On June 29, 2020, the US Supreme Court denied certiorari in the long-running Commodity Futures Trading Commission (“CFTC”) action against Monex Credit Company.1 This denial will eventually return the case to district court for further proceedings, potentially including a trial on the merits. It also leaves in place, at least for the time being, the Ninth Circuit’s interpretations of the definition of “actual delivery” in the context of retail commodity transactions and the agency’s antifraud authority.
This Legal Update discusses the background of the Monex case and explains the significance of the Supreme Court’s denial of certiorari and the Ninth Circuit’s interpretations.
The Dodd-Frank Act amended the Commodity Exchange Act (“CEA”) to expressly grant the CFTC authority over retail commodity transactions and additional authority to prohibit fraud and manipulation.2
Retail Commodity Transactions
A retail commodity transaction is any transaction for a commodity that is (i) with a person who is not an eligible contract participant or eligible commercial entity and (ii) entered into, or offered (even if not entered into), on a leveraged or margined basis or financed by the offeror.3
The effect of the amendments to the CEA was that, absent an exception, a retail commodity transaction may only be offered on or pursuant to the rules of a designated contract market (that is, a regulated futures exchange). Further, any entity soliciting or accepting orders for retail commodity transactions and accepting money, securities or property (or extending credit in lieu of) to margin, guarantee or secure such transactions must be registered with the CFTC as a futures commission merchant. This effectively precludes non-registrants from offering off-exchange, leveraged retail commodity transactions.
However, the Dodd-Frank Act amendments excluded from the definition of a retail commodity transaction any contract of sale that “results in actual delivery within 28 days or such other longer period” as the CFTC may determine.4 This means that a person is not subject to the on-exchange or registration requirements if they make such actual delivery of the commodity to the retail counterparty within 28 days.
In 2013, the CFTC issued an interpretation of the meaning of “actual delivery” that discussed the factors the commission would consider in determining whether actual delivery had occurred and provided five examples of situations in which actual delivery would or would not have occurred.5
One of the examples stated that actual delivery would occur within 28 days if the seller physically delivers the entire quantity of the commodity purchased by the buyer, including any portion of the purchase made using leverage, margin or financing, to a third-party depository6 and transfers title to that quantity of the commodity to the buyer. While the example contemplates that the customer would have title to the commodity and the seller would lack an agency relationship with the depository through which the seller could exercise control, the example does not explicitly address the degree of control the customer must have over the commodity.7
Shortly after the issuance of the 2013 guidance, the Eleventh Circuit interpreted the phrase “actual delivery” in granting injunctive relief in a CFTC action.8 In the decision, the Eleventh Circuit stated that actual delivery “denotes a transfer of possession and control,” which elevated the concept of control as an explicit and significant factor in the analysis.9
The Dodd-Frank Act also amended the CEA to expand the CFTC’s authority to prohibit fraudulent and manipulative behavior. In particular, the Dodd-Frank Act amendments imported language from Section 10(b) of the Securities Exchange Act of 1934 into the CEA to prohibit “any manipulative or deceptive device or contrivance” in connection with a swap, futures contract or forward contract.10 The CFTC implemented3 that authority in 2011 through a rulemaking that prohibited fraud and fraud-based manipulative schemes.11
Monex is a dealer of precious metals that, as relevant to the CFTC’s allegations, offered a program through which customers could purchase precious metals on margin (i.e., the customer pays only a portion of the full price and Monex finances the remainder). Monex controlled the transactions such that it was the counterparty to every customer and set the transaction price. Monex also required the customers to sign an account agreement that gave it control over the precious metals, which were held at a third-party depository retained by Monex. Monex could liquidate customer holdings without notice and customers could obtain physical possession of precious metals only by paying off their margin position, requesting specific delivery and having the precious metals delivered. Monex asserted that it transferred ownership of the metals at the depository to the customers through a book entry process.
Monex was not registered with the CFTC as a designated contract market or futures commission merchant. Therefore, the CFTC asserted that Monex’s program violated the retail commodity transaction requirements because it was an off-exchange commodity transaction with a retail counterparty that did not result in actual delivery within 28 days. The CFTC also alleged that Monex committed fraud in connection with the operation of its program.
The district court dismissed the CFTC’s allegations, determining that Monex’s program fit within the actual delivery exception of the retail commodity transaction requirements and that the CFTC is not authorized to bring standalone fraud claims under the relevant portion of the CEA. As discussed below, the Ninth Circuit reversed the district court’s determinations regarding the actual delivery exception and antifraud authority.13
Actual Delivery Interpretation
The Ninth Circuit first noted that the term “actual delivery” is not defined in the CEA and, therefore, is given its ordinary meaning. Looking to Black’s Law Dictionary and the case from the Eleventh Circuit, the court distinguished “actual delivery” from “constructive delivery” and focused on the use of “actual” as a modifier of “delivery.” It noted that “actual” modifies “delivery,” which indicates that Congress sought to ensure both the existence of the commodity and the delivery of the commodity, not its mere existence.
The court then determined that, under the plain language of the statute, “actual delivery requires at least some meaningful degree of possession or control by the customer.”14 This would not be possible under Monex’s program because the “metals are in the broker’s chosen depository, never exchange hands, and are subject to the broker’s exclusive control, and customers have no substantial, non-contingent interests.”15
The court also examined pre-Dodd-Frank cases that led to the creation of the retail commodity transaction requirements, finding that the requirements were created to “close the so-called Zelener loophole,” which allowed companies to offer rollover transactions that mimic futures contracts without being regulated as such.16
The court considered Monex’s argument that requiring transfer of possession or control would negate Monex’s collateral interest in the precious metals. However, the court rejected the argument on the grounds that the practical difficulty in permitting a customer to have significant control over or possession of the metals could not displace the plain meaning of the law.
Lastly, the court considered the broader context of the CEA and noted that the court had previously found that the unmodified term “delivery” could not be satisfied through “the simple device of a transfer of title.”17 Therefore, the presence of a modifier such as “actual” must mean that the term “actual delivery” requires more than “simple title transfer.”18
With respect to the CFTC’s 2013 guidance, the court noted that even if the law had been ambiguous, the court would have found the CFTC’s guidance to be persuasive authority. The court noted that, unlike the example in the guidance, the Monex program did not grant customers a contractual right to the precious metals because Monex retained total control over the customers’ accounts and the metals. To the court, this amounted to “sham delivery,” not “actual delivery.”19
With respect to the CFTC’s antifraud authority, the district court read the CEA to require “both manipulative and deceptive conduct, not one or the other.”20 The CFTC had not alleged that Monex manipulated the market for precious metals, and, therefore, the district court dismissed the fraud charge.
The Ninth Circuit determined that the use of a disjunctive in the statute (“or”) had meaning and should be read to create two alternative prohibitions: fraud or manipulation. Therefore, under the plain language of the CEA, “the CFTC may sue for fraudulently deceptive activity, regardless of whether it was also manipulative.”21
The Ninth Circuit also noted that the identical language in Section 10(b) had been interpreted to authorize fraud-only claims and that by reusing that language in the CEA, Congress had intended to adopt the judicial interpretations of Section 10(b).
The Ninth Circuit rejected Monex’s other arguments that the CFTC lacked enforcement authority to bring claims under the new provisions created by the Dodd-Frank Act and that an unbounded antifraud authority could subject non-margined retail cash commodity transactions to the CFTC’s jurisdiction. In particular, the court noted that the case before it involved only margined retailed commodity transactions, which clearly were subject to the CFTC’s jurisdiction.22
Monex appealed the Ninth Circuit’s decision to the Supreme Court, which declined to grant certiorari. Therefore, the case will be returned to the district court for further proceedings based on the Ninth Circuit’s decision. This may take the form of a trial on the merits or a settlement. In either situation, the Ninth Circuit’s decision remains the binding precedent of the circuit.
The 2013 guidance generally focused on ensuring that the commodity exists (through possession by an independent third-party depository) and is titled to the customer, although it implicitly recognized that a seller could not retain control through an agency relationship with the depository. The Ninth Circuit’s interpretation of the term “actual delivery” is significant because it focuses the analysis on the degree of control the customer may exercise over the purchased commodity (i.e., whether the customer has “some meaningful degree of possession or control”). Therefore, while the Ninth Circuit’s interpretation can be seen as consistent with the principles in the 2013 guidance, it brings to the fore the issue of the customer’s control over the commodity.
Based on its litigation against Monex and the position it took in the recent interpretation of the meaning of “actual delivery” of digital assets, the CFTC clearly has embraced control as an explicit and determinative factor for actual delivery.23 However, the degree of control that the buyer must have for the agency to say that meaningful control exists remains unclear. Such uncertainty may chill future retail investment in commodities. Further, this uncertainty is only magnified by the Ninth Circuit’s recognition of a standalone antifraud authority, which creates another avenue of risk for retail commodity dealers.
Therefore, retail commodity dealers should carefully consider if their existing delivery arrangements transfer sufficient control to customers to ensure that actual delivery is made within 28 days. While it may be preferable to shift more control to customers to ensure that actual delivery occurs and negate fraud claims, this must be balanced against the risk of losing rights to the collateral that secures a customer’s position.
1 Monex Deposit Co. v. CFTC, No. 19-933 (June 29, 2020), https://www.supremecourt.gov/docket/docketfiles/html/public/19-933.html.
7 The guidance noted that “actual delivery” under the CEA is synonymous with “physical delivery” under the Model State Commodity Code (“Model Code”). “Physical delivery” occurs under the Model Code if precious metals are “delivered (whether in specifically segregated or fungible bulk form) into the possession of a depository (other than the seller) … and such depository (or other person which itself qualifies as a depository as aforesaid) issues and the purchaser receives” a document of title. Model Code § 1.04(a)(2).
13 The Ninth Circuit reversed the district court’s determination regarding the agency’s authority under the antifraud provision of the CEA, finding that the CFTC has authority to bring standalone fraud claims. This determination also was appealed to the Supreme Court, which, as noted above, declined to grant certiorari.
19 The Ninth Circuit did not explicitly address Monex’s argument that the program resulted in actual delivery under the CEA because it was physical delivery under the Model Code. Presumably this is because the court relied primarily on the plain meaning of the CEA for its decision.
23 See 85 Fed. Reg. 37,734 (June 24, 2020), see also CFTC’s “Actual Delivery” Test For Digital Assets Misses Mark, Law360 (May 7, 2020), https://www.law360.com/articles/1264244.