CFTC says person-based prediction contracts are presumptively vulnerable to manipulation

The Commodity Futures Trading Commission’s Division of Market Oversight has warned that prediction-market contracts settled on what a person says, does or whom they interact with may be “presumptively readily susceptible to manipulation.” The Sept. 22 staff advisory says such products can put settlement in the hands of one person, a small group or people able to influence them.

The guidance covers contracts on whether an individual uses particular words or phrases in a speech, earnings call or social-media post, as well as whether they attend an event, shake hands, appear in a photograph or engage with someone online. It does not prohibit mention markets or create binding new obligations, but sets out the circumstances in which staff believe they could be listed consistently with existing law and regulations.

As covered in August, the CFTC had already begun reviewing mention-market contracts. The new advisory makes clear that designated contract markets must satisfy Core Principle 3, which requires them to list only derivatives that are not readily susceptible to manipulation.

The central concern is that a settlement outcome may not be independently generated or externally verifiable. A person with access to scripts, prepared remarks, guest lists or unpublished material could possess material nonpublic information, while traders or other outsiders might seek to induce the conduct that decides a contract.

The advisory offers the example of a live-streamed podcast market tied to a host saying a catchphrase. The host could simply say it, while a trader might prompt the outcome by submitting a question or paying for an on-air acknowledgement.

Private or informal conduct, and actions involving non-public individuals, can create still greater risks because they are less likely to receive public scrutiny or independent verification. Incidental words or conduct may also be easier to manipulate and harder to detect than actions material to a public event.

Staff said independent verification and substantial contemporaneous public scrutiny are essential attributes in assessing a contract. Mention markets differ, in its view, from contracts linked to economic data, election results or regulated sports outcomes, which are generated independently and are outside any one person’s control.

A contract can nevertheless overcome the presumption in limited circumstances. The agency said exchanges should assess four areas: obligations that constrain the person controlling settlement; vulnerability to social engineering, inducements or public-pressure campaigns; independent verification and public scrutiny; and the strength of trading rules, surveillance and other controls.

Legal, professional, contractual, fiduciary or organisational duties on the person whose conduct determines settlement may be relevant, but they do not replace an exchange’s own safeguards. The advisory says preventive measures should be designed to detect and deter manipulation, attempted manipulation and misuse of nonpublic information.

For Part 40 product filings, the agency expects contract-specific analysis identifying potential controllers and known insiders. Exchanges should explain their proposed position limits or accountability, reporting, recordkeeping, surveillance and other controls, and show in enough detail how those measures address the identified risks.

The warning follows an Aug. 28 CFTC settlement with Gabriel Perez, a former White House teleprompter operator who used advance access to presidential speeches to trade mention-market contracts between December and February. Perez was ordered to disgorge about $107,500 in profits, pay a $65,000 civil penalty and accept a three-year trading ban.

The advisory reflects the views of Division of Market Oversight staff, rather than necessarily those of the commission or other CFTC divisions, and is not a no-action position. The division encouraged exchanges to consult staff during early contract design and before submitting a filing.