CFTC “Special Rule” Interpretation Led to an October Surprise

By: Robert Ward

On October 2, 2024, the Court of Appeals for the District of Columbia Circuit issued a decision that permitted KalshiEx LLC (“Kalshi”) to legally offer election contracts, which allow buyers to put down money based on their predictions as to party control of Congress and presidential election results.[1]  This decision, and the district court decision that the Commodity Futures Trading Commission (“CFTC”) sought to stay, concern the application of the Commodity Exchange Act’s (“CEA”) “Special Rule,” under which the CFTC can review and prohibit an event contract involving five enumerated activities, including “gaming,” if it determines the contracts are “contrary to the public interest.”[2]

Neither the statute nor the CFTC’s regulations define “gaming.” On June 10, 2024, the CFTC issued a Notice of Proposed Rulemaking (“NPRM”) aimed at, among other things, filling this gap. The proposed rule would adopt a broad definition of “gaming,” defining it as “the staking or risking by any person of something of value upon: (i) the outcome of a contest of others; (ii) the outcome of a game involving skill or chance; (iii) the performance of one or more competitors in one or more contests or games; or (iv) any other occurrence or non-occurrence in connection with one or more contests or games.”[3]  It would also dramatically alter the application of the Special Rule to contracts involving gaming (and other enumerated activities), adopting a categorial approach to review under the Special Rule.[4] That is, under this proposal, the CFTC would no longer undertake a contract-specific public interest analysis—it would only review whether the contract involves one of the enumerated activities.[5] If it does, the CFTC would prohibit the contract from trading without a separate analysis of the public interest. This proposed rule appears to have been drafted as something of a safety valve, given that the CFTC was litigating the Kalshi case when it published the proposal. However, the district court’s September decision in Kalshi suggests both aspects of the proposed rule are vulnerable to challenge.

Starting with the definition, the court concluded that “gaming,” as used in special rule, “refers to playing games or playing games for stakes.”[6] It contrasted this with the broader definition the CFTC applied to Kalshi’s event contracts, which equated gaming with “gambling,” often defined as “staking something of value upon the outcome of a game, contest, or contingent event.”[7] As the court noted, the CFTC did not actually look to statutes that use the term gaming to support its definition. Instead, it drew from statutes that use terms such as “bet,” “wager,” or “gambling,” rather than those that use the term that appears in the statute.[8] The court, on the other hand, looked to federal and state statutes that use the term gaming, and concluded that gaming is “tied to games.”[9] The court therefore held that “‘gaming, as used in the special rule, refers to playing games or playing games for stakes.’”[10]

After rejecting the CFTC’s interpretation, the Court concluded that Kalshi’s congressional control event contracts were not subject to the Special Rule. According to the court, whether a chamber of Congress will be controlled by a specific party involved neither illegal or unlawful activity nor a game—“played for stakes or otherwise.”[11]

The district court’s decision, while still subject to review by the D.C. Circuit, suggests that both the Proposed Rule’s definition of “gaming” and adoption of a categorical approach to applying the Special Rule are unlikely to survive judicial scrutiny.

First, the court’s opinion strikes directly at the proposed rule’s definition of “gaming,” which, as in the CFTC’s Kalshi order, would include “the staking or risking by any person of something of value” upon “the outcome of a political contest, including an election or elections,” as well as “the outcome of an awards contest,” “the outcome of a game in which one or more athletes compete,” and “an occurrence or non-occurrence in connection with such a contest or game, regardless of whether it directly affects the outcome.”[12] But, as the Kalshi court concluded, this approach, which draws upon federal- and state-law definitions of gambling, betting, and wagering, is “much too broad” in the context of the Special Rule. [13]

Second, although not at issue in the Kalshi decision, its analysis of the CFTC’s definition of gaming, grounded in the text, structure, purpose, and legislative history of the CEA suggests that the Proposed Rule’s categorical approach is on shaky ground. Starting with the text, nothing in the Special Rule’s text permits this kind of categorical approach. Instead, under the statute, the CFTC must undertake a two-step analysis. It must first determine whether the contract at issue involves one of the enumerated activities.[14] If it does, the CFTC “may determine” that the contract is contrary to the public interest.[15]  The statute then provides that “[n]o agreement, contract, or transaction determined by the [CFTC] to be contrary to the public interest . . . may be listed or made available for clearing or trading on or through a registered entity.”[16] The Proposed Rule rewrites the statute to eliminate this contract-specific analysis. Moreover, other provisions of the CEA make clear that Congress knew how to authorize a categorical approach when it wanted the CFTC to take one. Under 7 U.S.C. § 2, Congress required the CFTC to, on an ongoing basis, “review each swap, or any group, category, type, or class of swaps” to determine whether they should “be required to be cleared.”[17] This authorization to conduct a categorical review is absent from the text of the Special Rule.

The Kalshi decision also calls into question the CFTC’s reliance on a brief colloquy on the Senate floor between then Senators Dianne Feinstein and Blanche Lincoln. In that colloquy, Senator Lincoln stated that the CFTC “needs the power to, and should, prevent derivatives contracts that are contrary to the public interest because they exist predominantly to enable gambling through supposed “event contracts.”[18] But, as the Kalshi court noted, the D.C. Circuit has warned that “judges must ‘exercise extreme caution’” with such floor exchanges.[19] Such caution is particularly warranted here, where the exchange says nothing about whether the legislation would provide for a categorical approach.

In fact, the colloquy itself could suggest that legislators viewed the proposed provision as requiring a contract-specific analysis. Senator Feinstein asked whether the CFTC would “have the power to determine that a contract is a gaming contract,” to which Senator Lincoln responded “[t]hat is our intent.”[20] Senator Lincoln continued, stating that the CFTC “needs the power to, and should, prevent derivatives contracts that are contrary to the public interest because they exist predominantly to enable gambling,” citing event contracts constructed around events such as the Super Bowl and the Kentucky Derby.[21] By pointing to these specific examples, this exchange could just as easily support the conclusion that the CFTC should perform a contract-specific analysis. This ambiguity counsels against relying on this brief exchange to enact such the kind of sweeping regulatory change set out in the NPRM.

The Kalshi decision’s analysis of the term “gaming,” as well as its application of the tools of statutory interpretation to the CEA should give the CFTC pause about proceeding with the Proposed Rule. This is particularly true with respect to the categorical approach, which is both contrary to the text of the CEA and bad policy, depriving, for example, licensed sportsbooks of useful hedging tools.[22] If the CFTC does choose to move forward with the Proposed Rule in its current form, however, the Kalshi decision suggests that this new rule may not survive for long.

[1] KalshiEx LLC v. Commodity Futures Trading Commission, — F. 4th —, 2024 WL 4364204 (D.C. Cir. 2024).

[2] 7 U.S.C. § 7a-2(c)(5)(C)(i).

[3] 89 Fed Reg. 48968, 48974 (June 10, 2024)

[4] Id. 48978.

[5] Id.

[6] KalshiEx LLC v. Commodity Futures Trading Commission, No. 23-CV-3257, 2024 WL 4164694, at *9 (D.D.C. Sept. 12, 2024) (“Kalshi”).

[7] Id. at *7.

[8] Among the statutes the CFTC cited in support are the Unlawful Internet Gambling Enforcement Act, 31 U.S.C. § 5361 et seq., as well as various state statutes.

[9] Kalshi, 2024 WL 4164694, at *9 (citing 25 U.S.C. § 2701; Iowa Code § 725.7(1)(a); Mass. Gen. Laws ch. 23K, § 2; La. Stat. § 27:205).

[10] Id.

[11] Id.at 13.

[12] 89 Fed. Reg. at 48975, 48983

[13] Kalshi, 2024 WL 4164694, at *8.

[14] 7 U.S.C. §7a-2(c)(5)(C)(i).

[15] Id.

[16] Id. § 7a-2(c)(5)(C)(ii).

[17] 7 U.S.C. § 2(h)(2)(A)(i) (emphasis added).

[18] 156 Cong. Rec. S5906-07, 2010 WL 2788026 (daily ed. July 15, 2010) (statements of Sen. Diane Feinstein and Sen. Blanche Lincoln)

[19] Kalshi, 2024 WL 4164694, at *12 (citing Tex. Mun. Power Agency v. EPA, 89 F.3d 858, 875 (D.C. Cir. 1996)).

[20] 156 Cong. Rec. S5906-07, 2010 WL 2788026.

[21] Id.

[22] See Comment Letter of RSBIX (Aug. 8, 2024), available at https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=74480.