TheCorporateCounsel.net

Prediction markets are all the rage these days. If you have a strong hunch as to what the high temperature at Los Angeles International Airport is going to be on Saturday, then prediction markets may be the thing for you! As a securities lawyer, I have generally perceived prediction markets to be largely outside of my purview, because the actual instruments underlying prediction market transactions are swaps that are referred to as “event contracts.” The CFTC is the federal regulator of event contracts that do not have a security component, first addressing the topic way back in 1992 in a no-action letter to the Iowa Electronic Markets, which is acknowledged to be the first U.S.-based prediction market platform. Given the regulatory divisions established by the good ole’ Dodd-Frank Act, the SEC has jurisdiction over security-based swaps, while the CFTC oversees all other swaps.

The landscape may be changing soon, as the exchange operator MEMX announced earlier this month that it had filed a proposed rule change with the SEC seeking to allow the exchange to list Equities Based Exchange Prediction Contracts, or EPCs. The announcement notes:

MEMX’s EPCs are event contracts on publicly traded companies designed to provide investors with targeted exposure to objective, quantifiable measures of a company’s financial performance, including earnings, revenue, sales and other key issuer-specific metrics.

Investors would be able to trade complementary YES and NO contracts with prices ranging from $0.01 to $0.99. The proposed contracts would trade on MEMX Options, a registered national securities exchange, and would benefit from central clearing, know-your-customer requirements and MEMX’s existing regulatory and market-surveillance programs.

Subject to the SEC’s approval of the proposed rule change and the achievement of operational readiness, MEMX is targeting an early 2027 launch for EPCs.

In its notice seeking comment on the proposed rule changes for MEMX, the SEC notes:

[T]he Exchange’s proposal responds to this growing market demand for event-based products by establishing a framework for the listing and trading of securities event contracts as standardized options on the Exchange. In doing so, the proposal would bring these securities products within the established regulatory infrastructure applicable to listed options, including exchange trading and surveillance, standardized disclosure, and centralized clearance and settlement through a registered clearing agency, as further described below. To implement this framework, the Exchange proposes to adopt new Chapter 30 of the Exchange Rules governing the listing and trading of securities event contracts on MEMX Options.

Securities event contracts are cash-settled, European-style binary options that are based on the outcome of an event question related to the financial performance of an issuer of an NMS stock. A securities event contract provides a fixed payout if the condition specified in the contract terms occurs in the manner specified in the contract terms and expires without a payout if that condition does not occur. The proposed rules are intended to support securities event contracts based on objective, verifiable events relating to the financial performance of the issuer of an underlying security. Under the proposal, the Exchange would initially list securities event contracts based on an underlying financial metric, such as whether an issuer announces earnings, revenues, sales, or another key financial metric that is equal to or exceeds a specified threshold. At the same time, the proposed framework preserves flexibility for the Exchange to propose additional securities event contract types in the future, including contracts based on other events affecting the issuer’s financial performance that may not involve an underlying financial metric, subject to a separate proposed rule change.

We will be monitoring this development, as the availability of EPCs or other securities-based event contracts could have significant implications for public company insider trading policies and compliance efforts.

– Dave Lynn