Comment Text:
In response to the questions proposed at 91 FR 12516 s. II.E. paragraph 30: I am a third-year law student that recently published an essay to the Penn State Law Review Forum Blog about individual control of events and event contracts. I will try to attach a PDF of the blog here. The point of my essay was this: in the financial world, whenever a group of individuals has control over value, that group is subject to strict government oversight. Such oversight will be hard for the Commodities Futures Trading Commission to achieve in prediction markets.
My essay distinguished between “commodities-like” and “securities-like” derivatives. No individuals control the value of “commodities-like” derivatives because commodities and commodities-like assets are usually only influenced by macroeconomic conditions, and individuals almost always do not have special, insider knowledge about commodities. Therefore, the Government does not have a notable interest in regulating commodities-like derivatives.
Unlike the value of commodities-like derivatives, groups of individuals control the value of “securities-like” derivatives. The values of securities and their derivatives are controlled by insiders, so the Government has a strong interest in regulating insiders. The Government addressed that strong interest with strong laws and enforcement. Securities & Exchange Commission is a massive agency that specializes in preventing insider abuse. It has strict restrictions on insider trading, and it imposes lock-up periods and reporting requirements on companies to avoid insider abuses and unfair advantages. The SEC requires enough paperwork and pursues enough violations to deter insiders from violating the law. Securities-like assets and derivatives similarly have enough enforcement to deter violations of the law.
Many event contracts are securities-like in the way that their values are controlled by insiders. For example, a company CEO can single-handedly exercise unfettered control over what they say on an earnings call. But unlike other securities-like assets, insiders to event contracts are not yet deterred by the laws. In that sense, they are much more susceptible to manipulation than other markets, including non-prediction-market DCMs and SEFs.
The CFTC will need a lot of time and resources before it can deter insider trading to the extent of the SEC. While the Commodities Exchange Act has an insider trading ban, it is not legally developed through case law or regulatory guidance, at least not to the extent of the SEC. Moreover, instances of insider trading would be difficult to catch. The CFTC has a smaller budget than the SEC (see footnote 27 of my essay) to investigate insider cases, and it is tasked with regulating more than just prediction markets. Combined with other pitfalls, like the lack of formalities relative to securities exchanges, the CFTC will likely struggle to deter insider trading for the immediate future.
Keeping in mind the need to develop both the law and enforcement of prediction-market regulations, the CFTC would be well-advised to start small: impose more insider restrictions now, be specific, and ease those restrictions later if all goes well. The main consideration for regulation should be whether the events are “commodities-like,” “securities-like,” or neither. “Commodities-like” events – those that don’t have insiders – don’t need heavy regulation. “Securities-like” events – those that are already subject to oversight without new CFTC regulations – don’t need heavy regulation. If an event is neither commodities-like nor securities-like, then it is ripe for abuse without proper oversight. Contracts on such events should be heavily restricted at this stage.
