The SEC shut down a “fantasy” stock picking game for allegedly violating securities laws. Forcerank LLC ran contests via mobile phone games where players paid a fee and predicted the order in which 10 securities would perform relative to each other. In each week-long game, players won points based on the accuracy of their prediction, and players with the most aggregate points received cash prizes at the end of the competition.
According to the SEC, Forcerank’s agreements with players were security-based swaps because they provided for a payment that was dependent on the occurrence, or the extent of the occurrence, of an event or contingency that was “associated with” a potential financial, economic, or commercial consequence and because they were “based on” the value of individual securities. A more detailed explanation of the legal rationale is set forth below.
While not central to the decision, the SEC noted that the Forcerank contests were an extension of business for Estimize, a private company based in New York that collects and sells data about securities and trading. Estimize’s main product is crowd-sourced predictions, primarily about public company earnings. Estimize collects predictions from market participants. It then keeps that raw data and creates aggregate predictions based on the crowd-sourced data. In the existing product, people who make predictions about a company get access to some data, specifically other people’s predictions about that company. In addition, Estimize sells live access to full data sets to hedge funds and other investors. The company cites academic research to argue that Estimize’s data are better predictors than estimates by sell-side investment bank analysts.
We continue to see innovative spins on fantasy contests. Some are likely legal and some not. It is imperative to get legal advice on these business models before commercially launching these apps and contests.
SEC’s Legal Analysis
According to the SEC, two provisions added by Dodd-Frank apply to the transactions entered by Forcerank LLC:
- Under what is currently Section 5(e) of the Securities Act, it is unlawful for any person to offer to sell, offer to buy, or purchase or sell a security-based swap to any person who is not an eligible contract participant without an effective registration statement. 15 U.S.C. § 77e(e).
- Under Section 6(l) of the Exchange Act, it is unlawful for any person to effect a transaction in a security-based swap with or for a person that is not an eligible contract participant, unless such transaction is effected on a national securities exchange.
15 U.S.C. § 78f(l).
The Commodity Exchange Act defines the term “swap” and includes agreements or transaction that provide for a payment dependent on an event or contingency “associated with” a potential financial consequence:
[T]he term ‘swap’ [includes] any agreement, contract, or transaction—… (ii) that provides for any purchase, sale, payment, or delivery (other than a dividend on an equity security) that is dependent on the occurrence, nonoccurrence, or the extent of the occurrence of an event or contingency associated with a potential financial, economic, or commercial consequence[.]
7 U.S.C. § 1a(47) (Commodity Exchange Act section incorporated into the securities laws).
The Exchange Act, as amended by Dodd-Frank, defines the term “security-based swap” and includes swaps that are “based on” a single security or the value of that security:
[T]he term ‘security-based swap’ means any agreement, contract or transaction that (i) is a swap as defined in [the Commodity Exchange Act] and (ii) is based on — (I) an index that is a narrow-based security-index, including any interest therein or on any value thereof; (II) a single security or loan, including any interest therein or on the value thereof; or (III) the occurrence, nonoccurrence, or extent of the occurrence of an event relating to a single issuer of a security or the issuers of securities in a narrow-based security index, provided that such event directly affects the financial statements, financial condition, or financial obligations of the issuer.
15 U.S.C. § 78c(a)(68) (Exchange Act Section 3(a)(68)).
Based on this, the SEC concluded that the Forcerank entries were security-based swaps as defined in Section 3(a)(68) of the Exchange Act for at least two reasons.
First, each Forcerank entry was a swap because each participant paid to enter into an agreement with Forcerank that provided for the payment of points and, in certain cases, cash. Those payments were dependent upon the occurrence, or the extent of the occurrence, of an event or contingency (i.e., the player’s predictions about the price performance of individual securities being compared to actual performance and the player’s aggregate points being compared to other players). Such event or contingency was “associated with a potential financial, economic or commercial consequence” because it was calculated by measuring the change in the market price of an individual security over a period of time and comparing that change to an identical metric based on the market price of other individual securities.
Second, each swap was a security-based swap because it was based on the value of single securities. The term “based on” does not require an exclusive relationship between the payment and the movement of a security. In the Forcerank contests, players received points based on the change in the market price of a single security relative to the change in the market price of other securities. For example, a player would receive 100 points if the player correctly predicted a security to finish first in a contest and it outperformed each of the other securities. In addition, a player could receive cash based on several factors, including 1) that player’s score, which was calculated by aggregating the points derived from the change in the market price of each single security in the contest relative to the change in the market price of other securities and 2) a comparison of that score to other players’ aggregate points derived from equivalent calculations. For example, a player would receive cash as the first place finisher if the player made predictions precise enough to receive points such that his or her score was higher than the other players’ scores.