Wednesday, August 05, 2015

Event Prediction Contracts Were ‘Commodity Options’ Within CFTC Jurisdiction

By Lene Powell, J.D.

Adding certainty to the status of event prediction contracts under federal commodities law, the D.C. federal district court handed the CFTC a win in its enforcement action against two Irish companies that operated an online event predictions market, ruling that the contracts offered by Intrade.com were commodity options within the CFTC’s jurisdiction and that one company had violated a 2005 CFTC administrative order prohibiting it from accepting orders from U.S. residents. The court also found the companies in civil contempt for failing to comply with a discovery order (CFTC v. Trade Exchange Network Limited, July 31, 2015, Lamberth, R.).

Event predictions market. Trade Exchange Network Limited (TEN) and Intrade the Prediction Market Limited were Irish companies based in Dublin. Between 2007 and 2014, the companies shared directors, office space, and equipment, and had a substantial overlap in shareholders. The companies operated www.intrade.com, an online platform where customers could buy and sell contracts predicting the outcome of real-world events, like sports events and changes in the price of commodities. There were two possible outcomes for each event: yes, the event would happen as described, or no, it would not happen. A customer bought shares if they believed the event would happen and sold shares if they believed it would not, and profited or not depending on the outcome.

In 2005, the CFTC entered an administrative order against TEN for violating Section 4c(b) of the Commodity Exchange Act (CEA) and Regulation 32.11 by accepting orders from U.S. residents for commodity options. TEN consented to entry of the order and agreed to refrain from violating the CEA, pay a $150,000 civil monetary penalty, and prevent U.S. customers from using the website to order contracts. Despite the agreed order, the companies accepted orders from U.S. customers between 2007 and 2012 via Intrade.com to trade various contracts including bets on future changes in the price of gold, the U.S. unemployment rate, and the price of currency pairs. In all, although 443 contracts were blocked to U.S. customers, over 2,000 contracts were not blocked.

According to notices on the Intrade.com website, Intrade ceased offering trading services to customers via the website as of March 10, 2013, and as of June 14, 2014, Intrade intended to fully liquidate all remaining customer accounts by December 31, 2014. A November 1, 2014 notice said the company was “working very hard” to resolve the CFTC case in order to resume commercial operations.

Commodity options. The court granted summary judgment on the first count of the CFTC’s complaint, that TEN and Intrade violated CEA Section 4c(b) and Regulation 32.11 regarding the offering of prohibited commodity options. The court rejected the companies’ narrow definition of the term “option,” noting that although case law was scant, the contracts met the characteristics of what are known to the trade as “binary options.” The CFTC has previously regulated binary options, and the companies did not fall into any exceptions that would allow them to lawfully offer commodity options for trading. Under Chevron and other Supreme Court precedent, deference was due to the CFTC’s construction of a statutory scheme it was entrusted to administer.

The court also declined to limit the definition of commodity options to contracts on commodities specifically enumerated by the CEA, like gold and crude oil. The “excluded commodity” category did not apply and served to demonstrate the span of the term “commodity.” Accordingly, Intrade’s contracts on climate and weather outcomes as well as U.S. economic numbers were commodity options under the CEA.

Orders from U.S. customers. The court also granted summary judgment on the CFTC’s second claim, that TEN violated CEA Section 6c by offering contracts to U.S. customers in violation of the 2005 order. Although TEN and Intrade had separate Irish corporate registration numbers, maintained separate bank accounts, and filed separate tax returns, they operated as a common enterprise because they had the same officers and directors, shared office space, and commingled funds. The companies violated the 2005 order by offering contracts to U.S. customers identical to contracts specifically prohibited by the order, and by not informing U.S. customers which contracts they were not allowed to trade. TEN was responsible for the actions of then-director and officer John Delaney, who was acting in scope of his employment and without an interest adverse to TEN.

The court did not grant summary judgment on Count III of the CFTC’s complaint, regarding violation of CEA Section 9(a)(3) concerning false statements and omissions. The court directed the parties to prepare a scheduling order regarding Count III and the appropriate amount of disgorgement and civil monetary penalties under Counts I and II.

Contempt. In a separate opinion and order, the court found the companies in contempt for failing to comply with a June 24, 2014 discovery order, which denied the companies’ motion for a protective order under the Irish Data Protection Act and directed them to produce documents and CEO Ronald Bernstein for a deposition. The companies were ordered to pay reasonable expenses incurred by the CFTC, including attorney fees, as a result of the failure to comply with the order.

The case is No. 12-1902 (RCL) [summary judgment, contempt].