ICI vs. CFTC
Commentary by Bob Zwirb
ICI has filed a brief with the U.S. Court of Appeals for the District of Columbia Circuit in connection with its appeal of a federal district court's decision that had rejected ICI's challenge to CFTC amendments to Rule 4.5 (which, among other things, provides certain exclusions from the definition of "commodity pool" and "commodity pool operator"). The CFTC amendments challenged by ICI had reinstated a trading threshold and marketing restriction for registered investment companies ("RICs") claiming an exclusion from the definition of "CPO" under Rule 4.5. (The CFTC had previously rescinded the trading threshold and marketing restriction in 2003.)
ICI's appeals brief argues that the CFTC: i) arbitrarily reversed its prior rulemaking with no meaningful justification; ii) failed to assess the adequacy of existing regulation of RICs by the SEC; and iii) relied on specific purported benefits not supported by analysis. The brief also argues that the only two specific benefits cited by the CFTC for these amendments - the promotion of fitness and competency of registered entities and the need to address wrongdoing - are already provided by SEC regulation.
See: Investment Company Institute v. CFTC - Brief for Appellants [U.S. Court of Appeals for the D. C. Circuit, 12-5413].
See also: Prior Zwirb Comment: ICI vs. CFTC to Go on Appeal (with Zwirb Comment).
See also: Prior Zwirb Comment: ICI Chamber of Commerce v. CFTC: CFTC Wins; Registration Rules for RICs Still Stand (with Zwirb Comment).
Commentary
We have twice before commented on this case as it was resolved by the lower court, opining that the court had set a low bar for the CFTC to satisfy in demonstrating its statutory duty to consider the costs and benefits of the Rule 4.5 amendments. On appeal, ICI targets the CFTC's abrupt reversal of its 2003 decision to eliminate the very restrictions that it is now re-imposing on RICs. A basic tenet of administrative law is that when an agency changes course, it must provide a "reasoned explanation" for disregarding facts and circumstances underlying a prior policy. In 2003, the CFTC did away with trading and marketing restrictions, thus exempting RICs from commodity pool registration and regulation, because it found that such entities were "otherwise highly regulated," and because it wanted to encourage their participation in the commodity futures markets so as to increase liquidity. Now less than ten years later, the CFTC has layered regulation by itself and NFA on top of existing regulation by the SEC, and furthermore, has cited increased participation by RICs in its markets as the reason for its reversal - something that the CFTC's 2003 action was designed to foster - as a ground for regulating such entities as commodity pools.
ICI also criticizes both the CFTC and the lower court for invoking a change in regulatory "philosophy" brought about by the 2008 financial crisis and the passage of Dodd-Frank in support of the Rule 4.5 amendments. ICI's brief relies heavily on the dissenting statement of (retiring) Commissioner Sommers in which she points out that Dodd-Frank did not mandate these amendments nor call for narrowing the scope of exemptions to the CFTC's commodity pool rules. More significantly, she also pointed out that there was no evidence to suggest that inadequate regulation of commodity pools contributed to the financial crisis. In our previous comments, we had pointed out that it was difficult to reconcile the CFTC's rationale with the points made by Commissioner Sommers. As with other CFTC rules that have been subject to court challenge, e.g., the position limit rules, the CFTC also relies upon general statutory authority provided by Congress for imposing the rule. But ICI's rebuttal is that the CFTC cannot rely on statutory authority to override its obligation to perform meaningful cost-benefit analysis.
This is not your father's cost/benefit case, given the CFTC's abrupt change in policy here and the points raised by Commissioner Sommers. Moreover, a lot is at stake here, for if ICI does not prevail on appeal, mutual funds that deal in swaps will be subject to duplicative regulation that is likely to prove quite expensive to the mutual funds and to the primarily retail investors in such funds.
Our own perspective is that the real reason for the CFTC's action here has little to do with that being debated by the parties. Recall that the rule amendments were adopted last year in response to a petition by NFA to capture off-shore RICs that were marketing themselves as commodity pools to U.S. investors. The petition appealed to the paternalistic instincts of the Commission and was quickly adopted with little analysis. But the rule amendments, according to ICI, will sweep in more than those operating as "de facto" commodity pools. It remains to be seen whether the analysis engaged in by the CFTC in support of its action will withstand scrutiny on appeal.