I respectfully concur on In re Falcon Labs Ltd.[1] because the cross-border issues raised in this matter re-open decades of settled Congressional intent and well-established Commission interpretation of the Commodity Exchange Act’s (CEA) extraterritoriality and cross-border application to foreign futures and options transactions and the futures commission merchant (FCM) registration requirement, as well as to swaps activity outside the United States. These are cross-border issues that have vast implications for the over $700 trillion notional global derivatives market and the potential to disrupt legitimate activity of multinational trading firms and the end-users that depend on derivatives markets for hedging and risk management. I believe the Commission’s unprecedented interpretation today in an administrative order constitutes a legislative rule that requires notice-and-comment rulemaking pursuant to the Administrative Procedure Act (APA) because it may impose new CFTC registration and trading requirements on scores of non-U.S. legal entities.

The Commission has chosen to ignore its comprehensive cross-border regulatory regime established under Part 1[2], Part 3[3], Part 30[4], Part 4[5], and Part 23[6] of CFTC regulations in favor of spinning up a brand-new test for extraterritorial application of the CEA without any cited statutory authority. The Commission creates a novel “U.S. location” test to “look through” non-U.S. legal entities in the latest of a series of ultra vires precedents that undermines the legitimacy of the CFTC and the integrity of global derivatives markets.[7]

If the Commission is attempting to establish a new interpretation of the extraterritorial statutory authority in CEA Section 4 and a new FCM registration regime for foreign transactions, today’s Order shockingly conflicts with the CFTC’s nearly 40-year-old comprehensive rules for foreign futures and foreign options transactions set forth in Part 1 and Part 30.[8] Any attempt to ignore the Commission’s decades of regulations and interpretations in an effort to rewrite history creates nothing more than a legal fantasy and is a breathtaking overreach to seize jurisdiction over the entire world. The reason why the Commission has never before found this kind of violation against an intermediary is because the legal argument in today’s Order is wrong.

Novel “U.S. Location” Test for Non-U.S. Legal Entities

In brief, the Commission finds that the basis for Respondent’s (a non-U.S. legal entity organized and existing under the laws of the Seychelles) alleged violation of the FCM registration requirement[9] is that Respondent had customers “located in the United States,” “such as non-U.S. incorporated entities operated and controlled by U.S.-based trading firms.”[10]

To make this finding, the Order establishes factors to “look through” a non-U.S. legal entity and thus determine whether it is “located in the United States,” including: (1) location of ultimate beneficial owners, (2) location of corporate organization, (3) principal place of business, and (4) location of personnel controlling a non-U.S. prime broker sub-account. These criteria are not set forth in the CEA’s statutory language, and the Order provides no legal authority to support these factors.

This novel “U.S. location” test could have the resulting effect of requiring any non-U.S. legal entity that transacts in futures, options, or swaps that has a U.S. parent entity or beneficial owner, or has personnel located in the U.S. that “control” (another undefined term with no cited statutory authority) a non-U.S. prime broker sub-account, to be deemed “located in the United States” even if its location of corporate organization is outside the United States and duly complies with the legal or regulatory obligations of the non-U.S. jurisdiction. In addition, at one fell swoop this test contravenes the entire body of treatment of a “proprietary account” under CFTC regulations including applicable exemptions from registration or other requirements.[11]

Let me be clear: in the past nearly 40 years since Congress amended the CEA to permit foreign transactions, the Commission has never interpreted or applied this novel “U.S. location” test. The proper legal analysis to determine the extraterritorial applicability of various sections of the CEA to a non-U.S. legal entity requires a sophisticated understanding of the CFTC cross-border regulatory regimes for, at a minimum, FCMs, CPOs, and swap dealers, as well as proprietary accounts.

Part 30 and FCMs

The Commission’s novel “U.S. location test” conflicts with the CFTC’s comprehensive regulatory regime for foreign futures and foreign options transactions, including definitions and registration requirements, set forth in Part 1 and Part 30 that was first promulgated in 1987 and the associated voluminous administrative record of the Commission’s interpretation of “located in the United States, its territories or possessions” in the many rulemakings amending Part 1, Part 30, and other associated regulations since then. Moreover, the Commission’s determination of a new look-through test for a non-U.S. legal entity that may be an FCM customer is impermissible in an administrative settlement order because it may impose new CFTC FCM registration requirements on non-U.S. brokers, which can only be promulgated through APA notice-and-comment rulemaking.

Part 4 and CPOs; Part 23 and swap dealers

Similarly, this novel “U.S. location” test would also conflict with the Commission’s comprehensive regulatory regime and voluminous administrative record of interpretations for cross-border application to commodity pool operators (CPO) and commodity trading advisors (CTA) set forth in Part 4 since 1981, and to swap dealers and major swap participants (MSP) set forth in Part 23 since 2012.

In fact, the Commission most recently established clear interpretations of the application of CFTC registration requirements to non-U.S. legal entities engaged in the activity of a CPO in its 2020 final rule, Exemption from Registration for Certain Foreign Intermediaries, including whether clearing through a registered FCM is required as a condition of the exemption.[12]

The Commission also recently established clear interpretations for swap activities outside the United States in its 2020 final rule, Cross-Border Application of the Registration Thresholds and Certain Requirements Applicable to Swap Dealers and Major Swap Participants, including an interpretation of CEA Section 2(i) and the CFTC’s extraterritorial jurisdiction, and definitions and tests for “U.S. person,” “non-U.S. person,” “United States,” and “U.S.,” all solely for purposes of Regulation 23.23, and not for any other CFTC regulations including those applicable to FCMs.[13]

I am astounded that the Commission would simply pretend these recent cross-border rulemakings did not exist.

Principal place of business for federal diversity jurisdiction

Further, the “principal place of business” prong of this novel “U.S. location” test appears to be rooted in the conflation of diversity jurisdiction in U.S. federal courts under the Federal Code of Civil Procedure, 28 U.S.C. 1332(c)(1),[14] and the Commission’s extraterritorial jurisdiction under the CEA. The case law on federal diversity jurisdiction only addresses the question of citizenship for a corporation in order to determine whether a complaint may be filed in U.S. federal court.

However, although the CFTC may sue a foreign party in U.S. federal court, that does not mean that the CFTC can apply a “principal place of business” analysis that is confined to the question of federal diversity jurisdiction, to the question whether specific provisions of the CEA apply extraterritorially to activities conducted by non-U.S. legal entities or activities conducted outside the United States. This basic conflation of foundational legal doctrines regarding federal diversity jurisdiction with the Commission’s extraterritorial jurisdiction does not make sense.

In addition, the administrative record for Part 30 and FCMs does not support a “principal place of business” analysis based on federal diversity jurisdiction case law, and is directly on point to the cross-border issues raised in today’s Order. In the preamble to the 1987 final rule on Foreign Futures and Foreign Options Transactions, the Commission noted that the then-new Part 30 to its regulations would “govern the domestic offer and sale of futures and options entered into on or subject to the rules of a foreign board of trade.”[15] The Commission then refers to “foreign futures and options transactions undertaken by U.S. domiciliaries” and notes “Congress’ intent that foreign futures and options products sold in the U.S. be subject to regulatory safeguards comparable to those applicable to domestic transactions.”[16] Taken together, it is clear that the dispositive fact is the physical location of the offer or sale of the futures transaction by a broker, evident from words such as “in” or “outside,” “domestic” or “foreign,” and, most tellingly, the phrase “sold in the U.S.” to express Congress’ legislative intent with respect to CEA Section 4’s statutory language “located in the United States, its territories or possessions.” This approach is not only the Commission’s historical and well-understood interpretation up until today’s Order, but it is also consistent with the extraterritorial application of U.S. securities laws that many of the CEA’s provisions are modeled on. And, the Commission’s reference to “U.S. domiciliaries” indicates, if anything, that the appropriate analysis for a non-U.S. legal entity would be more akin to interpretations set forth under the Internal Revenue Code and other U.S. taxation laws and regulations.

For all these reasons, the Order’s creation of a “principal place of business” extraterritorial standard based on divining the “citizenship” of a corporation [or other business organization] has no statutory authority in the CEA, and is nothing more than an attempt to re-litigate the well-settled Congressional intent and the Commission’s interpretations of its extraterritorial jurisdiction and the cross-border applicability of the CEA. Moreover, CEA Section 4 has a “clear statement of extraterritorial effect,” as do various other sections of the CEA, and the Commission has accordingly established a comprehensive regulatory regime over all its categories of registrants that interprets the CEA’s “extraterritorial effect.”[17] There is no gap to be filled.

Conclusion

As a final point on another threshold matter, I do not understand why the Commission unnecessarily engages in imaginative and incorrect extraterritorial application of the CEA and CFTC regulations. The Order’s alleged charge of failure to register as an FCM is supported by allegations that Respondent’s sales personnel were physically located in the United States and, therefore, were presumably engaged in the offer or sale of futures transactions (even if foreign futures transactions) physically in the United States. These allegations would also satisfy the domestic conduct requirement in Morrison v. National Australia Bank, if applicable. Because this is the appropriate and more direct basis for finding a violation of the FCM registration requirement against Respondent, I concur in this matter.

It is unwarranted to apply a novel ‘“U.S. location” test to “look through” a non-U.S. legal entity to determine that it is a U.S.-located FCM customer for purposes of the Order’s alleged charge of failure to register as an FCM. This sea change in interpretation cannot be done in an administrative settlement order, but must be carefully deliberated upon by the Commission with sufficient administrative record and rational basis to support a finding of reasoned decision-making by the Commission upon judicial review by an U.S. appellate court. The Commission must avoid establishing precedent in its administrative orders that has no cited statutory authority, conflicts with comprehensive CFTC regulations for cross-border activity, and disrupts the Commission’s well-established interpretation of its extraterritorial jurisdiction.

---

[1] See, CFTC Issues Order Against Crypto Prime Brokerage Firm for Illegally Providing U.S. Customers Access to Digital Asset Derivatives Trading Platforms (May 13, 2024), https://www.cftc.gov/PressRoom/PressReleases/8909-24.

[2] 17 C.F.R. Part 1.

[3] 17 C.F.R. Part 3.

[4] 17 C.F.R. Part 30.

[5] 17 C.F.R. Part 4.

[6] 17 C.F.R. Part 23.

[7] I have raised these concerns consistently for the past two years, most recently calling for a GAO study and proposing reforms to the CFTC’s internal procedures. See The CFTC Needs to Get Serious: A Strategic Plan for Reform, Statement of Commissioner Caroline D. Pham Before the Open Meeting on May 10, 2024, https://www.cftc.gov/PressRoom/SpeechesTestimony/phamstatement051024.

[8] Section 4 of the Commodity Exchange Act of 1974 (CEA), codified at 7 U.S.C. 6. CEA Section 4(a) sets forth a regulatory scheme for futures transactions “anywhere in the United States, its territories or possessions,” customarily referred to as “domestic transactions.” See, e.g., Foreign Futures and Foreign Options Transactions, 52 Fed. Reg. 28,959, 28,980 (Aug. 5, 1987) (citing S. Rep. No. 384, 97th Cong., 2d Sess. 45-46 (1982) and 51 Fed. Reg. at 12,107). CEA Section 4(b) sets forth the extraterritorial application to “the offer or sale of any [futures contract] that is made or to be made on or subject to the rules of a board of trade, exchange, or market located outside the United States, its territories or possessions,” engaged in by “any person located in the United States, its territories or possessions,” referred to as “foreign transactions.” For ease of reference, “located in the United States” as used in this statement includes U.S. territories or U.S. possessions pursuant to CEA Section 4.

[9] The Order finds a violation of CEA Section 4d(a)(1), 7 U.S.C. 6d(a)(1). In re Falcon Labs Ltd., Order Instituting Proceedings Pursuant to Section 6(c) and (d) of the Commodity Exchange Act, Making Findings, and Imposing Remedial Sanctions, CFTC No. 24-06 (May 13, 2024).

[10] Id. at 2.

[11] “Proprietary account” is defined in CFTC Regulation 1.3, 17 C.F.R. 1.3.

[12] Exemption from Registration for Certain Foreign Intermediaries, 85 Fed. Reg. 78,718 (Dec. 7, 2020).

[13] Cross-Border Application of the Registration Thresholds and Certain Requirements Applicable to Swap Dealers and Major Swap Participants, 85 Fed. Reg. 56,924 (Sept. 14, 2020).

[14] See, e.g., Hertz Corp. v. Friend, 559 U.S. 77 (2010) (establishing a uniform “nerve-center test” to determine a corporation’s principal place of business and citizenship for federal diversity jurisdiction).

[15] Supra note 8 at 28,980.

[16] Id.

[17] See, e.g., Morrison v. Nat’l Austl. Bank Ltd., 561 U.S. 247 (2010). Accord supra note 8.

I respectfully dissent from the Event Contracts Proposal because it takes the CFTC’s regulation of event contract markets backwards with its fundamental misunderstanding of how we regulate derivatives and the States regulate gaming. Instead of thoughtfully considering how to effectively regulate these markets while fostering innovation, the Event Contracts Proposal ties itself in knots over the bounds of gaming, which Congress has neither asked nor directed the Commission to regulate. I am simply disappointed in this wasted opportunity to regulate retail binary options, sidestepping our responsibility, and concerned about its legal impact.

The United States is built on a foundation of federalism. Federalism reflects the Founders’ understanding that a one-size-fits-all approach would not work for this country, and allows for States to govern in ways that best suit their residents.[1] The simple language of the Tenth Amendment to the Constitution (“The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people”) emphasizes that the Federal government is a government of limited and enumerated powers.[2] The Tenth Amendment, importantly, protects the American people from Federal encroachment.

State regulation of gaming, ranging from betting to lotteries, is long-established in the U.S., and is clearly a power reserved to the States.[3] No one understands their local cultures, economies, and values better than the States,[4] which leads to State laws that have been crafted to reflect the needs of their residents. This approach has allowed some States to embrace gaming and leverage it as a source of revenue and tourism, while others take a more conservative approach.[5]

When it comes to event contracts related to gaming, I have been clear that the CFTC should exercise caution, primarily because I believe the Commission fundamentally misunderstands the law in this area and Congressional intent.[6] That fear has proven well-founded with the Event Contracts Proposal.

The CFTC has a role in regulating event contracts as a market regulator, but it is essential that the CFTC does not encroach upon the prerogatives of States. An appropriate Event Contracts Proposal would have struck a balance between Federal oversight and State autonomy by focusing on the CFTC’s core mandate of promoting market stability and protecting market participants from fraud and abusive practices.[7] In doing so, the CFTC could have maintained the integrity of event contracts without undermining the authority of State governments.

Instead, as I will explain below, the Event Contracts Proposal bigfoots into State regulation of gaming by drawing unintelligible lines in the sand that will either at best result in confusion for State gaming authorities, or at worst push event contracts into illegal, unregulated offshore markets.

The Event Contracts Proposal Ignores the Supreme Court’s Preemption Doctrine

The Constitution’s Supremacy Clause provides that “the Laws of the United States . . . shall be the Supreme Law of the Land; and the Judges in every State shall be bound thereby, any Thing in the Constitution or Laws of any State to the Contrary notwithstanding.”[8] This language is the basis for the doctrine of Federal preemption, according to which Federal law supersedes conflicting State laws.[9]

The Supreme Court has identified two general ways in which Federal law can preempt State law: expressly, when a Federal statute or regulation contains explicit preemptive language; and impliedly when its structure and purpose implicitly reflect Congress’s preemptive intent.[10] But the Federal government cannot preempt traditional State powers that are the exclusive domain of States to regulate, recognizing the right to self-determination by the people.

The Event Contracts Proposal uniquely ignores the fact that the limits Congress placed on the Commission’s regulation of event contracts save the Commission from becoming a gaming regulator. In other words, 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.

Together, under CEA Section 5c(c)(5)(C), Rule 40.11, and the preamble to the final rulemaking for Rule 40.11, whether an event contract is prohibited by Rule 40.11 depends on the underlying activity that the contract is based upon. When the Commission reviewed an exchange’s political control contracts, I raised that the underlying activity was political control, which was neither terrorism, assassination, war, gaming, nor unlawful under any Federal or State law.[11] Therefore, Rule 40.11(a)(1) did not apply. Yet in disapproving the contracts, the Commission argued that “taking a position in the Congressional Control Contracts” (emphasis added) amounted to gaming.[12]

When taking a position in a derivatives contract is gaming, the Commission starts to look like a gaming regulator. Congress may not compel a State to enact or enforce a regulatory regime,[13] and indeed, Congress has not here. Yet in doubling down on its logic in the Event Contracts Proposal, when the act of entering into a derivatives contract that meets the Proposal’s overbroad definition of gaming, drawn from dozens of State laws, is now gaming under the Commission’s jurisdiction, we begin encroaching on State gaming oversight. State-regulated sportsbooks, in trying to comprehend where the Commission’s gaming derivatives begin and traditional bets end, will be captured in this confusion and question the need to register with the Commission as exchanges. I certainly don’t want the Commission to be registering Las Vegas sportsbooks and other betting venues.

The Commodity Exchange Act is Clear that the Commission Regulates Event Contracts

Congress has been clear in its direction for the CFTC.

First, in relevant part, the purpose of the Commodity Exchange Act is to deter and prevent price manipulation or any other disruptions to market integrity; to ensure the financial integrity of all transactions; to protect all market participants from fraudulent or other abusive sales practices and misuses of customer assets; and to promote responsible innovation and fair competition among boards of trade, other markets and market participants.[14]

Second, the Commission is authorized to review event contracts if the underlying activity that the contract is based upon is terrorism, assassination, war, gaming, or unlawful under any Federal or State law.[15]

Read together, Congress intended that the Commission regulate event contracts within the bounds of the section 5(c) prohibitions. Instead of telling market participants how we will regulate the innovative contracts and exchanges that have appeared in recent years, the Commission has decided to “identif[y] the types of event contracts that may not be listed for trading or accepted for clearing” (emphasis added), seemingly primarily to avoid the work. If the number of contract reviews has increased, then the Commission should increase its resources and capacity—not to prohibit public activity.

As referenced above, the Commission then embarks on a survey of state gaming definitions to insert the concept into the Commission’s rules. The Commission even notes the approach “reflects the similar approach taken in numerous state gambling statutes,” and mentions 35 States. The word “state” appears in the 95 page release 133 times. The Event Contracts Proposal reads as a defense against becoming a gaming regulator while inserting State gaming into our rules, which is not only confusing but unnecessary because Congress has clearly defined our role with respect to the States.

To make matters worse, the Commission then leaps from the overbroad, vague definition of gaming to provide examples of the types of event contracts that the Commission believes fall outside of the scope of CEA section 5c(c)(5)(C) and, by extension, Regulation 40.11. Given the fact that the Event Contracts Proposal repeatedly states that the broad range and volume of new contracts motivated this rulemaking, I find it stunning that the outer bounds provided are limited to contracts based on: (1) economic indicators, (2) financial indicators, and (3) foreign exchange rates or currencies.

Instead of creating a framework, the Commission is creating a vast gray area for exchanges. Where gaming begins and the scope of Regulation 40.11 ends is anyone’s guess now, and I fear State gaming authorities will be left to figure it out on their own.

Specific Areas for Public Comment

In addition to my concerns raised above, I highlight the following specific areas for public comment to aid in review of the Proposal:

Missing Comment Letters

The Event Contracts Proposal completely omits any discussion of the comment letters the Commission recently received on the definition of gaming, as well as Rule 40.11 and event contracts more broadly. All told, the Commission has received around 200 comments in response to requests for public comment on an exchange’s political control contracts.[16] These comments came from exchanges, academics, former CFTC officials, and other industry participants, and were directly on point on the issues raised in today’s Proposal.

The Commission cannot selectively decide to tell one side of the story. It strains credulity that the Commission has selective amnesia and makes no mention of these letters in the Event Contracts Proposal.

Misplaced Election Integrity Concerns

The Commission gets hung up on the fact that “it is not tasked with the protection of election integrity or enforcement of campaign finance laws” in justifying prohibiting event contracts based on political contests. However, the Federal Election Commission polices campaigns. Congress has never asked, nor suggested, the CFTC should police elections, much like the Commission has not become the weather police for weather derivatives. I will highlight a couple categories of event contracts that have been permitted since 1992:

The Commission is not the crop yield police and hasn’t displaced the role of the USDA. The Commission is not the police for changes to corporate officers or asset purchases and has not displaced the role of the SEC. The Commission is not the police for regional insured property losses, which is the domain of state insurance regulators. The Commission is not the bankruptcy police, which is the domain of the courts. The Commission is not the temperature police, and so on and so forth. I do believe that the 2008 concept release from which I drew these examples, was very thoughtful, and I wanted to familiarize myself with the full administrative record.[17]

Conclusion

I would like to thank Grey Tanzi, Andrew Stein, Lauren Bennett, Nora Flood, and Vince McGonagle in the Division of Market Oversight for their work on the Proposal.

The contracts causing so much consternation for the Commission have not been, and are not, gaming. If the Commission could accept that and move on, we could have a healthy discussion over how to effectively regulate these markets as we do any other and protect against abusive trading in retail binary options contracts. Instead, we have muddled it and made a mess.

I look forward to the comments.

Today, the Commodity Futures Trading Commission (CFTC) will take yet another step down a misguided path that encroaches so far onto States’ rights that it makes a mockery of the Tenth Amendment.  It pains me to say that despite the road here being paved with good intentions, today’s event contracts rulemaking is yet another example of how far the Commission has strayed from the requirements of the Administrative Procedure Act and the Constitution, and how little the Commission seems to care for fairness and due process under the law.  I have repeatedly raised troubling concerns that the breakdown of the Commission’s internal procedures and processes I have observed in the past two years severely compromises the Commission’s ability to fulfill our mission and statutory mandate set forth in the Commodity Exchange Act (CEA), faithfully serve the public interest, and treat market participants fairly.  That is why, before the Commission is granted or usurps any additional jurisdiction over products or asset classes, I believe that a Government Accountability Office (GAO) study is necessary of the Commission’s procedures for rulemaking, examinations and compliance reviews, investigations and enforcement, adjudicatory proceedings, due process protections, and compliance with the CEA, APA, Good Accounting Obligation in Government Act, Government Management Reform Act of 1994, Government Performance and Results Act (GPRA) Modernization Act of 2010, and other laws and requirements applicable to administrative agencies.  A GAO study and recommendations for improvement will ensure that the Commission has the internal operations, structure, technology, expertise, personnel, and funding to be effective in our oversight of commodity derivatives markets.  The Commission must be able to walk in a straight line before we run headlong into any expansion of jurisdiction.

As Commissioners, it’s our duty to ensure adequate governance of the CFTC.  We must support our talented staff with the tools, training, and resources to be successful, and ensure that we are sticking to our mission, our authority, and our own rules.  And it’s our duty to take appropriate corrective action if we ever lose sight of those principles.  The Commission must uphold the highest standards of integrity, diligence, and excellence to maintain the public’s trust in the CFTC’s ability to oversee our markets with fairness and in service to justice.[1]  Unfortunately, in the last two years, there has been a disturbing number of judicial opinions and public reports that the Commission is failing to meet those standards.[2]  This is a challenging time for all of us, and I thank Chairman Behnam for his leadership through it.

Identifying and Reporting the CFTC’s Issues

Six months into my term as a Commissioner, I gave a speech to leaders and practitioners in compliance and enforcement on the well-known maxim, “If you see something, say something.”[3]  In my career as a senior Compliance officer in the private sector overseeing billion-dollar compliance programs, my job was to implement policies and procedures, controls, monitoring, testing, and assessment to achieve compliance with laws and regulations to ensure safety and soundness of the bank and market integrity and conduct.  These efforts included processes to identify, escalate, and report issues, and ensure remediation and self-reporting to authorities as appropriate.  These responsibilities might not always be popular—as anyone familiar with Compliance and Internal Audit are aware—but they’re absolutely necessary.  Not only did they keep the firm out of trouble, but they promoted trust with our regulators and clients and upheld the firm’s reputation.

As a public company, nothing less than the highest standard is owed to investors and other stakeholders.  Well, the CFTC is a public institution, and I believe the Commission owes the American taxpayer that same high standard.  At my last job, if I discovered the kind of issues that I’ve seen here at the CFTC, I would escalate and report those issues so they could be fixed.  Now that I’m a Commissioner, it’s still my job to say something if I see something wrong. And it’s what the CFTC expects of its registrants.

In the government, the public trust is paramount.  Failing to adhere to the law and principles of fairness that are essential to U.S. democracy not only causes us to fail at our mission, but it ultimately hurts the Commission and its dedicated public servants.  We’ve seen a recent cautionary tale at one of our sister agencies that resulted in the resignation of two members of staff.[4]  It’s important that the Commission is proactive now and takes stock of our own approaches to rulemaking, enforcement, and other administrative actions, that we acknowledge our issues, and that we get help when we need it.

I have consistently raised concerns both internally and publicly about the CFTC’s lack of procedures,[5] improper expansion of jurisdiction,[6] incorrect application of the law,[7] increased delegation of authority,[8] dubious enforcement actions and unfair adjudicatory proceedings,[9] failure to comply with the APA,[10] and general disregard for due process.[11]  Over the past several years, a concerning number of CFTC complaints filed in litigation in federal court have been dismissed for failure to state a claim (insufficient facts to support a charge or incorrect as a matter of law) or on summary judgment (incorrect as a matter of law), or overturned in appellate court, meaning that the CFTC does not understand and is wrong about the application of our own statute and our own regulations.[12]  I am deeply disturbed that just a few weeks ago, a federal judge has called the CFTC’s recent actions in another litigation matter “troubling at best” and ordered a hearing on sanctions against the CFTC for an alleged “pattern of misconduct” that includes knowingly submitting false statements to the court and attempting to intrude on attorney-client privilege.[13]  This is cause for alarm and the Commission must address this crisis.

The Commission’s recent history with event contracts is another example of the CFTC’s issues.[14]  The CFTC is currently a defendant in two litigation matters relating to event contracts that allege that the CFTC violated the Administrative Procedure Act, due process, and other Constitutional rights.  In one of the lawsuits, the U.S. Court of Appeals for the Fifth Circuit has called the CFTC the “epitome of arbitrary and capricious,” and found that the CFTC violated the Fifth Circuit’s injunction.  U.S. Senators and Members of Congress have sent letters to the Commission to express their concerns with the CFTC’s conduct of the event contracts rulemaking.

My concerns are informed by my decades of experience in both the public and private sectors.  Not only did I have the privilege of serving at the CFTC between 2009 and 2014 during the response to the 2008 financial crisis, but I have also served at the Securities and Exchange Commission (SEC) and the Office of the Comptroller of the Currency (OCC).  I know the standards that the CFTC used to meet, and the standards expected at the SEC and the OCC, two of the preeminent U.S. financial regulators that are much larger and older than the CFTC.

I’ve had to use my voice not only because it’s my job as a Commissioner, but out of true devotion to an agency that I have loved and cared about so much that I’m back for the fourth time.  The CFTC is where I started my career, and I believe deeply in our mission and our people.[15]  Like a mom who will always hold her kids to a high bar and push them to reach their potential, I want to see us all succeed.[16]  That means not being afraid to look inward, seek guidance, and be honest with ourselves about our missteps.  The most important leadership lessons I’ve learned is to never be complacent, have a growth mindset, embrace diverse viewpoints, and focus on continuous improvement.[17]

GAO Study and Implementing Reforms to Ensure the CFTC’s Effectiveness

Sometimes fresh eyes are warranted, and that’s why I’m calling for a GAO study and recommendations.  And, I’m also calling for the Commission to adopt review and accountability measures to regularly assess the CFTC’s effectiveness and identify areas of improvement.  Absent these forward looking and proactive measures, I fear that the Commission will continue to lack the procedures and controls needed to be effective at our mission, making the CFTC susceptible to failure to protect our markets and the public.

If this sounds like a surprising request, consider this: Subtitle F—Improvements to the Management of the Securities and Exchange Commission of the Investor Protection and Securities Reform Act of 2010 (Dodd-Frank Act Title IX) required the SEC, which has existed nearly twice as long as the CFTC and has six times the amount of budget and employees, to hire an independent consultant to perform an organizational study and review of the SEC’s internal operations, structure, funding, and the need for comprehensive reform, and for the SEC to report to Congress on the progress of its implementation of the consultant’s organizational reform recommendations.[18]  Dodd-Frank also requires the SEC to submit annual reports and certifications to Congress with an assessment of the effectiveness of the SEC’s internal supervisory controls and procedures applicable to staff performing examinations, enforcement investigations, and reviews of corporate financial securities filings,[19] and for the GAO to conduct regular reviews of the adequacy and effectiveness of the SEC’s internal supervisory control structure and procedures.  And, Dodd-Frank requires the GAO to regularly review and report to Congress on the quality of the SEC’s personnel management, including effectiveness of supervisors, promotion criteria and fairness, competence of the professional staff, efficiency of communication between divisions and offices, staff turnover, excessive numbers of managers, initiatives to increase the competence of the staff, performance improvement and termination, and recommendations to use staff more effectively and efficiently to carry out the SEC’s mission.

At that time back in 2010, the SEC not only had greatly expanded jurisdiction over new products and categories of registrants, but was facing new challenges in securities markets from technological developments like high-frequency algorithmic trading.  These Dodd-Frank studies, reviews, and reports were a sensible way to ensure the SEC would be well prepared to take on its new oversight responsibilities.  The CFTC also had greatly expanded jurisdiction over new products and categories of registrants, including the swaps market and systemically important financial institutions, and the CFTC faced similar challenges from technological developments.  But there was no similar Dodd-Frank mandate to improve management at the CFTC.  Now in the present day, the CFTC may potentially have its jurisdiction expanded again, and is facing a new wave of technological developments like crypto assets and generative artificial intelligence (AI).  It’s time for the CFTC to finally have the benefit of comprehensive studies and recommendations to make sure we are prepared and able to carry out our mission.

These accountability measures are not only standard practice for management at any organization and common sense, but they have already been proven at our peer agencies.  I think we’d all agree that the CFTC’s mission is no less critical. Shouldn’t we be just as accountable?

In addition, a GAO study would provide a roadmap for implementation of reforms.  I have made a number of proposals to improve the CFTC’s effectiveness to better serve the American people.  These proposals have ranged from preserving our institutional knowledge by establishing a CFTC Historical Society,[20] to enhancing retail protection by establishing an Office of the Retail Advocate and considering a new registration category for direct clearing retail derivatives clearing organizations (DCO),[21] to promoting responsible innovation through market pilot programs, to creating executive champions for our employee resource groups, to launching leadership skills and professional development initiatives, to a transformation of the agency across five pillars: governance, culture, talent, operations, and excellence.[22]  Most urgently, I have proposed that the Commission establish a CFTC examination program for systemically important swap dealers because the CFTC is an outlier and the only regulator in the world who directly oversees global systemically important banks (G-SIB) and lacks such an examination program to protect financial stability and mitigate systemic risk.[23]

Demanding the CFTC’s Accountability

Government accountability is the cornerstone of the U.S. system of federalism and individual liberty.  As public servants sworn to uphold the Constitution, we should embrace the opportunity to improve.

Nobody, and no regulator, gets it right all the time.  This obvious fact is a good thing—it creates opportunities to address challenges, fix problems, and build for the future.  Change is hard, and transformation is even harder.  But as someone whose career has been to drive change and transformation, I know it’s worth it.

Some of my statements and staff questions as a Commissioner haven’t always been popular.  Speaking truth can be uncomfortable to hear, but that’s essential to governance and oversight to ensure accountability.  That’s been my job as a Compliance officer, and that’s my job as a Commissioner.  My objective has always been for the Commission to excel at its mission to promote market integrity, and to avoid embarrassment and the degradation of our reputation as a leading regulator.  I believe at this point, a third-party review could help us get back to the basics and on track to do what we do best.

Thank you.

I support the Commission[1] undertaking a rulemaking on event contracts, which is long overdue.  During my tenure on the Commission, I have consistently called for a rulemaking process to establish a framework for the Commission to exercise the discretionary authority with respect to event contracts that Congress granted to the agency in our governing statute, the Commodity Exchange Act (“CEA”).[2]

Unfortunately, though, I cannot support this particular proposed rulemaking (the “Proposal”).  At first blush, it appears to be “much ado about nothing,”[3] as it seems to do little more than rubber-stamp what the Commission has already said and done.  Upon closer inspection, though, it is a “wolf in sheep’s clothing”[4] because where the Proposal departs from our past practice, it lays the foundation to prohibit entire categories of potential exchange-traded event contracts whose terms and conditions the Commission has never even seen. 

In planting the seeds of future bans of countless event contracts, sight unseen, the Proposal—

• Exceeds the legal authority that Congress granted the Commission in the CEA;
• Relies heavily on a brief snippet of legislative history consisting of a colloquy between two Senators – cherry-picking parts of the colloquy it likes, while ignoring other parts of the same colloquy;
• Resurrects an “economic purpose test” for evaluating the public interest that was based on a provision of the CEA that was repealed by Congress nearly a quarter-century ago;
• Fails to do the hard work of analyzing the unique nature of event contracts, which are different in kind from traditional derivatives contracts more familiar to the agency;
• Relies on unsupported conjecture, treats similar circumstances differently, and raises more questions than it answers; and
• Flies in the face of the CFTC’s mandate to promote responsible innovation as Congress directed in the CEA.

My dissent should not be taken as an indication that I am a fan of all event contracts.  But it is hard not to conclude from the multitude of defects in this Proposal that its significant overreach is motivated more by a seemingly visceral antipathy to event contracts than by reasoned analysis. 

It does not matter whether we think event contracts are a good idea or a bad idea; the Commission must exercise its authority with respect to event contracts within the scope of the CFTC’s legal authority, and must appropriately implement the authority that Congress has provided us.  This Proposal fails both tests. 

I.             Event Contracts in Brief

CEA Section 5c(c)(5)(C), which was added to the CEA in 2010 by the Dodd-Frank Act,[5] permits the Commission to prohibit an event contract from being listed for trading on an exchange[6] if:  1) the contract involves one of five enumerated activities (i.e., activity that is unlawful under Federal or State law; terrorism; assassination; war; or gaming); and 2) the Commission determines that the contract is contrary to the public interest.  CEA Section 5c(c)(5)(C) also provides that the Commission may determine, by rule or regulation, that an event contract involves “other similar activity” to the five enumerated activities, which would subject event contracts involving that similar activity to the “contrary to the public interest” standard.[7]

Congress in CEA Section 5c(c)(5)(C) did not decree that event contracts involving enumerated activities are contrary to the public interest per se.  Rather, if an event contract involves an enumerated activity, the Commission “may” determine that it is contrary to the public interest and prohibited from trading – which necessarily indicates that the Commission also has the discretion to determine that it is not.

A year after enactment of the Dodd-Frank Act, the Commission adopted CFTC Rule 40.11[8] to implement the CEA’s new event contract provisions.[9]  It is Rule 40.11 that the Commission is now proposing to amend.

II.             The Proposed Definition of “Gaming” is Significantly Overbroad

Neither the CEA nor the Commission’s rules define the term “gaming.”  In the Rule 40.11 Adopting Release implementing CEA Section 5c(c)(5)(C), the Commission acknowledged that “the term ‘gaming’ requires further clarification,” and said that the Commission may issue a future rulemaking concerning event contracts that involve “gaming.”[10] 

I agree that, 13 years later, it is long past time for the Commission to do so.  But, the Proposal’s definition of “gaming” is much too broad. 

1.    The Proposal Sweeps in the Universe of Every “Occurrence or Non-Occurrence in Connection With a Game

The proposed definition of “gaming” includes both the outcome of a game and the performance of one or more competitors in a game.  So far, so good.

But it then tacks on an additional category of “any other occurrence or non-occurrence in connection with” a game.  The all-encompassing nature of the phrase “any other occurrence or non-occurrence” is self-evident.  And that universality is further reinforced by its attachment to the “in connection with” wording.

The motivation for this expansive wording in the Proposal is likely that, where the phrase “in connection with” appears in various enforcement provisions of the CEA, the Commission interprets it “broadly, not technically or restrictively.”[11]  And the Proposal gives no indication that it should be interpreted any differently here.  In fact, the Proposal (at page 29) goes so far as to say that staking or risking something of value on a contingent event “in connection with” a game “would be as much of a wager or a bet on the game . . . as staking or risking something of value on the outcome of the game . . . would be.”

Under this incredibly far-reaching formulation, there are countless “occurrence[s] or non-occurrence[s] in connection with” a game that the Proposal would deem to be “gaming.”  Obvious examples include event contracts involving the attendance at a baseball or football game, or whether a particular nation will be selected to host a soccer World Cup.  These would clearly be “in connection with” the underlying baseball, football, or soccer games – but there is no reason why staking something of value on those contingent events should be treated the same as staking something of value on the outcome of those games.

Indeed, there is no better illustration of the overbreadth of the “in connection with” aspect of the proposed “gaming” definition than the Proposal’s own example (at page 32) of “whether a particular individual will attend a game.”  It is difficult to fathom why an event contract involving whether Taylor Swift will attend a Kansas City Chiefs football game should constitute “gaming” – and impossible to understand why the Proposal treats similar things differently, since whether she attends a Beyoncé concert would not constitute “gaming.”

I acknowledge that it might be appropriate to extend the definition of “gaming” to include events that can affect the outcome of a game or the performance of a competitor in a game.  Event contracts involving, say, whether an injury to Shohei Ohtani would prevent him from playing in the World Series, or involving the score of a football game at halftime, might be examples of this.  But to broadly define as “gaming” every “occurrence or non-occurrences in connection with” a game – regardless of whether it has any bearing on the outcome of the game or the performance of a competitor in the game – is wholly unwarranted.

2.   Elections and Awards are Not “Gaming”

The Proposal rubber-stamps two prior Commission Orders that found that event contracts involving political control or elections are “gaming,”[12] essentially repeating the same discussion from those Orders – and then throwing awards into its “gaming” definition as well.  Yet, this definition is inconsistent with the legislative history of CEA Section 5c(c)(5)(C) – legislative history on which, for other issues discussed below, the Proposal relies heavily. 

That legislative history consists of a colloquy between Senators Blanche Lincoln and Dianne Feinstein.  Senator Lincoln was then the Chair of the Senate Committee on Agriculture, Nutrition, and Forestry, which is the CFTC’s authorizing committee.

In the colloquy, the Senators talked about “gaming” only in the limited context of sporting events.  In responding to Senator Feinstein’s question about the CFTC’s authority under Section 5c(c)(5)(C) to determine that a contract is a “gaming” contract, Senator Lincoln said that “[i]t would be quite easy to construct an ‘event contract’ around sporting events such as the Super Bowl, the Kentucky Derby, and Masters Golf Tournament.”[13]  Thus, Senator Lincoln clearly associated “gaming” with sporting events, i.e., games.[14]

But rather than remain true to the legislative history that equated “gaming” with only sporting events, the Proposal broadly sweeps all “contests” into its definition of “gaming.”  And it then concludes that elections and awards are “contests” and, therefore, “gaming” – even though neither Senator Lincoln nor Senator Feinstein ever mentioned elections or awards (or “contests,” for that matter). 

The Proposal attempts to squeeze elections and awards into the “gaming” category through the following tortured chain of reasoning: 

• Gaming means gambling;
• Some State statutes link gambling to betting or wagering on contests; therefore,
• Contests (including elections and awards) constitute gaming. 

Yet, one has to ask:  If Congress had intended for elections and awards to be enumerated activities, is it more likely that Section 5c(c)(5)(C) would have:

• Included elections and awards in its list of enumerated activities; or
• Enumerated “gaming” and hoped the Commission would—

o   Define “gaming” to include “contests;” and

o   Consider “contests” to include elections and awards?

Congress easily could have included elections and awards as enumerated activities, but it did not.  Confronted with this Congressional silence, I do not believe the Commission can simply decree that elections and awards are enumerated activities.  And this is especially the case when Congress in CEA Section 5c(c)(5)(C) provided the Commission with a ready-made process for determining, through a rulemaking proceeding, whether contests, elections, and/or awards are similar to the enumerated activities, including “gaming.” 

I am baffled at why the Commission is tying itself into knots by trying to reason its way from “gaming” to “gambling” to “contests” to elections and awards, rather than simply do what Congress said it could do: consider whether elections and awards are similar to “gaming” (or another enumerated activity).  This is not a matter of form over substance.  Approach matters when it comes to exercising our authority under the CEA, and I cannot support the Proposal’s approach to stretch the statutory term “gaming” to include elections and awards.   

III.          The Commission Lacks Legal Authority to Determine in Advance that Entire Categories of Event Contracts are Contrary to the Public Interest

The overbreadth of the Proposal’s “gaming” definition would suffice for me to dissent.  But the Proposal’s most brazen overreach is its determination, in advance, that every event contract that involves an enumerated activity is automatically contrary to the public interest – regardless of the terms and conditions of that contract. 

The Proposal would prohibit these contracts – sight unseen – through the shortcut of declaring entire categories of event contracts to be contrary to the public interest.  But the Commission lacks legal authority under the CEA to make public interest determinations by category. 

The Proposal’s justification for its approach (at page 37) is that “the statute does not require this public interest determination to be made on a contract-specific basis.”  This is backwards.  The CFTC is a creature of statute, and has only the authorities granted to it by the CEA.  There is no provision in CEA Section 5c(c)(5)(C) for public interest determinations regarding event contracts involving enumerated activities to be made by category.  Accordingly, the Commission cannot claim that authority through the ipse dixit of “Congress didn’t say we couldn’t.”

This is not a mere question of what procedure to follow.  The Proposal would allow the Commission to make the substantive policy determination that entire categories of event contracts, regardless of their terms and conditions, are contrary to the public interest.  And the consequences of such a determination are severe – a complete prohibition on exchanges’ ability to list event contracts, and on market participants’ ability to trade them.  If Congress had intended for the Commission to wield this immense authority, surely it would have said so.

In fact, in another CEA provision similar to CEA Section 5c(c)(5)(C) that also was added by the Dodd-Frank Act, Congress did say so.  CEA Section 2(h)(2)(A)(i) specifically states that the Commission shall review “each swap, or any group, category, type, or class of swaps to make a determination as to whether the swap or group, category, type, or class of swaps should be required to be cleared.”[15]  Thus, when it enacted the Dodd-Frank Act, Congress knew how to tell the Commission that it could make a determination on either an individual or categorical basis when it wanted to do so.[16]  In contrast, Congress did not say in CEA Section 5c(c)(5)(C) that the Commission could make public interest determinations for event contracts by category.      

The Proposal’s premise is that a grant of authority to make a determination about one thing necessarily includes authority to make a determination about a category of such things – unless Congress says otherwise.  But if that were the case, then there was no need for Congress to tell the Commission in CEA Section 2(h)(2)(A)(i) that it could make mandatory swap clearing determinations either by individual swap or by category.[17]  The Proposal’s determination would render statutory text in CEA Section 2(h)(2)(A)(i) mere surplusage in violation of established canons of statutory construction.[18]  It also would violate the canon of statutory construction that provisions enacted as part of the same statute (here, the Dodd-Frank Act) should be construed in a similar manner.[19]

In the absence of any statutory text in CEA Section 5c(c)(5)(C) like that in CEA Section 2(h)(2)(A)(i), I cannot accept that Congress silently authorized the CFTC to make life easier for itself through the shortcut of making impactful determinations that entire categories of event contracts are contrary to the public interest and thus are prohibited from trading on exchanges.

IV.          Even if there is Legal Authority, the Proposal Fails to Justify Making Advance Public Interest Determinations by Category – For a Host of Reasons

Even if the Commission has legal authority to make public interest determinations for event contracts by category, the Proposal is wholly unpersuasive in its attempt to justify doing so.  There are a multitude of failings.

1.    There is No Basis to Resurrect the Repealed “Economic Purpose Test,” Which Shouldn’t be Applied to Event Contracts in Any Event

The Proposal would ban entire categories of event contracts as being contrary to the public interest based largely on the proposition that they fail the “economic purpose test.”  There are four significant problems with this approach.

Congressional Intent:  First, the Proposal relies on a single, ambiguous, passage in the legislative history to conclude that Congress intended, for purposes of a public interest review of an event contract, to resurrect the “economic purpose test” that the Commission once used to determine whether a futures contract was contrary to the public interest – until Congress repealed that public interest requirement in 2000.[20]

The Proposal’s resurrection of the “economic purposes test” is based entirely on this one passage in the colloquy between Senator Dianne Feinstein and Senator Blanche Lincoln:

Mrs. Feinstein: . . . Will the CFTC have the power to determine that a contract is a gaming contract if the predominant use of the contract is speculative as opposed to hedging or economic use?

Mrs. Lincoln:  That is our intent.  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.  It would be quite easy to construct an ‘event contract’ around sporting events such as the Super Bowl, the Kentucky Derby, and Masters Golf Tournament.  These types of contracts would not serve any real commercial purpose.  Rather, they would be used solely for gambling.[21]  

To be clear, the Dodd-Frank Act did not codify the Commission’s prior “economic purpose test.”  And I cannot accept the Proposal’s assertion that this isolated colloquy between two Senators establishes an intent by the whole of Congress that the Commission conduct its public interest reviews of event contracts based on an “economic purpose test” that the Commission had withdrawn as a result of the repeal (by the whole of Congress) of the statutory provision it implemented a decade earlier. 

After all, neither Senator Feinstein nor Senator Lincoln used the term “economic purpose test” or referred to the Commission’s Guideline No. 1 that set out that test.  As someone who spent over a decade working in Congress, and who was present on the Senate floor for countless colloquies and even had a hand in preparing talking points for similar floor discussions, I am confident that if the Senators believed we should resurrect the “economic purpose test,” they would have said just that. 

Difference in Kind:  Second, the “economic purpose test” was designed for traditional futures contracts that have been listed and traded on exchanges for decades.[22]  These contracts differ in kind from event contracts, which typically are structured as binary (yes/no) options.

The two prongs of the “economic purpose test,” which the Proposal adopts as a primary basis for prohibiting entire categories of event contracts as being contrary to the public interest, evaluate:  1) the contract’s utility for price basing; and 2) whether the contract can be used for hedging purposes.  Yet, the Commission itself has previously recognized the difference between event contracts and the traditional futures contracts for which the “economic purpose test” was developed.  In a Concept Release issued in 2008, the Commission stated that “[i]n general, event contracts are neither dependent on, nor do they necessarily relate to, market prices or broad-based measures of economic or commercial activity,” and elaborated as follows:

Since 2005, the Commission’s staff has received a substantial number of requests for guidance on the propriety of offering and trading financial agreements that may primarily function as information aggregation vehicles.  These event contracts generally take the form of financial agreements linked to eventualities or measures that neither derive from, nor correlate with, market prices or broad economic or commercial measures.[23] 

In other words, the Proposal would ban entire categories of event contracts largely on the basis of price basing and hedging requirements that event contracts (described in the Concept Release as “information aggregation vehicles”) likely – because of their very structure – have little chance of satisfying. 

This problem is compounded by the fact that under the Proposal, some event contracts that fail to satisfy the “economic purpose test” would be banned, while other contracts failing the test would not.  For example, the Proposal’s statement (at page 52) that “most contracts falling within the proposed definition of ‘gaming’ would have no underlying cash market with bona fide economic transactions to provide directly correlated price forming information” is equally true of weather-related event contracts – but those contracts would not be banned. 

Since the weather is not an enumerated activity, event contracts involving the weather can trade because they are not subject to a public interest review under CEA Section 5c(c)(5)(C).  Thus, the Proposal’s reliance on the “economic purpose test” means that exchanges can list for trading event contracts (such as those involving weather) that the Commission believes are contrary to the public interest – which I find untenable.

These are the inevitable results of imposing an “economic purpose test” on event contracts that was not designed for event contracts.  Certainly, a rulemaking proceeding could be appropriate to fully explore the economic attributes of event contracts, and to consider how to incorporate such attributes into a public interest review that is tailored to the nature of event contracts.  But, that is not this Proposal.

Government paternalism:  Third, the Proposal asserts (at page 50) that “the economic impact of an occurrence (or non-occurrence) in connection with a contest of others, or a game of skill or chance . . . generally is too diffuse and unpredictable to correlate to direct and quantifiable changes in the price of commodities or other financial assets or instruments, limiting the hedging and price-basing utility of an event contract involving such an occurrence.” 

But to say that there are limits to the hedging utility of an event contract is simply a statement that the contract may not be a particularly good hedging vehicle.  Market participants should be permitted to make their own choices about what financial products meet their hedging needs.  It is not the CFTC’s role to deny them that choice altogether because we feel a given product’s hedging value is “limited.”   

The “Economic Purpose Test” Was Not Applied to Categories of Contracts:  Fourth, even assuming that the “economic purpose test” is an appropriate part of a public interest analysis for event contracts, it does not support making public interest determinations for event contracts by category – because the Commission applied its “economic purpose test” to the terms and conditions of individual contracts.  The Commission’s Guideline No. 1 provided that “[i]ndividual contract terms and conditions must be justified” in order for an exchange to demonstrate that it met the “economic purpose test.”[24]   

The Commission took no shortcuts in applying its subsequently withdrawn “economic purpose test” to futures contracts.  It did not group contracts into categories (such as all futures contracts on wheat, corn, gold, or silver) in evaluating the public interest through its “economic purpose test.”  Rather, the Commission looked at each contract’s “individual contract terms and conditions” to make that determination.  If the Proposal is going to (incorrectly) adopt that “economic purpose test” in determining whether an event contract is contrary to the public interest, then it should apply that test the same way. 

2.    The Proposal’s Application of Other Factors Falls Far Short of Justifying its Prohibition Entire Categories of Event Contracts

Aside from the “economic purpose test,” the Proposal points to a hodgepodge of other factors to try to justify prohibiting entire categories of event contracts, whose terms and conditions the Commission has never seen, from being traded on exchanges.  But its discussion of these factors is conjectural and without evidentiary support, calls into question other contracts that are trading on regulated exchanges, and raises more questions than it answers.  Taken as a whole, the Proposal falls far short of justifying the shortcut of prohibiting entire categories of event contracts (even assuming the Commission has the legal authority to do so). 

Examples of these defects in the Proposal abound, but I will focus here on just a few:

Hopelessly Impractical:  The category of activities illegal under State law demonstrates the type of problems inherent in determining that all event contracts in a category are contrary to the public interest.  Some activities are illegal in some States, but not others.  Yet, the Proposal does not provide any guidance on several obvious questions:  Is an event contract automatically contrary to the public interest if it involves an activity that is illegal in only a single State – and if so, why?  Or, if not, then how many States have to declare an activity illegal before the automatic prohibition on event contracts involving that activity is triggered?  More than half?  States comprising a certain percentage of the country’s population?[25]

The problem is exacerbated by the Proposal’s suggestion that the prohibition of event contracts can hinge on decisions by judges.  Is this reference limited to Supreme Courts of the States?  Or would a ruling by a lower court of a State that a particular activity is illegal trigger an automatic determination that an event contract involving that activity is contrary to the public interest?  What if that decision is appealed?

While I have focused here on the category of event contracts involving activities illegal under State law, these types of practical questions are a foreseeable and inevitable result of any determination that an entire category of event contracts is contrary to the public interest.  I recognize that a contract-specific approach to making public interest determinations regarding event contracts may be difficult and resource-intensive for the CFTC.  But aside from my view that a contract-specific approach is required by the CEA, it also is a better approach from a policy perspective precisely because it would permit the CFTC to consider these practical questions in the context of the specific circumstances applicable to a particular event contract.  We do not get to override a requirement under the law because it will be hard or require more work for us.

Absolutism Based on Conjecture:  Another defect in the Proposal is illustrated by the following (at page 50): “Generally speaking, the Commission believes that something of value is staked or risked upon an occurrence (or non-occurrence) in connection with a contest of others, or a game or [sic] skill or chance, for entertainment purposes – in order wager [sic] on the occurrence.  As such, the Commission believes that contracts involving such occurrences are likely to be traded predominantly ‘to enable gambling’ and ‘used predominantly by speculators or participants not having a commercial or hedging interest’ . . .”  (Emphasis added; footnote omitted) 

These assertions are entirely conjectural, as the Proposal does not cite any support for these statements.  One can readily envision an event contract involving whether a particular US city will be awarded the summer or winter Olympic games in a given year, which would be used by hotel and restaurant owners, as well as other businesses, that would make money if their city gets the Olympics but not if the Olympics are awarded elsewhere.  Such an event contract would not necessarily be used predominantly for entertainment or speculative purposes.

Indeed, the quoted text itself uses wording like “[g]enerally speaking” and “likely,” which is an acknowledgement that its conclusions are not universally true.  A belief for which no evidence is cited, and that is acknowledged not to be true across-the-board, cannot justify an absolutist determination that all event contracts involving an activity are automatically contrary to the public interest, nor can it justify a prohibition on trading all event contracts in that category. 

Calling into Question Traditional Futures Contracts:  I agree that an event contract involving the outcome of a sporting event, and that allows players or coaches to trade that contract, would be contrary to the public interest.  But consistent with its overreach, the Proposal also concludes that even where the terms and conditions of such a contract prohibit such persons from trading, the contract is nonetheless contrary to the public interest.  The Proposal’s stated rationale (at page 51) is that “the athlete or coach would potentially have a platform – for example, access to media, combined with public perception as an authoritative source of information regarding the team – that could be used to disseminate misinformation that could artificially impact the market in the contract for additional financial gain.”

The same can be said of many traditional exchange-traded futures contracts.  For example, oil companies (or companies in the agricultural or metals sectors, or other energy companies) also have “access to media, combined with public perception as an authoritative source of information regarding” the oil (or other) industry, “that could be used to disseminate misinformation that could artificially impact the market in the contract for additional financial gain.”  And yet, exchanges are permitted to list oil futures for trading (in fact, oil companies are permitted to trade them).

The Proposal offers no explanation for why a possible incentive to spread misinformation should render all event contracts involving sporting events (or occurrences or non-occurrences in connection with sporting events) contrary to the public interest when traditional futures contracts with the same incentive are not.  A contract-specific public interest analysis, by contrast, could take into account the terms and conditions of a particular event contract – such as whether athletes and coaches can trade, or whether there are guardrails against the spread of misinformation – to determine whether the threat of misinformation in that contract is such that it is contrary to the public interest.   

Fallacies Concerning the CFTC’s Regulatory and Enforcement Roles:  The Proposal raises in alarmist tones the red herring that sweeping public interest determinations are necessary so that the CFTC does not get drawn into a regulatory or enforcement role for which it is not well-equipped.  For example, the Proposal says (at page 44) that one factor that may be relevant in evaluating whether event contracts are contrary to the public interest is the extent to which they “would draw the Commission into areas outside of its primary regulatory remit.”[26]  Other examples are:  1) the statements (at page 55) relating to event contracts involving elections that the Commission “is not tasked with the protection of election integrity or enforcement of campaign finance laws;” and 2) the statement (in the first sentence of footnote no. 127) that “the oversight function in this area [regarding elections] is best reserved for other expert bodies.”

To be clear:  The CFTC does not administer, oversee, or regulate elections, sporting events, gambling, or any other activity or event discussed in the Proposal – and that will not change with respect to any event contract that is found not to be contrary to the public interest.  Rather, the CFTC would exercise its exact same authorities under the CEA that it does with respect to all other derivatives contracts.

Nor would the CFTC become some type of “election cop.”  After all, the CFTC has anti-fraud and anti-manipulation enforcement authority with respect to futures contracts on broad-based security indices, but that does not mean the CFTC regulates the securities markets or that it is tasked with the protection of the integrity of the securities markets or enforcement of securities laws – the Securities and Exchange Commission (“SEC”) does all that.  The CFTC similarly has enforcement authority with respect to natural gas and electricity since there are futures contracts on those commodities, but that does not mean the CFTC regulates the transmission of natural gas or electricity or that it is tasked with the protection of the integrity of physical natural gas or power markets, or enforcement of the Natural Gas Act or the Federal Power Act – the Federal Energy Regulatory Commission (“FERC”) does all that.

The same is true with respect to an event contract that is not contrary to the public interest and thus is permitted to trade on a regulated exchange.  As the Supreme Court has stated:  “This Court’s cases have consistently held that the use of the words ‘public interest’ in a regulatory statute is not a broad license to promote the general public welfare.  Rather, the words take meaning from the purposes of the regulatory legislation.”[27]  If a particular event contract involving elections were found not to be contrary to the public interest and thus permitted to trade, the CFTC would have absolutely no authority to administer, oversee, or regulate the elections that are the subject of that contract, or to enforce any campaign finance laws.  Its authority would extend only so far as is the case with respect to all commodities underlying derivatives contracts within our jurisdiction, as provided by Congress in the CEA. 

Why This is Important:  I can understand why some might ask:  You have been pleading for an event contracts rulemaking for some time now, and here it is – so what is the problem?  The problem is this:  CFTC Rule 40.11(a)(1) already prohibits the listing and trading of any event contract involving an enumerated activity.  As I explained in my Kalshi Dissenting Statement:

Rule 40.11 contradicts the statute.  CEA Section 5c(c)(5)(C) grants the Commission discretion to determine whether [an exchange’s] event contract that involves an enumerated activity is contrary to the public interest.  CFTC Rule 40.11(a), by contrast, provides that [an exchange] “shall not list for trading” a contract that involves . . . an enumerated activity (emphasis added).  Read literally, Rule 40.11(a) removes entirely the flexibility that Congress granted the Commission to evaluate [exchange] event contracts from a public interest perspective.[28] 

Rather than fix this problem, though, the Proposal doubles down on it.  By making categorical public interest determinations in advance, the Proposal would impermissibly transform the two-step analysis that Congress provided for event contracts into a single step.  It would transmogrify the discretion that Congress gave the Commission to determine that an event contract involving an enumerated activity is contrary to the public interest into a mandate that it do so. 

The Proposal actually is quite candid in acknowledging that it would re-write CEA Section 5c(c)(5)(C).  It states (at page 38):  “If, as proposed, [Rule 40.11] is amended to include a categorical public interest determination with respect to contracts involving each of the Enumerated Activities, the Commission would not, going forward, undertake a contract-specific public interest analysis as part of a review . . . Rather, the focus of any such review would be to evaluate whether the contract involves an Enumerated Activity, in which case, it may not be listed for trading . . .”

If Congress had intended that every event contract involving an enumerated activity is automatically contrary to the public interest and prohibited from trading, it could have provided for such a single-step process in CEA Section 5c(c)(5)(C).  But it did not do that, and instead provided that even if an event contract involves an enumerated activity, the Commission cannot prohibit the contract without exercising its discretion in a second step of determining that the contract is contrary to the public interest.  The Commission can’t short-circuit the process that Congress established by determining that an event contract is contrary to the public interest – in advance and without knowing the contract’s terms and conditions – simply because that makes things easier for the agency. 

Granted, the Proposal makes categorical public interest determinations only for the activities enumerated in CEA Section 5c(c)(5)(C).  I admit that I am not going to lose sleep over a determination that all event contracts involving terrorism, assassination, and war are contrary to the public interest. 

But this is where the “wolf in sheep’s clothing” arrives.  While this Proposal only addresses event contracts involving enumerated activities, it sets the precedent for how the Commission can handle event contracts involving other activities that it determines are similar to enumerated activities, too.

If the Proposal is adopted as final, then at any time in the future, the Commission could determine that other activities are similar to enumerated activities – and could then determine that every event contract involving that activity is automatically contrary to the public interest (and therefore prohibited from trading) regardless of its particular terms and conditions.  And given all the deficiencies in this Proposal’s categorical public interest determinations discussed above, that appears to be a low bar to clear. 

V.           Portions of the Proposal are Inaccurate or Extremely Weak, or Make No Sense

The fact that certain portions of the Proposal are inaccurate, extremely weak, or simply make no sense suggests that it either was hastily prepared, or is motivated primarily by the sheer hatred that the Commission seems to bear towards event contracts.  Here are a few examples: 

--The Proposal says (at page 44) that “the public good” is a relevant factor for consideration in an evaluation of whether an event contract is contrary to the public interest.  It makes no sense that the Commission should consider “the public good” in evaluating whether a contract is contrary to “the public interest.”  This is tautological – “the public good” and “the public interest” mean the same thing.

--The Proposal’s statement (at pages 39-40) that in the colloquy, Senators Feinstein and Lincoln “discussed the Commission’s authority, prior to the enactment of the Commodity Futures Modernization Act of 2000 (‘CFMA’), ‘to prevent trading that is contrary to the public interest” is incorrect.  Senators Feinstein and Lincoln did not “discuss” the Commission’s pre-CFMA authority.  Senator Feinstein referenced it in asking a question, but Senator Lincoln (the Committee Chair) did not talk about it – in fact, she did not even mention the CFMA.

--Footnote no. 49 cites the CFTC Reauthorization Act of 2019 as support for the Proposal’s view that an erroneous reference to a non-existent CEA Section 1a(2)(i) in CEA Section 5c(c)(5)(C) was intended by Congress to refer to CEA Section 1a(19)(i) instead, since the bill included a provision to replace the reference to Section 1a(2)(i) with a reference to Section 1a(19)(i).  But an amendment in a bill introduced in a subsequent Congress (nine years later) sheds no light on what was intended by the Congress that enacted the statutory provision in question – especially when the referenced bill was not enacted and nothing has happened on it during the ensuing five years.

VI.          Certain Implementation Timeline Provisions in the Proposal are Ill-Advised

Implementation Timeline:  As discussed above, I do not support the proposal to determine that all event contracts involving enumerated activities are contrary to the public interest.  But if the Commission decides to do so, I oppose applying that determination to contracts that are already listed for trading as of the date of publication of final rule amendments in the Federal Register. 

It is my hope that there would be few such contracts.  But for any contracts that would be impacted, the Proposal is pollyanaish in its rosy view that “a 60-day implementation period for these contracts will minimize any market disruption that might be caused by the rule amendments.”  For one thing, given the Proposal’s repeated emphasis (at pages 29, 33, and 54) that its examples of activities that constitute “gaming” under the proposed definition are non-exclusive, I am dubious that exchanges and traders necessarily will know exactly which existing event contracts the Commission believes are now suddenly prohibited.

Beyond that, this aspect of the Proposal is fundamentally unfair.  At any time during the 13 years since its adoption of Rule 40.11, the Commission could have concluded that a given event contract involving an enumerated activity is contrary to the public interest.  Exchanges and market participants that have listed and traded an event contract in good faith reliance on the fact that the Commission had not determined the contract to be contrary to the public interest should not pay the price (literally) for the Commission’s inaction by having to halt trading in a fixed amount of time because the Commission has finally gotten around to it. 

This would be the antithesis of “good government.”  Accordingly, I do not believe that any rule amendments finalized as part of this rulemaking should apply to an event contract that is listed and available for trading as of the date of their publication in the Federal Register.

VII.       Conclusion

Rather than undertake a rulemaking process to do the hard work of building a framework for evaluating event contracts pursuant to CEA Section 5c(c)(5)(C), the Commission squandered the 14 years since that provision was enacted as part of the Dodd-Frank Act.  While the Commission is now proposing an event contract rulemaking, that hard work still has yet to be done.  Instead, the Commission is skipping right over building a proper framework – and simply proposing to prohibit contracts outright. 

This result seems preordained, given the hostility that the Commission has displayed toward event contracts since the enactment of the Dodd-Frank Act.  This Proposal rubber-stamps the Commission’s two prior Orders finding proposed event contracts to be contrary to the public interest.  In addition, it continues the “tradition” of stretching a solitary, cryptic colloquy to form the basis for evaluating whether event contracts are contrary to the public interest through the “economic purpose test” that:  1) is not mentioned in the statute; 2) had previously been withdrawn due to Congress’ repeal of the CEA provision it implemented; 3) was not designed for this type of contract; and 4) many event contracts, due to their structure, likely will be unable to meet. 

And now the Proposal goes even further, adopting an overly broad definition of “gaming” and declaring entire categories of event contracts to be contrary to the public interest, sight unseen.  The Commission’s legal authority to make such determinations by category is questionable, at best; that it is inappropriate from a policy perspective cannot reasonably be questioned.  

The Proposal flatly contravenes Congress’ direction in the CEA that the CFTC “promote responsible innovation.”[29]  The unmistakable take-away for exchanges is not to expend resources developing an innovative event contract because the Commission will go to great lengths to find that it is contrary to the public interest and prohibit it from trading.[30]

I want to be very clear:  My dissent should not be taken as an endorsement of the wisdom of event contracts generally, or of any event contract in particular.  Rather, it reflects my application of Congress’ direction to the Commission in CEA Section 5c(c)(5)(C).  Whatever we may think of event contracts, we cannot re-write the CEA to claim an authority that Congress did not give us because we have been derelict in applying the authority that Congress did give us.  Nor should we be prohibiting an event contract without a proper showing that it involves an enumerated activity and is contrary to the public interest based on the application of well-defined factors to the particular terms and conditions of that particular contract.

Because this wolf in sheep’s clothing fails on many levels for the foregoing reasons, I respectfully dissent.

I support the proposed amendments to the Commission’s rules concerning event contracts.  Before further discussion, I would like to acknowledge the tremendous work by many CFTC colleagues.  I particularly would like to thank Vince McGonagle, Nora Flood, and Grey Tanzi for all of their thorough and thoughtful work on the proposal.

Starting in 2021, there has been a significant uptick in the number of event contracts listed for trading by CFTC-registered exchanges.  To put that increase into perspective, more event contracts were listed for trading in 2021 than had been listed in the prior 15 years combined.  And that has continued to be true each year since.

Given this exponential increase, the Commission today proposes to further specify the types of event contracts that fall within the scope of CEA section 5c(c)(5)(C) and are contrary to the public interest.  The amendments will support efforts by registered entities to comply with the CEA by more clearly identifying the types of event contracts that may not be listed for trading or accepted for clearing.  These changes will support responsible and efficient market innovation, by helping registered entities and new applicants to make informed decisions with respect to product design.

Specifically, the Commission is proposing to amend Commission Regulation 40.11 to, among other things, further specify types of event contracts that fall within the scope of CEA section 5c(c)(5)(C) and are contrary to the public interest, such that they may not be listed for trading or accepted for clearing on or through a registered entity.  The proposal defines “gaming” and provides illustrative examples of gaming, including the outcome of a political contest, the outcome of an awards contest, the outcome of a game in which one or more athletes compete, or an occurrence or non-occurrence in connection with such a contest or game.

The proposal includes a determination that event contracts involving each of the Enumerated Activities in CEA section 5c(c)(5)(C) (gaming, war, terrorism, assassination, and activity that is unlawful under state law) are, as a category, contrary to the public interest and therefore may not be listed for trading or accepted for clearing through a registered entity.  The illustrative examples of gaming that I just mentioned are therefore contrary to the public interest and cannot be listed for trading.

To be clear, that means that event contracts on the outcome of a political contest such as an election could not be listed for trading or accepted for clearing under the proposed rule.  Such contracts not only fail to serve the economic purpose of the futures markets—they are illegal in several states and could potentially and impermissibly preempt State responsibilities for overseeing federal elections.  This is not a new phenomenon for the CFTC. Over the course of the last 20 years, the CFTC has remained steadfast—through many administrations—that election or political contracts should not be allowed on the US futures and options markets.

Contracts involving political events ultimately commoditize and degrade the integrity of the uniquely American experience of participating in the democratic electoral process.  Allowing these contracts would push the CFTC, a financial market regulator, into a position far beyond its Congressional mandate and expertise.  To be blunt, such contracts would put the CFTC in the role of an election cop.

The CFTC’s jurisdiction as mandated by Congress and solidified in our statute, the Commodity Exchange Act, recognizes our expertise in markets for goods, services, rights, and interests—which can include events associated with financial, commercial, or economic consequences.  We are tasked with upholding the public interest by ensuring that America’s derivatives markets provide a means for managing and assuming price risks and providing for price discovery through liquid, fair, open, transparent, and financially secure trading facilities.  Market integrity is featured so prominently within that mandate that the CFTC has civil enforcement authority when it comes to the potential for fraud, manipulation, and other abuses such as the dissemination of false information in the underlying or commodity cash markets.  Political control contracts on CFTC-regulated exchanges would push the CFTC far beyond this historical expertise and jurisdiction, and potentially place the CFTC in the position of monitoring such markets for fraud and manipulation in elections themselves.

I thank the staff for their hard work in producing this important proposal.

Commodity Futures Trading Commission (CFTC) Commissioner Caroline D. Pham issued the following comment on the CFTC’s announced action regarding Australia and New Zealand Banking Group Ltd.:  

“It’s bad enough when a government entity takes aggressive administrative action without appropriate due process. In this case, the CFTC went even further by alleging a violation of an Australian law, which the agency is not qualified to interpret and which the local regulators have not pursued. The CFTC is not the world police and should not presume to be experts in other sovereign nations’ affairs. Doing so only serves to erode trust with our global partners.  

“The CFTC’s cross-border rule could not be more clear. Today’s action also fails to comport with the CFTC’s own precedent and longstanding interpretations of our own regulations. The meaning of our rules cannot continuously morph to feed the agency’s voracious enforcement appetite.  

“Make no mistake, today’s action is not business as usual. As regulators, our focus should be on writing and enforcing clear rules to promote integrity and stability in our financial markets in a manner that instills confidence in our mission both at home and abroad. When it comes to catching fraudsters and protecting our markets, the CFTC’s Division of Enforcement is unmatched. We cannot allow ourselves to be distracted from this core responsibility to the American people.”

 

Introduction

Good afternoon. It’s a pleasure to be here for today’s Technology Advisory Committee (TAC) meeting.

Three Significant Steps in Developing CFTC AI Guidance and Regulation

The discussion on artificial intelligence (AI) today marks another  significant initiative launched at the Commodity Futures Trading Commission (CFTC or Commission) to assess the role of artificial intelligence in our markets.

CFTC RFC

First, in January of 2024, my staff worked closely with a task force of senior CFTC leaders and Division Directors across the Commission in the development of the Commission’s Request for Comment on the Use of Artificial Intelligence in CFTC-Regulated Markets.

Commissioner-Led Policy Development and CFTC Advisory Committee - MRAC Future of Finance Subcommittee Work Plan

Second, in a series of public statements this spring, I advanced three proposals: a principles-based framework to assess the risks of integrating certain AI technologies in our markets to ensure responsible use of AI; heightened penalties for conduct that intentionally misuses powerful AI technologies; and the creation of an interagency task that will evaluate, assess, and harmonize guidance, supervision, and regulation that addresses the increasing integration of AI in financial markets.

In addition, at March and April meetings, the Future of Finance Subcommittee of the Market Risk Advisory Committee (MRAC) that I sponsor advanced a working plan approved by the Subcommittee and presented to the MRAC that will explore the benefits of integrating a survey that solicits greater transparency into the use of AI by CFTC-registered entities. The survey would complement traditional supervisory examination inquiries.

CFTC Staff Engagement

Finally, yesterday, the Commission announced the appointment of the CFTC’s first chief AI officer.

In addition to the recommendations in the TAC report, I anticipate delivering a speech tomorrow at a fintech and blockchain conference. In the speech, I will offer further details regarding the policy recommendations that my office is advancing. Allow me to preview two suggestions here.

Assessing Market Risk and Ensuring Market Integrity in CFTC Markets

MRAC and its members are engaged in a robust discussion regarding the efficacy of existing regulation in light of the increasing adoption of AI in CFTC markets. I anticipate that the debate and discussion will lead to thoughtful, consensus-driven ideas that will lead to valuable regulatory contributions.

AI Fraud Task Force

Beyond the MRAC’s efforts, I believe that the Commission should create an AI Fraud Enforcement Task Force that will focus on careful oversight and supervision in our markets to ensure against misuses of AI technologies.

Deep-Dive Regulatory Roundtables

Many of you will recall well the years’ long effort to establish mandatory clearing where appropriate in the over-the-counter swaps market following the recent financial crisis. Joint CFTC-SEC roundtables were among the most valuable regulatory initiatives adopted during that period. The roundtables included diverse stakeholders including market participants, other financial market regulators, public interest advocates, and academics, among others. These Roundtables offered staff an opportunity to engage in deep dive and in-depth discussions regarding a market that had not previously been subject to direct SEC or CFTC regulatory oversight.

Finding A Path Forward

We enthusiastically welcome the TAC Subcommittee report to enhance the regulatory toolkit available to the Commission. As the report and each of these steps demonstrates—much work remains.

With each of these steps, however, the Commission reinforces its commitment to ensure the integrity and stability of our markets.

With each step the Commission demonstrates leadership among U.S. and global financial market regulators as we begin to better understand increasingly advanced forms of AI.

A bit more on a few of the steps may offer useful guidance.

Coordinating Efforts Across the Commission

I applaud today’s focus on developments in AI and the tireless efforts of the members of the TAC to implement TAC’s charter and objectives.

The TAC is one of our five CFTC advisory committees and its charter explains that the critical mission of TAC is to identify and understand “the impact and implications of technological innovation in the financial services, derivative and commodity markets.”[1]

The MRAC has been deeply engaged in understanding the risks engendered by the use and deployment of AI across derivatives markets and other related markets with a view to promoting “the integrity, resilience, and vibrancy of the U.S. derivatives markets through sound regulation.”[2] We are extremely thoughtful about systemic risk issues, the stability of the derivatives market, and evolving market structure. It is critical that the Commission understand and mitigate AI-related risks in the derivatives market, taking into account the interconnectedness of financial markets, the broader financial system, and any potential systemic risk concerns.

This is the very mission of the MRAC and the guiding principles of the Future of Finance Subcommittee, which I stood up earlier this year to advance solutions to address AI-related risks. During my tenure as a Commissioner, “conversations among global regulators, market participants, customers, and investors have reached a fever pitch.”[3] Innovations, particularly in generative AI have the potential to fundamentally reshape society, including the operations of financial markets. Generative AI offers many promising new innovations. At the same time, the risks of AI require the adoption of appropriate safeguards.

The Future of Finance Subcommittee went right to work and on March 15, 2024, live streamed its meeting with industry experts, regulators, and academics participating as panelists and invited guests. Through careful and extensive deliberation and engagement among Subcommittee members representing broad viewpoints, the Subcommittee adopted a two-part work plan.

FIRST, the Subcommittee seeks to offer a template for a Commission survey of CFTC registrants’ use of AI in CFTC-regulated markets. The design of the survey may leverage the questionnaires distributed as part of the annual staff examinations process.

SECOND, the Subcommittee may advance recommendations for guidance, advisories, or formal rulemakings on the Subcommittee’s assessment of the risk that conduct in CFTC regulated markets signals gaps in existing regulations and guidance.

Industry leaders have suggested that “the CFTC’s consideration of AI should be focused on the application of the technology within the context of a particular use case, not the technology as a whole.”[4]

It is my strong hope that there may be opportunities for coordination and collaboration between TAC and MRAC as we support the important work of the Commission.

The work of the advisory committees is incredibly important and may inform Commission action.

Greater Details on Commission-Led Proposals

At a recent FIA conference, I outlined three specific interventions to address AI.

First, I have called for the Commission to adopt a principles-based regulatory framework for addressing the increasing prevalence of AI-related risks in our markets.

Second, I have advocated for heightened penalties for those who deliberately misuse AI to engage in fraud or market manipulation.

Third, I have called for an inter-agency task force to consider the adoption of parallel, harmonized safeguards that will focus on ensuring the stability and integrity of our markets.

I would like to address these in a bit more detail today.

Principles-Based Regulatory Framework

The Commodity Exchange Act (CEA) is a principles-based statute, and the CFTC is a principles-based regulator. Registered entities, such as DCMs, SEFs, and DCOs are required to comply with core principles. Generally, a registered entity has reasonable discretion to establish the manner in which it complies with a particular core principle unless the Commission adopts more prescriptive requirements by rule or regulation. I believe the Commission’s approach to mitigating the risks associated with the use of AI in our markets should be principles-based, retaining adaptability and remaining technology neutral.

One aspect of this approach is to consider existing regulations and whether certain key AI-related risks are addressed by existing risk-management requirements.

For example, DCOs are required to have an enterprise risk-management program that identifies, measures, monitors, and manages sources of risk on an ongoing basis.[5]

As another example, swap dealers are required to implement a risk management program designed to monitor and manage the risks associated with the swaps activities of the swap dealer.[6]

Heightened penalties

AI raises new challenges; we must be prepared to respond to these challenges. AI may be used in a manner that makes certain well-known challenges—fraud and market manipulation—even more difficult to detect and identify.

To address these concerns, the Commission should introduce heightened penalties for those who intentionally use AI technologies to engage in fraud, market manipulation, or the evasion of our regulations. Bad actors who would use AI to violate our rules must be put on notice and sufficiently deterred from using AI as a weapon to engage in fraud, market manipulation, or to otherwise disrupt the operations or integrity of our markets.

To address the increased danger that AI poses, Deputy Attorney General Monaco announced that the Department of Justice would “seek stiffer sentences for offenses made significantly more dangerous by the misuse of AI” and that the Department would seek reforms to enhancements where “existing sentencing enhancements don’t adequately address the harms caused by misuse of AI.”[7]

Such heightened penalties are also consistent with the CEA and the CFTC’s existing enforcement guidance. Under the CEA, penalties must relate to the gravity of the offense.[8] In applying this mandate, the CFTC’s enforcement manual notes that “the gravity of the violation is the primary consideration in determining the appropriate civil monetary penalty” and lists factors including the “[n]ature and scope of any consequences flowing from the violations,” “impact on market integrity [and] customer protection,” and impact on “the mission and priorities of the Commission in implementing the purposes of the CEA.”[9]

Thus, where AI is weaponized to increase the gravity of an offense, by increasing its scope, sophistication, or potential damage, heightened penalties may be appropriate.

The CFTC issued an enforcement advisory in October 2023, highlighting the importance of penalties that are “sufficiently high” to “achieve general and specific deterrence” so that entities do not “view[] penalties as a cost of doing business” and do not “view the potential rewards of misconduct as outweighing the potential risks.”[10] There are significant and growing opportunities for bad actors to misuse this emerging technology. A recent report from the Department of the Treasury on AI noted “an acceleration in the growth of synthetic identity fraud.” [11] The report recognized that “[t]he volume of these types of exploitations or cyber-enabled attacks is likely to rise as technological developments like Generative AI reduce the cost, complexity, and time required to leverage gaps in our digital infrastructure.”[12]

It is therefore essential that we calibrate the penalties rightly, so that it is clear that AI-enabled misconduct is not worth the risk.

Heightened penalties for deliberate misuse of AI to engage in fraud or misconduct is a crucial step. But it is not a cure-all. At present, AI is being used in CFTC markets in a number of different ways:[13]

• Trading (e.g., market intelligence, robo-advisory, sentiment analysis, algorithmic trading, smart routing, and transactions)
• Risk Management (e.g., margin and capital requirements, trade monitoring, fraud detection)
• Risk Assessments and Hedging
• Resource Optimization (e.g., energy and computer power)
• RegTech – Applications that enhance or improve compliance and oversight activities (e.g., surveillance, reporting)
• Compliance (e.g., identity and customer validation, anti-money laundering, regulatory reporting)
• Books and Records (e.g., automated trade histories from voice / text)
• Data Processing and Analytics
• Cybersecurity and Resilience
• Customer Service

Inter-agency task force

Our registrants may operate several businesses, may be dually-registered, or may be a part of a complex banking organization. AI-related risks may arise in various segments of their business. To continue to think holistically about the broader implications of AI-related risks and mitigate conflicting or inconsistent regulations, I have also proposed that the Commission lead in creating an inter-agency task force with market and prudential regulators including the CFTC, SEC, Federal Reserve System, OCC, CFPB, FDIC, FHFA, and NCUA.

The task force would focus on information sharing to identify AI-related risk across our financial system and support the AI Safety Institute (part of the National Institute of Standards and Technology), in developing guidelines, tools, benchmarks, and best practices for the use and regulation of AI in the financial services industry. It could also provide recommendations to the AI Safety Institute as well as evaluate proposals coming out of the Institute.

This proposal is consistent with the Biden Administration’s expectations articulated in the Executive Order on AI.[14] Other regulators are already engaging in this important work of coordination and collaboration. The Department of Justice is establishing “Justice AI” which “will convene individuals from across civil society, academia, science, and industry to draw on varied perspectives…to understand…how to ensure [to] accelerate AI’s potential for good while guarding against its risks.”[15]

The Department of the Treasury has “launched a public-private partnership dedicated to bolstering regulatory and private sector cooperation…. The [partnership] provides a forum for convening financial sector AI stakeholders across the member agencies of the Financial Stability Oversight Council (FSOC), the Financial and Banking Information Infrastructure Committee (FBIIC), and the Financial Services Sector Coordinating Council (FSSCC).”[16]

Such coordination has proved critical to the success of our regulatory efforts in the past, and it is only more critical now, as we face the unprecedented opportunities and challenges that AI brings.

Conclusion

I look forward to today’s discussion—the TAC is a valuable forum for addressing these critical issues, and I am hopeful that the conversations today will help further develop our understanding of AI’s benefits and challenges.

[4] FIA, CME, ICE, Response to Request for Comment on the Use of Artificial Intelligence in CFTC-Regulated Markets (Apr. 24, 2024).

[5] 17 C.F.R. § 39.10(d).

[6] 17 C.F.R. § 23.600.

[7] Id.

[8] 7 U.S.C. §§ 9a(1), 13a.

[9] Division of Enforcement, CFTC, Division of Enforcement Manual (accessed Apr. 28, 2024), Division of Enforcement | CFTC.

[10] CFTC, Enforcement Advisory on Penalties, Monitors and Admissions (Oct. 17, 2023), CFTC Releases Enforcement Advisory on Penalties, Monitors and Admissions | CFTC.

[11] Department of the Treasury, Managing Artificial Intelligence-Specific Cybersecurity Risks in the Financial Services Sector (March 2024), Managing Artificial Intelligence-Specific Cybersecurity Risks in the Financial Services Sector (treasury.gov).

[12] Id.

[13] LabCFTC, A Primer on Artificial Intelligence in Financial Markets (Oct. 24, 2019), https://www.cftc.gov/media/2846/LabCFTC_PrimerArtificialIntelligence102119/download.

[14] Exec. Order No. 14,110, 88 Fed. Reg. 75,191 (Oct. 30, 2023), Executive Order on the Safe, Secure, and Trustworthy Development and Use of Artificial Intelligence | The White House.

[15] Lisa O. Monaco, Deputy Attorney General, Department of Justice, Remarks on the Promise and Peril of AI, supra.

[16] Department of the Treasury, Managing Artificial Intelligence-Specific Cybersecurity Risks in the Financial Services Sector, supra.

Good morning. Thank you, Commissioner Goldsmith Romero, for convening this meeting of the Technology Advisory Committee (TAC). Over the past year, you and the TAC have really been leading the way at the CFTC on the issue of artificial intelligence (AI), and I look forward to the continuation of those efforts. I also want to recognize the TAC Designated Federal Officer, Anthony Biagioli, the Alternate Designated Federal Officers, Ben Rankin and Drew Rodgers, the CFTC staff, and everyone who worked to make today’s meeting possible. And of course, thank you to the committee members for taking time away from your day jobs to share your expertise and provide the CFTC with valuable insight into advancements in technology.

While AI has recently dominated the news and policy agendas around the world, especially with the development of generative AI, the financial services industry has been using various iterations of AI for years to improve automation and efficiency under the supervision of prudential and other regulators. At last July’s TAC meeting, I spoke about the importance of utilizing existing risk governance frameworks and risk management disciplines to identify, measure, monitor, and control emerging risks and new technologies[1]. One example is operational risk management, which includes technology risk, cyber risk, and third-party risk. I believe that model risk management is key for AI risk governance, and that one way to approach appropriate safeguards for the deployment of AI in trading and markets is by looking to the existing approach to risks and controls in algorithmic trading.

I look forward to the presentation of the TAC’s Emerging and Evolving Technologies Subcommittee Report Regarding Responsible AI in Financial Markets, and to the presentations by our colleagues at the Federal Reserve, U.S. Department of the Treasury, and the National Institute of Standards and Technology (NIST) on their current AI initiatives. I’m pleased that our partners at the National Futures Association (NFA) will be sharing their expertise with us, as well as leaders from the private sector.

Thank you, Commissioner Goldsmith Romero, and to the members for your service on this committee. I look forward to today’s discussion on artificial intelligence in regulated financial services.

I respectfully dissent from the Large Trader Reporting Rule primarily because it raises fair notice and due process issues for future regulatory changes. The Commission is also delegating its authority to a non-existent office, which I believe is not only impermissible, but makes no sense.

I would like to thank Owen Kopon, Paul Chaffin, Chase Lindsay, Jason Smith, Nora Flood, and Vince McGonagle in the Division of Market Oversight, as well as James Fay in the Division of Data and Daniel Prager in the Office of the Chief Economist, for their work on the Large Trader Reporting Rule. I appreciate the staff working with me to make revisions to address my concerns. While the revisions to the rulemaking preamble are intended to alleviate the fair notice concerns, they ultimately do not provide sufficient due process protections as required under the law because there were no associated revisions to the rule text.

Overall, I continue to support most of the rule amendments that would update the outdated large trader reporting submission standards in the Part 17 regulations.[1] The CFTC’s Commitment of Traders (COT) Report, derived from Part 17 data, provides transparency and aids in price discovery and risk management for market participants and end-users. I support improving the CFTC’s preparation of the COT Report. I also believe that the two-year implementation period will help to minimize disruptions and ensure a seamless transition with enough time for adequate testing of firms’ systems and processes for large trader reporting prior to the compliance date. I strongly encourage the Commission to include adequate implementation periods in all of our rulemakings, which will support compliance and risk management efforts that enhance market integrity.

However, I have two significant concerns. First, the Commission will make a new delegation of authority to the Director of the Office of Data and Technology (ODT) in Regulation 17.03(d) to determine the form, manner, coding structure, and electronic data transmission procedures for reporting the data elements in Part 17 appendix C and to determine whether to permit or require one or more particular data standards. I find it deeply troubling and against all common sense that the Commission is making a new delegation of authority to an office that no longer exists at the CFTC.[2]

I find it insincere, or incongruous at best, for the Commission to state that it is dedicated to providing certainty to market participants—or even clarity, which the Final Rule asserts seven times—when the Commission is delegating authority to a ghost office to make decisions that may cost firms millions of dollars to implement.

Second, multiple commenters requested that the Commission include a notice standard under Regulation 17.03(d) if the ODT Director changes these standards in the future.[3] Commenters raised concerns about potential costs associated with future changes, such as technology and infrastructure changes for reporting firms. Even seemingly minor changes to reporting requirements require firms to identify and allocate technology budget and resources; program and test reporting logic; and implement controls, among other things. Inexplicably, the Commission declined to adopt a reasonable notice standard in the regulation, even though fair notice is inherent to due process under the Administrative Procedure Act and other law.

Considering the CFTC’s aggressive enforcement posture towards pursuing reporting violations with a strict liability standard and no materiality threshold, resulting in seven-figure penalties for anything less than 100% perfection,[4] I am deeply concerned about using delegated authority to change reporting standards without reasonable notice requirements in the regulation. This would ensure that firms have adequate time for compliance and implementation of new requirements.

Accordingly, while I support most of the revisions to the Large Trader Reporting Final Rule, my outstanding concerns outweigh that support.

Today, the Commodity Futures Trading Commission (Commission or CFTC) adopts amendments to large trader reports. Ensuring the integrity and transparency of these reports fosters sound derivatives markets by providing the Commission with critical information concerning the largest positional exposures in futures and options markets. I support adopting the final rule, which amends certain provisions of the Large Trader Reporting Requirements for futures and options under Commission Regulation 17.00 (a) and (g) (Final Rule).

Sections 4a, 4c(b), 4g, and 4i of the Commodity Exchange Act (CEA) establish the Commission’s authority to create regulation imposing large trader reporting and recordkeeping requirements on registrants. Part 17 sets out the obligations for reports that markets, futures commission merchants, clearing members, and foreign brokers must provide to the Commission.[1] The Commission’s large trader reporting system has been foundational to ensuring market integrity, fostering price discovery, and promoting hedging utility of futures and options contracts for commercial end-users. The large trader reporting framework has admirably supported the Commission’s market surveillance efforts.

CFTC Regulation 17.00(a) requires reporting firms to report daily position information for special accounts—futures and options trader accounts that exceed certain Commission-prescribed levels—to the Commission, in accordance with the record format and data elements set forth in CFTC Regulation 17.00(g).[2] Data reporting technology has advanced since the time of Part 17’s promulgation such that the current data record format is outdated.

The Commission is adopting the Final Rule to modernize certain technical aspects of the reporting requirements and clarify aspects of the reporting requirements and instructions. The Final Rule will transition reporting format to the Financial Information eXchange Markup Language (FIXML). Additionally, the Commission is updating the data elements to be reported and delegating authority to the Director of the Division of Data to designate a data submission standard. Contemporaneously, the Commission will publish an updated Part 17 Guidebook.

The Commission issued a notice of proposed rulemaking on June 27, 2023 and received twelve substantive comment letters. The Final Rule is responsive to the comments received and reflects thoughtful engagement with market participants—an essential aspect of the notice-and-comment rulemaking process.

Access to more fulsome and reliable data will improve the Commission’s understanding of how traders employ futures and options, enable the Commission to surveil for market integrity in a single market or across markets, and facilitate the Commission’s detection of and enforcement many abusive trading practices.

As I have previously stated:

Appropriately-tailored regulatory disclosure is a powerful tool in identifying vulnerabilities and trends in our markets, mitigating systemic risk, and addressing financial stability concerns.  Disclosure of financial information to market regulators is critical to the regulatory oversight of our financial markets, particularly when such disclosure is accurate, timely, robust, and usable.[3]

Today’s Final Rule supports position reporting that meets these characteristics. Though facilitating effective supervision can engender costs, the important data reported to the Commission plays a crucial role in stemming broader market disruptions.

I commend the work of the staff of the Division of Market Oversight, including Owen Kopon, Paul Chaffin, Chase Lindsey, and Jason Smith, on the Final Rule.