The CFTC sued Kraft Foods Group, Inc. (and its successor in interest, Mondelēz Global LLC) in April, alleging, among other things, violations of both (i) CFTC Rule 180.1, the anti-fraud provision enacted as part of Dodd-Frank and modeled on Section 10(b) and Rule 10b-5 of the securities laws, and (ii) Rule 180.2, the CFTC’s traditional manipulation provision. As we wrote previously, the case is poised to be an important test for the CFTC’s new Dodd-Frank enforcement authority, and this certainly is true following the parties’ briefing on Kraft’s motion to dismiss the case, because the CFTC, in its opposition to Kraft’s motion, lays out the contours of its anti-manipulation authority and invites the court’s engagement on broad issues regarding its enforcement authority.
Specifically, in responding to Kraft’s argument that, to plead a violation of Rule 180.1, the CFTC must allege outwardly or inherently fraudulent or deceptive conduct, the CFTC sets forth an interesting, and in many ways expansive, interpretation of Rule 180.1 and the way in which it interacts with Rule 180.2. First, the CFTC distinguishes Rule 180.1 from Rule 180.2, asserting that Rule 180.1 “does not require a showing of a specific intent to manipulate a commodity price, nor does it require proof of actual artificial price.” That the two rules are different is unremarkable; they derive from different statutory prohibitions that prohibit different conduct and were enacted at different times, and Rule 180.1, as the CFTC identifies in its brief, stems from authority provided by Congress specifically to expand on the traditional manipulation regime manifested in Rule 180.2, which requires a showing of, among other things, specific intent and an artificial price.
After drawing this distinction between the old and the new anti-manipulation rule, however, the CFTC immediately blurs whatever line separates Rule 180.1 and Rule 180.2. In construing Rule 180.1, the CFTC focuses on the language of the underlying statute, which prohibits the use of any “manipulative or deceptive” device. By elevating the importance of the Rule’s use of the disjunctive “or,” the CFTC argues that Rule 180.1 prohibits two distinct classes of conduct: manipulation orfraud. And the CFTC argues, therefore, that not all violations of Rule 180.1 sound in fraud; a violation can arise from non-fraudulent, manipulative conduct. This means, according to the CFTC, that the CFTC does not have to allege any inherently or outwardly fraudulent or deceptive conduct to plead a violation of Rule 180.1, and it does not have to meet the heightened pleading standards of Rule 9(b) of the Federal Rules of Civil Procedure, which require that fraud be plead with particularity. Using this logic, the CFTC notably looks to case law interpreting its traditional manipulation regime (as embodied in Rule 180.2) to set forth the contours and substance of the anti-manipulation authority purportedly embodied by Rule 180.1.
The CFTC’s argument is noteworthy for a number of reasons. First, the CFTC’s focus on the disjunctive—“manipulative ordeceptive device”—ignores the plain language of the Rule, which the CFTC itself promulgated in order to effect the prohibition set forth in the underlying statute. Rule 180.1 prohibits the use of “any manipulative device, scheme, or artifice to defraud.” The phrase “to defraud” describes the type of device, scheme, or artifice the Rule prohibits. Read in context, the terms “manipulative” and “to defraud” complement each other and describe the fraudulent conduct the Rule was intended to combat. The CFTC’s litigation position thus conflicts with the language of the Rule that the CFTC drafted.
Second, as Kraft points out, under the CFTC’s interpretation, Rule 180.1 swallows Rule 180.2, rendering it a nullity. Although the CFTC still brings a claim under Rule 180.2, it is not clear why or when it would need Rule 180.2. Under the CFTC’s interpretation, Rule 180.1 and Rule 180.2 both reach pure, non-fraudulent “manipulation,” and, while Rule 180.2 requires a showing of specific intent and artificial price, the CFTC argues that Rule 180.1 does not. Therefore, the CFTC contends that there is nothing that Rule 180.2 captures that Rule 180.1 would not also prohibit, which cannot be what Congress intended.
Third, the CFTC’s logic seems to do a 180-degree turn mid-argument. Initially, the CFTC says that Rule 180.1 and Rule 180.2 are different. Then, it argues that Rule 180.1, just like Rule 180.2, prohibits non-fraudulent market manipulation, and it looks to precedent interpreting what is now Rule 180.2 to define “manipulation” under Rule 180.1. On one hand, the rules are different. On the other, they are the same. It is not clear where one ends and the other begins in the CFTC’s argument.
Fourth, the CFTC’s mental gymnastics seem motivated, at least in part, by a desire to avoid the heightened pleading standards of Rule 9(b) of the Federal Rules of Civil Procedure, which apply to allegations of fraud. Even to a casual observer, however, a CFTC pleading easily should be able to meet Rule 9(b)’s requirement that allegations of fraud be plead with “particularity.” This should not be a concern for the CFTC – ever. The CFTC is not a typical plaintiff. The CFTC is a government agency equipped with full-time investigative staff and the power to subpoena documents and testimony before ever filing suit. By the time the CFTC decides to bring an action in federal court, after an investigation of the alleged violation, its pleadings can and should be replete with Rule 9(b)’s required “particularity.” If the CFTC cannot plead fraud with particularity, after years of investigations, it should not bring the case. Therefore, other than simply giving itself as much enforcement authority and leeway as possible, it is not clear why the CFTC propounds such an odd interpretation of Rule 180.1.
Finally, as Kraft highlights, all of this is to say that the CFTC effectively advocates an “I know it when I see it” anti-manipulation regime. According to the CFTC, Rule 180.1 does not require outwardly or inherently fraudulent conduct. Nor does it require a showing of artificial price. Therefore, the CFTC contends, non-fraudulent open-market trading that has no price effect is actionable, and the CFTC does not delineate violations from lawful conduct, other than stating that a violation must be subjectively animated by some improper purpose. Market participants cannot meaningful tailor behavior (and the CFTC cannot meaningfully enforce the law) under such an amorphous regulatory regime, particularly in markets, such as commodities markets, that are based on asymmetrical information and where (unlike the securities markets) participants have no duty to disclose material non-public information before trading.
This is the real significance of the CFTC’s arguments in the Kraft case because no matter how it wants to interpret Rule 180.1 vis-à-vis Rule 180.2, the CFTC must interpret the rule in a way that market participants can observe and obey. By choosing to argue in this way, the CFTC renders the statute vague and ambiguous to the point of raising a question about the Rule’s constitutionality. Understanding that one must accord meaning to both rules, the only reasonable interpretation is that Rule 180.1 prohibits fraud and deceit, and manipulation designed to defraud, and Rule 180.2 prohibits traditional manipulation based on the principles of market power and abuse. The CFTC’s argument in the Kraft case is unmoored from the rules and the statutes, as well as common sense.