In litigation, is the person who will be most impacted by the outcome always at the table? Will they always have a voice?
Not necessarily. With important public policy matters, such as finance, it is often industry v. government, or some variation of that. Obviously, the case can be between two private litigants, or even the public and the government, but often, it’s industry v. government. In those settings, the largest impact may be felt by neither party. Rather, it may very well be the American public.
How? Let’s explore some commonalities in the cases we are most interested in, and write about:
It involves money.
Industry v. government.
At its core, the case involves definitions.
The industry’s vantage point is clear. They are in the business of making money. Often, this is justified by the “fiduciary duty” argument, profits need to be maximized, and the executives of the company, in their roles as stewards of the company, have to do whatever it takes. To be profitable, they need to convince the public to spend their money in a certain way. If that pursuit must include stretching the laws, so be it. In other words, don’t blame Kalshi.
Oftentimes, the opposing party is the government, and in many cases, a regulator. The regulatory agency has a mission, and the industry’s pursuit for profit maximization may very well clash with that mission. That shouldn’t be surprising because that’s probably why that regulatory body was created in the first place. Before the regulator came into existence, there was presumably some sort of legal gap, either because Congress did not contemplate something fully, there were some unintended consequences, the industry stretched the laws, or any combination of these factors. One way or another, a door was ajar, if not fully open, and the industry walked right through it, harming the public.
If this is the fact pattern, the outcome is often predictable. The harm eventually rises to the point that something must be done, so Congress gets together and fixes it, creates a regulatory body, then mandates that the regulator execute on their mission, whatever that is. In large part, we have the SEC because of the stock swindlers of the 1920s.
In theory, the government is a proxy for the public, and their interests are aligned. Ok, so why can’t the government be an advocate for the public? There are multiple headwinds:
The Boundaries of Authority
It remains to be seen how much leeway the regulatory agencies will have going forward with Chevron being overturned in 2024 after having been settled precedent for 40 years. The current judicial system seems to feel that the regulatory agencies have too much power, power that Congress didn’t necessarily give them. Certainly, the crypto industry continues pushing that narrative, framing cryptocurrencies as a major questions doctrine issue. While they have not exactly been successful on that front, the story is far from over.
All that said, we doubt that this is the best explanation for regulator behavior. It is true that a court can eventually usurp the agency’s power, but the same way industry tends to test the waters, the regulator will do the same. Generally, a regulator would like to regulate more things not less, and they won’t concede on their jurisdiction unless forced, which makes the CFTC behavior in Kalshi even more puzzling. As we covered in our last couple of posts, the CFTC willingly gave away more ground than they had to, and by doing so, they inadvertently turned the case from one that was supposed to be about economic purpose to one that is about definitions, and lost precisely for that reason.
The Revolving Door
The government may be a proxy for the public, but the people that work for the government are also people! They must also consider their own future and their families. Many will be out of public service in a few years and there is a legitimate question around whether somebody is truly incentivized to go hard on a potential future employer. We have always believed that one effective solution could be borrowing a tenure-like concept from academia. If a regulator does not worry about job security, perhaps they could approach public interest differently but that’s for another day.
Definitions
The first two factors certainly play a role, but in the subset of cases we look at closely, definitions emerge as the strongest headwind.
John Deaton is a lawyer and before running for the Senate to face Elizabeth Warren, he was especially vocal in the crypto space.
We chatted with ChatGPT a little bit this morning. We asked:
Does John Deaton believe the SEC made the best arguments possible in SEC v. Ripple?
ChatGPT’s (partial) response:
No, John Deaton does not believe the SEC made the best arguments possible in the SEC v. Ripple case. Throughout the legal proceedings, Deaton has been critical of the SEC’s arguments. He has pointed out inconsistencies in the SEC’s case and questioned the strength of their evidence and legal theories.
For example, he has emphasized the SEC’s reliance on outdated information, such as a 2014 tweet by Ripple's co-founder Chris Larsen, to support their claims. Deaton has also suggested that if the SEC had a better or more compelling argument, they would have presented it during the case. (emphasis added).
We can’t find the original tweet now, but we clearly remember Deaton saying something along the lines of “The SEC’s argument is weak, but they don’t have a better one. If they did, they would have presented it already.”
We suspect that this view is common, especially within the legal community. It certainly passes the smell test. You are an advocate in the courtroom, and you will make any argument necessary to win. Why wouldn’t you? Alas, things are not always what they seem.
If definitional issues are at play, particularly if prior positions have been taken that could render the best defenses inconsistent with previous statements, then the strongest argument may be left behind. Imagine this scenario: If you think there is a 50% chance you can win without looking inconsistent or a 75% chance to win when you will be forced to admit inconsistency, guess which way the incentives will lead you? The best argument for the SEC against crypto will always be that one can not invest in crypto; yet, even if they fully believed that, it’s now become a very difficult position to argue after publicly portraying crypto speculation as investing, when it isn’t.
The same forces are in play here, but it is nuanced. The SEC took the position that one can invest in crypto way too many times (here is one example); they can’t credibly walk that back. The CFTC was in a better position prior to this case. As far as we are aware, it wasn’t too late to properly define gambling in Kalshi v. CFTC; the CFTC had the opportunity to put a stake in the ground.
It is safe to say that that was a colossal missed opportunity. The result was not just losing the Kalshi case, but also making it more difficult to win future cases. Hypothetically, if the CFTC wants to challenge a Zuckerberg divorce contract in the future, how will they argue it? The right thing to do is to admit that their reading of the Dodd-Frank Act was wrong, that in this instance gaming really meant gambling, and gambling can happen with any contingent event contract (depending on whether there is economic purpose or not). It’s never too late to do the right thing, but there will be a rightful concern that the opposing counsel will have a field day with that one.
In fact, one doesn’t even need to hypothesize about exotic event contracts. The ones that are as old as humanity (the Romans bet on chariot races, after all), are happening as we speak. Recently, Crypto.com made a bold move and listed Super Bowl event contracts on its platform. The CFTC, quite predictably, said that they will review and asked Crypto.com to suspend trading until the review is complete. Crypto.com, unexpectedly (in our opinion at least), refused. The contracts are still trading and looks like people can gamble on Super Bowl outcomes on a CFTC-regulated exchange. We thought ErisX was making a bold move! They at least withdrew their contracts once they received pushback from the CFTC.
Perhaps emboldened by what Crypto.com did, Kalshi (who else?) followed the same playbook, and effectively listed the same contracts. As of today, the CFTC did not announce its intent to review. One can only speculate as to why.
Then, things just got even more interesting. Robinhood announced a partnership with Kalshi and became its first broker (Robinhood Derivatives is a futures commission merchant, but not a designated contract market like Kalshi). The CFTC did not like it, and “formally requested that [they] ‘not permit customers to access’ sports event contracts,” and Robinhood obliged!
What is the point of doing this if you are going to cave? Sure, it gets you on the front page of The Money Stuff and you gain free advertising, but is that really worth the effort?
We are also curious how Robinhood feels about all of this. One can imagine a hypothetical exchange:
RH exec: Let’s list the sports event contracts, all right? Crypto.com did it.
RH legal: Well, we can’t do it.
RH exec: Why the heck not?
RH legal: They have a designated contract market, and only a DCM can…
RH exec: Ok whatever, find me a DCM.
RH legal: Maybe we can do it with Kalshi? Remember, they did the election contracts? They are already offering sports contracts, so perhaps we can tag along?
RH exec: Make it happen!
The next day:
RH legal: Boss, we have a problem.
RH exec: What is it?
RH legal: The CFTC requested that we take the contracts down.
RH exec: What? Can we ignore them? I mean Crypto.com did it.
RH legal: Kalshi still has theirs up, too.
RH exec: What? Let’s get them on the phone.
Phones Kalshi:
Kalshi legal: Yes, Kalshi speaking.
RH exec: Hey how are you? My team is telling me that you have the sports bets up still.
Kalshi: Umm. We don’t use the B-word around here. They are event contr…
RH legal: Actually, you do. Right on your homepage, it says bet on the US election, Oscars, Bitcoin, the weather and more.
Kalshi: Well, yeah… But those are not gaming, so that’s ok.
RH legal: You actually say “live bets” right underneath the Philly/Kansas City graph, too.
Kalshi: Uhh…
RH exec: Guys, I’m confused. I mean, we basically said in our comment letter that single event contracts are associated with gambling and should be prohibited. Then along came Crypto.com who said it’s legal to trade sports events contracts. They said the same thing in their emails, and I quote: “sports event trading is regulated in all 50 states and available nationwide.”
Kalshi: Yeah, that’s our position, too.
RH legal: What do you mean that’s your position? Didn’t you just argue in court that gaming includes sports games? It’s in your complaint.
Kalshi: Which part, specifically?
RH legal: Hold on a minute. Ah, here it is. You said: “But buying one of these contracts is nothing like betting on a game of chance or even the Super Bowl.” That was your main argument as to why election contracts are different.
Kalshi: Yeah, I guess we said that. In fact, it’s the one thing that we agreed with the CFTC on.
RH legal: What about the court? Didn’t they also agree with that? The opinion talked about this, right?
Kalshi: Yes, this sentence is straight from the opinion: “event contracts related to any of the sporting events the senator mentioned on the floor could implicate the gaming category.”
RH legal: Remind me, the Super Bowl was specifically mentioned on that floor exchange, correct?
Kalshi: Yes.
RH exec: Wait a second. I’m totally lost. I’m not sure how this actually hangs together. Maybe we should have never done this. I mean, by giving our traders access, we actually contradicted what we told the CFTC in our comment letter, but let’s park that for a moment.
Kalshi: Ok.
RH exec: At the end of the day, the CFTC doesn’t like us giving our traders access through your platform, but they didn’t ask you to take the contracts down?
Kalshi: Not yet. They didn’t initiate a review yet.
RH legal: And if they do, what will you do? Will you rebuff them like Crypto.com?
Kalshi: We’ll cross that bridge when the time comes. They may not be willing to risk another public rejection.
RH legal: But one way or another this will eventually go to court. How will you argue this, after saying that gaming means games?
Kalshi: We’ll take our chances.
So, this is exactly what happens when you don’t get the definitions right. Investing, speculation, gambling. Three phrases that have continued to mystify people for eternity. Any court case where these terms are at issue, you can count on a few things:
The industry will always look for an outcome in which they can take more money from the public;
The regulator will show up in some way, but their arguments won’t necessarily be aligned to the public; and
The public will be the largest stakeholder in cases involving public policy without an effective advocate in the courtroom.
As the saying goes, when the elephants fight, it is the grass that suffers.
The public’s last hope? The courts. However, the challenge lies in the courts themselves, as they face significant headwinds due to their tendency to resolve cases through an adversarial lens. Unfortunately for the public, that lens is unlikely to produce the best public policy especially when there is misuse of definitions that are central to the case. We’ll explain why in our next post.