While the CFTC’s regulations can preempt state law, the agency has been reluctant to use that power until recently.
In 2024, when then-commissioner Caroline Pham dissented from the decision to prohibit Kalshi’s election contracts, she raised concerns about how heavily the CFTC relied on state definitions of “gaming” to guide the federal regulator’s interpretation of Kalshi’s political contracts:
“…the Commission could have relied on implied preemption to regulate event contracts as derivatives in our markets separate and apart from State gaming regulation. Instead, the Commission creates preemption concerns by proposing a gaming definition that incomprehensibly relies so heavily on State law that I don’t know how any exchange could understand where the Commission’s rules begin and end for these contracts.”
Pham was referring to the CFTC’s ban on Kalshi’s political event contracts, which was rolled back about five months after this statement. The CFTC concluded that the act of buying a contract on an election constituted “gaming.”
Pham also pointed out that political control is not one of the categories of event contracts that the CFTC originally forbade.
Rule 40.11 “prohibits event contracts that reference terrorism, assassination, war, gaming, or an activity that is unlawful under any State or Federal law, or that involves, relates to, or references an activity that is similar to any of those activities…” Even though election betting is prohibited under some state laws, elections are not unlawful activities.
In Pham’s view, because the activity the contracts are based on is neither a game nor unlawful, the CFTC’s reasoning unnecessarily put itself in conflict with state laws.
That was before event contracts moved into actual games.
Gaming may depend on CFTC interpretation
Now that prediction market platforms have moved into sports, the conflict between state law and federal regulation is even more direct. Rule 40.11 doesn’t end with a list of forbidden categories. The end of the rule states:
“…and that the CFTC determines by rule or regulation to be contrary to the public interest.”
The CFTC must determine that an event contract is contrary to the public interest to prohibit it. Trump’s nominee for CFTC chairman, Brian Quintenz, defended ErisX’s right to offer sports contracts in 2021. At the time, Quintenz stated:
“Whatever enumerated event contracts that have not been found to be contrary to the public interest are unequivocally allowed, even those that, on their face, could be blatantly immoral or inciteful of violence, so long as the Commission has not made a direct determination that that particular contract or group of contracts are contrary to the public interest.”
The likely next chairman of the CFTC also noted that the commissioners are not required to conduct public interest reviews. So, Quintenz will likely side with Kalshi’s sports contracts as he did with ErisX, the last derivatives exchange to try offering event contracts on sports.
However, state sports betting regulators aren’t accepting the CFTC’s preemption sitting down. As of Monday, six states had issued cease-and-desist letters to Kalshi and other prediction markets platforms ordering them to pull sports contracts from their states. Kalshi sued two state regulators and is likely to follow with more. However, Kalshi maintains that the company must only obey its federal regulator, and state regulators have no say in Kalshi’s event contracts.
Other federal agencies have adopted a range of responses to situations when conflicts with state law arise.
Federal agencies vary in their preemption responses
Federal regulations can overrule state laws, but federal agencies have varied in how aggressively they preempt state authority.
A 2009 report found that over the previous decade, the Environmental Protection Agency (EPA) was more reluctant to preempt state laws than other federal agencies. The EPA is unique in that it’s a co-regulator with the states. For the four EPA Clean Air Act rules the report studied, all four preempted state regulations, but the “EPA noted that it met and consulted with state and local officials in developing each rule.”
As a contrasting example, the report covered the Food and Drug Administration (FDA) preempting state laws over drug labeling. In 2006, the FDA approved a drug labeling rule “without offering States or other interested parties notice or opportunity for comment.” But in 2009, the Supreme Court ruled that the rule set a floor for labeling requirements, not a ceiling. So, states were free to require more stringent labeling requirements than the federal statute allowed.
That approach won’t work for the CFTC, since its ability to overrule state laws is critical for regulating the types of event contracts it may want to make available to the finance industry.
The CFTC’s prediction market roundtable targeted for the end of April will be a chance for the CFTC to hear from state gambling regulators and gambling industry lobbyists. However, the results of the roundtable may be a foregone conclusion. While Pham announced the roundtable in early February, Quintenz has already called all events, including sports, commodities. A former Kalshi board member, Quintenz appears likely to allow sports event contracts after his confirmation.
CFTC likely to try to exercise preemption on sports event contracts
While states may have their say in court and at the roundtable, the CFTC isn’t on track to be a co-regulator with the states akin to the EPA.
Event contracts on politics and sports arrived after the courts sided with Pham’s preferred interpretation of gaming. The District Court ruled that a contract couldn’t be gaming unless it was on a game.
Even so, if the Quintenz-led CFTC believes sports event contracts should be allowed, they will likely argue that the CFTC has not found them to be contrary to the public interest and exercise the agency’s right of preemption to allow them.
If the CFTC wants these contracts to remain available, then it will have to convince the courts that deciding not to conduct a public interest review is enough of a justification to preempt state laws prohibiting sports and election betting.
