Publications

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Prices have spiked to record levels in oil, wheat, gold and many other commodities.  In part this is because investors are seeking to stow their assets in safer places.  However, the spikes have also promoted fears that these and other commodities are being improperly manipulated.   Some consumers and lawmakers are demanding a crackdown on this perceived wrongdoing. 

 

In 2010, the Commodity Futures Trading Commission gained vast new powers from the Dodd-Frank Act.  What exactly is the CFTC empowered to do?  How might the CFTC go about using its new regulatory powers to rein in the commodities rush, and what does this mean for banks, hedge funds and other commodities investors?

 

The CFTC’s new regulatory prowess

Congress created the CFTC in 1974 as an independent agency with the mandate to regulate commodity futures and option markets in the United States.  From the outset, the CFTC has been plagued by limited budgets and manpower.  In addition, it has faced numerous efforts by the Securities and Exchange Commission to usurp its regulatory jurisdiction.  

In July 2010, President Barack Obama signed into law the Dodd-Frank Act.  Under this financial regulatory law, the CFTC is a big winner in the regulatory realignment of oversight of the markets, gaining new authority to regulate the commodities market.  A little-noticed provision of the Dodd-Frank Act, Section 753, gives the CFTC the same authority to police “manipulative and deceptive” conduct in the commodities market as the SEC has for securities fraud. 

Moreover, a new rule proposed by the CFTC, Rule 180.1, will surely extend the CFTC’s regulatory and enforcement reach.  The proposed rule parallels the SEC’s Rule 10b-5 by providing that it is unlawful “for any person, directly or indirectly, in connection with any swap, or contract of sale of any commodity in interstate commerce, or contract for future delivery on or subject to the rules of any registered entity, to intentionally or recklessly use or employ, or attempt to use or employ, any device, scheme, or artifice to defraud.”  The same requirements of scienter, i.e., intent to defraud, and materiality applied in SEC’s fraud cases also apply to the CFTC’s cases. 

To win manipulation cases in the past, the CFTC had to prove that a trader intended to manipulate prices.  Under the financial overhaul's new fraud-based manipulation powers, however, the CFTC's burden of proof will be lower.

Possible ramifications

 

            Wide-ranging policing of fraudulent activities

The CFTC’s new anti-fraud rule could be applied to frauds involving misstatements or omissions of material information, in much the same way that the SEC pursues a wide range of fraudulent activity involving corporate disclosures and investment scams.  Indeed, the CFTC already has targeted "spoofing" – where a trader makes a bid or offer and cancels it before it is carried out.  In February of this year, the CFTC issued an Interpretive Order to provide market participants with guidance on the scope of the new statutory prohibitions as they pertain to spoofing.  Comments were due in mid-May.

The CFTC has also indicated that "banging the close" – in which a trader acquires a substantial position leading up to the closing period and then offsets the position before the end of trading to try to manipulate closing prices – is a targeted activity.

            Significant increase in regulatory actions and investigations

All of this has resulted in a significant increase in regulatory actions and investigations by the CFTC.  In 2010, for example, the CFTC filed 57 enforcement actions (14 percent more than in 2009 and 42 percent more than in 2008).  During that same year, the CFTC opened 419 investigations (an all-time high, which is 66 percent more than the 251 investigations opened in 2009).  CFTC Chairman Gary Gensler has explained that these actions and investigations are aimed at reining in any improper manipulation that may be occurring in the commodities markets. 

Moreover, earlier this month, President Obama requested US$308 million for the CFTC next year, a boost of more than US$100 million over 2011 funding levels.  During the last 12 months, the CFTC has already boosted its staff from around 680 to 720.  The President's 2012 budget request would fund a total staff of 983.  All of this could result in unprecedented regulation, fines and government prosecution. 

Comprehending the CFTC’s new powers

As the CFTC continues to assert its authority in this area, defense lawyers otherwise familiar with the SEC will have to learn the new regulatory limits and powers of this new agency.  At a minimum, those with experience with the CFTC’s enforcement division could find themselves in much greater demand.

There is also the potential for class-wide violations of the new regulations.  Section 25(a) of the Commodity Exchange Act expressly provides that any person “who willfully aids, abets, counsels, induces or procures the commission of a violation” can be sued for violating the new antifraud rule.  Accordingly, it is likely that plaintiffs’ class-action firms will try to bring cases that allege violations of the new Rule 180.1 so that a wider array of defendants, particularly the outside lawyers, accountants and investment advisers, can be brought into the case.

For more information about the CFTC’s powers, please contact:

Perrie Weiner

Patrick Hunnius

Joshua Briones