There was recently a story about a reporter who faced threats because their reporting contained a detail that while not significantly impactful (although about a literal impact) in it's own right changed the win conditions on a prediction bet.

I think prediction markets worked as an idea to provide a wisdom of the crowd view when they were being used in good faith, but rewards cause people to prioritise winning and gaming the system pays better than playing fairly.

There is no unfairly or fairly playing a prediction market. That's kind of the point. They don't work if you try to regulate them like they are a stock market or sports betting market. If you place money on one as a layman, you should consider yourself the dumb money. Lots of folks have convinced themselves they "know better" though, so it's a very easy psychological sell.

You either allow a free for all, or they should be simply outright banned. I mean, they should probably be banned either way - but without the prediction part this is not a single redeeming factor for them to exist.

The consequences for someone betting on classified information would need to come from the agency/government/etc. that finds out their staff is engaging in betting on privileged information. The market itself is simply taking bets and doing what it's designed to do. The bettor gets to decide if the risk is worth it.