MicroSoft simply says that it supports the lobbying of CIM (Yahoo! + Google) in favor of (enteprise and public) prediction markets —PDF file. So, you would ask, why doesn’t MicroSoft join CIM? I heard the rumor that MicroSoft doesn’t like CIM’s legal counsel (Paul Architzel). Maybe Paul Architzel was opposite to MicroSoft, in a prior suit. Take this as a rumor, not as a fact —beware the “class-action” defamation suit.

- Republican nominee

- Democratic nominee

- Next US President

- Political Party of the Next US President

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- Should Slate add FT Predict in the odds comparison table?

- Slate has output an “explainer” on the legality of the prediction markets, which is the most insipid take I have ever read on Slate since the inception of this online magazine in the mid-nineties.

- See Slate’s 2007 guide to prediction markets, if you haven’t read it already.

Other External Link: Event Markets Evolve: Legal Certainty Needed. – [legalization of U.S.-based prediction exchanges] – by Paul Architzel (ex-CFTC) – 2006-03-??

In any case, the CFTC has approved a few event markets with little challenge. With the caveat that I have no special legal expertise, I believe that the agency has legal jurisdiction over prediction markets, but does not want to exercise it for the reasons listed last time. Keep in mind that this whole legal and regulatory challenge is only relevant to exchange-traded retail contracts. If someone has a bright idea for a larger-scale commercial, industrial or governmental contract, there are plenty of options available, including an EBOT or OTC transactions. The “safe-harbor” suggestion of Paul Architzel might also entail stifling limitations. When the CFTC granted safe-harbor status to swaps in 1989, it did so under the conditions that the contracts: 1) have individually tailored terms, 2) be used in conjunction with the counterparty’s line of business, 3) not be settled using exchange-style offset or a clearinghouse, and 4) not be marketed to the general public. Is it possible to negotiate a prediction market safe-harbor that would allow for some level of internet-based retail trading? Maybe, but what would it take? Likely more than a bunch of bloggers and scholars. In order to persuade the CFTC to spend time entertaining such a request, it would help greatly if you have a viable business ready to launch (and one which serves an uncontroversial social function). There is simply too much money at stake on the CFTC’s other operations for them to devote resources to help someone disinterestedly sow seeds — even if the agency is completely sympathetic and agreeable in principle.

The no-action possibility seems to be off the table, especially if you want to operate an exchange for profit. On the gambling law front, it is encouraging that state prosecutors have left IEM alone for so long, but this is also probably a function of its non-profit status and lack of advertising.

All of that said, I continue to be optimistic about the possibilities of a real-money prediction exchange operating legally in the United States in the not-too-distant future. Finally, we all owe Tom Bell many thanks for the work he has done on this topic.

First, is the Chicago Mercantile Exchange’s planned Credit Event Future within the jurisdiction of the CFTC? The Chicago Board Options Exchange protests that it is not. CME’s initial defense reduces the issue to whether or not the option-like swap “future” is a security. CBOE argues that the product should be considered a security based on the CEA because, although delivery of securities is not involved, the contract’s value is based on the “interest therein” or “value thereof” securities. CME’s stance is that while a default would also affect the value of securities, their contract’s “payout is fixed in advance of listing the contract and does not vary in relation to the price of the security or any referenced entity”. Thus, they argue that it is irrelevant whether credit events happen to cause changes in securities prices. The CBOE might then ask what would stop the CME from floating contracts based on earnings releases or dividend announcements, which might serve as a rough proxy for an equity. Again, it is increasingly nonsensical for the CFTC and SEC to remain as separate agencies, especially insofar as jurisdictional friction hampers or blocks innovation in the United States.

More generally, does the CFTC have jurisdiction over event futures? The answer seems to be yes, which might distress some prediction market followers. CBOE does not challenge this point, and references the CFTC’s approval of a Catastrophe Single-Event Contract in December 1997. Another example is CME’s weather futures, whose value is determined by multiple events accumulated in an index. CME also asserts that the CEA does not prohibit, “options whose value may depend on corporate events or economic events that directly impact companies.” Not only does the CEA not prohibit such contracts. It explicitly defines an “excluded commodity”, or one that may trade OTC or on an EBOT between eligible contract participants, to include “an occurrence, extent of occurrence, or contingency [...] associated with a financial, commercial, or economic consequence.” (Note that the fed funds future is based on a reference rate, not technically a (policy) event, though Hedgestreet’s release contracts would probably be considered event options.) Hahn and Tetlock also conclude that regulating “information markets” is within the power of the CFTC, based in part on discussions with the agency’s lawyers.

Speaking of Hahn and Tetlock’s proposal, what exactly is the relationship of the “economic purpose test” and CFTC jurisdiction? Upon my own reading of the CEA, not so much. That is, the economic purpose test pertains to the agency’s approval process, not its jurisdiction. If this interpretation is correct, we have a couple of puzzling statements out there. The first is from Hahn and Tetlock: “The CFTC currently administers a kind of public-interest test similar to the economic purpose test to determine whether futures contracts fall under its jurisdiction and are acceptable.” Again, by my reading, the economic purpose has little to do with CFTC jurisdiction — only approval or rejection of contracts that already fall within its jurisdiction by virtue of their instrument-type. I think that the “public-interest test” above instead refers more to consumer protection. That is, if an illegally operating exchange is within the CFTC’s jurisdiction, the degree to which participants are at risk will factor into whether or not the agency decides to pursue enforcement. This, along with potential objections from established US exchanges, helps to explain why the CFTC targeted TEN’s financial contracts, and not its more original and smaller markets. But given the definition of “excluded commodity” above, TEN’s other contracts probably could have been targeted as well. Which brings us to the next puzzling statement. At the FIA Event Markets Luncheon in February, Richard Shilts said that the CFTC was considering whether it had jurisdiction over futures that provided no hedging utility, but only price discovery. (This is from a note and memory; anyone else who was there, feel free to chime in.) My opinion, before considering Tom Bell’s argument, is that the CFTC in fact does have jurisdiction over event futures and options that yield information “with a financial, commercial, or economic consequence”, but are reluctant to 1) devote resources towards doing so given the small size of such markets, 2) broach the question of whether sports betting and other seemingly “frivolous” markets might have economic consequences. Also, the CFTC is made up of intelligent and thoughtful people who recognize the potential of prediction markets as well as the “baggage” that their regulation would entail.

What about Tom Bell’s argument against CFTC jurisdiction and Paul Architzel’s “safe-harbor” proposal? We’ll save those for next time. For now, the bottom line is that regulatory events are unfolding that we should make ourselves aware of. Otherwise, opportunities may slip by that will be very hard to recapture.

Hahn and Tetlock argue that presidential betting would pass their economic purpose test, and that sports betting would not pass their test. However, one can argue that sports teams, local sports bars, and even city governments could use sports betting markets to hedge risk. I believe that, as a practical matter, sports betting would simply have to be called out as an exception in any such test.

My Remarks: If I understood well Paul Architzel’s take in FI magazine, under a broad reading of the excluded commodity concept, “high-visibility” sports prediction markets could be offered by designated contract markets (such as HedgeStreet). As for presidential prediction markets, I did report on this blog that the CFTC is rumored to have already given its green light.

David Pennock’s second point:

Executives at TradeSports argue that these distinctions put them in safer legal territory than more typical online gamling operations. I’m not sure that US prosecutors would agree. The argument can sound like Napster’s argument that they were not directly responsible for users of their service who were violating the law.

My Remark: Betting market expert Niall O’Connor agrees with David Pennock:

The company [managing TradeSports/InTrade] continues to accept bets from US citizens, somewhat in denial of the scope of the new act, perhaps, not least the provision that a bet is “the staking or risking by any person of something of value upon the outcome of a contest of others, a sporting event, or a game subject to chance.” Trade Exchange Network is a privately held company. The company’s principal banker is believed to be the Allied Irish Bank.