The CFTC and Position Limits

Earlier this fall the Court in International Swaps and Derivatives Association v. CFTC, Civil Action No. 11-cv-2146 (D.D.C. Ruling Sept. 28, 2012) rejected the CFTC’s claim that Dodd-Frank required the imposition of position limits. The action challenged the position limits set by the agency on derivatives tied to 28 physical commodities. Plaintiff disputed the CFTC’s claim that it was required by Dodd-Frank to establish the position limits, thus excusing the agency from making findings to support the need for the limits.

The rule had been adopted by a 3-2 vote of the Commission. Those voting in favor took the position that the Act required the limits. The court rejected that view, holding that the Commission misinterpreted the statute. Section 6a(a)(1) of the Act “clearly and unambiguously requires the Commission to make a finding of necessity prior to imposing position limits.” This language from the CEA has remained largely unchanged from the time of its initial passage through Dodd-Frank.

Despite the court ruling however, it appears that there will in fact be position limits. The CFTC is preparing to both appeal the ruling of the district court and promulgate a new rule. In recent remarks, CFTC Commissioner Bart Chilton first reviewed rule making under Dodd-Frank and then addressed the need for position limits. Remarks, “Sin-Orgy and Energy,” an Address to the Globalization and Energy Markets: Investment and Commodity Price Cycles Conference (Huston, Tx. Nov. 9, 2012).

Initially, the Commissioner noted that Dodd-Frank requires 398 rules or regulations to be promulgated by various Federal agencies. At this point only 133 have been completed, about 33%. The CFTC has completed 39 rules of the 60 it was required to write.

Position limits is one of the rules the Dodd-Frank required the agency to write, according to the Commissioner. Those limits are necessary to curb excess speculation in the markets which can cause significant price increases not tied to the fundamentals of supply and demand. As an example Commissioner Chilton noted that “In 2008, the massive influx of long-side speculation levels coincided precisely, exactly with the highest-ever crude oil and gasoline prices in our country . . . West Texas intermediate crude oil . . . at $147 and gas prices at $4.10 a gallon . . . not a sole has ever provided a supply and demand fundamentals-only explanation to support this price movement. That’s because it doesn’t exist.”

The Commissioner went on to argue that there are numerous studies which establish that excessive speculation is responsible for driving up prices. One, authored by Professors Amy Myers Jaffee and Ken Medlock found: “So, as the market presence of noncommercial traders increased between 2003 and 2008 the stance of these noncommercial traders has fairly consistently been to hold bullish, long positions that supported rising prices. And, when their market share was highest, so was their net long position, which again roughly coincided (acting as a slight leading indicator) with the peak in oil prices at $147 a barrel in the middle of 2008.”

This type of activity causes a problem for two reasons, Commissioner Chilton noted. First, commercial hedgers such as energy companies that have investments, use the markets to mitigate business risks. Those markets were not made for gambling but for price discovery. Second, consumers and businesses benefit from relatively stable prices. Extremely volatile prices for commodities such as gasoline undercut that stability.

It is this backdrop, the Commissioner noted, that lead to the requirement in Dodd-Frank that the CFTC impose position limits. Accordingly, the Commission plans to appeal the ruling of the court. At the same time Commissioner Chilton noted that the issue is of such importance that his staff is preparing a new rule which he hopes to issue with a very short comment period.

The difficulty with the Commissioner’s position, at least in part, is that the court concluded Dodd-Frank did not require position limits. That means that the agency must make findings to justify the limits. In passing the rule it did not. If the court has correctly read the statute then the agency cannot prevail on appeal.

At the same time, there is nothing in International Swaps which precludes the CFTC from writing a new position limits rule. Indeed, the crux of the ruling was that the agency had not properly promulgated the rule because of its view that it was required to write it. In writing a new rule the Commission can correct this point. Accordingly, regardless of the merits of the court’s ruling, it appears there will be position limits. Whether this results from the Commission writing a new rule supported by the proper findings, the Court of Appeals reading Dodd-Frank as three CFTC Commissioners do or both remains to be determined.

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Seminar: The ABA’s premier program on securities fraud, the National Institute on Securities Fraud, will be held on November 15 and 16, 2012 in New Orleans (here).

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