ICI and U.S. Chamber of Commerce vs. CFTC (Challenging CFTC's Denial of Complete CPO Exemption for RICs) (with Materials) (with Lofchie Comment)

There were oral arguments on Friday in the ICI v. CFTC case that (combined with the recent decision in the ISDA suit vs. the CFTC, and the ongoing discussions with the CFTC over the regulation of securitization and like vehicles [see related Cadwalader C&F memo]) caused me to look at the case documents (the main ones are linked below). The general background of the case is as follows:

Investment Company Institute et al. v. Commodity Futures Trading CommissionPlaintiffs: Investment Company Institute (ICI) and U.S. Chamber of CommerceDefendant: U.S. CFTCAmicus: Mutual Fund Directors Forum, National Futures Association (NFA), Better Markets, Inc.

Since 2003, the CFTC under itsRule 4.5 has given registered investment companies a complete exemption from regulation as commodity pools under the CEA. (Section III ofChapter 3 of the CPO-CTA Guide provides an overview of the various exemptions from CPO regulation.) The NFA in 2010, following the adoption of Dodd-Frank, had submitted a petition to the CFTC for the purpose of suggesting a modification of this exemption to re-impose the prior conditions on the exemption that was available to RICs. The CFTC then issued a proposed rule amendment and a final rule amendment to this end. Link here to final rule amendment.

Subsequently, the ICI and the Chamber of Commerce filed a complaint in the U.S. District Court alleging that the rule modification had been adopted without proper consideration of its relative costs and benefits. The CFTC responded in summary by saying that (i) the bar as to the amount of cost-benefit analysis that it was required to conduct was set pretty low and (ii) whatever that bar was, the CFTC had hurdled it. The Better Markets Amicus Brief, on behalf of the CFTC, says that the CFTC is only required to "consider" any costs that its rules imposed in a philosophical, non-quantitative manner. The Mutual Fund Directors Amicus Brief on behalf of the ICI is pretty much in line with the ICI brief, with a particular focus on the argued absence of benefits and substantial costs.

On Friday, after hearing oral arguments, the court granted the CFTC permission to file an additional brief by October 15; and ICI is then allowed another week to file a reply brief.

Lofchie Comment: This case can be viewed through at least two different perspectives: (i) as a matter of administrative law (which is what the case is technically about) and (ii) as a matter of financial regulatory policy (which is what interests me). The CFTC's regulatory policy justifications for subjecting RICs to regulation as pools are summarized at pages 21-22 of the CFTC's brief of June 18th. Please take what I say with a grain of salt, given how critical I am of Dodd-Frank, but the policy reasons for such justification seem awfully thin. They include the following: (i) to eliminate "blind spots" in regulation [but these are all regulated vehicles that file detailed reports]; (ii) to enable the CFTC to regulate systemic risk [see prior comment]; and (iii) to regulate the "competency" of RIC operators [by making them take the Series 3?].Even if one were to agree with the CFTC that, in some theoretical world, dual regulation of SEC-regulated RICs might be, at some point, the best of all possible worlds, the next question is "why now?" The CFTC is, given the scope of its required tasks, much less the scope of its aspirations, strapped for resources. There are hundreds of Dodd-Frank rules still to be adopted, and many of the rules that the CFTC has already adopted or proposed will be required to be reconsidered (e.g. news item on the extension of the comment period on the CFTC's margin regulations). One of the CFTC's Commissioners has described the CFTC's Dodd-Frank rulemaking as being full of "regulatory inconsistencies, blatant mistakes, uncertainty and unexpected outcomes" (see news item). Against that background, it is simply hard to understand the dual regulation of RICs being a worthwhile priority for the agency's limited resources. I also note that while the CFTC and the NFA may have identified some group of RICs that are essentially commodity pools in disguise, this group looks to be awfully small relative to the number of RICs that the CFTC would regulate under the amendment to Rule 4.5, and the required expenditure in the CFTC's resources just seems ill-advised. I also note that Treasury still has not defined what FX trades constitute RICs. If Treasury's exemption of FX trades is unexpectedly narrow, one of (many) side effects could be still further increasing the number of RICs required to dually register with the CFTC. Again, assuming agreement with the arguments that the CFTC makes as to why it must dually regulate RICs, the question that follows for me is why do we have two regulatory agencies carrying out closely-related tasks with inconsistent rules. At some point, the weight on the economic system of multiple schemes of inconsistent regulation simply is too great to be justified even under the straight-faced test. The NFA in its brief, on page 1, does make one argument with which I agree as a policy matter. (I don't actually think it works as an argument for dual regulation since, while I agree with the NFA, it is actually an example of inconsistent regulation that would prove problematic for RICs required to register with both the CFTC and the SEC.) In short, the NFA says that the CFTC rules essentially require the managers/advisors of pools to require disclosure as to the performance of related funds, while the SEC rules do not (and the FINRA rules significantly discourage such disclosure). The purpose of the SEC's requirement is to prevent an improper suggestion that past performance of a different fund is meaningful for the future performance of a new fund; while the NFA would argue that it is useful for investors to see the manager's performance. (For more specifics, see Section III.C.6 of the Communications Chapter of the Broker-Dealer Guide; see Sectio III.B.4 of theCommunications Chapter of the CPO-CTA Guide.) On this issue, I agree with the NFA.

PDF Attachments:Notice of Filing of Administrative Record and Index Doc 30 - ICI v. CFTC U.S. District Court DC 12-00612National Futures Association Amicus Brief Doc 24 - ICI v. CFTC U.S. District Court DC 12-00612Mutual Fund Directors Forum Amicus Brief Doc 12 - ICI v. CFTC U.S. District Court DC 12-00612Motion Doc 8 - ICI v. CFTC U.S. District Court DC 12-00612Memorandum in Opposition Doc 16 - ICI v. CFTC U.S. District Court DC 12-00612Docket - Investment Company Institute U.S. Chamber of Commerce v. CFTC U.S. District Court District of Columbia 12-00612 (2)Cross Motion Doc 15 - ICI v. CFTC U.S. District Court DC 12-00612Consent Motion for Leave Doc 17 - ICI v. CFTC U.S. District Court DC 12-00612Complaint Doc 1 - ICI v. CFTC U.S. District Court DC 12-000612Better Markets Inc. Amicus Brief Doc 25 - ICI v. CFTC U.S. District Court DC 12-00612