A legal battle over the jurisdiction of sports event contracts is likely headed to the US Supreme Court, as industry stakeholders await developments from the court. Several circuit court decisions have complicated the legal landscape regarding swaps, particularly as a federal regulator released new proposed rules that broaden the definition of swaps. This proposal, unveiled last Friday, adds a new chapter to the ongoing discussions surrounding the multibillion-dollar sports betting industry.
On October 9, just ahead of an active football weekend, the US Commodity Futures Trading Commission (CFTC) issued a notice of proposed rulemaking. Historically, the CFTC has classified most event contracts under the Commodity Exchange Act (CEA). However, the latest proposal aims to expand the definition of swaps. Under the revised definition, the CFTC explicitly includes event contracts related to sports, politics, cultural occurrences, and weather.
CFTC Chairman Michael Selig emphasized the significance of event contracts, stating, "Americans use event contracts to hedge risks, speculate and provide the public with information about the outcome of future events. These products are commodity derivatives squarely within the CFTC’s regulatory remit under the Commodity Exchange Act and are within the agency’s exclusive jurisdiction."
Understanding swaps traditionally hinges on their role as transactions dependent on events that have potential financial, economic, or commercial implications. The Dodd-Frank Act outlines fundamental parameters regarding swaps regulated by the CEA, while excluding securities-based swaps, which fall under the oversight of the SEC.
In April, the US Court of Appeals for the Third Circuit supported the CFTC's stance by deciding that sports event contracts could indeed be classified as swaps per the CEA. The court in KalshiEX LLC vs Flaherty determined that the outcomes of such contracts are connected to real economic consequences. This ruling was frequently referenced in the recent proposed rules, highlighting the broad economic implications involving various stakeholders, including sponsors and television networks related to sports outcomes.
The CFTC provided a striking example, noting that Madison Square Garden Sports experienced a substantial increase in valuation correlated to the New York Knicks' pursuit of an NBA championship, which also generated around $380 million for New York City's economy during the playoffs.
In contrast to the Third Circuit's ruling, the Ninth Circuit, in an August decision, asserted that Kalshi's sports event contracts do not qualify as swaps. Judge Ryan Nelson, writing for the majority, argued that such contracts should be regarded as sports wagers rather than as financial instruments designed to transfer risk.
In addition, the Sixth Circuit determined that even if event contracts were deemed swaps, they would not override existing sports gambling laws. Generally, a split among circuit courts often raises the likelihood of the Supreme Court stepping in to resolve the discrepancies.
One area of particular interest is a provision that excludes casino-style games from the proposed definition of swaps. This change seemingly addresses the concerns of proponents of traditional casinos, who warned of the potential consequences of expanding event contracts. Earlier this year, stakeholders raised alarms about traditional casino games such as blackjack possibly evolving into event contracts.
An analysis from Citizens on October 11 indicated that it is improbable that companies like Kalshi and Polymarket would introduce casino-style games, suggesting these would not represent a major concern for investors, according to analyst Jordan Bender.
The arguments surrounding the jurisdiction of derivatives are among the most contentious discussions in the sports betting sector since the Professional and Amateur Sports Protection Act (PASPA). The American Gaming Association reports that the contracts have led to over $1 billion in lost state tax revenue.
During the Global Gaming Expo, Mike Dreitzer, chairman of the Nevada Gaming Control Board, expressed skepticism regarding the legality of these contracts, accusing prediction markets of engaging in dishonest practices. "All we as regulators ask for is a level playing field," Dreitzer remarked.
The CFTC intends to publish the proposed rulemaking in the Federal Register, allowing for public comment over a 30-day period following its publication.
