United States: CFTC/SEC Jurisdictional Battle Heats Up Over Dividend Indices

Last Updated: August 21 2015
Article by Michael M. Philipp and Ignacio A. Sandoval

The CFTC recently approved a futures contract on a dividend index as a non-security based index futures contract over the SEC's objection that the dividend index contract could be a security future; the CFTC's actions may have implications for market participants in this and other dividend index futures contracts and swaps.

On July 22, the US Commodity Futures Trading Commission (CFTC) issued a conditional order approving a proposed listing by the Chicago Mercantile Exchange (CME) of a futures contract (Index Contract) on the S&P 500 Dividend Index (Dividend Index).1 In approving the listing of the Index Contract as a futures contract, the CFTC determined that the Dividend Index is not a security-based index, but rather an "excluded commodity"2 subject to the CFTC's exclusive jurisdiction. The CFTC made this determination notwithstanding a comment letter filed by the staff of the US Securities and Exchange Commission (SEC) raising "substantial" legal and policy concerns over whether the product should be instead categorized as a security future subject to the joint jurisdiction of both agencies.3

As explained below, while the CFTC's action may clarify its position with respect to dividend index products, the fact that it acted without the concurrence of the SEC could have implications for a variety of market participants that wish to trade in dividend index futures or swaps.

DIVIDEND INDEX

As explained in the CFTC Order, the Dividend Index represents the accrued ex-dividend amounts associated with all the component companies of the S&P 500 cumulated over the course of a specific quarterly accrual period. At any given point, the Dividend Index represents a running total of dividends, through their ex-dividend dates, associated with all the stocks in the S&P 500. The Dividend Index is calculated through a bottom-up approach whereby a running total of the dividends paid by the component companies during the quarter is continuously calculated. The cumulative dividends for the S&P 500 are then converted into index points, which represent the dividend index levels. The issue in contention between the CFTC and the SEC is whether the Dividend Index is a security future (and in particular, a narrow-based security index as defined by the amendments to the federal securities and commodities laws made by the Commodity Futures Modernization Act of 2000 (CFMA)4)or a non-security based index futures contract. Under the CFMA, the SEC and CFTC have joint jurisdiction over security futures products. The effect of the CFTC Order is to exclude the SEC from having the oversight role over the Dividend Index that it would otherwise have if the Index Contract was considered a security future.

REGULATION OF SECURITY FUTURES

The CFMA eliminated a long-standing prohibition against the trading of security futures products by US investors and gave the SEC and the CFTC joint jurisdiction over such products. The Securities Exchange Act of 1934 (Exchange Act) and the Commodity Exchange Act (CEA) each define a "security future" 5 to mean, in relevant part, "a contract of sale for future delivery of a single security or of a narrow-based security index, including any interest therein or based on the value thereof." 6 Because a security future is both a security and a future, securities exchanges and boards of trades that list and trade security futures products, and persons that facilitate transactions in security future products, are subject to the joint jurisdiction of the CFTC and the SEC.7

Of particular relevance in connection with the Index Contract are the changes that the CFMA made to the statutes under the SEC's jurisdiction. The CFMA added Section 6(h) to the Exchange Act which, among other things, (1) makes it unlawful for any person to effect transactions in security futures products that are not listed on a national securities exchange or a national securities association registered under Section 15A(a) of the Exchange Act; 8 and (2) generally requires that security futures products conform with listing standards that are filed with the SEC and that meet criteria specified in Section 2(a)(1)(D)(i) of the CEA.9 In addition, the CFMA added Section 3(a)(14) of the Securities Act, which exempts security futures products from the requirements of that Act, including Section 5, which generally requires that securities be registered with the SEC to be sold. This exemption, however, is conditioned on the security future product being (i) cleared by a clearing agency registered under Section 17A of the Exchange Act or exempt from registration under Exchange Act Section 17A(b)(7) and (ii) traded on a national securities exchange or a registered national securities association.

CFTC ORDER AND SEC OBJECTIONS

In approving the Index Contract under Section 5c(c)(4) of the CEA, the CFTC stated that the Dividend Index is an excluded commodity as defined in Section 1a(19) of CEA because it is an "economic or commercial index based on . . . values or levels that are not within the control of any party to the relevant contract, agreement or transaction,"10 or, in the alternative, is an "occurrence, extent of an occurrence, or contingency . . . that is beyond the control of the parties to the relevant contract, agreement, or transaction and is associated with a financial, commercial, or economic consequence."11 Based on this reasoning, the CFTC took the position that the Dividend Index is not a security or security index and is under its exclusive jurisdiction.

In its comment letter to the CFTC regarding the Index Contract, the SEC stated that there was a reasonable basis for taking the view that the Index Contract is a security future subject to the joint jurisdiction of the agencies. The SEC stated that, because the definition of a security future is contained in statutes that are separately administered by the CFTC and the SEC, neither agency has a final say on whether a product is a security future. The SEC Letter then alluded to discussions between the staff of both agencies on how to analyze whether a future on a dividend index would be viewed as a narrow-based security index and thus a security future under the joint jurisdiction of both agencies. In support of its view that the Index Contract should be under the jurisdiction of both agencies, the SEC highlighted that the definition of a security future includes the concept of "any interest therein or based on the value thereof" relating to a security or a narrow-based index of securities. The SEC then cited to a 2009 order under which it stated that "'[t]he concept of an 'interest therein' in a security plainly includes rights generating a pecuniary interest in a security, such as the right to a dividend payout or bond (coupon) payment.'"12 The SEC Letter goes on to state that the 2009 SEC Order found that "options on the value of dividends declared by issuers of component securities of a group or index of securities are options on an interest in, or based on the value of an interest in, that group or index of securities."13 The SEC Letter then stated that the Index Contract could be viewed as satisfying all of the components in the definition of a narrow-based security index, and that there is a reasonable basis for taking the view that the Index Contract is a security future. It is worth highlighting, however, that while the SEC Letter takes a particularly forceful position, it was sent by the staff and not the SEC as an administrative body. While the SEC, as an administrative body, could take a different view than that expressed by the staff, it is unlikely that the various SEC commissioners were not aware that the staff would be sending the letter. Notably (and consistent with the position taken in the CFTC Order), CFTC staff submitted a comment letter to the SEC in connection with the 2009 SEC Order where it argued, among other things, that the Dividend Index was more akin to an event contract rather than a securities index.14

IMPLICATIONS

The CFTC's decision to approve the Index Contract over the SEC staff's objections will raise a number of uncertainties for market participants, as well as raising questions as to the SEC's authority over security-based swaps.

As an initial matter, because the SEC staff may view futures contracts on dividend indexes as security futures, the SEC may potentially view the listing of such contracts by a Futures Exchange that is not notice registered with the SEC as a violation of Section 6 of the Exchange Act, which requires securities exchanges to register with the SEC. Further, to the extent that persons transact in security futures products on a Futures Exchange that is not also registered with the SEC as a securities exchange (whether fully or through the notice provisions of Exchange Act Section 6(g)), such persons could potentially face liability under Section 6(h)(1) of the Exchange Act. As mentioned above, that section makes it unlawful for any person to transact in security futures products unless such products are traded on a national securities exchange or national securities association. In addition to liability under Exchange Act Section 6(h)(1), persons that transact in futures contracts on dividend indexes that the SEC deems to be security futures could also face liability under Section 5 of the Securities Act because the exemption from registration for security future products only extends to those that are traded on a securities exchange or securities association.15 Additionally, FCMs that are not registered as broker-dealers with the SEC (whether fully or through the notice provisions) could face liability for acting as unregistered broker-dealers when effecting transactions in such products if the SEC took the view that the Index Contracts should be regulated as security futures.

Although the CME is notice-registered as a securities exchange, it is possible that the SEC could argue that the listing of the Index Contract would violate Exchange Act Section 6(h)(2) (which requires that security futures products conform to listing standards as approved by the SEC). Further, the SEC could also take the aggressive view that the CME's notice registration as a securities exchange is ineffective as to the Index Contract.

The views expressed in the CFTC Order also have implications for the jurisdictional allocation between the CFTC and SEC over swaps and security-based swaps. Title VII of the Dodd-Frank Act16 (Title VII) created a comprehensive framework for the regulation of swaps and security-based swaps. Among other things, Title VII created a split approach to the treatment of swaps and security-based swaps, giving the CFTC jurisdiction over swaps and the SEC jurisdiction over security-based swaps. A security-based swap is defined in Section 3(a)(68) of the Exchange Act as any agreement, contract, or transactions that is as a swap (as defined in Section 1a(47) of the CEA) and is based on, in relevant part, "an index that is a narrow-based security index, including an interest therein or on the value thereof" (emphasis added). Although the CFTC and the SEC provided additional guidance in 2012 regarding the definitions of swap and security-based swap, as well as the meaning of a narrow-based security index, they did not specifically address dividend indices.17 To the extent that the CFTC applies its views regarding dividend indices to swaps, there will be implications regarding the regulatory status of swaps on dividend indexes, and whether such swaps are CFTC regulated swaps or are SEC regulated securities based swaps. Thus, concerns over regulatory uncertainty similar to those for Future Exchange, intermediaries, and market participants in the context of the Index Contracts are also present for swaps markets, swaps intermediaries, and swap market participants in the context of swaps on a Dividend Index.

Finally, the CFTC position has potential implications for registered investment companies (RICs) under the 1940 Act because the definition of a "security" under Section 2(a)(36) of that Act includes a "security future," and the CFTC is now characterizing at least some dividend indices as not being security-based indices (and therefore not security futures, and thus not securities). It is unclear whether the CFTC's position regarding dividend indices will give rise to tax issues for RICs under Subchapter M of the Internal Revenue Code. In this regard, RICs may want to consult with experienced 1940 Act counsel and tax counsel when transacting in particular Dividend Index products.

CONCLUSION

While the courts (or Congress) may ultimately have to decide whether the Index Contract and other futures contracts on a dividend index is a security future, in the interim, market participants need to weigh the degree of comfort from and level of regulatory uncertainty surrounding the CFTC Order and its implications. Until there is greater clarity on the SEC's potential actions with respect to the Index Contract and other dividend index contracts, market participants may want to exercise caution when entering into futures contracts on dividend indexes or entering into swap contracts on such products.

Footnotes

1 CFTC, Order Approving the Listing of the Chicago Mercantile Exchange's S&P 500 Dividend Index Futures Contract (July 22, 2015) (CFTC Order) available here.

2 Section 1a(19) of the CEA defines an excluded commodity as "(i) an interest rate, exchange rate, currency, security, security index, credit risk or measure, debt or equity instrument, index or measure of inflation, or other macroeconomic index or measure; (ii) any other rate, differential, index, or measure of economic or commercial risk, return, or value that is (I) not based in substantial part on the value of a narrow group of commodities not described in clause (i); or (II) based solely on 1 or more commodities that have no cash market; (iii) any economic or commercial index based on prices, rates, values, or levels that are not within the control of any party to the relevant contract, agreement, or transaction; or (iv) an occurrence, extent of an occurrence, or contingency (other than a change in the price, rate, value, or level of a commodity not described in clause (i) that is (I) beyond the control of the parties to the relevant contract, agreement, or transaction; and (II) associated with a financial, commercial, or economic consequence."

3 See letter from Brian A. Bussey, Associate Director, Division of Trading and Markets and David R. Fredrickson, Associate Director and Chief Counsel, Division of Corporation Finance, SEC to Christopher Kirkpatrick, Secretary, CFTC, dated July 2, 2015 (SEC Letter), available here.The letter states that the views expressed are only those of the undersigned divisions and not the views of the SEC or any other division or office within the SEC.

4 Public Law 106-554, 114 Stat. 2763 (2000).

5 See Section 3(a)(55)(A) of the Exchange Act and Section 1a(44) CEA. Section 2(a)(16) of the Securities Act of 1933 (Securities Act), Section 2(a)(52)) of the Investment Company Act of 1940 (1940 Act) and Section 202(a)(27) of the Investment Advisers Act of 1940 (Advisers Act) define a security future by cross reference to Section 3(a)(55) of the Exchange Act. A security futures products is defined as a security future or any put, call, straddle, option, or privilege on any security future. See Exchange Act Section 3(a)(56).

6 The Exchange Act and the CEA further define a "narrow-based security index" to "mean an index (i) that has 9 or fewer components; (ii) in which a component security comprises more than 30 percent of the index's weighting; (iii) in which the 5 highest weighted component securities in the aggregate comprise more than 60 percent of the index's weighting; or (iv) in which the lowest weighted component securities comprising, in the aggregate, 25 percent of the index's weighting have an aggregate dollar value of average daily trading volume of less than $50 million (or in the case of an index with 15 or more component securities, $30 million), except that if there are two or more securities with equal weighting that could be included in the calculation of the lowest weighted component securities comprising, in the aggregate, 25 percent of the index's weighting, such securities shall be ranked from lowest to highest dollar value of average daily trading volume and shall be included in the calculation based on their ranking starting with the lowest ranked security." See Exchange Act Section 3(a)(55)(B) and CEA Section 1a(35)(A). The Securities Act, the 1940 Act and the Advisers Act also define a narrow-based security index by cross reference to the definition of a security future in the Exchange Act. See supra note 5.

7 In this regard, the CFMA provided relief to securities exchanges, boards of trade, and market intermediaries to lessen some of the burdens associated with being subject to a dual jurisdictional structure. For example, in order to permit a board of trade that has been designated as a contract market by the CFTC under Section 5 of the CEA (a designated contract market, or "Futures Exchange") to serve as a marketplace for security futures products without having to fully register as a securities exchange with the SEC, Exchange Act Section (6)(g) (as added by the CFMA) permits Futures Exchanges to register as securities exchanges with the SEC through a notice process, subject to certain conditions. Similarly, Section 5f of the CEA (as added by the CFMA) permits securities exchanges to be deemed designated contract markets for purposes of trading security futures.

In addition, persons who intermediate transactions in security futures products are subject to the broker-dealer registration requirements of Exchange Act Section 15(b) and to the futures commission merchant (FCM) registration requirements of CEA Section 4d(a). As with exchanges and boards of trade, a firm that is fully registered as an FCM with the CFTC, or as a broker-dealer with the SEC, may register with the other agency through a notice process. See e.g., Section 4f(a)(2) of the CEA and Section 15(b)(11) of the Exchange Act, and the rules and regulations thereunder.

8 See Exchange Act Section 6(h)(1).

9 See Exchange Act Section 6(h)(2).

10 See Section 1a(19)(iii) of the CEA.

11 See Section 1a(19)(iv) of the CEA.

12 Exchange Act Release No. 61136 (Dec. 10, 2009), 74 Fed. Reg. 66711, 66713 (Dec. 16, 2009) (2009 SEC Order) (citing to Exchange Act Release No. 55871 (June 6, 2007), 72 Fed. Reg. 32376 (June 12, 2007)).

13 See supra note 12.

14 See letter from Julian Hammer, Assistant General Counsel, CFTC to Elizabeth King, Associate Director and James L. Eastman, Chief Counsel and Associate Director, dated May 4, 2009, available here.

15 In this regard, absent statements from the SEC or its staff that caution against market participants entering into these contracts other than on a registered or notice-registered securities exchange, it is unclear whether the SEC would seek to institute enforcement proceedings against end-users of the Index Contract.

16 The Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010).

17 Exchange Act Release No. 67453 (July 18, 2012), 77 Fed. Reg. 48208 (Aug. 13, 2012) (2012 Release). As reflected in the SEC Letter, the CFTC and the SEC did state in the 2012 Release that "a security index in most cases is designed to reflect the performance of a market or sector by reference to representative securities or interests in securities." Id. 77 Fed. Reg. at 48285.

This article is provided as a general informational service and it should not be construed as imparting legal advice on any specific matter.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions