CFTC's Legal Memorandum to Dismiss Challenge to Its Cross-Border Guidance
Commentary by Bob Zwirb and Steven Lofchie
The CFTC submitted a Memorandum responding to a Complaint filed in federal district court by three financial industry trade associations – ISDA, SIFMA and the Institute of International Bankers ("IIB") (together, the "Associations") – challenging the legality of the CFTC's Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations ("Cross-Border Guidance" or "Guidance"). In addition to arguing that the plaintiffs lack standing and that their challenge is not ripe, the CFTC contends in its latest response that the 2010 Dodd-Frank law "unambiguously" states that the agency's rules apply to overseas activities with a "sufficient" nexus in the United States.
In response to the contention that the Guidance is in reality a rule that was not issued in compliance with the Administrative Procedure Act, the Memorandum states that: 1) there is no requirement that the CFTC implement Dodd-Frank's cross-border authority by rulemaking, and 2) the CFTC reasonably chose not to issue a rule, but instead issued a general statement of policy that is not reviewable under the APA. The CFTC Memorandum also states that the CFTC's interpretation of CEA Section 2(i) (the provision in the CEA that provides for cross-border authority) is reasonable, and that it properly considered the costs and benefits and public comments associated with the Guidance.
See:CFTC Memorandum. Related news: Market Participants File Lawsuit Challenging CFTC Cross-Border Guidance for Being a Rule Adopted in Violation of the APA (with Lofchie Comment) (December 4, 2013); Market Participants File Amended Complaint Challenging CFTC Cross-Border Guidance (with Zwirb and Lofchie Comments) (January 7, 2014); Chamber of Commerce Submits Amicus Brief Regarding Lawsuit against CFTC Cross-Border Rule (with Zwirb Comment) (February 4, 2014); SIFMA and AFME Issue Statement on Transatlantic Financial Regulation Negotiations (with Lofchie Comment) (February 19, 2014).
Commentary
The CFTC's Memorandum observes that the U.S. has "moved faster than other jurisdictions" to enact laws and rules to oversee the derivatives markets since the financial crisis. This boast, however, may not make haste the virtue that the CFTC seems to think it is if one takes into account the reaction of international regulators. Just last week, a prominent member of the European Parliament's Committee for Economic and Monetary affairs, noting that European trading facilities might be refusing U.S. persons access to their platforms – out of fear that liquidity pools could be "contaminated" by such persons subjecting non-U.S. participants to U.S. rules – suggested that harmonization with the CFTC may not be working. She went on to criticize former CFTC Chairman Gensler for coming to London and actually stating that "he wanted to regulate global derivatives from the US," noting that this was "not a helpful stance." See Peter Madigan, "CFTC-EC swaps accord not working, says MEP Swinburne," Risk Magazine (Mar. 13, 2014) (quoting European Parliament Member Kay Swinburne).
Likewise, the assertion makes no mention of the fact that all of the problems inherent in the CFTC's rulemaking have caused it to issue no-action letters at a rate of approximately 100 a year. Itshould issue many more, no doubt, but its staff is already overburdened in trying to keep up with the economy's need for the clarification of rules that are not really workable.
What also may not be helpful to the CFTC's cause is the CFTC's vacillation between describing its Cross-Border Guidance as "guidance," "rules" or the moral equivalent of rules, depending on the circumstances. Moreover, from a policy perspective, the Guidance raises a number of serious questions.
First, is the cost-benefit analysis accompanying the Guidance really sufficient, as the CFTC's Memorandum insists? The Memorandum appears to be arguing both that no cost-benefit analysis is required, because the Guidance is not a rule, and that a cost-benefit analysis has been effectively completed. On the one hand, the CFTC asserts that a cost-benefit analysis is not required because the Guidance, which spans 83 pages in the Federal Register (replete with words of mandate such as "require," "shall," "will" and "must"), does not constitute a Commission "action." On the other hand, the CFTC insists that it engaged in an adequate analysis because each of the individual rules that it intended to apply to transactions that it deemed to have a cross-border element was subject to such a cost-benefit analysis. However, it is hard to see how the CFTC could conduct a meaningful cost-benefit analysis without specifying in detail the persons to whom and transactions to which its rules would apply.
Not a word on this appears in the Memorandum, which raises the question as to whether the CFTC ran this by the Office of Information and Regulatory Affairs, the agency that the CFTC, under pressure, entered into an MOU with in 2012 for that very purpose. Moreover, as it has done elsewhere in similar court challenges, the CFTC's General Counsel's office advocates for a standard of economic analysis – e.g., that it need not consider outside empirical studies – which sets a very low bar for satisfying this requirement.
Second, if the CFTC Guidance is really "non-binding," as the Memorandum insists, then why did the letter of November 14th issued by CFTC staff to interpret the interpretation use the words "would generally be required to comply" when responding to an inquiry as to whether non-U.S. swap dealers must comply with the Transaction-Level Requirements when entering into swaps with non-U.S. persons that are arranged, negotiated or executed by personnel of the non-U.S. SD located in the United States? (CFTC Staff Advisory No. 13-69.)
Third, the Memorandum's assertion that the Guidance is not a rule was expressly contradicted by former Chairman Gensler – the architect of the CFTC's cross border policy – who characterized it as something that global market participants should "come into compliance with" (Remarks by Chairman Gensler). Was Mr. Gensler speaking "colloquially," as the CFTC Memorandum characterized it, or did he mean what he said? At the very least, it must be somewhat difficult for the CFTC General Counsel's office to have to explain away the words of its former chairman to a court of law – words that facially conflict with its position. Further, it seems disingenuous for the CFTC to argue that the Guidance is not a rule when there is such an obvious enforcement threat behind it.
Finally, even if we accept the view that a "non-binding" policy statement is the proper way to address issues of cross-border jurisdiction, does it really provide useful guidance for market participants, as the Memorandum suggests? Serious doubts arise when one looks at what the Memorandum cites as guideposts for market participants to follow:
"The facts-and-circumstances approach is reiterated numerous times, id. at 45313, 45316, 45320, 45330, 45359, and the Guidance states that 'economic reality' will control, id. at 45309. Consistent with that approach, the Guidance urges market participants to consult CFTC staff regarding individual circumstances."
Reading over this advice, one is reminded of Justice Scalia's criticism of the facts-and-circumstances approach as "that test most beloved by [agencies] unwilling to be held to rules (and most feared by litigants who want to know what to expect): th' ol' 'totality of the circumstances' test". United States v. Meade Corp., 533 U.S. 218, 241 (2001) (Scalia, J., dissenting).
Commentary
That the CFTC's Guidance is actually a "rule" issued in contravention of the Administrative Procedures Act is a widely held view. Robert Zwirb, in his comment below, summarizes a few of the reasons that the CFTC should be required to implement a formal rulemaking process in place of the Guidance.
With regard to a "race to finish" rulemaking, a loss on this case will be very damaging to the CFTC, as it will be forced to reexamine many of the rules that it had raced to complete. Notwithstanding the short-term damage that would be done to the CFTC's rulemaking by losing this case, in many ways, the CFTC could be better off with a loss. If it wins the case, it will have done so by conceding that the Guidance is not binding on anyone. This means that, in every future CFTC enforcement action that has a cross-border element, the CFTC will be forced to re-argue how its nonbinding guidance applies to that action. Among other consequences, this would be a great waste of the agency's resources. Perhaps even more significantly though, losing the case might create an avenue that would allow the CFTC to revisit many of its recent and poorly considered rules.