How boxoffice trading could flop

Crucial question involves who would be deemed an 'insider'

Making money off movies never has been so controversial as two financial firms seek final regulatory approvals to offer big investors and normal folks the opportunity to bet on the success or failure of films.

Media Derivatives of Chicago, which targets big investors with its Trend Exchange, and Wall Street's Cantor Fitzgerald, which would put domestic movie futures contracts within reach of smaller players through the Cantor Futures Exchange, have leaped past the first hurdle, creating the structure for a new commodity market. Now they face a greater challenge to win approvals for the specific investment products they want to offer.

Even as members of the U.S. Commodity Futures Trading Commission approved the idea of the new marketplace, concerns are being expressed about what they can offer. That's where the battle now shifts.

"I continue to have serious concerns regarding the trading of media contracts," CFTC commissioner Scott O'Malia said Tuesday after Cantor won initial approval. "I support a very thorough review of all of these first-of-a-kind products to ensure they will provide a useful commercial hedging tool and are free from fraud and manipulation."

These are real concerns because boxoffice results are quite different from such commodities as oil and orange juice, which exist in the real world. Movie boxoffice, which is not a retail product, is based on the performance of creative works that, unlike a bushel of wheat, is different every time in overall value and often appeals to very different audiences. As a creative product, movies can be analyzed in ways unlike, say, pork bellies -- ways that could provide a tip-off as to ultimate appeal, especially in the age of the Internet, when research methods are being invented almost daily.

Consider the Movie Experience. This research study at UCLA taps into the views of people online by asking them to rate prospects of a major movie before it bows and, beginning on opening day, how much they liked it and whether they would recommend it to a friend. The researchers say they can predict how a picture will rank at the boxoffice with 86% accuracy.

Then there is an ongoing research project at HP Labs in Palo Alto, Calif., that measures how often a movie is mentioned on Twitter before and after release. Those researchers say that by the end of opening weekend, they can predict boxoffice performance with 90% accuracy.

Although both studies originally were envisioned as a way to aid Hollywood in making better movies, they clearly take on new meaning if investors are able to trade futures contracts based on boxoffice. And that is only the tip of the data iceberg.

There already are years of experience to back up the quality of research from such firms as Nielsen's National Research Group, CinemaScore, Marketcast, Rentrak and OTX, many of which already provide data to studios.

None has revealed plans to sell research to investors, and several insist they never will. However, the very existence of that level of information generates a buzz among potential investors seeking an edge when and if trading does commence. It has some players salivating at the idea that with the right info, their investments could approach a sure thing.

"There is going to be a sub group of people out there that are going to have more information than the public, and that's not a good thing for the public or the industry," said Bob Pisano, interim head of the MPAA. "That presents an opportunity that is ripe for manipulation."

Naturally, Media Derivatives and Cantor disagree. They promise there will be safeguards against fraudulent or insider trading and promote their exchanges as a way for legitimate businesses as well as individuals to hedge their bets on the upside or the downside of movie investments. They have rules about who can trade and promise to keep close tabs on any unusual activity. They also believe big investors instantly will be aware of any large, unusual trading.

However, the MPAA -- with support from movie exhibitors, the Hollywood guilds and many politicians -- plans to fight against final regulatory approvals while opening a second front in Congress. A Senate committee Wednesday approved an amendment to a financial bill that would nix the idea of movie derivatives outright.

Cantor Fitzgerald and Media Derivatives have limited their public comments while pursuing the approval process. However, both will have execs speak Thursday during a House subcommittee hearing in Washington. Also testifying will be Pisano and Schuyler Moore, an attorney, UCLA professor and regular THR columnist who first wrote about the idea of a "boxoffice exchange" in 2003. According to an advance summary of his testimony, Moore will support plans for movie futures.

"The studios have mentioned fear of manipulation as a grounds for objection," Moore will testify. "But this can't be their real concern since they don't have to participate in the market at all."

Moore also discounts the danger of insider trading. "I don't believe that insider-trading laws apply to futures exchanges," he said, because "they don't have much better information than what is otherwise widely known and available."

That brings a chuckle from insiders who have seen the kind of research that NRG, CinemaScore and others provide the studios, especially data based on exit polling during opening weekend that indicates who paid to see a movie and whether they liked it.

Thus, who is defined as an insider, and hence barred from trading, becomes crucial.

Cantor bylaws say anyone who knows the screen count for a movie, detailed ad-spend plans or boxoffice results is an insider "until such information has been disseminated in a manner that makes it generally available."

In response to a question from THR, Media Derivatives CEO Robert Swagger said there is a "firewall" inside studios between those who have such info and those who are responsible for investing millions of dollars in movies, which is why they think hedging by studios is viable. It only would be a problem if a studio tries to invest a large amount to offset risk, according to Swagger, and that would be "an anomaly in the market" that "professional traders would pick up on." He said that could trigger an audit by his firm and ultimately by the CFTC.

"Any participant who wants the economic benefits has to agree to the rules," he added.

Whether staffers at NRG or CinemaScore would be deemed insiders remains fuzzy (the companies declined comment). Beyond that is the question of whether projects such as those at UCLA and HP would be covered by insider rules.

At UCLA, professors Bill McKelvey and Nadine Escoffier have spent three years developing their database and signing up online participants, who view movie trailers beginning two weeks before opening, then again when a movie opens.

"So far, we have just predicted if a movie will be a top performer or not," said McKelvey, adding that the research could be expanded to more detailed predictions.

Bernardo Huberman, who with Sitaram Asur has been studying social media at HP, said that by analyzing about 3 million tweets based on a set of algorithms they've developed, they are able to predict boxoffice performance more accurately than investors on Cantor's Hollywood Stock Exchange.

"We are tapping into the attention that the collective intelligence provides," he said.

Pisano said the lure of investing will lead to other less-savory means of gathering intelligence, such as stealing data from researchers or studios or pirating a copy of a movie from a postproduction facility to view it before investing.

"The piracy play here to short or otherwise attempt to influence the opening of a movie is a rampant and serious consideration," Pisano said.

So whether it is safeguarding data or determining just who is an insider, there are serious concerns before the CFTC, even as Congress considers legislation that could kill the whole thing.