Judge to CFTC: Heads You Win, Tails You Win Too

Last week was a big week for the Commodity Futures Trading Commission. As Commissioner Sharon Bowen pointed out, the CFTC held its first meeting at which "all of the Commissioners have arrived after passage of the Dodd Frank Act." Also this week, a judge largely upheld CFTC guidance regarding the extraterritorial application of CFTC rules governing swaps (a type of derivative). In doing so, the judge gave the freshly minted CFTC commissioners a green light to continue the bad practices of their predecessors.

The lawsuit, which was brought by several industry organizations, came in response to an 80-page, 650-footnote CFTC guidance document that-along with some letters issued by the CFTC staff-defined the scope of the agency's extraterritorial jurisdiction. The industry argued that the CFTC essentially wrote a binding rule without calling it a rule and thus avoided requirements that govern binding rulemaking.

The judge thought the CFTC's approach was just fine: The CFTC's guidance "looks, walks, and quacks like a policy statement," not like a binding rule. This conclusion rested in part on the agency's assurances to the judge that it did not consider itself to be bound by the policy statement. It could depart from it whenever it wanted. As the court sees it, companies also can choose not to be bound by the guidance. Sure, the CFTC's last chairman told companies that they should comply with it, but that "encouragement merely conveys the CFTC's understandable desire that market participants voluntarily comply with the otherwise nonbinding policies within the Cross Border Action."

Since the guidance isn't binding, the industry can't challenge it in court. The CFTC also avoids the accountability that comes from statutory requirements to involve the public in the rulemaking process and analyze the costs and benefits of the guidance.

The plaintiffs superficially prevailed in the part of the case that involved indisputably binding rules. Because they are binding, the CFTC did a cost-benefit analysis, but the court held that the CFTC failed to do an adequate job. Rather than voiding the rules, the judge sent the CFTC back for a second try at the cost-benefit analysis. The court made it clear, however, that all the CFTC needs to do is check a few boxes.

To see why all this procedural stuff matters, let's go back to last week's CFTC meeting. One of the items on the agenda was reversing-in the words of Commissioner Christopher Giancarlo-"a regulatory action inspired by the Dodd-Frank Act [that] would have increased utility rates for millions of Americans." That is the type of problem that could have been flagged through a rigorous cost-benefit analysis before the rule was adopted. Instead, the CFTC put its rule out only to discover that it would prevent utilities from protecting themselves from risks. The message from the judge, however, is that the CFTC need only do a superficial cost-benefit analysis to check the statutory box, rather than a meaningful analysis to productively inform rulemaking and identify market disruptions before they happen.

The second matter on the meeting agenda was the re-proposal of a rule governing margin on uncleared swap transactions. That proposal has some positive elements, but it could partially depart from the course set in the cross-border guidance. Commissioner Wetjen cautioned his colleagues not to forget "that many operational and compliance decisions have been made with significant costs incurred by firms ... pursuant to the cross-border guidance."

Commissioner Wetjen recognizes something the court failed to: When the CFTC puts out a statement telling firms what they have to do, firms go to great lengths and expense to comply with it. The judge can call it nonbinding, but there is nothing voluntary about it for the industry. Of course, now with the court's blessing, the CFTC can change the guidance whenever it wants.

The court's ruling just encourages the CFTC to continue using statements that don't bind itself to bind the industry. Likewise, the court encourages the agency to continue treating cost-benefit analysis as a fill-in-the-blank exercise rather than a rigorous examination. That is hardly a model of good government. In its policymaking endeavors, the newly reconstituted CFTC should voluntarily embrace strong rulemaking procedures, instead of the court's form-over-substance alternative.