Inv. Co. Inst. v. U.S. Commodity Futures Trading Comm'n, Civil Action No. 12–00612 (BAH).

891 F.Supp.2d 162

INVESTMENT COMPANY INSTITUTE, et al., Plaintiffs,

v.UNITED STATES COMMODITY FUTURES TRADING COMMISSION, Defendant.

Civil Action No. 12–00612 (BAH).

United States District Court, District of Columbia.

Dec. 12, 2012.

As Amended Jan. 2, 2013.

Eugene Scalia, Daniel J. Davis, Gibson, Dunn & Crutcher LLP, Washington, DC, for Plaintiffs.

Jonathan L. Marcus, Nancy R. Doyle, Melissa C. Chiang, Robert A. Schwartz, U.S. Commodity Futures Trading Commission, Washington, DC, for Defendant.

MEMORANDUM OPINION

BERYL A. HOWELL, District Judge.

Plaintiffs Investment Company Institute (“ICI”) and Chamber of Commerce of the United States of America, two business associations, filed this lawsuit under the Administrative Procedure Act (“APA”) and the Commodity Exchange Act (“CEA”) challenging recent amendments to two sections, 17 C.F.R. §§ 4.5 and 4.27, of regulations promulgated by the U.S. Commodity Futures Trading Commission (“CFTC”) regarding Commodity Pool Operators (“CPOs”). See Final Rule, Commodity Pool Operators and Commodity Trading Advisors: Compliance Obligations, 77 Fed.Reg. 11,252 (Feb. 24, 2012) (“Final Rule”), as corrected due to Fed.Reg. errors in its original publication, 77 Fed.Reg. 17,328 (Mar. 26, 2012). The challenged amendments rescind certain CPO registration and reporting exclusions, which have been in effect for less than a decade, in order to respond to significant legislative changes enacted in the aftermath of the financial crisis by the Dodd–Frank Wall Street Reform and Consumer Protection Act, Pub.L. No. 111–203, 124 Stat. 1376 (2010) (“Dodd–Frank”). The gravamen of the plaintiffs' Complaint is that, through these amended rules, the CFTC has, without sufficient explanation, extended its regulatory reach to registered investment companies (“RICs”) ¹ that engage in derivatives trading.

Notably, the plaintiffs do not dispute that the CFTC has the authority to regulate derivatives trading by RICs or that the CFTC has broad discretionary power to set eligibility criteria for entities covered by the statutory definition of CPO, which triggers registration and concomitant reporting and disclosure requirements. Rather, the plaintiffs challenge the sufficiency of the rule-making process underlying these challenged amendments. Specifically, amended Section 4.5 reinstates, with some modifications, a pre–2003 trading threshold and marketing restriction for advisers to mutual funds and RICs claiming an exclusion from the definition of CPO, and thereby from CFTC regulation. See77 Fed.Reg. at 11,253–54. The new section 4.27 “imposes[s] new quarterly reporting obligations on commodity pool operators,” including the advisers to mutual funds and RICs that now qualify as CPOs. Compl., ECF No. 1, ¶ 1 (citing 77 Fed.Reg. at 11,285).

In their six-count Complaint, the plaintiffs offer two legal bases for their challenges to Sections 4.5 and 4.27 of the Final Rule, arguing that, in promulgating the amendments, the CFTC, first, proceeded in an arbitrary and capricious manner in violation of the APA, and, second, failed to comply with the analysis required under Section 15(a) of the CEA. As a result, the plaintiffs seek vacatur of Section 4.5 in its entirety and of Section 4.27 as applied to RICs.² Pending before the Court is Plaintiffs' Motion for Summary Judgment, ECF No. 8, and Defendant Commodity Futures Trading Commission's Cross–Motion for Summary Judgment, and Motion to Dismiss in Part, ECF No. 15. After hearing argument on these motions, and for the reasons explained below, the Court will deny Plaintiffs' Motion for Summary Judgment, grant the CFTC's Motion to Dismiss in Part, and grant the CFTC's Cross–Motion for Summary Judgment.

I. FACTUAL AND LEGAL BACKGROUNDA. The Regulation of Registered Investment Companies

There is no dispute that RICs are heavily-regulated. Indeed, the plaintiffs assert that investment companies are “among the most highly regulated entities in the financial industry” and are subject to all four major federal securities laws: the Investment Company Act of 1940 (“ICA”), the Investment Advisors Act of 1940, the Securities Act of 1933, and the Securities Exchange Act of 1934. Compl. ¶¶ 2, 12; see also id.¶ 12 (noting that “ ‘[a] mutual fund is one of the most regulated types of companies in the United States' ” (quoting Clifford E. Kirsch and Bibb L. Stench, 1 Mutual Funds and Exchange Traded Funds Regulation, § 1:4.1 (3d ed. 2011))); id. ¶ 13 (noting that the ICA “ ‘imposes an extensive federal regulatory structure on investment companies' ” (quoting Thomas P. Lemke, et al.,1 Regulation Of Investment Companies § 1.01 at 1–2 (2011))). Underlying the plaintiffs' claims is their view that the CFTC must demonstrate why this extant regulation is not sufficient before imposing more regulation on RICs. See id. ¶ 3 (“In adopting the rule in issue here the Commission ... nowhere explained or determined in any manner that SEC regulation was proving to be insufficient....”); Pls.’ Mem. at 1 (noting that, the CFTC, in promulgating the Final Rule, “pointed to no protections resulting from its new Rule that were not already supplied by the SEC”).

Investment companies are subject to some CFTC regulations that “apply broadly to market participants regardless of registration status,” Pls.' Mem. in Supp. of Mot. for Summ. J. (“Pls.' Mem.”), ECF No. 8, at 6 (citing 17 C.F.R. Parts 15–21), and, for most of the history of the CEA, have been required to register with the CFTC when engaging in financial activities that qualify as a commodity pool, unless they met certain eligibility restrictions for an exclusion. The term “commodity pool operator” (“CPO”) is broadly defined to include “ ‘any’ person or entity operating a business in which they solicit or accept value ‘for the purpose of trading in commodity interests, including any ’ commodity future, option, swap, or certain other specified types of instruments.” Def.'s Mem. in Supp. of Cross–Mot. for Summ. J., Opp'n to Pls.' Mot. for Summ. J., and Mot. to Dismiss in Part (“Def.'s Mem.”), ECF No. 15, at 5 (quoting 7 U.S.C. § 1a(11)(A)). For a period of less than a decade since 2003, RICs have been “effectively exclude[d]” altogether from the definition of CPO, and consequently from CFTC registration of CPOs. See Compl. ¶¶ 18–21; Pls.' Mem. at 16–18. Thus, the CFTC's regulation of these entities pursuant to the Final Rule is not an entirely new regulatory scheme for RICs.

The plaintiffs here argue that registration by RICs with the CFTC is unnecessary because these entities are already regulated by the SEC. The CFTC explains, however, that, given its congressional mandate to administer the CEA “to foster open, competitive, and financially sound commodity and derivatives markets,” 77 Fed.Reg. at 11,278, the Final Rule regulates RICs in their capacity as CPOs operating in derivatives markets and with respect to CFTC-regulated products, rather than targeting RICs operating in SEC-regulated markets. Thus, the CFTC's view is that the regulation of RICs operating as CPOs, after a brief period of deregulation, is not duplicative of the SEC's regulation of investment companies. Id. at 11,262 (“The Commission does not believe it is accurate to state that Congress intended to avoid oversight by both agencies, and indeed Congress clearly anticipated some overlap.... Therefore, the Commission concludes that dual registration of certain entities is not irreconcilable with the Congressional intent underlying the Dodd–Frank Act.”).

1. CFTC's Regulation of Registered Investment Companies from 1974 to 2003

A brief review of the history of the regulation of RICs by the CFTC is helpful in understanding the context of the plaintiffs' challenges to the Final Rule. The CFTC was established in 1974 by the Commodity Futures Trading Commission Act, Pub.L. No. 93–463, 88 Stat. 1389. Pursuant to the CEA, the CFTC is the exclusive federal regulator of many derivative instruments and markets. See7 U.S.C. § 2(a)(1).³

The CEA provides that all CPOs must register with the CFTC and file such reports as the CFTC may prescribe. 7 U.S.C. § 6k. Since the CEA “sets no minimum trading threshold for qualification as a CPO, .... a pooled investment vehicle operator is a statutory CPO if it trades even a single commodity, option or swap.” Def.'s Mem. at 6 (citing 7 U.S.C. § 1a(11)(A)). ⁴ Unless subject to an exemption or exclusion, all CPOs must register with the CFTC, see7 U.S.C. § 6k, and are subject to regulatory requirements related to disclosure to investors, see17 C.F.R. §§ 4.21– 4.22, 4.24– 4.25, recordkeeping, id. § 4.23, segregation of investor assets, id. § 4.20, and registration and reporting obligations, see7 U.S.C. §§ 6k, 6n. See Pls.' Mem. at 7. CPOs must also become members of the National Futures Association (“NFA”), the self-regulatory organization for the commodities industry. Id.⁵

Under the CEA, the CFTC has statutory authority to exclude entities from the definition of “CPO,” thereby relieving such exempted entities from the CFTC's registration requirements and attendant obligations. See7 U.S.C. § 1a(11)(B) (“The Commission, by rule or regulation, may include within, or exclude from, the term ‘commodity pool operator’ any person engaged in a business that is of the nature of a commodity pool, investment trust, syndicate, or similar form of enterprise if the Commission determines that the rule or regulation will effectuate the purposes of this chapter.”). The CFTC “has exercised this authority over the years to expand and contract exclusions in response to new information and changing circumstances.” Def.'s Mem. at 6.

During the CFTC's early years, when entities raised questions concerning their coverage as a CPO, the CFTC would evaluate their operations on a case-by-case basis and issue “not a pool” letters affording relief from the CPO regulations when the entity met certain conditions, including that the entity:

(1) was subject to extensive Federal...