SEC Says Mobile Phone Game is an Illegal Security-Based Swap
I previously discussed an SEC Investor Alert which said fantasy stock trading for small amounts of money can violate provisions of securities laws implemented by the Dodd-Frank Act. According to the SEC, the terms “swap,” “security-based swap,” and “derivative” includes any agreement, contract, or transaction whose value is based upon – or “derivative” of – the value or performance of some other financial product, event, or characteristic. The SEC stated there are many different ways that virtual games referencing securities could involve a security-based swap. For example, a website could charge people an entry fee to join an online fantasy stock trading competition in which they would “buy” or “sell” a virtual portfolio of securities and in which they could win a prize.
At the time the Investor Alert was issued, I also noted the SEC announced the first settlement with a company that illegally offered “complex derivatives” products to retail investors. The Dodd-Frank Act implemented two key requirements for any security-based swaps offering to a retail investor who doesn’t meet the high standard of an “eligible contract participant” defined in the law. A registration statement must be effective for the offering, and the contracts must be sold on a national securities exchange.
The “complex derivative” was an online business involving the valuation of private startup companies along the lines of a fantasy sports league.
Now the SEC has announced another settled enforcement action against Forcerank, LLC, a provider of a mobile phone game. For a $5 entry fee, entrants would rank 10 stocks or ETFs in the contest from #1 to #10 based on the expected percentage change in market price, predicting for each security where it would fall from the best-performing (#1) to the worse-performing (#10) in the upcoming week. In each week-long game, players won points for each instrument based on the accuracy of their prediction, and players with the most aggregate points received cash prizes at the end of the competition. Forcerank LLC kept 10% of the entry fees and obtained a data set about market expectations that it hoped to sell to hedge funds and other investors.
According to the SEC, each Forcerank entry was a swap because each participant paid to enter into an agreement with Forcerank LLC 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.
In addition, the SEC said 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 a security to finish first in a contest and it outperformed each of the 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.
Forcerank did not admit or deny the SEC’s findings and agreed to pay a civil money penalty in the amount of $50,000.
Contact Steve Quinlivan for more information.