The United States District Court for the District of Columbia granted the agency summary judgment in Investment Company Institute v. Commodity Futures Trading Commission (CFTC), leaving intact the Commodity Pool Operators and Commodity Trading Advisors: Compliance Obligations final rule (as corrected) (the “pool” rule). Plaintiffs claimed that the CFTC had violated the Administrative Procedure Act (APA) and the Commodity Exchange Act (CEA) by, among other things,
- failing to consider adequately factors mandated by the CEA,
- failing to harmonize the rule with Securities and Exchange Commission (SEC) rules, and
- imposing unwarranted burdens.
The court analyzed the specific merits in a lengthy and detailed opinion, but numerous administrative law issues leave much food for thought.
Background: Securities and commodities lawyers please skip this summary – it cannot begin to do justice to the complicated and arcane subject; anyone with a more general interest in administrative law, read on.
The CFTC regulated certain commodities pool operators and commodity trading advisors until 2003, when it promulgated certain compliance and reporting exclusions – the “pool” rule (not to be confused with the position limits rule). After the economic turmoil, the Dodd-Frank Wall Street Reform and Consumer Protection Act, or Dodd-Frank, directed the CFTC to once again regulate these registered investment companies. The CFTC proposed and promulgated (in February 2012) a new provision that reinstates, with some modifications, a pre-2003 trading threshold and marketing restriction for advisers who were claiming an exclusion from CFTC regulation. In effect, the CFTC rescinded certain registration and reporting exclusions that had been in effect for the last nine years to respond to the legislative changes enacted in the Dodd-Frank.
CFTC made the “pool” rule provisions effective on April 24, 2012, and July 2, 2012, but postponed “swap” compliance with these challenged sections pending harmonization with SEC rules when the “swap” rule was promulgated and effective. The CFTC proposed the “swap” rule at the same time it promulgated the “pool” rule, and the joint CFTC / SEC promulgated the “swap” rule in August 2012.
Plaintiffs sued in district court (in April 2012), making a number of arguments the CFTC failed to:
- Perform a proper cost benefit analysis under the CEA’s explicit requirements;
- Explain its reversal of its 2003 decision that CFTC regulation of was unnecessary, burdensome and would impair liquidity;
- Articulate discernible benefits from the rule –beyond those already provided to investors through existing regulation;
- Provide rational justifications for the changes to Rule 4.5 as well as the added regulatory requirements and restrictions faced by funds that can no longer rely on the previous exclusions rule.
The parties cross-moved for summary judgment (with the defendant moving also for appropriate dismissals) – a typical mechanism to resolve APA cases. The court found none of plaintiffs’ arguments to have merit, but some aspects of the decision raise additional administrative law concerns worth noting.
Swaps Definition: Plaintiffs complained that the CFTC had not defined a core term that made its analysis of costs and benefits impossible: “swaps.” Whatever a “swap” may be in derivatives regulations, the CFTC imposed requirements on swaps and separately – and later, after this litigation was filed – adopted a joint rule with the SEC defining “swaps.” The court, however, relied upon the detailed definition of swaps in the Dodd-Frank Act and the Dodd-Frank requirement that the CFTC and SEC adopt a joint rule as sufficient.
How the statutory definition and a later regulatory definition can justify the assessment of costs to be done during an earlier proposed and final rule remains something of a mystery and the court’s analysis demystifies little. The argument harkens back to the definitions in the Environmental Protection Agency (EPA) “NESHAP & CISWI” rules, but the CFTC avoided the problem. This problem is not, however, whether an agency may develop regulatory programs incrementally, but whether the increments used give sufficient notice of the requirements and the analysis supporting those requirements in a timely fashion to permit public comment and notice of the “rules of the game.”
Harmonization & Ripeness: The district court found that the plaintiffs’ claims that the CFTC failed to harmonize its rule with the SEC rules was not “ripe” for review – particularly because the CFTC delayed the compliance date until the effective date of the “swaps” definition. The “swaps” definition and the “pool” rule mandate compliance at the same time, but the compliance date in the “swaps” rule is not entirely clear from the face of the rule. Indeed, the final swaps rule appears, in some ways, not to be final at all.
Plaintiffs, however, could not have known the CFTC’s harmonization process with any certainty at the time of the “pool” proposed rule, and only to some degree in the delay in final rule. The court may be correct that the definition issue is not “ripe” for review because of the imposed compliance delay, a problem that has arisen elsewhere, but the lack of harmonization and ripeness leaves a rule in place with some fixed compliance date that is not clear.
The Office of Management and Budget (OMB) performs a harmonization function within the Executive Branch, and Dodd-Frank requires two independent agencies to perform this function among them. The court’s opinion and the various rules adopted by the CFTC and SEC leave this harmonization less than clear and the regulated parties need to figure it out.
Statutory Cost & Benefit Factors: Plaintiffs argued that the CFTC failed to analyze under the CEA: “(A) considerations of protection of market participants and the public; (B) considerations of the efficiency, competitiveness, and financial integrity of futures markets; (C) considerations of price discovery; (D) considerations of sound risk management practices; and (E) other public interest considerations.”
The district court disagreed, distinguishing previous failures – Chamber of Commerce, American Equity, and Business Roundtable – because the agencies in those cases failed to consider statutory factors, whereas, here, the court found that the CFTC considered and evaluated the costs and benefits, as required by the CEA. The court concluded that the CFTC fulfilled its obligation under the CEA to consider the costs and benefits of its proposed rule, and the CFTC considered the relevant factors, acted within its discretion, and was not arbitrary or capricious in promulgating the final rule.
The decision does not appear, however, to coordinate the CEA factor consideration requirements with broader APA “examine the relevant data and articulated a satisfactory explanation” analysis applied to factors that are relevant as points of contention. Judicial review of an agency’s duty to “examine the relevant data and articulated a satisfactory explanation” ought to be understood in a structured, tiered way:
- “higher” scrutiny of agency compliance with detailed statutes such as the CEA (in other D.C. Circuit cases) because it is a specific statutory requirement than;
- “upper middle” scrutiny of costs on small entities in an initial and final regulatory flexibility analysis under the Regulatory Flexibility Act (RFA), or even certification that a rule will not “have a significant economic impact on a substantial number of small entities;”
- “lower middle” scrutiny of cost and benefit analysis applicable to an Executive Branch agency consideration in an regulatory impact analysis under Executive Order 12,866, and
- “generalized” (or lowest) scrutiny applicable to ensure that an agency has “examined the relevant data” under the APA where no external direction applies.
Applying these levels of scrutiny would follow the level of specific direction provided by Congress, and, in certain cases, the Executive. The courts may find a need to consider the “searching review” issue (and the inverted deference to agency interpretation of ambiguous statutes under Chevron more closely.