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Lawyer-reader A.R. in Los Angeles, CA, read with interest an item we had last week, and has sent in a fuller breakdown:
Last week, this site had an item about a D.C. case between the Commodity Futures Trading Commission (CFTC) and Kalshi, a company that operates a derivative exchange, who wanted to list event contracts that allow trading on which party will win control of Congress. I thought I'd dig into it a little more to see what actually happened in the case. It turns out that, upon closer inspection, it's much more nuanced and interesting than we realized.
First, this is not a case of a court going rogue and ignoring federal law. In fact, it's just the opposite. The district court specifically stated in the opinion that the case was not about whether these types of contracts are a good idea or whether betting on elections hurts election integrity: "Although the Court acknowledges the CFTC's concern that allowing the public to trade on the outcome of elections threatens the public interest, this Court has no occasion to consider that argument. This case is not about whether the Court likes Kalshi's product or thinks trading it is a good idea. The Court's only task is to determine what Congress did, not what it could do or should do. And Congress did not authorize the CFTC to conduct the public interest review it conducted here."
The basic setup is this: Congress passed a law, the Commodities Exchange Act (CEA), which authorizes the CFTC to regulate derivatives. Event contracts, where one trades based on the likelihood of a certain event, are a type of derivative regulated by the CFTC. (As an aside, many of these contracts are about risk mitigation—so, if you own property in a hurricane zone, you could buy a contract that a certain hurricane will hit your area as a hedge against any losses you may incur from said hurricane.) You can't list an event contract without being registered with the CFTC. Typically, companies "self-certify" that they're in compliance with CFTC's requirements and they get their certificate—the whole process is pretty quick. But there's a special rule that allows the CFTC to conduct a 90-day review to determine if the contract is in the public interest, if the contract "involves" specific subjects: illegal activity, terrorism, assassination, war, or gaming. Yes, "gaming" is listed right after "war" in the law. You can see what Congress was getting at, right? They don't want people trading on whether someone will be murdered, or whether war will break out, or on some illegal activity like whether someone will rob [X] bank. And gaming is there to prevent trading on big sporting events. You'll notice that what is not listed here is elections. And elections are not an otherwise illegal activity (well, not yet anyway, assuming Donald Trump doesn't get his way).
Nevertheless, the CFTC invoked this special rule, conducted a 90-day review, determined the contract was not in the public interest and denied the registration. Kalshi sued and claimed the CFTC had exceeded its authority in conducting the review in the first place. So, the Court wasn't asked whether these contracts are a good idea or whether CFTC was correct in its assessment that they are contrary to the public's interest—even if there's a good argument that assessment is on the money. Instead, the Court was asked whether the CEA authorized the CFTC to conduct the review at all under the terms of the special rule.
The Court said no, the special rule doesn't apply here. And its opinion is an exercise in judicial restraint, which is exactly what we want from our judicial system. The CFTC really tied itself in knots trying to fit this square derivative into the round categories in the special rule. First, it said the contract involves an illegal activity because while elections aren't illegal, state law prohibits betting on elections, and these contracts involve betting on elections, so it's an illegal activity. The Court said whoa, that's not really what "involves an activity that is unlawful" means. The phrase "involves" an illegal activity references the subject of the contract: Is the subject of the contract illegal? It's not about whether trading on the subject could make it illegal. And you can see why that reading of that phrase makes sense, because a broader interpretation could subject more categories of contracts to the special rule than are actually listed in the special rule. Plus, whether trading on something is illegal under state law is irrelevant, as the CEA specifically preempts any conflicting state laws regarding derivatives.
Second, the CFTC said that these contracts involve "gaming," because gaming is synonymous with gambling and gambling means betting, which is what these contracts involve. But the Court said whoa again, because under that logic, every event contract that involves betting on some event would be considered gaming and would be subject to this 90-day review. And that can't be right because then there would be no need for a "special" rule specifying when these reviews can be conducted. Maybe the CFTC has seen Music Man, where they have trouble in River City because it starts with T, which rhymes with P and that stands for Pool!
So, the Court, not unreasonably, concluded that Kalshi was correct that the CFTC had exceeded its authority here. Interestingly, this is one of the first cases to be decided under the new standard of review for agency decisions. You'll recall that SCOTUS, in Loper Bright, overturned Chevron, so now courts conduct an independent review rather than a more deferential review of agency decisions.
But wait, there's more. In denying the CFTC's request for an emergency stay pending appeal, the D.C. Appeals Court pointed out that if these types of contracts were so bad, the agency had the power all along to enact a rule to subject them to greater scrutiny. You can practically hear Glinda the Good Witch telling Dorothy she had the power to go home all along. Turns out the last category of that special rule is this: "(VI) other similar activity determined by the Commission, by rule or regulation, to be contrary to the public interest." Well, would you look at that! The CFTC could have enacted a "rule or regulation" with the requisite comment period, etc. to state that events contracts involving elections are contrary to the public interest and cannot be registered. Far from a case about a Court going rogue, this is a case about an agency asking the Court to fix its screw-up. Thankfully, the Court declined this invitation.
Finally, if Sen. Jeff Merkley (D-OR) was going to weigh in, what he should have said is that the Court was right not to write what Congress did not, and either the CFTC needs to draft a rule addressing this subject, or Congress needs to amend the CEA giving the CFTC specific authority to regulate these types of contracts. But to misrepresent what the Court did and what the case was actually about is lazy, irresponsible and just wrong. We need to be shoring up our beleaguered courts and not piling on because it's politically expedient.
Thanks, as always, A.R.! (Z)