its payroll Paul Wolfowitz, the bright masterminder of the Iraq war).
• The CFTC is going to close the comments in 3 days. We have 3 days left to convince the CFTC to accept FOR-PROFIT prediction exchanges (e.g., InTrade USA or BetFair USA), and counter the puritan and sterile petition organized by the American Enterprise Institute (which has on its payroll Paul Wolfowitz, the bright masterminder of the Iraq war).
• The CFTC is going to close the comments in 11 days. We have 11 days left to convince the CFTC to accept FOR-PROFIT prediction exchanges, and counter the evil petition organized by the American Enterprise Institute (which has on its payroll Paul Wolfowitz, the bright masterminder of the Iraq war).

The Commodity Futures Trading Commission (CFTC)’s recent request for comments about the regulation of prediction markets includes a number of specific questions. I am not sure whether I will manage to write up answers to all of them before the July 7 deadline, but question in particular—question 14—has attracted my attention. The CFTC there asks, “Should certain underlying events or measures–such as those based on assassinations or terrorist activities—be prohibited altogether due to the social perception and impact of such events? What statutory or other legal basis would support this treatment?”

I answer the first part of question 14, “No,” (and thus need not answer the second part). I doubt that the CFTC wants to hear that sort of reply, frankly; I instead suspect that it wants a legal excuse to avoid the sort of political firestorm that followed the Pentagon’s proposal to create a Policy Analysis Market that included claims about assassinations and terrorist events. My draft answer to question 14 explains why I’m willing to risk disappointing the CFTC:

The CFTC should not forbid trading in claims based on assassinations, terrorist activities, or other criminal acts. Because event markets would offer only relatively thin and traceable trading, they would not offer an attractive investment option to anybody planning to profit from wrongdoing. A would-be terrorist would risk revealing both his plans and his identity if, for instance, he invested in a contract predicting another 9/11. He would instead find it more safe and profitable to simply short certain publicly traded stocks.

Furthermore, event markets in terrorist or criminal acts might benefit the public by revealing life-saving information. Suppose, for instance, that an anthropologist’s study of corrido culture convinced her that narcoterrorists had begun planning military raids on border checkpoints in Arizona and California. If she had the opportunity to buy terrorist event claims, she might both profit from her research and tip us all off about looming trouble. Sound public policy suggests that we should encourage that sort of trading—not forbid it.

To judge from their reactions to the Policy Analysis Market proposed by the Pentagon in 2003, politicians might need to learn more about the benefits of using trading to help predict assassinations or other terrorist events. That poses a public relations problem, however—not a legal one. The CFTC thus has no sound reason to presumptively forbid trading in contracts related to such events.

Notably, my answer to question 14 differs sharply from the answer offered by Jed Christiansen. He said, “There should never be any incentive to break a law, so there should never be any contracts that would pay someone if a law was broken.” I disagree, of course, but I thank him for stimulating me to offer an alternative take.

[Crossposted at Agoraphilia and Midas Oracle.]

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• Chris Masse’s first comment to the CFTC on “event markets” (prediction markets)
• The Case for Decrimininalization of Prediction Markets
• A draft response to the CFTC
• What Robin Hanson told the CFTC about “event markets” (prediction markets)
• The American Enterprise Institute’s proposals to legalize real-money prediction markets in the United States of America

My draft paper, Private Prediction Markets and the Law, offers a variety of detailed suggestions about how to protect the former from the latter. Specifically, I offer strategies for avoiding the scope of CFTC regulation, for discouraging liability for illegal insider trading, and for ensuring that a private prediction market does not offer gambling. Because I’ve already blogged about the CFTC angle several times, I’ll pass over that topic. Here, though, is my conclusion about how to guard against illegal insider trading and gambling laws:

Publicly-traded firms subject to U.S. law can minimize the risks of illegal insider trading by either making public all prices and claims traded on their prediction market or by:

• Keeping trading by traditional insiders separate from trading by others;
• Broadening safeguards against illegal insider trading to cover all traders;
• Treating the market’s claims and prices as trade secrets; and
• Seeding the market with decoy claims and prices.

Although the skill-based trading emphasized on private prediction markets should in theory remove them from the scope of gambling regulations, a prudent firm could help to ensure that result by:

• Forbidding traders from investing their own funds in the market; and
• Requiring its agents to participate in its market.

As should perhaps go without saying (but as hereby will not), any firm implementing these legal strategies should back them up with ample record-keeping. Each person who trades on a firm’s market should, for instance, receive clear notification that the market does not deal in CFTC- or SEC-regulated instruments, and that it does not offering services subject to oversight by any state gambling commission. Better yet, traders should be required to access the market only through a click-through agreement in which, among other things, they consent to that stipulation.

[Crossposted at Agoraphilia and Midas Oracle.]

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• How to run enterprise prediction markets… legally
• Building Exits into CFTC Regulation
• What Robin Hanson told the CFTC about “event markets” (prediction markets)
• Are US-based real-money prediction exchanges to become federally regulated (as DCMs)? Or semi-regulated (as ECMs, or as exchanges covered by “no-action” letters)?
• Insider Trading and Private Prediction Markets

Much of my draft paper, Private Prediction Markets and the Law, focuses on nuts-and-bolts fixes for the legal uncertainty that currently afflicts private prediction markets under U.S. law. I’ll say more about those in later posts to Agoraphilia and Midas Oracle. The paper also dicusses a more theoretical and general issue, though: The benefits of designing regulatory schemes to include exit options.

The Commodity Futures Trading Commission recently issued a request for comments about whether and how it should regulate prediction markets. In earlier papers, I explained why the CFTC cannot rightly claim jurisdiction over many types of prediction markets. I recap that view in my most recent paper, but add some suggestions about how the CFTC might properly regulate some types of prediction markets. In brief, I suggest that the CFTC build exit options into any regulations it writes for prediction markets, allowing those who run such markets the same sort of freedom of choice that U.S. consumers already enjoy, thanks to internet access to overseas markets like Intrade, with regard to using prediction markets. Here’s an excerpt from the paper:

Those practical limits on the CFTC’s power should encourage it to write any new regulations so as to allow qualifying prediction markets to operate legally, and fairly freely, under U.S. law. . . . Ideally, the CFTC would offer prediction markets something like these three tiers, each divided from the next with clear boundaries.

• Designated Contract Markets. Regulations designed for designated contract markets, such as the HedgeStreet Exchange, would apply to retail prediction markets that offer trading in binary option contracts and significant hedging functions.
• Exempt Markets. Regulations for “exempt” markets, which impose only limited anti-fraud and manipulation rules, would apply to prediction markets that:
  • offer trading in binary option contracts;
  • thanks to market capitalization limits or other CFTC-defined safe harbor provisions do not primarily support significant hedging functions; and
  • offer retail trading on a for-profit basis.
• No Action Markets. A general “no action” classification, similar to the one now enjoyed by the Iowa Electronic Markets, would apply to any market that duly notifies traders of its legal status and that is either:
  • a public prediction market run by a tax-exempt organization offering trading in binary option contracts but not offering significant hedging functions;
  • a private prediction market offering trading in binary option contracts, but not significant hedging functions, only to members of a particular firm; or
  • any prediction market that offers only spot trading in conditional negotiable notes.

Notably, regulation under either of the first two regimes would definitely afford a prediction market the benefit of the CFTC’s power to preempt state laws. It remains rather less clear whether the third and lightest regulatory regime would offer the same protection, though the cover afforded by its two “no action” letters has allowed the Iowa Electronic Markets to fend off state regulators. Markets that by default qualify for the third regulatory tier described above thus might want to opt into the second tier, so as to win a guarantee against state anti-gambling laws and the like. So long as they satisfy the first two conditions for such an “exempt market” status, public prediction markets run by non-profit organizations or private prediction markets that offer trading only to members of a particular firm should have that right. Why offer this sort of domestic exit option? Because it would, like the exit option already open to U.S. residents who opt to trade on overseas prediction markets, have the salutatory effect of curbing the CFTC’s regulatory zeal.

The footnotes omitted from the above text includes this observation: “Because they fall outside the CFTC’s jurisdiction, markets offering only spot trading in conditional negotiable notes could not opt into the second regulatory tier.”

Please feel free to download the draft paper and offer me your coments.

[Crossposted at Agoraphilia, Technology Liberation Front, and Midas Oracle.]

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• How to run enterprise prediction markets… legally
• Protecting Private Prediction Markets
• What Robin Hanson told the CFTC about “event markets” (prediction markets)
• COMMENTS TO THE CFTC: What should be expected, next.
• COMMENTS TO THE CFTC: What to expect from Tom W. Bell and Jason Ruspini

People who run in-house, corporate prediction markets have told me that U.S. laws against illegal insider trading give them nightmares. The problem arises because a private prediction market typically generates material nonpublic information about the corporation that hosts it. If somebody misuses that information to time the purchase or sale of the corporation’s stock, liability for illegal insider trading could follow.

I plan to say a great deal more about this problem, and some proposed cures, in a paper I’m writing for the Journal of Prediction Markets. In very brief, I propose several strategies that should help to mitigate the risks that private prediction markets create under illegal insider trading laws:

• Segregate markets for traditional insiders from other markets.
• Broaden safeguards against illegal insider trading to reach beyond traditional insiders.
• Treat the market’s claims and prices as trade secrets.
• Set up decoy claims and prices.

Alternatively, of course, a corporation could simply make public the claims and prices of its in-house prediction market. Illegal insider trading laws only speak to material nonpublic information, after all. It seems very unlikely that any corporation would willing disclose so much and such probative information about its management, however.

[Crossposted at Agoraphilia and Midas Oracle.]

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• How to run enterprise prediction markets… legally
• Protecting Private Prediction Markets
• Yet another prediction market newbie who should be meeting with Robin Hanson one on one to get a little injection about conditional prediction markets and how they could be useful for BOTH private decision makers AND public policy makers.
• Nokia’s Enterprise Prediction Markets = Competitive Advantage
• Micro-geography analysis of trading in Google’s enterprise prediction markets

I really enjoyed attending the Collective Intelligence FOO Camp, sponsored by Google and O’Reilly Media, last weekend. I’d been expecting a sort of geek slumber party, and had looked forward to rolling out my awesome Darth Vader impersonation. I was all set to cut loose with a growling, “I’m your father, Luke.” It didn’t quite come to that, but I still had a blast, meeting lots of smart, informed, articulate, creative, and successful people. Friendly people, too.

I described how to establish the legality of real money, open-access prediction markets under U.S. law. I called my presentation, Getting from Collective Intelligence to Collective Action [PPT file]. In very brief, I proposed this algorithm:

1. Set up an enterprise prediction market, make playing it a condition of continued employment, and offer valuable prizes to the best predictors.
2. Set up a limited access prediction market, hire a number of independent contractors researchers to play it, pay them a relatively low salary for doing so, and offer valuable prizes to the best predictors.
3. Set up an open-access prediction market but require anyone playing it to go through a click-wrap license that creates the sort of independent researcher relationship described at step 2, above.

When and if standing for declaratory judgment obtains, a litigation team should bring suit seeking to establish the legality of the prediction market under U.S. law. The market should be run by a worthy institution and deal only in claims likely to generate large positive externalities. Google.org, for example, might set up a market in earthquake claims and ask for a court’s blessing.

That strategy would stand a fair chance–a 75% chance, I’d say–of establishing the legality of a great many in-house and (effectively) public prediction markets under U.S. law. The strategy would not impose great costs or risks, though it would take some careful planning and execution, and would almost certainly generate large private and public goods. It might even save lives; we could really use a reliable early-warning system for major earthquakes.

This legalization program would most directly benefit subsidized markets; it would not plainly establish the legality of markets where traders could invest their own funds or hedge against off-market risks. I’m still working out a legal hack for that step. It will be an easier step to take, however, if we’ve already made it as far as establishing the legality of open-access, real money prediction markets under U.S. law.

We should still pursue other routes to establishing the legality of prediction markets under U.S. law, of course. It already helps that so many U.S. residents evidently make and lose money on Ireland-based InTrade. That at least goes to show that prediction markets hurt nobody. Getting the CFTC to issue safe-harbor regulations would help, too. All of those routes to public, real money prediction markets in the U.S. merit exploration. Any of them might offer a shortcut to a better, freer future.

[Posted at Agoraphilia, The Technology Liberation Front, and Midas Oracle.]

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• Zocalo in use at MIT’s Center for Collective Intelligence
• Collective Intelligence = Wisdom Of Crowds
• MIT CCI’s Handbook of Collective Intelligence = a Wiki
• Collective Intelligence vs. The Wisdom of Crowds
• MIT Center for Collective Intelligence - Play-money prediction exchange

Markets offer us a potentially useful tool for predicting earthquakes. Imagine the San Andreas fault divided into segments, each of which carries a price based on the present discounted disvalue of a future quake. That price would reflect both a quake’s place in time and its place on the Richter scale. Such a market in quake claims would probably generate some useful–even lifesaving–data. If sufficiently thick, it might offer hedging, too.

I’ve not yet found that sort of quake market. Has any of you? If none exists, at least one should! Plenty of people and institutions would love to know more about earthquakes. Some of them would gladly support an earthquake market, I’d bet. There remain some legal risks, granted, but I think I’ve got a good hack for those. (Long story short: independent contractor researchers paid a base salary for making trades and winning bonuses for correct predictions.)

One nice thing about a quake market: Done right, it would generate powerfully positive externalities, benefiting even those who do not trade on the market. Imagine a map of the San Andreas fault, the price of each tradable segment illustrated by color coding or line thickness. One glance at that picture, and you would know whether it was time to relax, double-check your emergency kit, or head for the hills.

[Crossposted to Agoraphilia.]

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• Reading the Markets - Forecasting Prediction Markets By News Content Analysis
• How political prediction markets save lives
• CFTC Requests Public Input on Possible Regulation of “Event Contracts” —a.k.a. event derivative markets, event futures markets, betting markets, bet markets, prediction markets
• What Robin Hanson told the CFTC about “event markets” (prediction markets)
• Prediction Markets in the Classroom: Inkling Markets

Koleman Strumpf has tapped me to discuss the legality of in-house prediction markets, tomorrow, at the Conference on Corporate Applications of Prediction/Information Markets, at the Kauffman Foundation Conference Center, in lovely Kansas City, MO. I call my presentation, Private Prediction Markets’ Legality Under U.S. Law. It discusses the legal hurdles faced by in-house PMs, and some possible cures. You can download the PowerPoint file, together with ample notes, here. I look forward to meeting many fellow PM-geeks, and to hearing the thoughts of Robert E. Litan and the other conference participants.

[Crossposted to Agoraphilia.]

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• Presentation on Legality of Prediction Markets Under U.S. Law
• Conference: Corporate Applications of Prediction/Information Markets (Thursday, 1 November 2007)
• Reminder: Corporate Applications of Prediction Markets Conference (1 November)
• Intro to Prediction Markets Presentation
• Insider Trading and Private Prediction Markets