Recent Court Decisions Shine Spotlight on Scope of CFTC’s Dodd-Frank Anti-Fraud and Anti-Manipulation Enforcement Authority

Recent federal court decisions, and a pending appeal in the Ninth Circuit, highlight disagreement among the courts as to the scope of the Commodity Futures Trading Commission’s (CFTC) anti-fraud and anti-manipulation authority under the Dodd-Frank Act, with significant implications for virtual currency markets in particular.

Although the Commodity Exchange Act (CEA) grants the CFTC exclusive jurisdiction over only swaps and commodity futures contracts, the CFTC has historically had anti-fraud and anti-manipulation enforcement authority over markets for transactions that are actual purchases of a commodity, sometimes called “spot” or “physical” transactions.¹ Under the Dodd-Frank Act, Congress gave the CFTC new enforcement authority for futures, swaps and spot commodity markets mirroring the Securities and Exchange Commission’s Rule 10b-5 enforcement authority.² Congress added CEA Section 6(c)(1), which prohibits manipulative or deceptive devices or contrivances, and the CFTC subsequently adopted Rule 180.1(a), which implements Section 6(c)(1) and prohibits any manipulative device, scheme or artifice to defraud. The CFTC has forcefully asserted those powers in a number of contexts, including alleged fraud in spot market sales of virtual currencies. The results have been mixed, reflecting the fact that the CFTC’s enhanced enforcement powers have brought to the fore significant questions regarding the scope of the CFTC’s spot market anti-fraud and anti-manipulation authority and the relationship of that authority to the CFTC’s exclusive regulatory jurisdiction over swaps and commodity futures contracts.

In May, a California federal district court rejected the CFTC’s contention that the agency has anti-fraud authority in connection with “contracts of sale of a commodity” in the over-the-counter spot market “in the absence of [an] actual or potential market manipulation.”³ In CFTC v. Monex Credit Co., the CFTC alleged that the defendants had defrauded retail customers in connection with the sale of precious metals.⁴ The CFTC charged that the defendants violated CEA Section 6(c)(1) and CFTC Rule 180.1(a).⁵ Both Section 6(c)(1) and Rule 180.1(a) are operative “in connection with” any swap, futures contract or contract of sale of any commodity in interstate commerce.

The Monex defendants argued that the CFTC’s anti-fraud authority did not reach the sale of precious metals.⁶ In response, the CFTC asserted that two CEA provisions granted anti-fraud authority. First, the CFTC pointed to its traditional anti-fraud authority in CEA Section 4b, which the Dodd-Frank Act extended to reach “retail commodity transactions” (e.g., sales of precious metals), which are contracts entered into on a leveraged or margined basis and are not actually delivered within 28 days.⁷ (Section 4b does not apply to “a contract of sale of a commodity in interstate commerce” except for contracts that fall within the scope of a “retail commodity transaction.”)⁸ Furthermore, the CFTC argued that the anti-fraud authority in CEA Section 6(c)(1) and Rule 180.1(a) also independently reached the sale of precious metals because the statute expressly references “contracts of sale of a commodity in interstate commerce.”⁹

The district court rejected both of the CFTC’s legal theories. First, the court found that Monex’s precious metals transactions met the “actual delivery” requirement; therefore, CEA Section 4b did not apply.¹⁰ Second, the district court analyzed the plain language of CEA Section 6(c)(1), considering doctrines of statutory construction, legislative history and the agency’s interpretive statements in the Rule 180.1 rulemaking process. The Monex court concluded that read in its entirety, the CEA limits the application of Section 6(c)(1), and therefore, the application of Rule 180.1, to instances of manipulation that involve fraud. The court reasoned that reading Section 6(c)(1) and Rule 180.1 to prohibit fraud absent manipulation would render Section 4b superfluous.¹¹ This construction of the statute would mean that the CEA does not extend the CFTC’s anti-fraud authority to over-the-counter “contracts of sale of commodities in interstate commerce” unless the conduct also involves market manipulation or the contract qualifies as a “retail commodity transaction.”

This decision is on appeal in the Ninth Circuit and, if upheld, could restrict or eliminate the CFTC’s ability to prosecute fraudulent or deceptive conduct in the over-the-counter spot market. Such an outcome would cast doubt on the CFTC’s enforcement authority in certain pending and future enforcement actions alleging fraud, but not price manipulation, in other over-the-counter spot markets, such as contracts for virtual currency¹² or precious metals.

A New York federal district court made clear that it disagrees with Monex.¹³ In CFTC v. McDonnell, the CFTC alleged that the defendants had violated Section 6(c)(1) and Rule 180.1 by operating a fraudulent scheme involving...