Dodd/Frank gave the Commodities Futures Trading Commission (CFTC) more power to pursue fraud and manipulation in commodities, but is that power limitless?
That was the question in the latest Futures Industry Association (FIA) webinar entitled “CFTC’s Jurisdiction over Fraud in the Cash Markets: Are there any Limits?”
While fraud and manipulation has always been legal, lawmakers felt the laws needed to be strengthened.
In particular, Section 6 © 1 of Dodd/Frank was added to address spoofing in particular, “It shall be unlawful for any person, directly or indirectly, to use or employ, or attempt to use or employ, in connection with any swap, or a contract of sale of any commodity in interstate commerce, or for future delivery on or subject to the rules of any registered entity, any manipulative or deceptive device or contrivance.”
Democratic Senator Maria Cantwell, from the State of Washington, was one of those who championed adding this section and she explained at the time why it was necessary, “Some people might be thinking: Why do we need legislation like that? Don’t we already have something in place? Unfortunately, current law does not have enough protections for our consumers, and we have found in other areas that it is very important to have a strong bright line, a law on the books against manipulation. . . . [T]he federal courts have recognized that with the CFTC’s weaker anti-manipulation standard, market ‘manipulation cases generally have not fared so well.’ In fact, the law is so weak that in the CFTC’s 35-year history, it has only had one successfully prosecuted case of market manipulation.”
Many in the derivatives industry felt that this new language would give the CFTC sweeping, and possibly unlimited, power; in fact, the CFTC addressed this fear by stating, “the Commission expects to exercise its authority under 6(c)(1) to cover transactions related to the futures or swaps markets, or prices of commodities in interstate commerce, or where the fraud or manipulation has the potential to affect cash commodity, futures, or swaps markets or participants in these markets,” after Dodd/Frank was adopted.
Regulation 180.1 instituted by the CFTC, according to the webinar, gave the CFTC broad new powers.
(1) Use or employ, or attempt to use or employ, any manipulative device, scheme, or artifice to defraud;
(2) Make, or attempt to make, any untrue or misleading statement of a material fact or to omit to state a material fact necessary in order to make the statements made not untrue or misleading;
(3) Engage, or attempt to engage, in any act, practice, or course of business, which operates or would operate as a fraud or deceit upon any person
Since, several cases which have made it through federal court, have seen an expansion of that power, particularly in virtual currency.
Largely, the argument has fallen on how broad the definition of commodity is.
The CFTC defines a commodity as, “A commodity, as defined in the Commodity Exchange Act, includes the agricultural commodities enumerated in Section 1a(9) of the Commodity Exchange Act, 7 USC 1a(9), and all other goods and articles, except onions as provided in Public Law 85-839 (7 USC 13-1), a 1958 law that banned futures trading in onions, and all services, rights, and interests in which contracts for future delivery are presently or in the future dealt in; (2) A physical commodity such as an agricultural product or a natural resource as opposed to a financial instrument such as a currency or interest rate.
For instance, the CFTC prosecuted Coin Drop Markets, a firm which traded certain virtual currencies for its clients.
This case was heard by Judge Jack Weinstein, who defined commodity as, “Where a futures market exists for a good, service, right, or interest, it may be regulated by CFTC as a commodity, without regard to whether the dispute involves futures contracts.”
This was important because, even though Coin Drop was not itself trading derivatives, their securities were still defined as derivatives because futures markets for them existed somewhere.
“The district court found that the CFTC’s broad authority extends to fraud or manipulation in the derivatives markets and underlying spot markets and that the CFTC may exercise its enforcement power over fraud related to virtual currencies sold in interstate commerce,” one slide noted of the decision.
The definition became even more expansive with another case.
The CFTC took up a case against My Big Coin, its own virtual currency.
Whereas Coin Drop traded Bitcoin and other virtual currencies which had futures contracts- even if it wasn’t trading these futures contracts themselves- My Big Coin was its own virtual currency with no futures market, but the courts have thus far accepted even this as a commodity.
Here is part of another slide.
Defendants filed a motion to dismiss arguing that, because no futures contracts are traded on My Big Coin, My Big Coin was not a “commodity.” As a result, the defendants argued, the CFTC had failed to allege that the supposed fraud involved the sale of a “commodity” and therefore had not stated a cause of action under 6(c)(1).
The CFTC countered that a “commodity” under the Commodity Exchange Act is broader than any particular type or brand of that commodity. Given the existence of Bitcoin futures contracts, the CFTC contended that contracts for the future delivery of virtual currencies are “dealt in”, therefore My Big Coin as a virtual currency is therefore a commodity.
Defendants also argued that Section 6(c)(1) and Regulation 180.1 are restricted to cases involving market manipulation and did not reach the fraud that was alleged in the CFTC’s complaint. The district court disagreed and stated that Section 6(c)(1) and Regulation 180.1 explicitly prohibit fraud even in the absence of market manipulation.
In the broadest ruling, the CFTC sued Monex, even though Monex was never charged with manipulation, but rather with misrepresenting the safety of investments, and there were no derivatives sold.
One slide explained, the CFTC’s position in the case, “The CFTC alleged that, while Monex represented that leveraged precious metals was ‘a safe, secure and profitable way for retail customers to invest,’ the Atlas program was a way for customers to lose money because Monex would be the counterparty to each transaction. As such, the CFTC contended that Monex engaged in fraudulent activity in violation of Section 6(c)(1).”
Monex, on the other hand, argued this according to another slide.
- Monex argued that the CFTC’s anti-fraud authority did not reach the mere fraudulent sale of precious metals.
- Monex contended that Section 6(c)(1) only confers anti-fraud jurisdiction where a particular commodity transaction manipulates or potentially manipulates the derivatives market.
The CFTC continued losing until July 2019, when the US 9th Circuit Court of Appeals issued a favorable decision.
Here is part of an article from National Law Review, “Most relevant to parties trading (non-leveraged) commodities in interstate commerce, the three-judge panel relied upon the plain language of CEA §6(c)(1) to interpret the CFTC’s anti-manipulation authority to not be limited to allegations of market manipulation but also to reach allegations of stand-alone fraud (i.e., fraud in the absence of market manipulation), at least in the context of the sale of leveraged commodities. This interpretation could encourage the CFTC to continue to expand its regulation of commodities in interstate commerce beyond the traditional scope of the agency’s authority.”