Position limits head for showdown in court
March 31, 2011 Leave a comment
(Reuters) Consultation has closed on the Commodity Futures Trading Commission’s latest proposal for position limits. Now the rulemaking process embarks on the final stage, which will probably end up before the U.S. Supreme Court.
The last day of the two-month consultation on Monday witnessed a volley of carefully coordinated submissions from Goldman Sachs, Barclays Capital, Morgan Stanley, the International Swaps and Derivatives Association (ISDA) and a host of others, all urging the CFTC to withdraw the proposed rulemaking.
Many of the objections build upon the criticisms set out at length by the Futures Industry Association (FIA) at the end of last week. The responses help lay the legal paper trail that will be cited when the rule is eventually challenged in the courts.
The gulf between the commission and the industry is so broad it is unbridgeable. A legal challenge to the CFTC’s authority to impose position limits appears inevitable. The only question now is who will bring it. None of the big banks, oil companies or institutional investors is likely to want to court controversy by acting as plaintiff.
But the rule could be challenged by an industry association on behalf of its members (there is safety in numbers) or by any individual firm willing to stand up and accuse the CFTC of over-reaching.
The submissions contain a wealth of legal exegesis, some very good, some less so. Objectors urge the commission to alter all aspects of its proposal, from calculation of deliverable supply and spot-month limits to restrictions on out-months, granting bona fide hedging exemptions, treatment of futures and swaps, the aggregation of positions and the independent account holder exemption.
But more fundamentally, most objectors argue the CFTC has no rationale and no legal authority to impose position limits at all, notwithstanding passage of the Dodd Frank Act in July 2010 (PL 111-203).
The FIA continues to argue the commission has no authority to impose limits unless it can come up with objective evidence that speculation has actually burdened interstate commerce and position limits are necessary to cure the problem.
Since the FIA and others argue there is no objective evidence linking speculation to rising commodity prices or excessive volatility, the commission lacks any factual or legal basis to proceed with the rulemaking.
FIA and ISDA cite a lengthy list of studies failing to establish any statistical link — including studies by the IMF, IOSCO, the CFTC’s own economics department and most recently the OECD. Since the studies mostly rely on the same limited underlying data and have been conducted by the same small group of authors, most are really literature reviews rather than independent evaluations.
The burden of proof before proposing limits lies with the CFTC, and the commission has failed to meet it. It is the same argument the FIA raised during the previous consultation on position limits in March 2010 before the passage of the Dodd-Frank Act.
CFTC Chairman Gary Gensler and others at the commission seem to believe that Section 737 of the Dodd-Frank Act cured any problem with its jurisdiction by removing any question about its authority to impose position limits. In fact Section 737 (entitled “Position Limits”) was inserted into the legislation precisely to clarify the commission’s authority in this area and was largely written by the CFTC itself.
Section 737 states “the commission shall by rule, regulation or order establish limits on the amount of positions, as appropriate, other than bona fide hedge positions, that may be held by any person”. This might have appeared to end the debate.
Not so, argues the FIA and most major commodity trading banks. The FIA notes that Section 737 stipulates position limits must be imposed “as appropriate”, which “we submit requires factual support for position limits based on diminishing, eliminating or preventing excessive speculation or deterring and preventing market manipulation balanced against the impact on market liquidity and price discovery“. The original requirements in the Commodity Exchange Act for the Commission to impose limits as “necessary” are also still in force (7 USC 6a(a)).
In a related move, Goldman Sachs argues that if position limits are imposed, they must meet the four-part test set out later in Section 737. This requires the commission “as appropriate” to set limits “to the maximum extent practicable … (i) to diminish, eliminate or prevent excessive speculation … (ii) to deter and prevent market manipulation, squeezes and corners (iii) to ensure sufficient market liquidity for bona fide hedgers and (iv) to ensure the price discovery function … is not disrupted”.
The argument has come full circle. Even after the passage of the Dodd-Frank Act, which appeared to give the commission an unambiguous instruction and power to enforce limits, industry lawyers continue to argue the commission has no authority to do anything of the sort unless it can come up with evidence first.
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This reading of the statute appears strained. It is also at odds with the legislative history. If Section 737 did nothing more than restate existing authority, why did Congress bother to pass it at all? And if Section 737 did not confer new authority to set position limits, why was it one of the parts of the law that was most fiercely resisted by lobbyists on behalf of the industry?
Questions about statutory construction are properly for the courts to decide. The question of how the various phrases in Section 737 fit together and the meaning of “as appropriate” can only be settled by the U.S. Court of Appeals for the District of Columbia Circuit, which hears appeals about rulemakings by independent agencies, and ultimately by the U.S. Supreme Court.
The matter seems bound to end up before the courts. The FIA was quite careful to leave its options open. It urged the commission to withdraw the proposed rule until it has collected and analysed more information to determine whether limits are necessary and appropriate. But “in the alternative” it requested the commission consider various detailed modifications to its proposals. In case anyone missed the hint, the FIA observes that the proposals “may be legally infirm and therefore subject to judicial challenge”.
Other objectors are more circumspect about threatening the regulator with legal action. But the challenge to the CFTC’s rulemaking authority in this area is there. Perhaps the challenge is merely a move to soften up the commission and make it more amenable to specific changes that make position limits less onerous. Or perhaps it is designed to intimidate the commissioners into withdrawing the proposals completely. Only Chairman Gensler and Commissioner Bart Chilton have expressed clear support. Commissioner Jill Sommers is hostile. Commissioners Michael Dunn and Scott O’Malia have wavered and not yet revealed where they stand.
But intimidating the commission is tricky. Dunn is scheduled to retire this summer. President Barack Obama and Senate Majority Leader Harry Reid will try to ensure Dunn’s replacement is a more reliable supporter of limits. Frontrunner Mark Wetjen has previously served as a legislative aide to Reid.
The industry could try to block a pro-limits appointment, but its chances of success are uncertain. The Senate is very clubbable and looks after its own. So later this year the commission could get its third pro-limits vote. And then the matter will head to the courts for a final resolution.
Even if the FIA and the banks decide not to pursue the matter, someone is bound to take it up. Only the courts will be able to settle what “as appropriate” and “necessary” mean in the context of position limits.