The SportsFolio Journal - April 1, 2021

Apr 2, 2021

Asking the Right Question Too Early

Back in the day, there was a dispute between one of the ASM traders and CEO Chris Rabalais. We’ll spare you the details of that dispute, which still continues today. What is relevant for today’s issue is the fact that Chris took it all the way to the Supreme Court …

The technical name for the petition is Writ of Certiorari. People generally call it just “the Cert.” The chances of any such petition being granted is rare; in fact, just roughly 1% of the total petitions are granted. Just like with everything else, you need a lot of hard work, some publicity and a bit of luck.

If there is any chance to get in at all, it has to start with a killer question. You have to have the Court at hello.

The question has to be related to the case of course. It also has to have broad economic significance. Why should society care? How will the resolution of the question make the country better? Any petition is effectively a Hail Mary pass. So at a minimum, the ball needs to get in the air and travel a fair bit for it to have any shot at being successful at all.

Back then, it took our team a while to arrive at the right question and it ended up being this:

Is sports performance an excluded commodity under the Commodity Exchange Act?

In non-legal terms, what that really meant was the following: One could speculate on the weather because it was approved by a federal regulator, i.e. the CFTC. One could not speculate on President Obama (or any presidential candidate for that matter) winning the elections because that was prohibited by the same regulator, the CFTC. Either way, the CFTC was the decision-maker. Our question simply became: Why is sports any different? We believed that sports as a whole is not any different and that any financial contract that settled on sports-related events (game outcomes, athlete performance, attendance metrics, etc.) was under CFTC’s jurisdiction.

The Hail Mary did not work. Despite the team trying to drum up some interest around the case, there wasn’t any press. Arguably, the question was premature. Other than Nevada, there was no sports betting happening in the country, our novel market (ASM) was not operating at the time and daily fantasy sports had not become a thing. The question was important, but perhaps not urgent. The Supreme Court declined to hear the case.

Fast forward to 2021, it is nice to see that some urgency has started to develop around this question. In fact, it is more than that. One of the CFTC commissioners now agrees with us. Here is an excerpt of the statement from Brian D. Quintenz:

When we think of commodities, we think of tangible things. Oil, corn, gold. There are intangible commodities too, most of which have a connection to the financial system, like a broad stock index (S&P 500) or a borrowing rate (LIBOR). But what about an event? An election? Whether the Summer Olympics will occur in Japan? A …. football game? Those, too, are commodities!

We realize this is one commissioner’s view and not necessarily the entire Commission’s. Yet, it is good to get an answer to the question that we asked back in 2013.

Here is some additional context. This statement from Commissioner Quintenz came about because ErisX, in collaboration with RSBIX (Regulated Sports Book Index Exchange) self-certified certain NFL contracts just before the New Year. The CFTC initiated a 90-day review and opened it up for public comments. We felt strongly that these contracts did not serve the public interest and NSEI submitted a long and detailed letter to the CFTC. The NFL and the NBA weighed in, too, among others.

We don’t know the details behind the CFTC’s thinking, but the word on the street was that they were going to reject these contracts. Before the CFTC issued a detailed order, ErisX pulled their contracts. Commissioner Quintenz then made his views public, stating:

I would have dissented from the Order prohibiting the ErisX NFL contracts due to significant concerns around the statute’s constitutionality, the regulation’s validity, and the order’s arbitrariness.

Commissioner Quintenz listed three commodities in his statement. The first one was election contracts. They are prohibited from listing and trading by a 2012 CFTC order. The Olympics contract was another. Here, the example Commissioner Quintenz gave was more around the timing of the Olympics, i.e. whether the Olympics will happen when the world is not exactly out of the gates with respect to the pandemic just yet, but where the Olympics will happen is also an interesting question with broad economic consequences. We actually designed such a contract back in the day, but then started focusing on another product, before the world came down on us during the Great Recession of 2008.

Football? Yes, and we agree with Commissioner Quintenz that football is a commodity. Here is the question that Commissioner Quintenz did not address though:

If football is a commodity, then why is sports gambling allowed?

When SCOTUS took the PASPA case, Murphy v. NCAA, NSEI submitted an amicus brief (.pdf). We said:

Sports gambling contracts can also potentially be classified as commodity contracts. In relevant part, the Commodity Exchange Act defines the excluded commodity as an occurrence, extent of an occurrence, or contingency … that is (I) beyond the control of the parties to the relevant contract, agreement, or transaction; and (II) associated with a financial, commercial, or economic consequence. 7 U.S.C. § 1a (19). “A broad interpretation of ‘excluded commodity’ might include betting transactions on sporting and other events. Wagers on sporting events might satisfy the definition because, absent chicanery, the occurrence or contingency is not within the control of the parties to the relevant contract and the outcome may be ‘associated with an economic consequence,’” Paul Architzel, Event Markets Evolve: Legal Certainty Needed, Futures Industry, March/April 2006.

We are still of the same view and Commissioner Quintenz’s public statement just reinforces the question in our opinion. If football, or more broadly, sports performance is a commodity, then a traditional sports bet, which is simply an event contract that settles based on sports outcomes, is a claim that is under CFTC’s purview. The same goes for daily fantasy sports. Unless those contracts are blessed by the CFTC, which we don’t think will ever happen, those contracts should be prohibited.

Commissioner Quintenz believes that the statute and regulations are not in sync. To the extent that is the case, we don’t think the solution is for the CFTC to adopt a hands-off approach. Just looking at things from 30,000 feet, if the CFTC is not taking the lead on evaluating these types of contracts, then who will? Congress created the CFTC for this exact purpose and we stated as much in our 2013 SCOTUS petition:

The Commodity Futures Trading Commission (CFTC) was created by Congress through the Commodity Futures Trading Commission Act (CFTC Act) of 1974, which also expanded the definition of a commodity to reflect the shifts in the U.S. economy away from its agricultural roots. The CFTC Act of 1974 also introduced the public interest standard for designation of commodity futures contracts and included an Economic Purpose Test, which permitted listing and trading of contracts that could be used for hedging and price basing on a more than occasional basis.

It is true that there is technically no Economic Purpose Test anymore; it was repealed with the Commodity Futures Modernization Act of 2000. That probably wasn’t a great move, because it makes it less clear what standard should be used to distinguish gambling claims from socially useful claims. Nevertheless, it seems that the Commission was still relying on the Economic Purpose Test in its ErisX decision and Commissioner Quintenz seems to have taken issue with that:

As to the “legislative history” interpretation on which the Order so heavily relied, I suspect that the reference is to a simple colloquy between Senator Lincoln and Senator Feinstein, which stated that the Commission “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.” I assume that this conversation between two senators was the basis from which the Order drew out the inference that the economic purpose test has been restored by statute. I assume this from indications from the staff who drafted the Order, but also because there is nothing else that comes close, which should be a disqualification of the interpretation in and of itself. Relying on legislative history, let alone a single colloquy, to support a view of a mandated narrow decision-making framework is a Hail Mary. As Justice Gorsuch wrote, “Hopes and dreams are not law.” Neither is a colloquy.

We don’t think that the exchange of the senators is the only basis. There are at least three times that the Commission itself signaled the continued reliance on the Economic Purpose Test.

The first one was the Event Contracts Concept Release, back in 2008 when the CFTC stated:

Although repealed by the CFMA, former Section 5(g) of the Act may be relevant to analyzing the findings and purposes discussed in Section 3 of the Act.

Then, when the box office movie futures were up for discussion, one of the Commissioners stated:

Under the economic purpose test, exchanges could only list for trading contracts that could be used on more than an occasional basis for hedging or price-basing purposes. As a result of the changes of the CFMA, staff does not routinely consider the economic purpose served by proposed contracts in its reviews. However, in view of the comments expressed by interested parties and several commissioners related to the potential hedging uses of the contracts, staff will consider the potential hedging utility of the proposed contracts.

Then, when the CFTC prohibited the listing and trading of the election contracts, it stated (.pdf):

[T]he legislative history … indicates Congress's intent to restore, for the purposes of that provision, the economic purpose test that was used by the Commission to determine whether a contract was contrary to the public interest … prior to its deletion by the Commodity Futures Modernization Act of 2000.

In short, while the Economic Purpose Test may officially be off the books, the Commission continued to signal to society that it still has some relevance, and it should. Because it ultimately comes down to these two questions when innovative contracts are involved:

Somebody must be the decision-maker on these contracts. If not the Commission, then who?
Some guiding principles should be used to distinguish gambling claims from socially useful contracts. If not the Economic Purpose Test, then what?

Thus, even if one were to agree with Commissioner Quintenz that there is a disconnect between the statute and the regulations, and some gap between the Commission and Congress, until and unless Congress decides on an alternative system, we believe it would be in everybody’s best interest for the Commission to continue to rule as if the Economic Purpose Test was still alive. We believe it is, at least in spirit.

The most poignant message here is that sports finance is now on the map. For us, developers of novel sports-based financial contracts, this is an important step in the right direction. We do agree with Commissioner Quintenz that there is more innovation to come. He stated:

But the legal analysis and interpretations will remain secret until forced into the open by another, bolder exchange’s decision to see a self-certification process through to a conclusion.

To all the bold exchanges out there. You have a license to trade contracts and we’ve got the contracts.

We may have developed them too early, but we’ve got them.