Thoughts on ISDA SIFMA v. U.S. CFTC

In reading Judge Wilkins Memorandum Opinion regarding Civil Action No. 11-cv-2146 (RLW), in which ISDA and SIFMA challenged the CFTC on position limits on derivatives tied to 28 physical commodities, we are reminded of an insightful line from a paper on behavioral finance:

"What has happened is that we've used these assumptions for so long that we've forgotten that we've merely made assumptions, and we've come to believe that the world is necessarily this way." ISDA SIFMA v US CFTC - Civil Action 11-Cv-2146 - Memorandum Opinion

The underlying flaw in the law is the supposition that "excessive speculation" is an eye-of-the-beholder standard, not black letter law. The same can be said of the phrase, "undue and unnecessary burden on interstate commerce". Thus, in a semantic tour de force the ruling reveals two insights into the rule making process.

First is the reliance on economic thought, and how philosophical disagreements amongst economists within the so-called "dismal science" is the "gift that keeps on giving" with respect to obfuscating rule-making intent. In an "appeal to authority" Judge Wilkins references various CFTC Commissioners prior statements forecasting the Plaintiff's argument as to the need for "statutorily-required findings of necessity prior to promulgating the Position Limits Rule". Given that the veracity of "position limits" ability to constrain "excessive speculation" is something economists will dispute infinitum, the seeds of the Rule's destruction is fait accompli.

Second, given that the law states that limits for exempt commodities are required to be established within 180 days after July 21, 2010, and that limits for agricultural commodities are required to be established within 270 days after July 21, 2010, the CFTC was faced with a conundrum. How can it both comply with the law's deadline requirement, and serve the needs of its constituency which generally stands against imposition of position limits [see comment letters]?

The answer seems to have been in the CFTC's decision to avoid first performing "any reliable economic analysis," as suggested by Commissioner Dunn, lending support to the Plaintiffs claims:

1. Violation of the CEA and APA--Failure to Determine the Rule to be Necessary and Appropriate under 7 U.S.C. $ 6a(a)(1), a(2)(A), (a)(5)(A))
2. Violation of the CEA--Insufficient Evaluation of Costs and Benefits under 7 U.S.C. $ 19(a) 
3. Violation of the APA--Arbitrary and Capricious Agency Action in Promulgating the Position Limits Rule 
4. Violation of the APA--Arbitrary and Capricious Agency Action in Establishing Specific Position Limits and Adopting Related Requirements and Restrictions 
5. Violation of the APA--Failure to Provide Interested Persons A Sufficient Opportunity to Meaningfully Participate in the Rulemaking 

The above arguments are not a one-off situation. In many of the Final Rules promulgated by the CFTC, the agency has not engaged in cost-benefit analysis. Depending on which way the election goes, one can assume that if President Obama wins re-election, in the years ahead we'll be seeing more of these kinds of cases being brought before court with this ruling providing precedent. Should that scenario prevail, we may not see full implementation of Title VII for many years, if ever.

The irony for the industry is the ongoing uncertainty surrounding the applicability of the CFTC's Final Rules involving Title VII. In other words, what may suffer most from an industry strategy to undermine Dodd-Frank through the courts is SIFMA's own claimed mission, that of "building trust and confidence in the financial markets".

Regardless, we think that this ruling's potential impact on all other Final Rules issued by the CFTC is significant. It sets precedence and legitimizes an avenue of attack to pull the rug from CFTC's reliance on a 1981 rulemaking upon which it assumed that cost-benefit analysis can be avoided.