Key Points
- Multiple federal appellate circuits are currently facing or have issued preliminary decisions regarding prediction markets.
- On April 2, the CFTC announced it filed complaints in three federal district courts against state attorneys general and governors in Arizona, Connecticut and Illinois.
- How soon the Supreme Court gets involved might also depend on how determined state agencies and officials are to establish some level of oversight over prediction market trading within their borders.
The dispute over whether and to what extent state governments can regulate prediction market exchanges won’t have a clear and permanent resolution until the United States Congress and/or Supreme Court act on the matter. Recent litigation initiated by the US Commodity Futures Trading Commission (CFTC) could prompt those actions on a faster timeline than if the CFTC had left exchanges to litigate their futures with the various states trying to restrict their operations on their own.
Multiple federal appellate circuits are currently facing or have issued preliminary decisions regarding prediction markets, creating the possibility for divergent opinions that might prompt Supreme Court review. The CFTC’s lawsuits amount to “venue shopping” with an eye on the clock, though.
Photographer: Gabby Jones/Bloomberg via Getty Images
CFTC sues three states in federal courts to block enforcement actions
On April 2, the CFTC
announced that it had filed complaints
in three federal district courts against state attorneys general and governors. Those defendants are in Arizona, Connecticut, and Illinois.
In the release, CFTC Chair Michael Selig is quoted as stating that the agency “will continue to safeguard its exclusive regulatory authority over these markets and defend market participants against overzealous state regulators.” The statement mentioned the body’s “clear and longstanding exclusive jurisdiction to regulate event contracts under the Commodity Exchange Act.”
Jamie Wright, the founder of the Wright Law Firm in Los Angeles, explained the CFTC’s role in this dispute. As Selig alluded to, the Commodity Exchange Act (CEA) is paramount.
“Prediction markets fall under the federal CEA, which was created by Congress to regulate derivative trading,” Wright commented. “Under this Act, the CFTC has taken the position that it has sole responsibility for regulating derivative trades. This provides the companies who run these prediction markets with a valid federal preemption claim. More importantly, it also gives the CFTC the power, and more so, the motivation to protect them if/when states try to classify their offerings as forms of illegal gaming.”
The complaints against Arizona, Connecticut, and Illinois all ask the respective federal district courts to enjoin the defendants against taking enforcement actions against CFTC-registered designated contract markets (DCMs) like Kalshi and Polymarket. In all of the petitions to the court, the language of the CEA in defining the DCMs and arguing that it preempts any state-level statutes that might regulate prediction markets are the focus of the CFTC’s arguments.
Those are familiar arguments in terms of lawsuits involving DCMs in federal courthouses across the U.S. Kalshi and other exchanges have levied the same criticisms of states’ attempts to restrict their operations in their own complaints.
The CFTC’s selection of Arizona, Connecticut, and Illinois all represent jurisdictions where the agency likely believes the venue will be favorable to their interests. Otherwise, the CFTC might have also filed similar complaints against other states like Nevada, Ohio, and Washington.
This action reshapes the conversation from exchanges defending their own businesses to a question of federalism. It also widens the field of possibilities for the winding track of these cases through the federal court system.
The current landscape of federal and state prediction market litigation
To date, petitions have been filed with the federal Third, Fourth, and Ninth circuit courts of appeal, with the Fourth yet to rule on the motion put before it. The Ninth rejected Kalshi’s request for a stay blocking an order issued by a state court in Nevada that threatened to shut down most of Kalshi’s markets in the state.
The Third upheld a district court’s preliminary injunction against New Jersey enforcing its gaming laws against Kalshi. The Fourth is considering an appeal by Kalshi of a district court ruling to not grant a similar injunction against enforcement actions in Maryland.
More appeals could be on the way, too. Robinhood has sued Washington authorities while a federal district judge in Ohio has handed an unfavorable decision to Kalshi.
Kentucky’s legislature has also sent bills to Gov. Andy Beshear that could tax prediction market transactions and ban sports wagering licensees from offering DCMS in the state. Beshear’s signature on either could prompt more filings.
Arizona Attorney General Kris Mayes has taken the extraordinary step of
filing criminal charges against Kalshi
for violating the state’s gaming laws. In Nevada and Washington, state officials have sought remedies in state courts, with the Nevada Gaming Control Board succeeding in securing a temporary restraining order against Kalshi offering most of its contracts to people in the state.
All of these disputes could rise to the level of federal appellate courts apart from the CFTC’s complaints against Arizona, Connecticut, and Illinois. Disparate opinions from justices in these cases would be prime fodder for petitions to the Supreme Court.
Divergent interpretations of the CEA could facilitate Supreme Court review
If necessary, there is little doubt that the CFTC or exchanges would supplicate to the Supreme Court for an appeal of a case related to prediction markets.
Wright added that, “companies involved with prediction markets are motivated to take their cases all the way through litigation. If successful, they will receive federal approval and be able to offer their services throughout the United States. If unsuccessful, they can still determine what parts of their services were found to be regulated by the CFTC.”
The main question when it comes to litigation regarding prediction market regulation isn’t whether there will be at least one case in which a party to the lawsuit asks the Supreme Court to review the appellate court’s decision. The question is actually how soon that will occur and whether the Court will grant cert (hear the appeal).
Kalshi had a chance to do so already when the Ninth rejected its request for a stay against Nevada officials. However, that is leverage that is best used judiciously.
Multiple requests from the same party regarding similar issues don’t mean the likelihood of the Supreme Court granting cert to any of the petitions improves. For that reason, Kalshi likely decided that the Ninth’s decision to not grant the stay wasn’t the right opportunity.
At this point, Kalshi could elect to let the CFTC’s complaints against Arizona, Connecticut, and Illinois play out, to see whether the CFTC or the defendants in those cases will make the move to involve the Supreme Court. Kalshi might also wait to see if it wins its cases in the federal district courts for Maryland and New Jersey or upon further appeals on their merits before supplicating the Supreme Court.
How soon the Supreme Court gets involved might also depend on how determined state agencies and officials are to establish some level of oversight over prediction market trading within their borders. Favorable rulings on the merits of cases at the federal appellate level for Kalshi will test the commitment of state attorneys general and gambling regulators to proving their point, as they would take on the appellant role in that scenario.
New Jersey officials’ response in the coming days to the Third’s decision to uphold the preliminary injunction against it restricting Kalshi’s platform could lend some insight into the limits for spending precious resources on this dispute. The state may concede this matter if it looks like the chances of successful appeals don’t merit the use of limited money and time.
At the same time, the CFTC, Kalshi, and other prediction market operators are in somewhat of a race against the clock. Regime change in Washington, DC could mean a less favorable environment.
The race to squeeze the toothpaste out of the tube
The current landscape of the U.S. federal government is favorable to prediction market operators but there is no guarantee that will be the case moving forward. If the Republican Party’s trifecta in Washington, D.C. ends, that could mean a less favorable landscape, and thus the need to establish a “toothpaste is already out of the tube” situation.
Among the 14 pieces of legislation in the current Congress that seek to introduce new rules regarding DCMs and exchanges, none of them are solely sponsored by Republican members. Only three of the 14 have Republican co-sponsors.
These bills range from measures that restrict who can trade event contracts and penalties for insider trading to bans on contracts related to certain outcomes like sporting events. With a new Congress, and later a new chief executive, comes another possible landscape change in the coming years.
Justice Clarence Thomas will turn 81 years old in 2029 while Justice Samuel Alito will turn 79 that same year. That could mean the 48th president of the United States may have up to two vacancies to fill during their term, should both retire.
Replacements for Alito and Thomas may not be as amenable to prediction market preemption arguments, although that is difficult to prognosticate at this time. The future becomes murkier if a new Congress is active on legislation pertaining to prediction markets as well.
The current composition of Congress makes the progress of any of the 14 existing proposals unlikely. New leadership may be more keen to move similar proposals unless there has already been a Supreme Court ruling on the preemption question.
To be clear, a Supreme Court decision reinforcing the preemption question would not mean that Congress couldn’t introduce new rules governing prediction market activity. That would especially apply in the case of restrictions on who can trade on the platforms and clearer guardrails to prevent insider trading.
However, the Supreme Court upholding preemption protection for prediction markets might curtail any proposals that restrict the types of events the exchanges can offer contracts on. That gets to the heart of what the dispute over prediction markets and state sovereignty are about.
Sports contracts and gambling tax revenue are the heart of the dispute
While state officials have levied criticisms of prediction market exchanges pertaining to dangers for people who experience disordered gaming and a lack of insider trading controls, the most poignant enforcement actions have come from these officials in states where sports wagering is regulated. In addition to their sovereignty, state officials seek to protect tax revenue from sports bets.
Profits realized from trading DCMs are subject to taxation from corporate income, individual capital gains, and personal income tax perspectives. Kalshi and other exchanges do not pay separate gambling taxes to state governments on their revenue like licensed sportsbooks in the same jurisdictions do. These corporations only pay corporate income tax if they are registered in a state that assesses such tax, and even then, only to that state.
It’s difficult to place firm numbers on the potential cost of lost tax revenue for state coffers due to prediction market trading on contracts related to sporting events because conjectures toward that end make several unquantifiable assumptions. For example, it’s difficult to assume that all the people trading sports-related contracts would spend the same amount of money at regulated sportsbooks if those contracts weren’t available.
Moreover, even if that were the case, it’s impossible to guarantee that additional handle at those sportsbooks would translate to revenue for the books. A percentage of that handle would be returned to bettors as winnings.
Regardless, it’s equally as unfathomable that prediction market trading related to sports is having zero impact on states’ revenue from legal sports wagering. That’s the principle that some state officials may be willing to fight for to the end.
Perception of revenue loss may motivate Supreme Court clash
Nathan Goldman and Christina Lewellen considered the tax implications of prediction market proliferation for state governments for
Poole Thought Leadership, and instead of attempting to prognosticate totals, they quantified the gap between corporate income tax rates and tax rates for licensed sportsbooks in the various states. They used the example of a 2.25% income tax rate for corporate income compared to an 18% rate for legal sports wagering revenue producing a gap of 15.75% to demonstrate the principle.
Applying the same formula in New York, where Kalshi is headquartered, produces a gap as large as 43.75%. New York has a graduated corporate income tax that caps at 7.25% while assessing a rate of 51% on taxable revenue from licensed online sportsbooks.
That is why state governments may provide a different take on sports-related event contracts to the Supreme Court in potential oral arguments. The pitch will focus on the nature of such contracts instead of the legitimacy of federal preemption.
The counterargument regarding DCMs connected to sporting events
The rationale countering the preemption arguments offered by the CFTC, Kalshi, and others has focused on three main points.
- Congress has enacted multiple statutes giving state and tribal governments the authority to regulate gaming
- DCMs connected to sporting event outcomes are in practice identical to wagers on sports
- The CEA does not extend the CFTC’s authority to replace state sovereignty over gambling
In light of those arguments, a potential Supreme Court decision would definitively classify contracts connected to sporting events as gambling or something distinct in the absence of Congressional action to provide guidance. Whether the Court considers them gambling or not will inform the response to the preemption question.
Because of the CFTC’s intervention, the Court could be considering all these issues sooner rather than later.
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