US courts restrict territorial reach of Commodity Exchange Act

Recent cases make it harder to pursue instances of overseas misconduct

US courts have recently taken a more restrictive view of the overseas reach of US derivatives law, something that is likely to hamper anti-manipulation claims in US courts and could even dampen the overseas investigations of the Commodity Futures Trading Commission (CFTC), say lawyers.

“There’s been some very significant developments in US case history recently, and an emerging doctrine that may make it harder to bring cases to US courts that involve alleged misconduct in overseas markets, unless the conduct directly and significantly impacts US markets,” says Daniel Waldman, head of the derivatives practice at law firm Arnold and Porter Kaye Scholer (APKS), and former CFTC counsel.

Rulings on two recent misconduct cases involving commodity derivatives reined in the extraterritorial application of the US Commodity Exchange Act, a key statute used by private civil plaintiffs and the CFTC to bring anti-manipulation cases involving commodity derivatives. In both cases, plaintiffs claimed – among other things – that defendants violated certain sections of the CEA. Both cases ruled the CEA should not apply extraterritorially in those circumstances.

Although the cases in question were private civil litigations using different provisions of the CEA to the ones used by the CFTC, the provisions are alike enough that in future a similar analysis and conclusion could be applied to the CFTC provisions, some lawyers believe.  

“The provisions are similar enough for it to be feasible that the courts could apply a similar analysis to the CFTC sections and conclude the CFTC is similarly limited,” Waldman says.

It should be noted the CEA does have a statutory provision allowing for the extraterritorial application of swaps regulation. This, the CFTC says, was overlooked in the most recent case ruling, which prompted the regulator to ask the judge for certain amendments.

The emerging doctrine has its roots in securities law where a 2010 landmark ruling by the US Supreme Court set a precedent for determining whether US law can be applied extraterritorially. In Morrison versus National Australia Bank, the plaintiffs were Australians who had purchased shares in National Australia Bank (NAB). The shares were sold on the Australian Stock Exchange after the bank had acquired a mortgage servicing company in Florida. The plaintiffs alleged that NAB engaged in deceptive conduct in Florida by manipulating the mortgage company’s financial models and making misleading statements.

The provisions are similar enough for it to be feasible that the courts could apply a similar analysis to the CFTC sections and conclude the CFTC is similarly limited

Daniel Waldman, Arnold and Porter Kaye Scholer

The case was dismissed on the grounds that US courts did not have jurisdiction to hear it. In reaching that decision the Supreme Court applied a presumption that Section 10(b) of the Securities and Exchange Act (SEA) was not intended to apply extraterritorially. It reasoned that if a statute does not contain a “clear indication” that Congress intended it to apply extraterritorially, the presumption should be that the statute has no overseas application. Having determined that section 10(b) of the SEA was not intended to apply extraterritorially, the Morrison court then asked whether the claims required extraterritorial application and determined they did.

Thus a court applying the Morrison decision must determine whether a statute gives a clear indication of extraterritorial application. If it does not, then the claimant must prove they have a sufficiently US-based case.

Prior to Morrison, it had been much easier to bring claims to US courts involving alleged damage to US markets by misconduct in overseas markets, even if those markets had only an indirect link to the US market, say lawyers.

“[In the past] every plaintiff’s lawyer in a US class action [would] allege that trading in London or Singapore or elsewhere has an impact on pricing in the US because the markets are all interrelated. That has been a touchtone in all these types of cases in the US,” says Peter Haveles, a partner in the commercial litigation practice group of law firm Pepper Hamilton.

Morrison changes that, he says. “On the civil litigation side it will become increasingly difficult to establish extraterritorial jurisdiction simply on the premise that there is price impact because every market affects every other market,” he adds.

APKS’s Waldman agrees: “This is a big deal because the assumption has been for many, many years, that if you had an impact on the US derivatives market, both from a civil litigation and from a CFTC enforcement standpoint, you are at risk in the US as a matter of jurisdictional power. That is no longer a given.”

The law in action

Loginovskaya versus Batratchenko was the first court of appeals decision to apply Morrison to a private claim under the CEA. The plaintiff, a Russian citizen living and conducting investments in and from Russia, had entered into investment contracts with a New York-based investment manager that invested in commodity futures and other products. When the plaintiff tried to take her money out she was unable to do so and claimed her investment had been misappropriated. A lower court dismissed the case, saying the CEA was “impermissibly extraterritorial” and, in 2014, the appeal court affirmed the dismissal on the grounds that the alleged misconduct took place outside the US. The court concluded “the CEA as a whole … is silent as to extraterritorial reach”.

Brent case

On June 8 this year, a similar conclusion was reached in the dismissal of a long and complex claim involving allegations of misconduct in the physical North Sea Brent crude market. In re: North Sea Brent Crude Oil Futures Litigation (Brent), a group of US-based plaintiffs operating in the US oil futures markets claimed they were harmed by alleged misconduct in the London-based physical Brent market. The defendants include oil majors BP, Royal Dutch Shell and Statoil, commodity traders Phibro, Vitol and Trafigura, and Morgan Stanley. 

The alleged misconduct occurred between 2010 and 2012 and included spoofing – placing orders with no intent to execute – in order to move the price of physical benchmark ‘dated’ Brent. Defendants were also accused of manipulative reporting to price reporting agency Platts during the London market-on-close window, and conducting wash trades – offsetting transactions of the same product among the same parties – involving cargoes of Brent crude. Plaintiffs claimed the misconduct in physical markets based in Europe had “ripple” effects across futures markets, impacting Brent and West Texas Intermediate futures prices traded on US exchanges. The case was dismissed on the grounds that the sections of the CEA being used did not apply extraterritorially in these particular circumstances, and that the plaintiffs had failed to show sufficient linkage between the overseas market where the alleged misconduct occurred and the US market they claim was affected.

In reaching the decision, the court relied on the Loginovskaya case when determining the relevant sections of the CEA were not designed to be applied extraterritorially. Once it had applied that presumption, the court then had to decide whether the case ran afoul of the extraterritorial block. Because it was concluded that the link between the dated Brent market and the price of US futures was tenuous, it was ruled the case needed extraterritorial application that didn’t exist. 

“The district court’s application of Morrison here demonstrates that even claims [involving] US futures markets may not be sufficient to overcome an extraterritoriality challenge where [the] alleged misconduct is committed abroad and the connection between that conduct and plaintiffs’ domestic trading is too attenuated,” commented lawyers at Skadden, Arps, Slate, Meagher & Flom in a July 6 report.

This effectively limits the liability of non-US traders to certain claims in US courts, says Haveles at Pepper Hamilton. “Within the context of this case, for foreign traders it has limited the extent of their financial liability for class actions,” he says. “It might not immunise them from the CFTC’s enforcement actions, but it certainly will provide substantial protection from plaintiff lawyers in the States suing for class action based on conduct that largely, if not solely, occurs in a different market.”

Taken together, the Loginovskaya and Brent cases show the implications of the Morrison decision on commodity futures claims with an overseas component that are using the CEA, say lawyers. “Together, the Loginovskaya and Brent … decisions make clear that Morrison presents a daunting obstacle to private CEA claims – at least with respect to futures transactions – involving some element of foreign conduct,” says the Skadden report.

The Brent and Loginovskaya cases are two of a handful of cases (see box: CFTC’s enforcement record) to apply Morrison to the CEA since 2010, all of which have been private civil actions. They apply different sections of the CEA to those used by the CFTC in enforcement actions, but lawyers believe there could be potential implications for the commission.

Michael Spafford and Daren Stanaway, partner and senior associates in the white collar defence practice of law firm Paul Hastings, suggest the cases severely restrict the regulator: “The text of the CEA and recent jurisprudence suggest the CFTC generally may not pursue CEA claims stemming from allegedly fraudulent or manipulative conduct occurring abroad – at least insofar as that conduct concerns transactions executed extraterritorially or on non-US exchanges – regardless of their impact upon the United States,” they write in an analysis in the Futures and Derivatives Law Report.

CFTC’s enforcement record

Since having its authority increased by the 2010 US Dodd-Frank Act, the CFTC has developed a formidable enforcement programme, filed increased numbers of actions and pursued significantly more complex cases.

According to the CFTC, it filed 68 enforcement actions in 2016, a 70% rise from 2008, with civil monetary penalties rising from $280 million in 2009 to a peak of $3.14 billion in 2015. It has forged relations with enforcement agencies worldwide and now regularly pursues cases that involve misconduct in overseas markets. From 2012 onwards it aggressively pursued and prosecuted defendants in the Libor and Isdafix interest rate swaps scandals where much of the misconduct occurred outside the US but had a clear impact on US futures markets.

This work marked it out as an enforcement agency to be reckoned with as it meted out some eye-watering penalties to domestic and overseas firms. For example, it fined UK-based bank Barclays $200 million in June 2012 for attempted manipulation and false reporting around Libor and Euribor benchmarks, followed by a further $115 million in May 2015 for attempting to manipulate US interest rate swaps through the Isdafix benchmark. The commission also fined Royal Bank of Scotland $85 million in February 2017 for attempted manipulation of the Isdafix.

Statutory provision

The CFTC declined to comment on the specific cases mentioned in this article or the implications of the Morrison decision on the agency’s authority, but it did respond in writing to point out that the CEA does have a statutory provision allowing for the extraterritorial application of swaps regulation.

This is Section 2(i) of the CEA that was inserted into the Act by the US Dodd-Frank Act in 2012. The provision makes it clear the CEA can apply extraterritorially in certain circumstances. However, it relates only to swaps, not futures or physicals.

The CFTC feels it is a provision that was overlooked in the judge’s statement on the Brent case – something the commission points out in a July 25 letter to the presiding judge. In the letter to Judge Carter, CFTC general counsel David Daniels asks the court to amend “certain incorrect statements” in his opinion concerning the extraterritorial reach of the CEA.

Carter’s opinion states the “CEA does not contain any statements suggesting that Congress intended the reach of the law to extend to foreign conduct”. The CFTC points to section 2(i) of the CEA, saying it “states that provisions relating to swaps apply outside of the United States if there is sufficient nexus to US commerce”.

Further, the pre-Dodd-Frank version of the CEA was applied in Loginovskaya as the case did not involve swaps. It was therefore erroneous to apply that case’s ruling to Brent, argues the CFTC. The letter says because of these errors, “we think the opinion incorrectly analyses the extraterritorial reach of [certain sections of the] CEA”.

It goes on to explain why this issue is “critically important” to the commission. “Section 2(i) is a lynchpin of the Dodd-Frank swaps market reforms. The swaps activities that catalysed the 2008 financial crisis included activities that occurred overseas, but which nevertheless contributed to economic turmoil in the United States.”

It concludes by saying the judge’s “erroneous statements” could “create a flawed line of precedent that could hamper the CFTC’s enforcement and regulatory efforts in the future.”

Anne Termine

If future decisions were based on this view, it would certainly be worrying for the CFTC, say lawyers. “The CFTC would have to think twice about whether it wanted to spend the time and resources to bring a case that may get thrown out of court,” Waldman says. “The problem for the CFTC is that it is limited by what the courts say and its authority is under the CEA.”

Others see the Brent ruling as having little impact on the CFTC’s enforcement programme, which can use the CEA more widely. Private civil claims have to meet more exacting criteria: claims must be based on specific transactions and are only allowed under section 22 of the CEA in four specific circumstances. In contrast, CFTC cases can involve more generalised market behaviour, say lawyers. They point to the fact that the CFTC’s Libor cases have tended to be much more successful than private litigants’ cases.

Nevertheless, it is important for the CFTC that Section 2(i) is properly acknowledged, they say. “I don’t think the Brent case ruling will deter any enforcement programme by the CFTC on an extraterritoriality basis,” says Anne Termine, counsel at law firm Covington & Burling and former chief trial attorney at the CFTC’s Department of Enforcement. “However, it does give pause because some parts of the language are incorrect according to the CFTC, and I think that’s why the CFTC wants a correction before it becomes cemented bad law. Even if the ruling gets turned over by the courts later on, the language would still be out there and somebody could try to use it at some stage,” she says.

So far there has been no public response by Judge Carter to the CFTC letter and he is under no legal obligation to make one. Lawyers are watching with interest to see what the outcome will be. “Usually in private litigation cases, the courts will give great deference to the agencies who are responsible for interpreting and enforcing those rules, deferring a great deal to them,” Termine says. “So it will be interesting to see how a court that’s not dealing with the agency directly but with private litigants responds to an agency’s concerns in this instance.”

While it appears Morrison is likely to have a far greater impact on private civil cases, even there it is still early days, lawyers say. There is a limit to what can be concluded from the Brent and Loginovskaya cases as the decisions are based on specific facts. Importantly, in both cases the plaintiffs failed to show a sufficient connection between the markets where they transacted and the markets where the alleged misconduct took place. So the question remains, if the plaintiff had proved a tight connection, would the court have ruled that the CEA could be applied?

“There was no real allegation of any US activity in the Brent case, so you have to wonder if there had been some US activity would that have changed the analysis?” asks Waldman. “If the allegation had been that the defendants acted overseas but they intended to directly affect a US market, and those markets were sufficiently intertwined that they did affect the plaintiff’s markets, they might well have concluded that the CEA would have applied, notwithstanding the fact that the conduct occurred overseas,” he adds.

The plaintiffs in the Brent case will be appealing the various defendants’ dismissals in an appeals process beginning in November, says David Kovel, interim lead counsel for the plaintiffs and partner at New York-based law firm Kirby McInerney. The cases will be watched carefully to see if the rulings are upheld or reversed.

Future anti-manipulation cases involving the CEA will be followed closely for how they decide the CEA’s extraterritorial reach should be applied. “It’s not as if Dodd-Frank completely fixed the problem for plaintiffs,” says Waldman. “Extraterritorial application of the CEA will continue to be discussed in cases and it will depend on the specific facts and whether the swaps market was impacted and how future courts interpret this emerging doctrine.”