United States: Ninth Circuit Reinstates CFTC Anti-Fraud Enforcement Action

Last Updated: August 1 2019
Article by Robert Zwirb

Most Read Contributor in United States, July 2019

The Court of Appeals for the Ninth Circuit ruled in favor of the CFTC in connection with fraud-related charges against a precious metals credit company. This decision overturned the District Court's decision to dismiss the CFTC enforcement action.

The CFTC alleged that Monex Credit Company ("Monex"), which sells precious metals to investors, defrauded thousands of retail customers through illegal, off-exchange leveraged commodity transactions. In March 2018, the district court dismissed the CFTC's case against Monex, saying that (i) it lacked "authority" over the alleged fraud due to the fact that Monex makes "actual delivery" of precious metal to customers and (ii) the relevant anti-fraud provision of Commodity Exchange Act (the "CEA"), prohibiting the employment of "any manipulative or deceptive device," prohibits only fraud related to market manipulation.

The Ninth Circuit reversed both prior rulings, holding that "actual delivery" requires clear "transfer of some degree of possession or control" under the CEA, which it found did not occur in this case. Further, the Ninth Circuit ruled that the CEA prohibits fraud regardless of whether there has been market manipulation, rejecting the respondent's argument that the words "any manipulative or deceptive device" (emphasis added) requires proof of both fraud and manipulation.

Commentary Bob Zwirb

The outcome in this case represents a clear and significant victory for the CFTC. It clarifies two points of contention: (i) whether "actual delivery" can be satisfied by simply transferring title to the customer (the answer is No), and (ii) whether the CFTC's new anti-fraud authority bestowed by Dodd-Frank allows it to go after what the Court calls "stand-alone" fraud in the absence of manipulation (the answer is Yes). To answer both questions, the Ninth Circuit relied upon the plain language of the CEA (as amended by Dodd-Frank), or, as the Court put it, upon "[a] two-letter conjunction and a two-word phrase" in the statute.

One would think that given the plain language of the statute, this case would have been a slam dunk for the CFTC from the start. But, as the Court alluded to, the case was inextricably tied to a series of previous decisions unanimously rejecting the CFTC's position that similar contracts offered to farmers and retail investors constitute illegal futures contracts. See, e.g., Nagel v. ADM Investor Svcs., 217 F.3d 436 (7th Cir. 2000) (holding that hedge-to-arrive contracts between a farm cooperative and grain producers are forwards, not illegal futures); CFTC v. Zelener, 373 F.3d 861 (2004), reh'g and reh'g en banc denied, 387 F.3d 624 (7th Cir. 2004), CFTC v. Erskine, 512 F.3d 310 (6th Cir. 2008), reh'g and reh'g en banc denied (6th Cir. 2008) (rejecting CFTC's position that "rolling spot" forex contracts sold to the general public are illegal off-exchange futures). As the Court in Bank Brussels Lambert, S.A., v. Intermetals Corp., 779 F. Supp. 741, 748-49 (S.D.N.Y. 1991) observed, "[t]he Act does not purport to cover all speculation . . . that is extended over a period of time. It covers futures contracts."

Those cases, all of which preceded Dodd-Frank, dealt with whether contracts that did not result in delivery were futures or not. Notwithstanding the lack of delivery for contracts that closely resembled futures, the Courts in these cases held that they were not futures, but rather forwards or spots. Dodd-Frank got around this judicial roadblock, as the Ninth Circuit noted, by extending the CEA to certain retail commodity transactions offered on a leveraged or margined basis "as if they were futures." With this enhanced authority, the CFTC's jurisdiction as to potential misconduct is far broader.

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