Where the Fed battles with states over prediction markets

As prediction market trading volume increases at a relentless pace, the business is being challenged by states across the country. The federal government is fighting a multi-pronged battle to block state action and assert regulatory authority.

Sixteen states are involved in legal proceedings against prediction market platform companies, and one state is moving to ban them altogether.

The Commodity Futures Trading Commission argues that it is the only entity that can regulate these platforms, and the commission is suing six states to defend its “exclusive jurisdiction” over prediction markets.

Minnesota became the latest government target Tuesday when the commission sued the state after Gov. Tim Walz signed the state’s first bill as part of a broader online safety measure banning the operation of prediction markets in the state.

Jeff Le Rich, a former CFTC chief prosecutor and now a partner at Husch Blackwell, said this aggressive strategy is not typical of a federal agency. “It’s unusual to sue the state,” he said. “That’s definitely a different tactic.”

CFTC Chairman Michael Selig has made his views on the CFTC’s oversight of prediction markets clear since he was confirmed by the U.S. Senate in December. He is also currently the only member of the committee, which normally consists of five people.

“States cannot circumvent the clear direction of Congress,” Selig said in an April press release announcing the lawsuit against Wisconsin. “Our message to Wisconsin is the same as our message to states like New York and Arizona: If they disrupt the administration of federal law in regulating financial markets, we will sue.”

Scrambling partisan divisions

The battle between states and the federal government over oversight of prediction markets has disrupted typical partisan divides.

Eleven states with ongoing lawsuits against prediction markets have Democratic attorneys general, and five states have Republican attorneys general. In Minnesota, where the state legislature moved to ban prediction markets, the law passed overwhelmingly in both the state House and Senate, even though both chambers were narrowly divided along party lines.

“I wouldn’t say this is all that surprising just because it’s a state versus federal issue,” said John Ammons, a partner at law firm Reed Smith who focuses on regulatory issues related to commodities, derivatives and digital assets. “I think states have this idea that they are the ones regulating games and things that look like games.”

Regulators in the 16 states involved in the prediction markets lawsuit are represented on both sides, but the six states where the CFTC has filed suit so far (Wisconsin, New York, Connecticut, Illinois, Arizona, and Minnesota) all have Democratic attorneys general.

“We cannot answer why the Trump administration chose to prosecute only certain states under Democratic leadership, ignoring other states with similar enforcement stances,” Connecticut Attorney General William Tong (D) said in a statement to CNBC.

The only action the CFTC has taken against a state with a Republican attorney general is Ohio, where the state filed an amicus brief defending its sole jurisdictional basis.

Richie Taylor, a spokesman for Arizona Attorney General Chris Mays, said in an email that his ability to comment is limited because the lawsuit is ongoing, but noted the bipartisan nature of the state’s lawsuit.

“In red states and blue states alike, Secretary Mayes believes the CFTC is unfairly infringing on states’ rights to enforce gambling laws,” Taylor said.

The battle over monitoring event contracts

The states allege that the prediction market platforms operate illegal sports betting operations, saying that related event contracts make up a large portion of the trading volume on the platforms. The CFTC argues that its power to regulate swaps and derivatives puts all event contracts under its jurisdiction, regardless of their content.

A CFTC spokeswoman denied that the commission’s legal strategy involved anything other than defending its regulatory authority.

“These states sought the CFTC’s intervention because they sought to regulate or prosecute legitimate CFTC-regulated exchanges that operate in full accordance with federal law,” an agency spokesperson said in a statement. “It is based solely on the CFTC’s responsibility to ensure that states do not interfere with event contract transactions that are regulated by federal law.”

In previous litigation, the CFTC won a preliminary injunction in Arizona that would block criminal charges against Calci, the nation’s largest prediction market platform. Cases are still ongoing in five other states, and no initial decisions have been made.

Separately, the U.S. Court of Appeals for the Third Circuit ruled that New Jersey cannot enforce its gambling laws against prediction markets. But the legal battle is still in its early stages, and many supporters of the legal battle say the final verdict will likely be decided by the country’s highest court.

“There are substantial circuit-splitting elements to this case that seem to indicate that this case is likely to reach the Supreme Court,” Ammons said.

Disclosure: CNBC and Kalsi have a commercial relationship that includes customer acquisition and minority ownership.