I respectfully dissent from the Event Contracts Proposal because it takes the CFTC’s regulation of event contract markets backwards with its fundamental misunderstanding of how we regulate derivatives and the States regulate gaming. Instead of thoughtfully considering how to effectively regulate these markets while fostering innovation, the Event Contracts Proposal ties itself in knots over the bounds of gaming, which Congress has neither asked nor directed the Commission to regulate. I am simply disappointed in this wasted opportunity to regulate retail binary options, sidestepping our responsibility, and concerned about its legal impact.
The United States is built on a foundation of federalism. Federalism reflects the Founders’ understanding that a one-size-fits-all approach would not work for this country, and allows for States to govern in ways that best suit their residents.[1] The simple language of the Tenth Amendment to the Constitution (“The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people”) emphasizes that the Federal government is a government of limited and enumerated powers.[2] The Tenth Amendment, importantly, protects the American people from Federal encroachment.
State regulation of gaming, ranging from betting to lotteries, is long-established in the U.S., and is clearly a power reserved to the States.[3] No one understands their local cultures, economies, and values better than the States,[4] which leads to State laws that have been crafted to reflect the needs of their residents. This approach has allowed some States to embrace gaming and leverage it as a source of revenue and tourism, while others take a more conservative approach.[5]
When it comes to event contracts related to gaming, I have been clear that the CFTC should exercise caution, primarily because I believe the Commission fundamentally misunderstands the law in this area and Congressional intent.[6] That fear has proven well-founded with the Event Contracts Proposal.
The CFTC has a role in regulating event contracts as a market regulator, but it is essential that the CFTC does not encroach upon the prerogatives of States. An appropriate Event Contracts Proposal would have struck a balance between Federal oversight and State autonomy by focusing on the CFTC’s core mandate of promoting market stability and protecting market participants from fraud and abusive practices.[7] In doing so, the CFTC could have maintained the integrity of event contracts without undermining the authority of State governments.
Instead, as I will explain below, the Event Contracts Proposal bigfoots into State regulation of gaming by drawing unintelligible lines in the sand that will either at best result in confusion for State gaming authorities, or at worst push event contracts into illegal, unregulated offshore markets.
The Event Contracts Proposal Ignores the Supreme Court’s Preemption Doctrine
The Constitution’s Supremacy Clause provides that “the Laws of the United States . . . shall be the Supreme Law of the Land; and the Judges in every State shall be bound thereby, any Thing in the Constitution or Laws of any State to the Contrary notwithstanding.”[8] This language is the basis for the doctrine of Federal preemption, according to which Federal law supersedes conflicting State laws.[9]
The Supreme Court has identified two general ways in which Federal law can preempt State law: expressly, when a Federal statute or regulation contains explicit preemptive language; and impliedly when its structure and purpose implicitly reflect Congress’s preemptive intent.[10] But the Federal government cannot preempt traditional State powers that are the exclusive domain of States to regulate, recognizing the right to self-determination by the people.
The Event Contracts Proposal uniquely ignores the fact that the limits Congress placed on the Commission’s regulation of event contracts save the Commission from becoming a gaming regulator. In other words, the Commission could have relied on implied preemption to regulate event contracts as derivatives in our markets separate and apart from State gaming regulation. Instead, the Commission creates preemption concerns by proposing a gaming definition that incomprehensibly relies so heavily on State law that I don’t know how any exchange could understand where the Commission’s rules begin and end for these contracts.
Together, under CEA Section 5c(c)(5)(C), Rule 40.11, and the preamble to the final rulemaking for Rule 40.11, whether an event contract is prohibited by Rule 40.11 depends on the underlying activity that the contract is based upon. When the Commission reviewed an exchange’s political control contracts, I raised that the underlying activity was political control, which was neither terrorism, assassination, war, gaming, nor unlawful under any Federal or State law.[11] Therefore, Rule 40.11(a)(1) did not apply. Yet in disapproving the contracts, the Commission argued that “taking a position in the Congressional Control Contracts” (emphasis added) amounted to gaming.[12]
When taking a position in a derivatives contract is gaming, the Commission starts to look like a gaming regulator. Congress may not compel a State to enact or enforce a regulatory regime,[13] and indeed, Congress has not here. Yet in doubling down on its logic in the Event Contracts Proposal, when the act of entering into a derivatives contract that meets the Proposal’s overbroad definition of gaming, drawn from dozens of State laws, is now gaming under the Commission’s jurisdiction, we begin encroaching on State gaming oversight. State-regulated sportsbooks, in trying to comprehend where the Commission’s gaming derivatives begin and traditional bets end, will be captured in this confusion and question the need to register with the Commission as exchanges. I certainly don’t want the Commission to be registering Las Vegas sportsbooks and other betting venues.
The Commodity Exchange Act is Clear that the Commission Regulates Event Contracts
Congress has been clear in its direction for the CFTC.
First, in relevant part, the purpose of the Commodity Exchange Act is to deter and prevent price manipulation or any other disruptions to market integrity; to ensure the financial integrity of all transactions; to protect all market participants from fraudulent or other abusive sales practices and misuses of customer assets; and to promote responsible innovation and fair competition among boards of trade, other markets and market participants.[14]
Second, the Commission is authorized to review event contracts if the underlying activity that the contract is based upon is terrorism, assassination, war, gaming, or unlawful under any Federal or State law.[15]
Read together, Congress intended that the Commission regulate event contracts within the bounds of the section 5(c) prohibitions. Instead of telling market participants how we will regulate the innovative contracts and exchanges that have appeared in recent years, the Commission has decided to “identif[y] the types of event contracts that may not be listed for trading or accepted for clearing” (emphasis added), seemingly primarily to avoid the work. If the number of contract reviews has increased, then the Commission should increase its resources and capacity—not to prohibit public activity.
As referenced above, the Commission then embarks on a survey of state gaming definitions to insert the concept into the Commission’s rules. The Commission even notes the approach “reflects the similar approach taken in numerous state gambling statutes,” and mentions 35 States. The word “state” appears in the 95 page release 133 times. The Event Contracts Proposal reads as a defense against becoming a gaming regulator while inserting State gaming into our rules, which is not only confusing but unnecessary because Congress has clearly defined our role with respect to the States.
To make matters worse, the Commission then leaps from the overbroad, vague definition of gaming to provide examples of the types of event contracts that the Commission believes fall outside of the scope of CEA section 5c(c)(5)(C) and, by extension, Regulation 40.11. Given the fact that the Event Contracts Proposal repeatedly states that the broad range and volume of new contracts motivated this rulemaking, I find it stunning that the outer bounds provided are limited to contracts based on: (1) economic indicators, (2) financial indicators, and (3) foreign exchange rates or currencies.
Instead of creating a framework, the Commission is creating a vast gray area for exchanges. Where gaming begins and the scope of Regulation 40.11 ends is anyone’s guess now, and I fear State gaming authorities will be left to figure it out on their own.
Specific Areas for Public Comment
In addition to my concerns raised above, I highlight the following specific areas for public comment to aid in review of the Proposal:
New Delegation of Authority
The Event Contracts Proposal contains an alarming new delegation of authority to let staff—rather than the Commission—decide when event contracts fall within a prohibited category under Rule 40.11.[16] Combined with an overbroad definition of gaming, this will exponentially increase the number of self-certified exchange contracts suspended from trading at the whim of staff with no check or oversight from the Commission.
This stunning overreach flies in the face of the Commission’s self-certification framework. I encourage commenters to review this new delegation and comment on whether it upends the self-certification processes exchanges currently employ.
Missing Comment Letters
The Event Contracts Proposal completely omits any discussion of the comment letters the Commission recently received on the definition of gaming, as well as Rule 40.11 and event contracts more broadly. All told, the Commission has received around 200 comments in response to requests for public comment on an exchange’s political control contracts.[17] These comments came from exchanges, academics, former CFTC officials, and other industry participants, and were directly on point on the issues raised in today’s Proposal.
The Commission cannot selectively decide to tell one side of the story. It strains credulity that the Commission has selective amnesia and makes no mention of these letters in the Event Contracts Proposal.
Misplaced Election Integrity Concerns
The Commission gets hung up on the fact that “it is not tasked with the protection of election integrity or enforcement of campaign finance laws” in justifying prohibiting event contracts based on political contests. However, the Federal Election Commission polices campaigns. Congress has never asked, nor suggested, the CFTC should police elections, much like the Commission has not become the weather police for weather derivatives, or the crop yield police when we have the USDA, the changes to corporate officers or asset purchases police when we have the SEC, the regional insured property losses police when we have state insurance regulators, or the bankruptcy police when we have the courts, or the temperature police.
The Commission’s concern over policing elections would be akin to worrying that the Commission might have to look over the Federal Reserve’s shoulder to ensure rates increases are fair and become the Fed police.
Conclusion
I would like to thank Grey Tanzi, Andrew Stein, Lauren Bennett, Nora Flood, and Vince McGonagle in the Division of Market Oversight for their work on the Proposal.
The contracts causing so much consternation for the Commission have not been, and are not, gaming. If the Commission could accept that and move on, we could have a healthy discussion over how to effectively regulate these markets as we do any other and protect against abusive trading in retail binary options contracts. Instead, we have muddled it and made a mess.
I look forward to the comments.
[1] See Bernard Dobski, Ph.D., America Is a Republic, Not a Democracy, The Heritage Foundation (June 19, 2020) (examining whether current egalitarian efforts threaten, among other things, the diverse interests the Founders sought to protect from factionalism), https://www.heritage.org/american-founders/report/america-republic-not-democracy. Interestingly, the Event Contracts Proposal repeatedly claims to be motivated by the increase in volume and “diversity of event contracts listed for trading by Commission-registered exchanges.” However, the Proposal admits only one CFTC registered exchange currently offers the types of event contracts covered by the Proposal, out of the six CFTC registered exchanges that are authorized to offer event contracts. I question the motivations of any rulemaking that seeks to quash unique products offered by one exchange because their products are “diverse.”
[2] See Gary Lawson and Robert Schapiro, Common Interpretation: The Tenth Amendment, National Constitution Center, https://constitutioncenter.org/the-constitution/amendments/amendment-x/interpretations/129#:~:text=by%20Gary%20Lawson,-Phillip%20S.&text=The%20Tenth%20Amendment%20formally%20changed,Tenth%20Amendment%20is%20unconstitutional%20afterwards.
[3] See Tim Lynch, Gambling Regulation Belongs to the States, Cato Institute (July 23, 1998), https://www.cato.org/commentary/gambling-regulation-belongs-states.
[4] See America Is a Republic, Not a Democracy.
[5] See LexisNexis Legal Insights, States Embracing New Form of Gambling: iGaming (Mar. 3, 2024), https://www.lexisnexis.com/community/insights/legal/capitol-journal/b/state-net/posts/states-embracing-new-form-of-gambling-igaming.
[6] Dissenting Statement of Commissioner Caroline D. Pham Regarding the Review and Stay of KalshiEX LLC’s Political Event Contracts (Aug. 26, 2022), https://www.cftc.gov/PressRoom/SpeechesTestimony/phamstatement082622.
[7] Commodity Exchange Act (CEA) Section 3(a), 7 U.S.C. 5.
[8] U.S. Const. art. VI, cl. 2.
[9] Congressional Research Service, Federal Preemption: A Legal Primer, 1 (Jul. 23, 2019) (citing Gade v. Nat’l Solid Wastes Mgmt. Assn., 505 U.S. 88, 108 (1992)), https://crsreports.congress.gov/product/pdf/R/R45825/1.
[10] See id. at 2 (citing Gade, 505 U.S. 88, 98). The Court has identified two subcategories of implied preemption: “field preemption” and “conflict preemption.” Field preemption occurs when a pervasive scheme of federal regulation implicitly precludes supplementary state regulation, or when states attempt to regulate a field where there is clearly a dominant federal interest. Id. In contrast, conflict preemption occurs when compliance with both federal and state regulations is a physical impossibility (impossibility preemption), or when state law poses an “obstacle” to the accomplishment of the “full purposes and objectives” of Congress (obstacle preemption). Id. at 2 (citing Fla. Lime & Avocado Growers, Inc. v. Paul, 373 U.S. 132, 142-43 (1963) and Hines v. Davidowitz, 312 U.S. 52, 67 (1941)).
[11] Dissenting Statement of Commissioner Caroline D. Pham Regarding the Review and Stay of KalshiEX LLC’s Political Event Contracts.
[12] See CFTC Order, In the Matter of the Certification by KalshiEX LLC of Derivatives Contracts with Respect to Political Control of the United States Senate and United States House of Representatives (Sept. 22, 2023), https://www.cftc.gov/PressRoom/PressReleases/8780-23.
[13] See New York v. United States, 505 U.S. 144 (1992).
[14] CEA Section 3(a), 7 U.S.C. 5.
[15] CEA section 5c(c)(5)(C), 7 U.S.C. 7a–2(c)(5)(C)(i)(I)-(VI).
[16] Section II.E in the Event Contracts Proposal, amending Regulation 40.7 (Delegations).
[17] The CFTC maintains the public comment files at: https://comments.cftc.gov/PublicComments/CommentList.aspx?id=7311, and https://comments.cftc.gov/PublicComments/CommentList.aspx?id=7394.
