A roadmap through the dishonest judicial "reasoning" used to subvert Dodd-Frank.
Distilled down to the simple basics, the "rationale" behind ISDA v. CFTC, which neutralizes a key provision of Dodd-Frank, is simple. Nothing in the law--no newly enacted statute, no regulatory practice, no clear expression of intent by Congress--has changed since 1936.
Imagine a Federal District Court Judge who interpreted telecom law by referencing the Radio Act of 1927, while disregarding the Federal Communication Act of 1934, which first established the FCC. Or imagine a judge who interpreted bank regulations based on the Aldrich-Vreeland Act of 1908, and disregarded the impact of the Federal Reserve Act of 1913, which first established the Fed.
ISDA v. CFTC, handed down on September 28, 2012, is that kind of travesty. To emasculate a key part of Dodd-Frank, U.S. District Court Judge Robert L. Wilkins offered up a logically incoherent decision, a masterwork of duplicity .
Putting it all in context, and unraveling all of his dissemblance, takes a bit of explaining. So let’s start out with the smoking gun.
The Smoking Gun
Judge Wilkins purports to interpret a single statute, 7 U.S.C Section 6(a)(1), which directs the Commodity Futures Trading Commission (which Wilkins refers to as “the Commission” or “the CFTC”) to impose position limits on certain commodity futures contracts. It says:
Excessive speculation in any commodity under contracts of sale of such commodity for future delivery …is an undue and unnecessary burden on interstate commerce in such commodity. For the purpose of diminishing, eliminating, or preventing such burden, the Commission shall… proclaim and fix such limits on the amounts of trading which may be done or positions which may be held by any person… as the Commission finds are necessary to diminish, eliminate, or prevent such burden.The statute, in its original incarnation, was part of the Commodity Exchange Act of 1936 (which Wilkins refers to as “the CEA”). Wilkins writes:
The contested language in Section 6a(a)(1) has remained largely unchanged from the initial passage of the CEA to the Dodd-Frank amendments… The text does not state (nor has it ever) that the CFTC may do away with or ignore the necessity requirement in its discretion. There is no ambiguity as to whether the statute requires the CFTC to make such findings, and the CFTC has never apparently treated the statute as ambiguous on this point.His analysis is a complete crock. The statute uses defined terms that had been dramatically altered since the initial passage of the CEA. So it is absolutely untrue that, for 45 years after the passage of the CEA, the CFTC made necessity findings prior to imposing position limits under Section 6a(a). Wilkins can cite no evidence that the CFTC ever made necessity findings prior to imposing such position limits. Certainly, from 1981 up until 2011, the CFTC imposed position limits without preliminary “necessity findings,” and no one, no trader, no member of Congress, nobody, ever objected.
Accordingly, the Court concludes that § 6a(a)(1) unambiguously requires that, prior to imposing position limits, the Commission find that position limits are necessary to “diminish, eliminate, or prevent” the burden described in Section 6a(a)(1)… For 45 years after the passage of the CEA, the CFTC made necessity findings prior to imposing position limits under Section 6a(a).
Simple arithmetic destroys his "legislative history." The CFTC never existed prior to April 1975, when it was established pursuant to the passage of the Commodity Futures Trading Commission Act of 1974. So it was impossible for the CFTC to do anything for 45 years.
The 1974 Act, which dramatically revamped the entire regulatory structure for overseeing futures contracts, awarded the CFTC had brand new, more expansive, regulatory powers, just as the Federal Communication Act of 1934 set up the FCC with new regulatory powers, and just as the Federal Reserve Act of 1913 set up the Fed with new regulatory powers.
As the Comptroller General explained in a 1978 Report:
The Commission, an independent agency, was created by the Commodity Futures Trading Commission Act of 1974 on recommendation of GAO. The agency has broad regulatory powers, which its predecessor, the Commodity Exchange Authority in the Department of Agriculture, did not.The Problems With "Excessive Speculation"
It may be worthwhile to recap why excessive speculation has caused such wreckage in commodity markets. Only a small percentage of commodity trades are executed on regulated exchanges, such as the CME. But the vast majority of over-the-counter trades are priced according to the benchmarks set by the exchanges. So, for instance, a bilateral sale of natural gas in Los Angeles might priced at a premium over the price of gas sold at the Henry Hub in Louisiana, according to prices set by contracts traded on the NYMEX in New York. If there are no position limits on the exchanges, then it's very easy to corner the market in a commodity and manipulate prices up or down.
Price discovery in commodity markets is based on the balance between actual production and actual consumption. Nobody can estimate future commodity prices based on the secret manipulations of a few hedge funds that never disclose their positions. If someone corners the market on the exchange, he can subvert that price discovery mechanism. And though extreme price volatility harms producers and consumers, it works to the benefit of savvy traders.
Traders at Enron manipulated gas prices to the harm of consumers in Los Angeles. They manipulated gas prices when they worked at Enron, and they manipulated gas prices after they left Enron, and worked at hedge funds. A report prepared by Carl Levin's staff on Senate Permanent Subcommittee on Investigations showed how two hedge funds founded by former Enron employees--Amaranth and Centaurus--went to extreme lengths to manipulate gas prices and subvert the price discovery function of the exchanges. They were able to get away with it as long as they could, because Mr. and Mrs. Enron, aka Phil and Wendy Gramm, neutered the CEA, first with a secret side deal with Goldman, then by circumventing the rules to exempt Enron's energy trading business, and then with legislation, passed in 2000, known as the Enron Loophole.
Consequently, the CFTC's ability to protect the integrity of the commodity markets through position limits had become virtually a dead letter, prior to the enactment of Dodd-Frank. While exchanges like the NYMEX erratically enforced rules on position limits, trading of identical contracts on electronic exchanges, like the defunct EnronOnline and the ICE, were exempt from any kind of real CFTC oversight or rulemaking. The reason why Amaranth and Centaurus were able to manipulate gas prices so shamelessly was because of their dark trading on the ICE, which had no position limits.
The CFTC’s Response to Dodd-Frank
Dodd-Frank reverses much of the Enron Loophole, and expands upon the legal mandate for imposing position limits first set forth in the Commodity and Exchange Act of 1936.
What is "Excessive Speculation"? As CFTC Chairman Gary Genzler explained in his Senate testimony:
This most recent rule really used a formula that we put in place through notice and public hearings in the late 1980s and early 1990s, so it is about 20 years ago, and it is roughly 2.5 percent of the speculators. The speculators could not each have more than 2.5 percent... In the oil or natural gas markets, about 13 to 18 percent of the market are producers and merchants, and the other 80-plus percent are hedge funds and swap dealers and other financial actors. What we do is we use our authorities to police against fraud and manipulation and ensure transparency, that people see that price function, and then also to have positions to help prevent against manipulation, corners and squeezes, as I mentioned, help ensure the integrity of the market with regard to the all-months combined, that no one speculator has an outsize position. [Emphasis added.]The CFTC studied the issue of position limits at length. It held numerous open hearings and meetings, and reviewed more than 15,000 comments, including those submitted by ISDA, over a span of 11 months. The process of ascertaining the proper position limits to curtail excessive speculation is described, in about 98,000 words, in the Federal Register. It included an extended cost/benefit analysis to establish, among other things, that such position limits would not impair market liquidity.
Dodd-Frank also imposes something new and specific. The CFTC must also set posiion limits, to the maximum extent practicable to deter and prevent market manipulation, squeezes, and corners.
Framing A Decision Around Republican Denial of The Truth
However Republican members of the Commission, seeking to neutralize financial reform, denied the existence of anything that refuted their agenda. They denied that there was evidence of a problem with excessive speculation; they denied that the CFTC had performed any kind analysis prior to setting certain position limits; they denied that the CFTC had the authority to impose such limits without first making initial “necessity findings.” Wilkins frames his decision around these denials, in pursuit of the same agenda.
Wilkins quotes departed Commissioner Michael V. Dunn, who claimed that:
[T]o date CFTC staff has been unable to find any reliable economic analysis to support either the contention that excessive speculation is affecting the market we regulate or that position limits will prevent excessive speculation.Wilkins quotes a GOP Commissioner Scott D. O'Malia, whose written dissents are almost certainly ghostwritten by an outside law firm, as detailed by a reporter from Reuters. O'Malia lied when he said:
The Commission voted on this multifaceted rule package without the benefit of performing an objective factual analysis based on the necessary data to determine whether these particular limits . . . will effectively prevent or deter excessive speculation.O'Malia also deceptively claimed:
[T]he Commission ignores the fact that in the context of the Act, such discretion is broad enough to permit the Commission to not impose limits if they are not appropriate.Finally, Wilkins quotes Jill Sommers, who, while working at the CME, helped draft the Enron Loophole, and who opposes the parts of Dodd-Frank that reverse the Enron Loophole. She did “not believe position limits will control prices or market volatility.”
In fact, the CFTC evaluated a mountain of evidence demonstrating how increased volatility and market manipulation was enabled by excessive speculation, by the absence of position limits, and by certain statutory loopholes. (See a list of a few of those studies here and a few more at the end of this piece.) The GOP commissioners deemed this evidence to be "not credible." Instead, they point to industry-funded studies that drew different conclusions.
Anyone familiar with the energy markets knows that hedge funds, mutual funds and ETFs have dominated trading on the exchanges. And Wall Street insiders trade around the trading activities of these funds. Denying the magnitude of speculation in the energy markets is like denying the drug trade in Mexico. And if the CFTC gives stronger weight to some studies over others, that is within the agency's discretion, not the Court's.
Selectively Parsing Words
As may be evident, the case revolves around the ways that lawyers parse statutory language. In plain English, the plaintiffs argue that the statues do not authorize the CFTC to “fix” something that may not necessarily be broken. The CFTC argues that the law directs the agency to prevent problems that may occur in the future.
More specifically, two Wall Street groups, the International Swap and Derivatives Association and the Securities Industry and Financial Markets Association, argue that the CFTC must first make a specific finding on the “necessity” of any position limit. That is, the CFTC must first make a threshold finding that, in the absence of new position limits, speculation is “excessive.” Only after going through formal proceedings to arrive at such a determination, may the agency then proceed, after extended hearings and review, to consider what position limits may be set.
The CFTC argued that the statutory language did not require formal proceedings to determine whether positions limits were “necessary.” Rather, the a Commission argued, the word “necessary” in the following phrase as the Commission finds are necessary to diminish, eliminate, or prevent such burden.
Judge Wilkins ruled that the CFTC's effort was illegitimate and therefore void. The CFTC must first go through a brand new process to establish the "necessity" of any new position limits, and only after such a process can it then move to the second step, and repeat the process it went through in order to establish the size of those position limits.
[See the relevant statutes at the end of Wilkins' decision.]
Judge Wilkins' Highly Selective, Logically Incoherent, Legislative History
Agin, for Wilkins the critical words are:
[T]he Commission shall… proclaim and fix such limits on the amounts of trading which may be done or positions which may be held by any person… as the Commission finds are necessary to diminish, eliminate, or prevent such burden.He then wrote:
Section 6a [the statue mandating position limits] is ambiguous as to the precise question at issue: whether the CFTC is required to find that position limits are necessary and appropriate prior to imposing them.After declaring that the language was ambiguous, Wilkins reversed himself a few paragraphs later, when he wrote:
The precise question, therefore, is whether the language of Section 6a(a)(1) clearly and unambiguously requires the Commission to make a finding of necessity prior to imposing position limits. The answer is yes.Notice the rhetorical sleight of hand. He says the language itself is unambiguous, not that the language, when considered in the context of other information, indicates Congress's intent. Taken at face value, Wilkins' words sound logically incoherent. In fact, he ascertains the "unambiguous" nature of the language based on an “Explanation of the Bill," i.e. the 1936 Act, which was drafted in 1935. He also refers to some marginally relevant actions taken by the Commodity Exchange Authority taken in the 1930s.
But any suggestion that he consider legislative action taken after the 1930s is, according to Wilkins, an argument "without merit." He ignores the protestations of the Senators and Congressmen who drafted Dodd-Frank and insisted that the CFTC was enforcing the law exactly as Congress intended. His reason: The language was ambiguous. He wrote:
The Court has considered [the senators' and representatives'] interpretations of both the legislative history and statutory text. Given the fundamental ambiguities in the statute, however, the Court is not persuaded by their arguments.Wilkins' contempt for the written word, and for legislative history, is breathtaking.
What About Statutes That Redefined "Commission," "Commodity," and "Necessity"?
Let's quickly go through the changed definitions that nullify Wilkins' bogus analysis:
Redefining Commission: As noted already the 1974 Act changed the definition of Commission to mean the newly created, Commodity Futures Trading Commission. Here’s how one law review article characterized the difference between the Commodity Exchange Authority (CEA) and the CFTC:
Under the old CEA's regulatory scheme, all regulated futures were traded on "contract markets" by registered futures commission merchants and brokers. All exchanges had to satisfy certain statutory requirements intended to prevent fraud and manipulation before they could be designated "contract markets." Once the CEA made the designation, the contract markets regulated themselves. The CEA intervened only if the exchanges failed to enforce their own rules, and then the principal sanction it had was to suspend or revoke the "contract market" designation. Since the CEA was reluctant to take such a drastic step, it followed a passive regulatory policy.Redefining "commodity": Under the 1936 Act the regulator of futures contracts was kept on a very tight leash, because back then, “commodity” was defined as cotton, rice, millfeeds, butter, eggs, Irish potatoes, wheat, corn, oats, barley, rye, and flaxseed. Subsequently, in 1940, Congress changed the meaning of the word “commodity” to include vegetable oils, cottonseed meal, cottonseed, peanuts, and soybean meal on the list. And then in 1955, Congress added onions to the list.
The CFTC Act gives the Commission the ability to take an active role in preserving the integrity of futures trading by extending its authority to cover what is traded, who may trade, where trading may occur, and the rules under which it may be conducted. The Commission is empowered to compile information concerning futures trading in order to identify and discourage market abuses and to encourage investor activity. In marked contrast to the CEA, the Commission has broad enforcement power to seek injunctive relief in court, to take action in emergency circumstances to restore orderly trading, and to impose increased penalties to punish violations.
But under the 1974 Act, the word “commodity” referred to any and all commodities, with very limited statutory carve-outs, in order to afford the CFTC a great deal of discretion.
The meaning of the word "commodity" was changed again in late 2000, under the Commodity Futures Modernization Act of 2000, aka the Enron Loophole, which, among other things, exempted energy and metals commodities and "electronic exchanges" from regulatory oversight. The meaning of "commodity" was subsequently changed with Dodd-Frank, which rescinded much of the Enron Loophole.
This is but one illustration of the crackpot notion that you can pluck one fragment of legislative history, to exclusion of everything else, to divine the meaning of a statute.
Redefining "Necessary": Legislation enacted after the 1936 Act also changed the meaning of “necessary,” as in, “as the Commission finds are necessary…” Wilkins rejects this notion. Again, he argues that the context an d meanings of the words have not changed since an “Explanation of the Bill” was drafted in 1935.
The 1974 Act altered the meaning of what was "necessary" because of the CFTC's new regulatory mandate, and because it specifically gave the CFTC the authority to define "bona fide hedge exemptions," which were long or short positions on the exchanges, but, because those positions were offset by other positions taken in the ordinary course of business--say, American Airlines hedging its physical position in jet fuel--they were not subject to position limits.
The meaning of "necessary" has also been altered dramatically by other legislation enacted subsequent to 1936. In order to establish that any position is "necessary," the CFTC must first complete a cost-benefit analysis. More specifically:
The costs and benefits of the proposed Commission action shall be evaluated in light of -In addition, Dodd-Frank modified the meaning to "necessary" by imposing additional requirements:
(A) considerations of protection of market participants and the public;
(B) considerations of the efficiency, competitiveness, and financial integrity of futures markets;
(C) considerations of price discovery;
(D) considerations of sound risk management practices; and
(E) other public interest considerations.
- to ensure sufficient market liquidity for bona fide hedgers; andThough the CFTC considered all these issues when establishing position limits, Wilkins, like the GOP Commissioners, cherry-picks from the record to suggest that the opposite is true. He quotes from Commissioner Sommers, who claimed that the CFTC had Sommers claimed that, in her view, the Commission had, "created a very complicated regulation that has the potential to irreparably harm these vital markets." Wilkins quotes from Commissioner Dunn, who claimed that, "position limits may harm the very markets we’re intending to protect."
- to ensure that the price discovery function of the underlying market is not disrupted.
Of course, these opinions reflect the GOP agenda, which states that there is no evidence of excessive speculation, and that any type of regulation will cause extraordinary harm, and completely disregards the actions by the CFTC, pursuant to specific statutory obligations, to prevent any such harm.
Wilkins selectively quotes from GOP members, whom he never identifies as Republican, while ignoring the record the legal record that refutes such claims.
Falsifying Legislative Intent
So, though Wilkins cites a 1935 “Explanation of the Bill,” to establish that the text was "unambiguous," he disregards the summary of Dodd-Frank, drafted by the Congressional Research Service, which states:
(Sec. 737) Directs the CFTC to establish position limits on: (1) trading or positions held by any group or class of traders; and (2) positions (other than bona fide hedge positions) that may be held by any person with respect to either contracts of sale for future delivery, or options on contracts or commodities traded on or subject to the rules of a designated contract market.The summary does not suggest that the CFTC may establish position limits only after an initial finding that position limits are necessary. There's an extensive legislative history on this particular provision, which the drafters of Dodd-Frank lifted verbatim (except for deadline dates) from S. 447, the Prevent Excessive Speculation Act, sponsored by Sen. Carl Levin in February 2009. As he noted at the time, his bill, "would require the CFTC to set limits on the holdings of traders in all of the energy futures contracts traded on regulated exchanges to prevent traders from engaging in excessive speculation or price manipulation." Not "authorize the CFTC to set limits," but "require" CFTC to set limits.
And when you read the statute introduced by Levin in 2009 and passed by Congress in 2010, it's quite clear that the CFTC must enact position limits, not consider whether position limits are necessary and only then decide what position limits should be enacted. Every law student knows the meaning of the verb "shall" in a legal document. Shall is a command that something must be done. You shall observe the traffic laws. You shall pay your mortgage on time. And when the statute said CFTC shall impose position limits, everyone knew what it meant.
Ignoring The Plain Meaning of The Text
Wilkins' most transparently egregious stunt was to ignore the way new statutes added under Dodd-Frank modified the meaning of Section 6a(a)(1). Here's the language:
6a(a)(2) [T]he Commission, within __days after the date of the enactment of this paragraph, shall issue a proposed rule, and within __ days after issuance of such proposed rule shall adopt a final rule, after notice and an opportunity for public comment, to establish limits on the amount of positions that may be held by any person with respect to contracts of sale for future delivery or with respect to options on such contracts or commodities traded on or subject to the rules of a contract market or derivatives transaction execution facility, or on an electronic trading facility with respect to a significant price discovery contract.Wilkins simply ignores the mandatory language of the new statute. And any second-year law student would see right away that the new language--stating that the CFTC shall set position limits to the maximum extent practicable to deter and prevent market manipulation, squeezes, and corners --is a brand new legal requirement, something clearly above and beyond what existed prior to the passage of Dodd-Frank. You don't need to demonstrate that speculation is "excessive" in order to deter and prevent market manipulations.
`6a(a)(3) In establishing the limits required in paragraph (2), the Commission shall set limits--
`(A) on the number of positions that may be held by any person for the spot month, each other month, and the aggregate number of positions that may be held by any person for all months; and
`(B) to the maximum extent practicable, in its discretion--
`(i) to diminish, eliminate, or prevent excessive speculation;
`(ii) to deter and prevent market manipulation, squeezes, and corners;
`(iii) to ensure sufficient market liquidity; and
`(iv) to ensure that the price discovery function of the underlying cash market is not distorted or disrupted.
But Wilkins disregarded that language altogether, or rather, he labled all of the Dodd-Frank language "ambiguous" and therefore virtually irrelevant.
Inventing "Unambiguous" Language By Falsifying CFTC Policy
To establish that the statute "unambiguously" required a two-step regulatory process, Wilkins injects a red herring that stinks to high heaven. He writes:
The Commission does not argue—nor could it—that this section standing alone strips the agency of any discretion not to set position limits if it would be unnecessary to do so. In fact, the statute expressly directs the agency to set position limits “from time to time.”Again, Wilkins is playing with words to create a false impression. The CFTC chooses to exempt certain contracts because the possibility of market manipulation or market distortion does not present itself. In that sense, it does establish "necessity" prior to setting each and every position limit. You don't need to prevent or deter something that is not possible. For instance, the CFTC determined that the MGEX Index Contracts should be considered exempt from position limits because "cash-settled index contracts are not subject to potential market manipulation or creation of market disruption in the way that physical-delivery contracts might be."
That's very different from Wilkins' false assertion, that the CFTC must first prove that market manipulations are distorting the market before the agency can ever take action to prevent and deter such manipulations.
It's hard to imagine a more clear-cut abuse of judicial power than Wilkins' response to the amicus briefs of senators and congressmen who said that they wrote the law and the CFTC is enforcing the law as they intended. "Given the fundamental ambiguities in the statute," Wilkins writes, "the Court is not persuaded by their arguments."
There is not a shred of integrity or intellectual honesty in this decision.
Why would an Obama appointee, a Harvard law grad, abuse his position so shamelessly? We don't know for sure, but given the billions of dollars in profits available to hedge funds and banks who can continue cornering the markets, it's not hard to venture a guess.
If want an education in how different commodity markets operate, and how they are abused, there is no better place to go than to reports prepared by Carl Levin's Permanent Subcommittee on Investigations. You should read about excessive speculation in the natural gas markets (don't miss the Appendix), in the oil markets, and in the wheat markets. Something a bit more technical, but still enlightening is Chapter III of the UNCTAD Report on the Financial Crisis. No one can honestly read those reports and deny that the necessity for position limits is well established.