Derivatives lawyers are not known to be an excitable bunch.  But a recent opinion from the U.S. District Court in the Northern District of Texas has derivatives lawyers excited, and not in a good way.  The judge has vastly restricted the CFTC’s traditional jurisdiction over energy, metal, financial, and other commodities through misreading a core provision of the Commodity Exchange Act (CEA), which is the primary source of U.S. derivatives regulation.  If a judge had read the SEC’s authority to regulate securities as not covering debt securities, the holding would be neither as momentous nor as absurd.

The case is an action by the CFTC and a number of states against a variety of related entities and individuals that operated the website Metals.com (the defendants collectively, “Metals”).  This website offered investment opportunities in gold and silver bars and coins.  It advertised the markups it charged on these investments, which the government alleges gave a falsely low impression of the actual markup.  The government likewise alleges that Metals defrauded at least 1,600 people into buying substantial amounts of gold and silver bullion at inflated prices. All told, customers invested over $140 million in retirement savings and $45 million in cash accounts.  As part of marketing, Metals assisted customers in transitioning their retirement plans into self-directed individual retirement accounts so they could access Metals products in lieu of parking their savings in traditional instruments such as diversified mutual funds and ETFs.

The court, however, did not ask whether the defendants defrauded hundreds of retirees out of their life savings.  The court stopped at a jurisdictional issue.[1]  The CFTC was proceeding under Section 6(c)(1) of the CEA, which provides in relevant part that “It shall be unlawful for any person, directly or indirectly, to use or employ, or attempt to use or employ, in connection with any . . . contract of sale of any commodity in interstate commerce . . .  any manipulative or deceptive device or contrivance, in contravention of such rules and regulations as the Commission shall promulgate.”  My ellipses exclude references to derivatives instruments (swaps and futures) and focus attention on the CFTC’s authority to pursue fraud involving a “commodity.”  Since the enactment of the CEA in 1974, the term commodity has been understood to reference markets for underliers to derivatives.  The drafting defining the term “commodity.” however, is purposefully tricky, and engagement with it is part of every budding U.S. derivatives lawyer’s education.

The term commodity is defined in the opening of the CEA as follows with braces (i.e., {}) added by me to help parse the definition:

The term ‘commodity’ means {wheat, cotton, rice, corn, oats, barley, rye, flaxseed, grain sorghums, mill feeds, butter, eggs, Solanum tuberosum (Irish potatoes), wool, wool tops, fats and oils (including lard, tallow, cottonseed oil, peanut oil, soybean oil, and all other fats and oils), cottonseed meal, cottonseed, peanuts, soybeans, soybean meal, livestock, livestock products, and frozen concentrated orange juice}, and all other goods and articles, {except onions (as provided by section 13–1 of this title) and motion picture box office receipts (or any index, measure, value, or data related to such receipts)}, and all services, rights, and interests (except motion picture box office receipts, or any index, measure, value or data related to such receipts) in which contracts for future delivery are presently or in the future dealt in.[2]

In other words, the term commodity (a) includes a number of agricultural products referenced in the first set of braces, (b) excludes onions and motion picture box office receipts (as well as related items) referenced in the second set of braces, and (c) also includes any goods, articles, services, rights and interests “in which contracts for future delivery” are presently or in the future dealt in.  Contracts for future delivery are a synonym for futures.  In other words, the structure of the definition of commodity allows the term to encompass anything (i.e., any good, article, service, right or interest) that underlies a futures contract that derivatives exchanges offered in 1974 or come to offer subsequently (other than onions and box office receipts, for anecdotally interesting reasons).  This key feature enables the term commodity to expand as derivatives exchanges develop new futures products.[3]

Much has been said about how this ties CFTC jurisdiction to private market activity.  And the breadth of the term commodity most recently received heated attention after futures and other derivatives developed on Bitcoin and Ether.  Arguments were subsequently made as to whether the term “commodity” includes other cryptocurrencies or just Bitcoin and Ether tokens, and much thinking was done regarding fungibility of various crypto tokens.[4]  But that is a discussion for another post.  I want to come back to the language defining the term commodity on the basis of what underlies a futures contract.

The judge who wrote the Metals.com opinion did not appreciate that language.  Instead, he applied the ejusdem generis canon of interpretation and limited the term commodity to agricultural items, writing:

The CFTC hangs its hat on “all other goods and articles . . . in which contracts for future delivery are presently or in the future dealt in.” But as the Supreme Court famously explained, “Congress . . . does not alter the fundamental details of a regulatory scheme in vague terms or ancillary provisions—it does not, one might say, hide elephants in mouseholes.“ Rather, we must read all other goods and articles in its context, which is a lengthy, enumerated list of predominantly agricultural items—with onions getting very special treatment. (internal citations and footnotes omitted).

As a result, in the Northern District of Texas, the CFTC now lacks authority to police markets for commodities like energy products (e.g., oil or natural gas), metals and countless financial instruments (e.g., interest rate and foreign exchange products).  This may not be the end of the story.  Many derivatives lawyers are excited, as I mentioned above, and an appeal is possible.  The CFTC has also filed briefing at the trial court, asking the judge to reconsider his views.  Good sense, after a painful struggle, may prevail.  But what is more interesting is not the end but an earlier part of the story that happened about half a century ago.

The difficult language comes from maneuvering between congressional committees at the birth of contemporary derivatives regulation in 1974, when the CFTC was formed and the CEA’s jurisdiction expanded beyond agricultural products.  The House and Senate committees on agriculture appreciated that the CEA was greatly expanding their jurisdiction and placing them in conflict with the committees that oversaw financial markets (and their regulators, e.g., the SEC and banking regulators).  There were key questions at the time about what would happen if a derivatives exchange offered futures trading on securities or other financial products such as mortgages.  Would these futures expand the definition of commodity and have the CEA reach products within the SEC’s jurisdiction or traded in markets for banking products regulated by the banking regulators?  Paired with these questions and making them more acute was a provision in the CEA providing the CFTC with exclusive jurisdiction over derivatives on commodities.

Philip F. Johnson provides a masterful account of the maneuvering and misdirection in the Senate and House as the legislation wound through Congress.[5]  Members of the agricultural committees tried to reassure their colleagues, who may not have carefully read the legislation before voting on it, that the impact on other committees (and their agencies) were minimal.  The tricky drafting that dwells on agricultural products without mentioning the myriad other products derivatives exchanges were already offering (including metals futures) and had plans to offer (which at the time included interest rate and foreign exchange products) can be seen as part of those efforts to distract attention from the massive land grab the agricultural committees were making in 1974.  That the agricultural committees in the House and Senate oversee massive markets in derivatives on energy products, metals, and various financial instruments is an anomaly that reflects path dependency and congressional politics.  The minimization of non-agricultural products in the 1974 drafting reflects these politics.  This minimization helped confuse the judge in Metals.com, just as it helped persuade members of the 1974 Congress that the grant of jurisdiction over commodities to the CFTC (and its parent congressional committees) was not a big deal.  Oh, what a tangled web we weave, when first we practice to deceive.

ENDNOTES

[1] Notably the court did not approach the question with a scalpel but with a nuclear-powered chainsaw.  It would have been far more reasonable to ask if the collectible coins the defendants were selling were commodities, as arguments can be made that no derivative has coins as an underlying asset and the coins are not all fungible.

[2] 7 U.S.C. 1a(9).

[3] William L. Stein, The Exchange-Trading Requirement of the Commodity Exchange Act, 41 Vand. L. Rev. 473, 485-86 (1988) (explaining that “Congress recognized the need for an open-ended definition that would capture the emerging futures markets in financial products and indices as well as innovative products in non-traditional goods and services”).

[4] CFTC v. McDonnell, 287 F.Supp.3d 213 (E.D.N.Y. 2018).

[5] Philip F. Johnson, The Commodity Futures Trading Commission Act: Preemption As Public Policy, 29 Vand. L. Rev. 1 (1976).

This post comes to us from Professor Ilya Beylin at Seton Hall Law School.