Investment Company Institute v. CFTC

Under the Commodity Exchange Act, the Commodity Futures Trading Commission (CFTC) (defendant) has significant regulatory authority over the derivatives markets. The Commodity Exchange Act requires that commodity pool operators register with the CFTC and adhere to various requirements such as certain record-keeping and reporting. The Commodity Exchange Act, however, allows the CFTC to exclude an entity from regulation as a commodity pool operator if the CFTC determines that exclusion would be in furtherance of the purposes of the Commodity Exchange Act. The CFTC has exercised this authority through Rule 4.5, the scope of which has varied over time. The initial iteration of Rule 4.5 excluded entities if they (1) used commodity futures or options solely for bona fide hedging, (2) did not enter into commodity futures or options positions for which the margin exceeded 5 percent of their assets; (3) did not market themselves as an investment vehicle for trading in the commodity futures or options markets; and (4) made certain disclosures to prospective participants. The conditions were amended in 1993, when the CFTC removed the bona fide hedging requirement and excluded bona fide hedging from the trading threshold. In 2003 the CFTC amended Rule 4.5 again, eliminating the 5 percent trading ceiling. This had the effect of excluding registered investment companies, regulated by the Securities and Exchange Commission, from most CFTC regulations applicable to commodity pool operators. Then, in 2010, after the Dodd-Frank Act, the CFTC adopted stricter policies. The CFTC proposed regulations reinstating most of the pre-2003 criteria for exclusion under Rule 4.5. Additionally, the proposed regulations would include swaps within the trading threshold. The proposed regulation was finalized in substantially similar form. In finalizing the regulation, the CFTC provided a reasoned explanation, including a specific discussion of the Securities and Exchange Commission’s oversight role and the costs and benefits associated with the regulation. The regulation had the effect of requiring more registered investment companies to register with the CFTC. The Investment Company Institute and the Chamber of Commerce of the United States (collectively, the industry representatives) (plaintiffs) filed an action in federal district court against the CFTC, claiming that the rulemaking violated the Administrative Procedures Act by (1) failing to address the rationale for broader exclusions such as those that were adopted in 2003, (2) failing to analyze the costs and benefits, (3) including swaps in the trading threshold, narrowing the definition of bona fide hedging, and failing to justify the 5 percent threshold, and (4) providing inadequate opportunity for notice and comment. The district court ruled in favor of the CFTC, and the industry representatives appealed.