October 25, 2008


Progressive Review - If much of the derivative market is not regulated under federal law, might it not represent a form of illegal gambling under state or local law? Even if this proved not to be the case, might not an aggressive investigation by state or local prosecutors - unlike the indifference at the federal level - produce valuable information about what has actually been going on, such as the extent of laundered drug money in the derivative markets?

By way of analogy, we asked a couple of good lawyers this question: let's say that a hedge fund had a rule that participants would be killed if they didn't pay up when they were meant to. The attorneys agreed that the hedge fund officials could be prosecuted for murder at the state or local level. So why not for violating criminal gambling laws?

One of the few things we've found dealing with this issue is a 1999 report of the Japanese Financial Law Board. While the legal references are not American, it does raise some interesting issues:

||||| It was once the case that some derivatives transactions such as interest rate and cross- currency swaps, futures and interest rate and cross-currency options, which are now regarded as “basic” financial derivatives transactions (or products), entailed the risk of constituting illegal gambling under the Criminal Code. Additionally, there has been speculation that relatively new derivatives transactions related to securities (such as equity swaps), FRAs (forward rate agreements), FXAs (forward exchange agreements) and credit derivatives transaction also involve the possibility of being subject to criminal penalties for gambling.

These situations became a prime factor for discouraging the participation in such derivatives transactions through market players. Since there were no clear standards about these financial derivatives transactions to indicate what kinds of derivatives transactions constituted illegal gambling, or what kinds of requirements had to be met, to avoid the application of the criminal law relating to gambling, the debate surrounding derivatives transactions and the risk of penalties for gambling has become one of the factors causing legal uncertainty for interested parties in financial transactions in the Japanese financial markets. . .

Various financial derivatives transactions, which are actually currently utilized, are not in fact covered by the above new regulations in terms of the participants and the precise kinds of transactions. According to these situations, there still remains some legal uncertainty as to whether derivatives transactions may correspond to the penalty for gambling and, indeed, some uncertainty on other related points. In light of the above situation, this note examines whether it is possible to establish a proper standard for the application of the crime relating to gambling to certain financial derivatives transactions. . . |||||


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