The United States District Court for the District of Columbia last week struck down the Commodities Futures Trading Commission (CFTC)’s Position Limits for Futures and Swaps final rule and interim final rule in International Swaps and Derivatives Association v. CFTC. The court found that the CFTC failed to determine that such position limits were “necessary to diminish, eliminate, or prevent … [undue] burden” on interstate commerce. In a unique conflict over plain language, the court provides an opinion replete with subtle application of the canons of statutory construction. At bottom, the court found that the CFTC was wrong that a provision of the massive Dodd-Frank Wall Street Reform and Consumer Protection Act required the CFTC to adopt position limits. Under the correct interpretation, the CFTC failed to make a statutorily required finding of necessity, dooming the position limits rule.
Swap Primer: One can argue about the fundamental reasons for the financial meltdown several years ago, but one key element that contributed may be the need to understand swaps and derivatives. At great hazard, taking lead from the court, three types of “commodity derivatives” are implicated in this case:
- Futures contract: a contract to buy or sell a specific quantity of a commodity (lumber, corn, pigs) at a particular date and location in the future.
- Options contract: a contract where the buyer has the right (may), but not the obligation (must), buy or sell a specific quantity of a commodity at a specified price at a point in the future. The parties essentially gamble on the price being higher or lower at that future date. Some options are for actual delivery, but most are pure ‘money’ cash settlement contracts.
- Swaps: contracts involving one or more exchanges of payments based on changes in the prices of specified underlying commodities without transferring ownership of the underlying commodity. Some may refer to this as ‘gambling on gambling.’
A “position limit” is a limit on the maximum number of derivatives contracts that a trader or group of traders may own during a given period. Even more detail abounds, but that can be left to securities and commodities experts.
Issue: The Commodity Exchange Act of 1936 (CEA) grants the CFTC discretion to set position limits on futures and options contracts in commodity derivatives markets as the CFTC “finds are necessary to diminish, eliminate, or prevent” excessive speculation. This required consideration appears as a determination in many pre-Dodd-Frank rules. In the post-Dodd-Frank position limits rule, the CFTC made no such determination.
This case largely turns on whether the CFTC, in promulgating the Position Limits Rule, correctly interpreted [CEA requirements] as amended by Dodd-Frank. Although both sides forcefully argue that the statute is clear and unambiguous, their respective interpretations lead to two very different results: one which mandates the Commission to set position limits without regard to whether they are necessary or appropriate, and one which requires the Commission to find such limits are necessary and appropriate before imposing them.
Chevron reminder: The core lesson of Chevron applies here: A court must first determine whether the plain language of a statute dictates a result and, if so, follow that result (Chevron Step 1). If, however, the statute is ambiguous, the agency has delegated jurisdiction and expertise (not issues here), has interpreted the ambiguity, and the interpretation is reasonably within the bounds of the statute, the court must defer to the agency’s interpretation (Chevron Step 2). In this case, the court never passed Chevron Step 1.
Arguments & Remedies: The more-than-143-word statutory sentence is deeply complicated – and the court set out a pre- and post-Dodd-Frank redline as a helpful appendix – but that does not mean that the statute is not clear:
For the purpose of diminishing, eliminating, or preventing such burden, the Commission shall, from time to time, after due notice and opportunity for hearing, by rule, regulation, or order, proclaim and fix such limits on the amounts of trading which may be done or positions which may be held by any person … under contracts of sale of such commodity for future delivery on or subject to the rules of any contract market or derivatives transaction execution facility, or swaps traded on or subject to the rules of a designated contract market or a swap execution facility, or swaps not traded on or subject to the rules of a designated contract market or a swap execution facility that performs a significant price discovery function with respect to a registered entity, as the Commission finds are necessary to diminish, eliminate, or prevent such burden.
Taking the task to heart, the court summarized the Chevron Step 1 problem:
In sum, although each party believes the statute is clear and unambiguous, their respective “plain readings” compel different results. Ultimately, however, this Court need not choose between the competing interpretations. As explained below, Section 6a is ambiguous as to the precise question at issue: whether the CFTC is required to find that position limits are necessary and appropriate prior to imposing them. Because the Position Limits Rule is based on the CFTC’s erroneous conclusion that the CEA is unambiguous on this issue, the Court “may neither defer to the agency’s construction nor endorse plaintiffs’ construction.”
The problem for the court, in part, was pinning down the CFTC’s shifting positions, which the court takes pains to explain. The CFTC made numerous arguments, abandoned some, and made others poorly.
In the end, under Chevron Step 1, the CFTC position was not supported by the language of the statute under the normal canons of statutory construction. Although the court’s opinion does not specifically reference the interpretive rules of thumb, the application is clear.
The court could not reach Chevron Step 2 because deference to the CFTC’s interpretation of a statute is not appropriate when the CFTC wrongly believed that Congress compelled that interpretation. The court was left with no choice but to remand to the CFTC, and necessarily vacated the rule because, applying the Allied Signal test, the court could not be sure that the CFTC would reach the same conclusion and permitting the rule to be effective would be more disruptive than vacating it.
Do not expect the CFTC to act again soon on the position limits rule – it has much work to do to determine whether position limits are necessary to diminish, eliminate, or prevent burdening interstate commerce resulting from excessive speculation. This analysis is more complex than most supporting analyses required of agencies and the CFTC may need to start from scratch and seek public comment on a new interpretation of Dodd-Frank.