SEC may get involved as prediction markets bring in new contracts

The Commodity Futures Trading Commission has served as the lead regulator of event contract exchanges for more than 30 years, beginning with a 1992 ruling against the Iowa Electronic Market, widely known as the first prediction market.

With prediction markets now booming, there is growing speculation among legal experts that the CFTC’s sister agency, the U.S. Securities and Exchange Commission, will soon play a role in this new asset class.

“While the CFTC has stated that it has jurisdiction over event contracts, there are some areas where it appears to be more in the realm of the SEC,” said Joe Zales, a partner at King & Spalding.

This question is not just a hypothesis. This is an issue that both institutions are currently considering.

Last month, the SEC and CFTC issued a joint request for public comment regarding updates, clarifications, and harmonization of certain definitions and issues. Topics they are considering include definitions related to swaps (derivatives under which event contracts are classified), as well as the treatment of “new or emerging products”.

A spokesperson for prediction market platform Polymarket confirmed to CNBC that the company is working with both the CFTC and the SEC on the definition framework for prediction market products. Rival platform Kalsi declined to comment on whether it had communicated with the agency regarding the matter.

Some companies already use the SEC as a starting point for event contracts. In its filing, the CBOE seeks to operate within the SEC’s regulatory framework for creating binary options contracts based on key performance indicators from a number of large companies.

Jurisdictional issues that exist between the SEC and the CFTC are not new, especially when it comes to emerging asset classes. However, both institutions have not taken any major direction on this issue, although they have been in similar positions before.

“This is a real jump ball,” said Jeff Le Rich, partner at Husch Blackwell and former chief prosecutor at the CFTC. “No one knows what will happen.”

Possibility of SEC

It is thanks to the Dodd-Frank Act of 2010 that the SEC may play a role in regulating prediction markets, even though there is currently no market. Under the law, while the CFTC generally regulates swaps, the SEC has jurisdiction over security-based swaps.

A security-based swap is a financial contract tied to a single security. If there is a question about a public company in an event contract, it may appear to be a security-based swap rather than a traditional swap.

According to legal experts, a clear example of this is a contract that requires a trader to: Nvidia This is directly related to listed stocks, and the prediction market resolution depends on the stock’s performance.

However, to further complicate matters, security-based swaps are also defined as financial contracts that directly affect a company’s financial statements and financial condition.

“The problem is that what it means to ‘directly impact’ is actually an open question,” said Sara Razak Saris, a partner at Husch Blackwell. “That ambiguity is exactly what is being tested in real time right now.”

For example, consider the following contract: apple will release a new model of iPhone. While this has no direct bearing on the company’s stock price, when the highly anticipated product launches could impact Apple’s stock price.

Whether the contract is a security-based swap will determine how big a role the SEC could potentially play.

The SEC declined a request for comment from CNBC, and the CFTC did not respond.

complicated history

It would not be unheard of for the SEC and CFTC to split prediction market duties.

In the options market, the CFTC regulates options based on futures contracts and the SEC regulates options related to securities.

But despite examples of cooperation between the two, the sibling agencies have had decades-long conflicts over who is in charge of what.

“These agencies have been pitted against each other over jurisdiction,” said Jerome Thomas, a partner at Baker McKenzie and former SEC official. Most recently, the SEC and CFTC clashed over who has jurisdiction over cryptocurrencies ahead of harmonization efforts this year.

It goes without saying that the two institutions work differently. The SEC is much larger and has a longer history, while the CFTC is smaller and younger.

“Although the two institutions are structurally similar, their approaches to regulation are very different,” Le Riche said. “The way the CFTC writes rules and the way the SEC writes rules are fundamentally different approaches.”

In March, the two agencies announced they had agreed to a memorandum of understanding to coordinate on enhanced oversight and data sharing, as well as establish clear regulatory definitions and jurisdictional boundaries. Experts are now focused on whether the two agencies can work seamlessly together despite past regulatory battles.

“I think they’re trying not to step on each other’s toes or duplicate work,” said Elena Kotralski, a partner at King & Spalding.

Aaron Klein, a senior fellow at the Brookings Institution think tank, said now is a good time for the two Republican-led institutions to work together. Both agencies require a five-person board of commissioners, which currently has vacancies.

Only three of the SEC’s five commissioners are currently seated, and all are Republicans. Meanwhile, CFTC Chairman Michael Selig, also a Republican, is the only sitting member of the normally five-member board. Mr. Selig previously served as principal advisor to the SEC Cryptographic Task Force and senior advisor to SEC Chairman Paul Atkins.

“I think this is the most convenient time for these two agencies to come to terms,” ​​Klein said.

Clearer, stricter protocols

But legal experts largely expect the CFTC to maintain its primary role, while the SEC will likely take a more supportive role in regulating prediction markets. This may be welcome news for platforms that have previously had to deal with one federal agency.

Peter Chan, a partner at Baker McKenzie and a former SEC official, said the harmonization would benefit prediction markets if the agencies could avoid a repeat of past regulatory disagreements and provide clear definitions.

Although Karshi is the largest regulated prediction market in the United States, Polymarket derives much of its trading volume from international exchanges. Polymarket’s US platform became available to domestic traders in May.

A Polymarket spokesperson added that the company is concerned about the potential for overlapping or conflicting compliance requirements that could negatively impact innovation. This supports the willingness of government agencies to work together to create an efficient and harmonious structure.

Troy Dixon, Co-Head of Global Markets trade web market A market infrastructure firm affiliated with Karshi said it was important for financial institutions considering trading in prediction markets to get clarification from both institutions. Gaining Wall Street adoption has become a key priority for prediction market platforms these days.

“As long as the SEC actually steps in and there’s some sort of broad cooperation between the two agencies, that will be facilitated quite significantly,” Dixon said of institutional implementation.

Zeles expects the SEC’s involvement could result in more protections for traders, such as making the process of opening an account on prediction market platforms more cumbersome.

Despite the uncertain legal situation, Chan doesn’t think government agencies should rush to harmonize too quickly. Instead, he said agents should take the necessary time to understand the market and products offered on event contract exchanges.

“I don’t think what’s needed is necessarily real-time rule writing, but I think real-time learning is needed,” Chan said.

Disclosure: CNBC and Kalsi have a commercial relationship that includes customer acquisition and minority ownership.