Lets Tell the CFTC Where to Go.

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Update: I&#8217-ve extended the deadline for signing up until 7 p.m. Pacific, Sunday, July 6. Also, I fixed a typo in paragraph 3, changing &#8220-denying&#8221- to &#8220-giving.&#8221- (Thanks, Gil!)&gt-

The deadline looms for interested parties to respond to the Commodity Futures Trading Commission&#8217-s request for comments about regulating prediction markets (&#8221-event markets&#8221- in the CFTC&#8217-s usage). I may or may not get around to a detailed, point-by-point response to the CFTC&#8217-s many questions. In the meantime, though, I&#8217-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 (&#8221-CFTC&#8221-) 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 &#8220-no action&#8221- status enjoyed by the Iowa Electronic Markets (&#8221-IEM&#8221-). 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 &#8220-no action&#8221- option: Thanks in part to the &#8220-no action&#8221- 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&#8217-s &#8220-no action&#8221- letters do not specify the exact criteria the IEM had to satisfy, they took favorable note of the IEM&#8217-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 &#8220-no action&#8221- 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 &#8220-no action&#8221- 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&#8217-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&#8217-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&#8217-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&#8217-ll have to contact me before noon Pacific time on Sunday, July 6.

[Crossposted at Agoraphilia and Midas Oracle.]

13 thoughts on “Lets Tell the CFTC Where to Go.

  1. Chris F. Masse said:

    Your petition is a good step forward and better than the AEI’s petition.

    I’d like bolder proposals, if it were me, but your text is satisfying enough that I have decided to send a new mass e-mail to the Midas Oracle blog users to alert them about this petition.

    Best wishes, and thanks for all your hard work.

  2. Chicago Boyz » Blog Archive » The Government Wants Your Opinion on Prediction-Markets Regulation said:

    […] comment on what its regulatory stance toward this nascent industry should be. IMO, Tom Bell’s proposal, posted at the indispensable Midas Oracle, is a good start. Tom will submit his response to the […]

  3. Tom W. Bell said:

    Thanks, Chris.

    Thanks, too, for being such an effective gadfly. I might well have blown off the whole exercise if you had not kept blogging about how you were awaiting my comment!

  4. 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 Ins said:

    […] – Tom W. Bell’s petition, which will be sent to the CFTC. […]

  5. Adonis said:

    This seems to be a political issue of definition. One which is likely to enrich lawyers more than either investors or would-be gamblers.

    Seems to me that the US Government needs to grasp that one man’s “investment” is another man’s “gamble”. There is, actually, no logical difference betweeen the two.

    Unless of course you know of an “investment” that is risk free? (Betcha ya can’t!!!!! )

    More important is the foundation logic involved: NEITHER can be of sufficiently high Integrity unless properly structured, REGARDLESS OF ITS LEGALITY!!!!

    Integrity cannot be managed unless due account of Time itself is taken in EVERY single element of Operation and Regulation.

    Regulation and Governement involvement in what might be illegal activities?

    Why YES!!!!

    Is a criminal liable for income tax on his ill-gotten gains???

    You bet he is!

    So if a body conducts gambling operations (legally or not) can they avoid the Regulatory requirement to protect the interests of the players, even though if caught they might be prosecuted??? Or taxed on their winnings???

    Simply and plainly, you can argue about semantics (investment or gamble) but to engage in your choice, you MUST have Integrity to survive. And you CAN’T have Integrity without constant reference to Time.


  6. Medemi said:

    “Unless of course you know of an “investment” that is risk free? (Betcha ya can’t!!!!! )

    There must still be some people who believe that. Not so long ago stocks were a safe investment. More recently, housing. It makes more sense to believe in fairy tales than to make an objective evaluation and come to the conclusion that gambling is just another form of investing. People want to believe Adonis… please don’t take that away from them.

  7. Medemi said:

    Let’s say I had to spend $100,000 and choose between

    1) buy a house

    2) put it on red or black at the casino.

    Interesting choice. :-)

  8. Chris F. Masse said:

    “Those account limits effectively prevent the IEM from supporting significant hedging functions.”

    If you want hedging on prediction markets, then why don’t you argue for the “excluded commodities” solution, then? :-D

  9. Tom W. Bell said:

    I wasn’t saying that I want hedging on PMs; I was simply observing that the IEM does not effectively provide hedging (and, thus, impliedly, that the CFTC lacks jurisdiction over it).

  10. Chris F. Masse said:

    “Those account limits effectively prevent the IEM from supporting significant hedging functions.”

    It sounded to me, at the reading, that if you argued for the lifting of that $500 cap, that’s because you’d favor hedging.

    “it should adopt limits considerably more generous”

    Maybe, in the rest of the document that we don’t see here, you argue that lifting the cap would give more accurate predictions.

    I don’t know. Anyway, good luck.

  11. Tom W. Bell said:

    I meant only that, even with much higher caps, the IEM would not support hedging functions. It follows, to my thinking, that the CFTC would have no authority to regulate the market; CFTC jurisdiction reaches only to markets that offer significant hedging functions, IMO.

  12. Chris F. Masse said:

    @Tom W. Bell: Kapeshe.

    However, I would like to see Tom W. Bell’s critique of the HedgeStreet’s argument, and HedgeStreet’s critique of the Bell’s argument.

    PS: Funny nobody talks about ECMs in this debate.

  13. Jason Ruspini said:

    It’s nice that you have that opinion Tom, but I would think that the CFTC and most practicing lawyers would disagree.

    Not to say that no markets deserve an exemptive treatment.

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