(CN) - The Dodd-Frank Act expanded the authority of the Commodity Futures Trading Commission in policing off-exchange, retail commodity transactions, the 11th Circuit ruled.
In so finding, the federal appeals court affirmed Tuesday an injunction against Harold Martin Jr. and Fred Jager, executive officers of Hunter Wise Commodities.
This brokerage was at the center of a CFTC civil enforcement action involving 20 entities and individuals that allegedly funded transactions, but ultimately did not actually trade, store or transfer any metals.
Finding that the CFTC had presented a prima facie case of illegality and a likelihood of future violations, U.S. District Judge Donald Middlebrook had issued the injunction two months ago and appointed a special monitor to administer the businesses.
earlier this year after finding that the transactions were subject to the CFTC's enforcement authority under Dodd-Frank because they were financed commodity transactions made with retail customers.
Though Martin and Jager claimed that Hunter Wise bought and sold precious metals, and resold them to retail customers via a network of dealers, the CFTC maintained the firm did no such thing.
Rather it said a complex derivative scheme allowed the brokerage to manage its risk exposure related to customer transactions by not actually holding a physical inventory of metals for customers but by instead trading derivatives in its own margin trading accounts with precious-metals trading companies.
The appeal presented a question of first impression regarding whether Dodd-Frank actually did expand the CFTC's authority, according to the ruling.
"After careful consideration of the record and, with the benefit of oral argument, we hold that it does," Judge Joel Fredrick Dubina wrote for a three-judge panel. "Because the commission has authority to regulate the transactions alleged in this case and the requirements for a preliminary injunction are satisfied."
Dubina liked the officers' argument to a claim that the CFTC failed to state a valid claim for relief because there is purportedly no cause of action for preliminary injunction under Dodd-Frank.
It is conclusive, however, that the agency does indeed have the authority to regulate certain retail commodity transactions, the court found. In this case, moreover, the customers who engaged in the metals trades through Hunter Wise portal were individuals rather than "commercial entities," thus making the transactions retail in nature.
Though the CFTC's authority does not extend to all retail commodity transactions under Dodd-Frank, it does cover those "entered into or offered 'on a leveraged or margined basis, or financed by the offeror, the counterparty, or a person acting in concert with the offeror or counterparty on a similar basis,'" the 28-page ruling states.
The injunction ruling found that the commission's authority covered the transactions because the dealers - in cooperation with Hunter Wise - financed the transactions.
Martin and Jager were unsuccessful in parsing the statutory language, trying to rely on a definition of "leveraged" to argue Hunter Wise's transactions were fundamentally different from leveraged transactions, meaning that they could not be characterized as financed on a similar basis to margined or leveraged transactions, or as margined or leveraged themselves.
"First, the ordinary meanings of the terms used in § 2(c)(2)(D) do not support Martin and Jager's argument," Dubina wrote.
The court also found "no statutory authority for the position that the term 'leveraged' as used in § 2(c)(2)(D) ;is the same language as presented" in Section 23.
In fact, "the term of art 'leverage contract' does not appear in § 2(c)(2)(D)," Dubina wrote.
Adopting the interpretation Martin and Jager advance would render the relevant section of the Dodd-Frank meaningless, the court concluded.
Martin and Jager also failed to persuade the panel that Hunter Wise was beyond the CFTC's reach as a "wholesaler not engaged in the retail transactions."
"The commission alleges Hunter Wise controlled the entire scheme with a tight fist, and it is beyond dispute that Hunter Wise at least had its fingers - if not its hands - in each stage of the scheme," Dubina wrote. "The evidence demonstrated that Hunter Wise administered the Portal, extended credit to retail customers through the dealers, and finalized retail customers' transactions."
"Martin and Jager's arguments appear to rest in large part on their insistence that the Portal's retail customers were buying more than a margined interest in precious metals," the ruling concludes. "That insistence is incompatible with the District Court's factual findings at this stage, which we hold were not clear error. In light of the District Court's factual findings and legal conclusions with which we agree, we hold that the commission has enforcement authority over these transactions, and no exception applies. Because thecommission has pleaded a prima facie case of a violation of the act, we affirm the District Court's grant of the preliminary injunction."
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