Kalshi v. CFTC: Effect on the CFTC’s Rulemaking and a New Era for Event Contracts

October 1, 2024

Introduction

While the world anticipates the upcoming US presidential and congressional elections, two parallel proceedings are unfolding that relate directly to the elections: (1) litigation related to political-event contracts regulated by the US Commodity Futures Trading Commission (CFTC) (Kalshi v. CFTC); and (2) a CFTC rulemaking on the same subject.

Regarding the judicial proceeding, the US District Court for the District of Columbia (the "District Court") issued an order siding with KalshiEx LLC ("Kalshi") on the question of whether a designated contract market ("DCM") should be allowed to offer political-event contracts for trading. That question turned on whether the term "gaming" includes "gambling", a long-unsettled issue under the CFTC's regulations. The CFTC appealed the District Court's decision to the United States Court of Appeals for the District of Columbia Circuit (the "Circuit Court"). The CFTC views this case as pivotal in deciding whether such contracts will lead to "election gambling" on US futures markets and thereby place the agency in what it argues is the inappropriate role of monitoring election activities.

At the same time, the CFTC is set to finalize their proposed amendments to rules on events contracts released on May 20, 2024, with the comment period ending on August 8, 2024. The judicial proceeding will weigh heavily on whether and how the CFTC will move to finalize that proposal.

Kalshi v. CFTC

Kalshi, a regulated trading platform, sought to offer binary option contracts concerning which political party would control each chamber of Congress ("Congressional Control Contracts") certifying their compliance with the Commodity Exchange Act ("CEA") in June 2023. Kalshi describes these Congressional Control Contracts as event contracts. However, after reviewing the contracts, the CFTC determined they may involve activities prohibited under CFTC Regulation 40.11, such as gaming and/or unlawful activities. On September 22, 2023, the CFTC filed an order disapproving of Kalshi's contracts, determining that they involved "gaming". In support of this order, Chairman Rostin Behnam stated that the "approval of political events contracts of the type presented… would require the CFTC to exercise its oversight and enforcement authorities in the manner of an election cop," with such a role outside the CFTC's mandate. Kalshi challenged this decision in court in November 2023, arguing the CFTC exceeded its authority and acted arbitrarily.

On September 6, 2024, Judge Cobb of the District Court reviewed the CFTC's order disapproving of Kalshi's Congressional Control Contracts under the Administrative Procedure Act ("APA"), and interpreted the underlying statue using "traditional tools of statutory construction" rather than deferring to the CFTC. Notably, this is the first federal court decision that cited the Loper Bright Enterprises v. Raimondo decision in reviewing the actions of the CFTC regarding how the agency interpreted the CEA. The District Court adhered to the Supreme Court's decision in Loper Bright and endeavored "to independently interpret the statute and effectuate the will of Congress subject to constitutional limits."

The District Court sided with Kalshi on the definition of "gaming," rejecting the CFTC's broader interpretation that "gaming" includes "gambling". Judge Cobb found that "gaming" referred to playing games, consistent with Kalshi's position, and as such, granted Kalshi's motion for summary judgment. Because the District Court found that none of the enumerated activities from Rule 40.11 were referenced by the Kalshi contract, it did not undertake the analysis on whether the contract was against the public interest under the rule.

Following the District Court's decision, both Kalshi and the CFTC took immediate action. Kalshi sought to offer its Congressional Control Contracts, while the CFTC attempted to block Kalshi's contracts from trading. On September 12, 2024, Judge Cobb denied the CFTC's emergency motion to stay the judgment, allowing Kalshi to briefly launch the contracts. However, later that day, the CFTC appealed the District Court's judgment, and secured an emergency stay from the Circuit Court. As a result, Kalshi paused its Congressional Control Contracts pending further legal proceedings. The Circuit Court held a hearing to review the District Court's ruling on September 19, 2024, and the public now awaits its opinion.

CFTC Rulemaking

Under the CEA Section 5c(c)(5)(C) and CFTC Rule 40.11, events contracts that involve "gaming" among other enumerated activities (i.e., activities that are unlawful under federal or state law; terrorism; assassination; and war) are prohibited from being listed. On June 10, 2024, the CFTC published proposed amendments to its rules concerning event contracts in certain excluded commodities. The purpose of the proposed amendments is to clarify the types of event contracts that fall within the scope of section 5c(c)(5)(C) of the CEA and are contrary to the public interest, potentially barring them from being listed for trading. More specifically, the proposal focuses on the term "gaming" and how it should be defined under the statute.

The proposed amendments may clarify the definition of "gaming" and that event contracts related to gaming are "against the public interest". Critics of the proposed amendments, however, have argued that the proposed definition of "gaming" is too broad, a position that the District Court now has agreed with in Kalshi v. CFTC. Critics of the proposed amendments also have argued that (1) the proposal misreads the statute and does not allow the CFTC to prohibit categories of contracts as the proposal is written; (2) the statute requires that the "public interest" analysis should be done on a contract-by-contract basis; and (3) the proposal's arguments used to show that "gaming" contracts fail the "public interest" test are infirm (e.g., the proposal erroneously relies on an "economic purpose test" that is no longer based in statute and takes a paternalistic view of what is useful as a hedging tool).

What Happens Next - The Effect of Kalshi on the CFTC Rulemaking

At the time of this writing, the Circuit Court has not issued its opinion addressing the District Court's order in Kalshi. Presumably, the CFTC would wait until after that decision is rendered before finalizing the rulemaking to amend Rule 40.11, due to the fact much of the basis for how the proposal defines "gaming" has now been litigated.

But what if the Circuit Court rules in favor of the CFTC and overturns the District Court's order? Would the CFTC move ahead and finalize the proposal soon thereafter? And practically speaking, would or could the agency do so before the election? It's unclear. And CFTC action after the election will depend significantly on what the election results are.

Also notable here is the fact that the two Republican commissioners dissented on proposing the Rule 40.11 amendments. If political-party control of the White House changes after the upcoming election, it becomes even less clear whether and how the CFTC would move forward with finalizing the current proposal to amend Rule 40.11.

Meanwhile, the marketplace awaits the Circuit Court's decision as the next important development in this novel CFTC rulemaking proceeding. If the Circuit Court reverses the District Court's opinion, market participants should watch carefully to see if the CFTC moves quickly thereafter to finalize the proposed amendments to Rule 40.11