Wager, Insurance, Bucketing or Swap?

In yesterday’s post, I mentioned Professor Joan Heminway’s recent essay on crowdfunding. She notes that some crowd funding arrangements may “may look less like investment instruments commonly known as common stock or debentures, and more like loans, gambling bets, rights to consumable products or services or charitable or other nonprofit donations.” See What is a Security in the Crowdfunding Era?“, 7 Ohio St. Entrepren. Bus. L.J. 335 (2012).

Suppose that I bet that my house won’t catch fire in the next year. This kind of bet could run afoul of Penal Code Section 337(a) which criminalizes bookmaking and related offenses. Paragraph (a)(5) of the statute makes it illegal to record, or register any bet or bets, wager or wagers, upon the result, or purported result, of any chance, casualty, unknown or contingent event whatsoever. Incidentally, this conduct is illegal regardless of whether it is done for “gain, hire, reward, or gratuitously, or otherwise”. Many public policies have been advanced for prohibiting or limiting gambling. Often these policies are directed at protecting the general public rather than the individual making the bet. See, e.g., Monterey Club v. Superior Court of Los Angeles County, 48 Cal. App. 2d 131, 138 (1941) (criminal complaint alleged that gambling “tends to and does in fact debase and corrupt the public morals, encourages idle and dissolute habits, draws together great numbers of disorderly persons, disturbs the public peace, brings together idle persons and cultivates dissolute habits among them, and is thereby injurious to health, indecent and offensive to the senses, and impairs the free enjoyment of life.”)

Alternatively, my bet could characterized as the purchase of an insurance contract. Section 22 of the Insurance Code defines “insurance” as “a contract whereby one undertakes to indemnify another against loss, damage, or liability arising from a contingent or unknown event”. The Insurance Code, unlike the Penal Code, permits parties to wager on the occurrence of some contingent event. Moreover, the policies underlying insurance regulation are focused on protecting the person making the bet (i.e., the “insured” (Section 23)) by ensuring the financial viability of the counterparty and regulating the terms of the transaction.

If I happen to bet on another contingency such as the movement in the price of shares of stock, then the arrangement could be viewed as a violation of California’s Bucket Shop Law, Corporations Code Section 29000 et seq. That law prohibits, among other things, the making of a contract with respect to the purchase or sale of securities or commodities that is settled based on publicly quoted prices but without a bona fide purchase or sale of the securities or commodities. Cal. Corp. Code § 29008(a).

The overlapping nature of these regulatory schemes is recognized in the Commodity Exchange Act. Section 1(47)(A)(iii) of the CEA defines a ”swap” to include any agreement, contract or transaction ”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”. Section 12(h) of the CEA provides that a swap is not insurance and may not be regulated as an insurance contract by the law of any state. Section 12(e) separately preempts state and local laws regulating gaming or the operation of bucket shops as to certain agreements, contracts or transactions excluded or exempted from the CEA by specified sections of that act. See Does the Dodd-Frank Act Revive the CA Bucket Shop Law?