Amicus Curiae Brief — Dunn v. Commodity Futures Trading Comm'n

(10) Supreme Court, U.S 7

oot hy i

No. 95-1181 AUG 20 1996

In THE ~ tn

Supreme Court of the United States

OcTOBER TERM, 1995

WILLIAM C. DUNN and

DELTA CONSULTANTS, INC.,

Petitioners,

Vv.

COMMODITY FUTURES TRADING

COMMISSION, et al.,

Respondents.

On Writ of Certiorari to the United States

Court of Appeals for the Second Circuit

BRIEF OF THE

CHICAGO MERCANTILE EXCHANGE

AS AMICUS CURIAE

IN SUPPORT OF RESPONDENT

JERROLD E. SALZMAN

(Counsel of Record)

JAMES T. YSIAK

ALBERT F. ETTINGER

FREEMAN, FREEMAN

& SALZMAN, P.C.

401 North Michigan Avenue

Suite 3200

Chi , Illinois 60611

(312) 100

Counsel for the

Chicago Mercantile Exchange

Midwest Law Printing Co., Chicago 60610, (312) 321-0220

4 vv

TABLE OF CONTENTS

Page

TABLE OF CONTENTS ...............eee0e: i

TABLE OF AUTHORITIES ................. iii

STATEMENT OF INTEREST ............... 1

STATEMENT OF FACTS ...........cceeeees 2

Futures and Options: Background and Regu-

DIET ccdenedaueeescbestesseenece 2

The 1974 CEA Amendments: Creating the

CFTC and its Jurisdiction ............... 4

Statutory Exclusions from the CEA...... 5

SUMMARY OF ARGUMENT ................ 7

EE Second eh eeceee heb tkverseveveeees )

I. FUTURES AND OPTIONS ARE NOT “TRANS.-

ACTIONS IN” COMMODITIES ............ 9

Il. THE HISTORY, PURPOSE AND STRUCTURE

OF THE CEA AND THE 1974 AMENDMENTS

SUPPORT THE VIEW THAT THE TREAS-

URY AMENDMENT DOES NOT EXCLUDE

GREED ce ecevocesvecccvcecccscocecccce 12

III. PETITIONERS ARE CORRECT THAT OP.

TIONS AND FUTURES SHOULD BE TREAT-

ED SIMILARLY UNDER THE CEA BUT

THAT REQUIRES HOLDING THAT THE CEA

COVERS OFF-EXCHANGE FOREIGN CUR-

BESO GE EUUEMD cocccccccccccccsccccess 15

IV. THE 1982 AND 1992 AMENDMENTS TO THE

CEA SUPPORT CEA COVERAGE OF FOREIGN

CURRENCY FUTURES AND OPTIONS ... 18

ii

V. THE FOURTH CIRCUIT ERRED BY HOLD.-

ING IN SALOMON FOREX THAT THE

TREASURY AMENDMENT EXCLUDES CATE-

GORIES OF TRADERS FROM THE CEA .... 21

CONCLUSION ......cccccceevevccvessvvnsees 25

iii

TABLE OF AUTHORITIES

Cases Page

Abrams v. Oppenheimer Gov't Sec., Inc., 737 F.2d

i i cccckeeseeeseedeecececes 11

A.H. Phillips, Inc. v. Walling, 324 U.S. 490 (1945) . 14

Atkins v. Rivera, 477 U.S. 154 (1986)......... 18

Bank Brussels Lambert, S.A. v. Intermetals Corp.,

779 F. Supp. 741 (S.D.N.Y. 1991) .......... 11

Board of Trade v. SEC, 677 F.2d 1137 (7th Cir.),

vacated as moot, 459 U.S. 1026 (1982) ..... 10-11, 19

CFTC v. American Board of Trade, 473 F. Supp.

pee rec ceeeecccsoecece 10

CFTC v. American Board of Trade, Inc., 803 F.2d

ED pc ceccbeeecoccescceccce 10

CFTC v. Dunn, 58 F.3d 50 (2d Cir. 1995) ..... 10

CFTC v. Co Petro Marketing Gy up, Inc., 680 F.2d

i ee cd cee cedeecceseescececs 6, 16

CFTC v. National Coal Exch., Inc., [1980-1982

Transfer Binder) Comm. Fut. L. Rep. (CCH)

4 21,424 (W.D. Tenn. 1982) ................. 16

CFTC v. Standard Forex, Inc., [1992-1994 Transfer

Binder] Comm. Fut. L. Rep. (CCH) 4 26,063

EE ee 11

CFTC & State of Georgia v. Sterling Capital Co.,

[1980-1982 Transfer Binder] Comm. Fut. L.

Rep. (CCH) 421,169 (N.D. Ga.), modified,

Comm. Fut. L. Rep. (CCH) 4 21,170 (N.D. Ga.

ChE Pech ueeeeebbecesececessecvece 11

iv

Chicago Mercantile Exchange v. SEC, 883 F.2d

537 (7th Cir. 1989), cert. denied, 496 U.S. 936

GE Rancaccddanesdsd de deddaddacesaesiics 3, 11

GREED covccccccescvccccecentdedsevtcvesas

ae FD Ge we cccncccccdesdsccccecdésees 22

v. Alloyd Co., 513 U.S. __, 115 S.Ct.

BEES GERSED cccccccccsecccccccesscccessecss 9

Lavanthall v. General Dynamics Corp., 704 F.2d

407 (8th Cir.), cert. denied, 464 U.S. 846 (1983) . i)

Merrill Lynch, Pierce, Fenner & Smith, Inc. v.

Curran, 456 U.S. 353 (1982) ............... 4

North Haven Board of Education v. Bell, 456 U.S.

Te 18

Salomon Forex, Inc. v. Tauber, 8 F.3d 966 (4th

Cir. 1993), cert. denied, _ U.S. __, 114

ae nbc cccedesssceecat 8, 21, 22, 23, 24

Stovall, In re, [1977-1980 Transfer Binder] Comm.

Fut. L. Rep. (CCH) 4 20,941 (CFTC 1979) .... 16

United States v. Ron Pair Enterprises, Inc., 489

a GD GED cc ccccccccscndeseedesecness 9

Zipes v. Trans World Airlines, Inc., 455 U.S. 385

GED Scccescecevovcehovsvecoccsquecsseuss 19

Statutes

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rere 16

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Regulations

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Miscellaneous

61 Cong. Rec. 1,318 (1921)

(Remarks of Rep. Voight) .................

120 Cong. Rec. 34,736 (Oct. 9, 1974)

(Remarks of House Conference Committee

SD ED deci cidbsensedecesscesnscs

120 Cong. Rec. 34,997 (Oct. 10, 1974)

(Remarks of House Conference Committee

SD WED caccccecccsecscosceses

132 Cong. Ree. $17,023 (Oct. 17, 1986)

(Remarks of Sen. Melcher)................

CFTC Interpretive Letter No. 77-12,

[1977-1980 Transfer Binder] Comm. Fut. L.

Rep. (CCH) 420,467 (Aug. 17, 1977).......

H.R. Conf. Rep. No. 102-978,

102d Cong., 2d Sess. 76 (1992) .............

14

14

16

vii

H. Rep. No. 97-626,

97th Cong., 2d Sess., Part I............... 19

H. Rep. No. 97-626,

97th Cong., 2d Sess., Part II .............. 19

H.R. Rep. No. 975,

93d Cong., 2d Sess. 76 (1974) .............. 5

S. Rep. No. 102-22,

102d Cong., 2d Sess. 17 (1992) ............. 20

S. Rep. No. 1131,

93d Cong., 2d Sess. 19 (1974)........... 4, 5, 6, 13

Stein, The Exchange-Trading Requirement of the

Commodity Exchange Act, 41 Vand. L. Rev.

GP Sadi pbasde cdvussceveccnesseeds 3, 14, 22

BRIEF OF THE CHICAGO

MERCANTILE EXCHANGE AS AMICUS CURIAE

IN SUPPORT OF RESPONDENT

Pursuant to this Court’s Rule 37, the Chicago Mercan-

tile Exchange (“CME”) respectfully submits this brief

with the consent of the parties.

STATEMENT OF INTEREST

The Commodity Exchange Act (“CEA”) and the regula-

tions of the Commodity Futures Trading Commission

(“CFTC”) provide that all commodity futures contracts

and virtually all commodity options must be traded on

“contract markets” approved by the CFTC (unless spe-

cifically exempted from such requirement). Exchange

traded futures and options contracts are subject to the

CFTC’s exclusive regulatory jurisdiction. 7 U.S.C. §§ 2,

6(a) and (c), and 6c(b); 17 C.F.R. § 33.3. The CME has

been designated hy the CFTC as a “contract market”

under the CEA. 7 U.S.C. §§ 7 and 8. The CME pioneered

foreign currency futures and options trading in the early

1970s and is designated as a contract market for many

currency futures and options.

Congress found futures and options trading to be “af-

fected with a national public interest . . . rendering regu-

lation of such transactions imperative for the protection

of such commerce and the national public interest.” 7

U.S.C. § 5. Petitioners ask this Court to hold that a

minor provision of the CEA—the “Treasury Amend-

ment”—vitiates Congress’ regulatory scheme. Petitioners’

position is that a dealer may avoid the CEA and CFTC

regulation by trading in its back office rather than

through a regulated market. Any entity, no matter how

unscrupulous or under-capitalized, would be free to oper-

2

ate as a dealer in options contracts and offer those in-

struments to any customer without complying with any

of the regulatory dictates of the CEA that Congress

found “imperative.” 7 U.S.C. § 5. Further, because op-

tions and futures are generally interchangeable as an

economic matter, judicial acceptance of petitioners’ posi-

tion would directly affect both options and futures con-

tract markets.

Adoption of petitioners’ position also would foster an

unprincipled competitive disadvantage for exchange mar-

kets that are subject to costly regulation and would judi-

cially sanction unregulated off-exchange markets in op-

tions that would continue to drain volume and liquidity

away from the exchanges. The CME therefore has a sub-

stantial interest in the Court’s decision. Adoption of the

position argued by petitioners would eliminate the cur-

rent statutory mandate that futures and options be

traded on CFTC-approved markets or subject to CFTC

regulatory exemptions. The CME urges this Court to

affirm the position taken by the Second Circuit which

joined the Seventh Circuit in reading the Treasury

Amendment in accordance with its plain meaning and

the public interests Congress has found to be served by

the CEA.

STATEMENT OF FACTS

Futures and Options: Background and Regulatory

Regime.

Futures and options contracts are instruments that are

traded by parties seeking to hedge the risk of future

commodity price changes or to speculate on those future

3

price changes. On exchanges today, over 95% of futures

and options trading is done by market professionals,

commercial businesses and financial institutions—not

the general public. Futures and options generally are not

used to transfer title to or ownership of a commodity,

and for many purposes futures and options trading are

equally viable economic alternatives. See Chicago Mer-

cantile Exchange v. SEC, 883 F.2d 537, 543 (7th Cir.

1989), cert. denied, 496 U.S. 936 (1990).

In a futures contract, the buyer (long) and seller (short)

agree upon a price at which the future sale of a commod-

ity will occur. In an option contract, the buyer (holder)

and seller (writer) agree upon the price of the premium

the buyer will pay to the seller for the right to buy or sell

a commodity or a futures contract at a specified price on

a specified date. In return for the premium, the option

seller is obligated to sell or buy the commodity if the

holder “exercises” his rights under the option.

As a practical matter, very few futures result in de-

livery and very few traded options result in delivery of a

physical commodity. Instead, the parties to futures and

options contracts typically offset their original contract

to buy or sell a commodity at a future date, with a sub-

sequent, corresponding sell or buy contract.

Farly in this century, Congress considered banning

futures trading and actually banned options trading for

many years. See Stein, The Exchange-Trading Require-

ment of the Commodity Exchange Act, 41 Vand. L. Rev.

473, 477 (1988) (“Stein”); 7 U.S.C. §§ 6c(a¥ B), 6e(c). Since

futures and options provide hedging and price discovery

benefits to the American economy, Congress has allowed

futures and, over time, options to be traded, but only

under the CEA and subject to exclusive CFTC jurisdic-

4

tion. 7 U.S.C. §§ 2 and 5. The CEA relies heavily on self-

regulation by approved contract markets, 7 U.S.C. §§ 7

and 7a, subject to CFTC oversight. The CEA also prohib-

its fraud and manipulation, requires futures profession-

als to be registered, imposes limits on speculation, and

contains many other regulatory safeguards. See 7 U.S.C.

§§ 6a, 6b, 6d, 6e, 6f, 6k, 6m, 6o and 9.

Until 1992, Congress required all futures and virtually

all options to be traded on CFTC-designated contract

markets. 7 U.S.C. §§ 6(a), 6c(b) and 17 C.F.R. 33.3. In

amending the CEA in 1992, Congress granted the CFTC

the authority to exempt particular instruments from the

contract market designation requirement provided that

such an exemption was found to be in the public interest

and consistent with the purposes of the CEA. See 7

U.S.C. § 6(cX2). The CFTC has used that authority to

exempt certain currency, interest rate and commodity

swap agreements, and certain so-called “hybrid” transac-

tions, from the contract market designation and most

other CEA requirements. See 17 C.F.R. Parts 34, 35.

The 1974 CEA Amendments: Creating the CFTC and

its Jurisdiction.

In 1974, Congress substantially strengthened the CEA.

Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Curran,

456 U.S. 353, 366 (1982). The 1974 amendments created

the CFTC to exercise “exclusive jurisdiction” over futures

and options under the CEA, thereby superseding any ap-

plicable jurisdiction of other federal agencies and pre-

empting state regulation. 7 U.S.C. § 2; S. Rep. No. 1131,

93d Cong., 2d Sess. 19, 23 (1974).

5

The 1974 amendments also defined foreign currencies

and government securities as commodities under the

CEA and subjected futures and options involving those

new “commodities” to the same regulatory structure as

all other CEA-regulated commodities. Jd. Congress recog-

nized that unregulated currency futures were already

being traded, yet expanded the “commodity” definition

because it saw “no reason why a person trading in one of

the currently unregulated futures markets should not re-

ceive the same protection afforded to those trading in the

currently regulated markets.” H.R. Rep. No. 975, 93d

Cong., 2d Sess. 76 (1974). Congress knew that “markets

in a number of foreign currencies” were among the “im-

portant futures markets” that were “completely unregu-

lated by the Federal Government.” S. Rep. No. 1131,

at 19. Congress enacted the 1974 CEA Amendments “to

fill all regulatory gaps—to regulate trading in futures

and in options . . . because such trading is now poorly

regulated, if it is regulated at all.” 120 Cong. Rec. 34,736

(Oct. 9, 1974) (Remarks of House Conference Committee

Chairman Poage); 120 Cong. Rec. 34,997 (Oct. 10, 1974)

(Remarks of Senate Conference Committee Chairman

Talmadge).

Statutory Exclusions from the CEA.

Since its inception, the CEA generally has had only

limited application to contracts that result in immediate

delivery of a commodity (cash or spot transactions) or to

so-called forward contracts designed to allow commercial

enterprises to transfer actual ownership of a commodity

in the future. Forward contracts are carved out of the

‘CEA’s description of a futures contract (“contract for the

purchase or sale of a commodity for future delivery,” 7

U.S.C. § 6(a)) by a provision that states: “The term

6

‘future delivery,’ as used in this Chapter, shall not in-

clude any sale of any cash commodity for deferred ship-

ment or delivery.” 7 U.S.C. § 2.

When enacted in 1922, the forward contract provision

was designed to apply to common commercial transac-

tions in the agricultural commodities that were then the

only commodities covered by the statute. Thus, the pro-

vision excluded contracts whereby a “farmer [would] sell

part of next season’s harvest at a set price to a grain ele-

vator or miller.” CFTC v. Co Petro Marketing Group, Inc.,

680 F.2d 573, 577 (9th Cir. 1982) (footnote omitted). Un-

like futures, where offset is routine, “both parties to the

[forward] contracts deal in and contemplate future de-

livery of the actual [commodity].” 680 F.2d at 578 (em-

phasis in original).

In the 1974 amendments to the CEA, Congress enacted

a corollary exclusion—the Treasury Amendment. During

the pendency of that legislation, the Treasury Depart-

ment expressed concerns relating to the CFTC’s jurisdic-

tion over transactions in certain financial instruments—

including currency and government securities—that be-

came commodities under the expanded “commodity” defi-

nition in the pending bill. S. Rep. No. 1131, at 49-51. To

address that concern, Congress provided (7 U.S.C. § 2)

that:

Nothing in this chapter [7 U.S.C. § 1, et seq.|

shall be deemed to govern or in any way be ap-

plicable to transactions in foreign currency, secur-

ity warrants, security rights, resales of install-

ment loan contracts, repurchase options, govern-

ment securities, or mortgages and mortgage pur-

chase commitments, unless such transactions in-

volve the sale thereof for future delivery con-

ducted on a board of trade.

7

SUMMARY OF ARGUMENT

In effect, petitioners argue that in enacting the Trea-

sury Amendment Congress wrecked the comprehensive

regulatory framework it was constructing through the

rest of the 1974 CEA Amendments by excusing options

in foreign currency and other important instruments

from the CEA’s safeguards and regulatory costs. The

plain language of the Treasury Amendment and the

history of the 1974 CEA Amendments refute this argu-

ment.

The Court below and the Seventh Circuit have ruled

that since the Treasury Amendment’s exclusionary

phrase encompasses only actual “transactions in” the

listed commodities (7 U.S.C. § 2), it does not exclude

from CEA coverage options which are derivative transac-

tions designed for hedging or trading, rather than actual

ownership of, for example, currency. This straightforward

reading of the statutory language is also sound policy be-

cause interpreting the Treasury Amendment’s statutory

exclusion narrowly—especially given the fact that the

CFTC’s broad exemptive powers has allowed the CFTC

to address the legitimate concerns regarding unnecessary

regulation voiced by banks and certain other market par-

ticipants—is preferable to judicially undermining the

CEA’s basic framework. Excluding all over-the-counter

options trading in major commodities like currency and

government securities from the CEA would be a major

departure from the seventy-year history of the CEA.

Petitioners and the amici who have supported petition-

ers correctly state that the CEA should treat foreign cur-

rency options in the same manner as foreign currency

futures. However, implicitly contradicting themselves,

petitioners’ argument actually entails that futures con-

8

tracts for foreign currency and the other instruments

covered in the Treasury Amendment are subject to the

CEA but options contracts for these commodities are

completely outside the CEA’s protections. As a matter of

proper statutory interpretation and sound regulatory

policy, the CEA should be held to regulate transactions

in both options and futures contracts for foreign currency

and the other instruments listed in the Treasury Amend-

ment. Moreover, there is nothing unworkable or unrea-

sonable about the Second Circuit’s interpretation of the

Treasury Amendment’s treatment of foreign currency op-

tions.

Still further, Congress’ implicit adoption in the 1982

and 1992 Amendments to the CEA of the Second and

Seventh Circuits’ holding that transactions in options are

not “transactions in” the underlying commodities pro-

vides further grounds for affirming the Second Circuit in

this case.

Finally, the Court should reject the holdings of Salo-

mon Forex, Inc. v. Tauber, 8 F.3d 966 (4th Cir. 1993),

cert. denied, __ U.S. ___, 114 S.Ct. 1540 (1994), and re-

ject an interpretation of the Treasury Amendment that

would subject foreign currency futures and options to

CEA regulation only if the transactions were entered into

by small or unsophisticated investors. Even aside from

the unworkability of making CEA jurisdiction depend on

the sophistication of the transacting parties, there is no

basis in the CEA for drawing such a distinction.

9

ARGUMENT

One must begin with the language of the statute.

United States v. Ron Pair Enterprises, Inc., 489 U.S. 235,

241 (1989). Petitioners agree, but actually seek to rewrite

the statute by focusing exclusively on the word “transac-

tions” while ignoring the preposition “in” that modifies

“transactions.”

In the CEA, Congress did not employ the phrase

“transactions in” a commodity to describe futures or op-

tions contracts; instead that phrase was designed liter-

ally to mean cash and forward contracts where delivery

and therefore an actual transaction in the commodity is

contemplated.

I. FUTURES AND OPTIONS ARE NOT “TRANSAC-

TIONS IN” COMMODITIES.

The Treasury Amendment’s key phrase limits its cov-

erage to “transactions in” foreign currencies and the

other listed instruments. The plain meaning of “transac-

tions in” compels affirmance of the Second Circuit’s de-

cision. In common language one would not say that one

had engaged in a currency transaction if one bought or

sold the right to enter into a transaction. Cf. Lavanthall

v. General Dynamics Corp., 704 F.2d 407, 412 (8th Cir.),

cert. denied, 464 U.S. 846 (1983) (under securities laws,

purchases of stock options have no “transactional nexus”

with underlying stocks). Certainly no one can deny that

a word used in a statute must be construed in context

and that prepositions and adjectives may change the

meaning of a word or phrase used in a statute. See Gus-

tafson v. Alloyd Co., 513 U.S. __, 115 S.Ct. 1061, 1069

(1995) (“a word is known by the company it keeps”).

10

The Second and Seventh Circuits have held that, when

read literally, the Treasury Amendment excludes only

actual “transactions in” the enumerated commodities

(here, foreign currency), not options and futures. See

CFTC v. American Board -f Trade, Inc., 803 F.2d 1242

(2d Cir. 1986); Board of Trade v. SEC, 677 F.2d 1137

(7th Cir.), vacated as moot, 459 U.S. 1026 (1982). The

Second Circuit concluded in American Board of Trade,

803 F.2d at 1248, that:

an option to buy or sell foreign currency is not a

purchase or sale of the currency itself and hence

is not a transaction “in” that currency, but at

most is one that relates to the currency.

This reasoning was adhered to in the decision below:

Our reasoning [in American Board of Trade} was

that an option was simply the right to engage in

a transaction in the future, and, until this right

matured, there was no exempt “transaction.” The

exercise of an option would constitute a “transac-

tion in foreign currency,” but the purchase or sale

of the option itself would not be such a “transac-

tion” under the Treasury Amendment. CFTC v.

Dunn, 58 F.3d 50, 53 (2d Cir. 1995).

The Seventh Circuit reasoned similarly in Board of

Trade v. SEC, 677 F.2d at 1154 in holding that the Trea-

sury Amendment does not apply to the trading of govern-

ment securities options:

“The option transaction is a long step removed

from a transaction in the commodity involved,

since the option purchaser, if he or she does noth-

ing more when the specified date arrives, will

simply see the option die.” Commodity Futures

Trading Commission v. American Board of Trade,

473 F.Supp. 1177, 1183 (S.D.N.Y. 1979); see

11

also Commodity Futures Trading Commission &

State of Georgia v. Sterling Capital Co. [(1980-

1982 Transfer Binder] Comm. F. L. Rep. (CCH)

4 21,169 at 24,783-24,784 (N.D. Ga.), modified,

{ 21,170 (N.D. Ga. 1981).] Only when the option

holder exercises the option is there a transaction

in a government security.’

The distinction between transactions “in” commodities

and derivative transactions that “involve” commodities

goes to the heart of the CEA. Congress did not intend the

CEA’s entire regulatory scheme to apply to actual trans-

actions in commodities—that is, transactions where title

or ownership is transferred or is expected to be trans-

ferred. Rather, the CEA primarily regulates derivative

transactions (futures and options) that involve commodi-

ties where the parties do not expect to and routinely do

not transfer title to or ownership of the commodity. Fu-

tures and options are traded in order to hedge or spec-

ulate in future price changes in a commodity without the

cost and expense of acquiring a commodity through

transactions “in” the commodity.

' The Seventh Circuit subsequently confirmed that, as with

— contracts, “[t}rading [of futures contracts) occurs in

contract’, not in the commodity.” Chicago Mercantile Ex-

change v. SEC, 883 F.2d at 542. also Abrams v. Oppen-

heimer Gov't Sec., Inc., 737 F.2d 582, 589-593 (7th Cir. 1984),

(GNMA forward contracts that typically resulted in delivery

excluded from the CEA by Treasury Amendment); Bank Brus-

sels Lambert, S.A. v. Intermetals Corp., 779 F. Supp. 741, 748-

750 (S.D.N.Y. 1991) (cash market currency transactions ex-

cluded from CEA Amendment); CFTC v. Stan-

dard Forex, Inc., (1992-1994 Binder) Comm. Fut. L.

Rep. (CCH) 4 26,063 (E.D.N_Y. 1993) (foreign currency futures

contracts not excluded from CEA by Treasury Amendment).

12

The Treasury Amendment itself evidences congres-

sional appreciation and endorsement of that distinction.

That provision excludes actual “transactions in” the

listed commodities, while including within the CEA’s

purview derivative “transactions involv(ing]” those com-

modities for future delivery conducted on a board of

trade. 7 U.S.C. § 2.

The Treasury Amendment’s exclusion should be limited

to cash and forward contracts in the listed commodities

as the Second and Seventh Circuits have held. The Trea-

sury Amendment was enacted by Congress only to assure

the Treasury Department that the CFTC would not regu-

late spot and forward contracts in the instruments listed

in the Amendment unless those transactions actually in-

volved trading on a board of trade.

ll. THE HISTORY, PURPOSE AND STRUCTURE OF

THE CEA AND THE 1974 AMENDMENTS SUPPORT

THE VIEW THAT THE TREASURY AMENDMENT

DOES NOT EXCLUDE OPTIONS.

While the statutory language of the Treasury Amend-

ment supplies more than adequate reason to affirm, the

history and structure of the CEA also support affir-

mance.

First, the Treasury Department’s much-cited letter to

the Senate Committee in 1974 nowhere mentioned for-

eign currency options or any other options except repur-

chase options. Indeed, although the Treasury Depart-

ment’s letter referred loosely to the need to exempt

“futures” in the listed commodities from the CEA and

this terminology was used by the Senate Committee in

paraphrasing the Treasury Department’s letter, the key

13

congressional reports do not suggest that options or

futures are among the excluded transactions. See S. Rep.

No. 1131, 93d Cong., 2d Sess. 23 at 49-51. Thus, the

legislative history of the Treasury Amendment does not

provide any evidence of congressional intent to exclude

any options or futures contracts from the CEA.

Second, petitioners’ reading of the Treasury Amend-

ment conflicts with Congress’ expressed intention in 1974

to fill all regulatory gaps in the marketing of options con-

tracts and to subject previously unregulated options con-

tracts to exclusive CFTC jurisdiction. Surely if Congress

intended the Treasury Amendment to create new, large

gaps in the CFTC’s jurisdiction and leave whole catego-

ries of options contracts unregulated, Congress would

have made that intent explicit. The congressional policy

underlying the 1974 expansion of the CEA requires that

options contracts not be excluded from that statute’s cov-

erage.

* The Treasury Department's letter shows no awareness of

the difference between futures and forwards and is thus con-

sistent with an intent to exclude only spot and forward trans-

actions from the CEA. Further, given the Treasury Depart-

ment’s use in the “unless” clause of the extremely broad, statu-

tory-defined term “board of trade” in drafting the exclusion

from the Treasury Amendment, it is im ible to determine

a types of transactions the ury Department

wanted to exclude from the CEA.

In any event, the issue here is not what the Treasury De-

partment intended, but what Congress intended. The language

and the legislative history of the 1974 Amendments

to CEA demonstrate that Congress only intended to ex-

clude spot and forward contracts.

14

Finally, as a general matter of statutory construction,

statutory exceptions are to be strictly construed so that

the exception does not swallow the rule. See A.H. Phil-

lips, Inc. v. Walling, 324 U.S. 490, 493 (1945). Petitioners

would read the Treasury Amendment’s exclusion to scrap

the CEA’s regulatory scheme for trading in the listed

commodities thereby creating an unwarranted vacuum in

statutory coverage and regulatory policy. That result

would destroy the core of the CEA, at least for such im-

portant commodities as foreign currencies and govern-

ment securities. Under petitioners’ view of the CEA, con

artists operating “bucket shops” would obtain a “safe

harbor” for offering fraudulent off-exchange produets in

Treasury Amendment commodities without any fear that

their misconduct would violate the CEA.*

Adoption of petitioners’ argument also would defeat the

CEA’s emphasis on exchange self-regulation. See 7 U.S.C.

§§ 7, 7a and 8 (requiring exchanges to police for price

manipulation and to enforce their rules). It would also

mean:

* Congress required trading of options and futures on CFTC-

designated cantons markets in order to eliminate bucket

8 , which were businesses that purveyed non-exchange

t futures contracts to investors through various forms of

fraud and deceit. See, e.g., 61 . Rec. 1,318 (1921) (Re-

marks of Rep. Voight) (stating that “[t)he bucket shop is wiped

out in this bill”); 132 fone, ten $17,023 (Oct. 17, 1986) (Re-

marks of be Melcher) (stating that oo. ae of 1"

shops ca Congress to uire ures

traded on federally sngueved aumngueh See also Stein, 41

Vand. L. Rev. at 481-482.

15

* no antifraud rules, 7 U.S.C. § 6b; 17 C.F.R.

33.10;

* no record-keeping or audit trail requirements,

17 C.F.R. 1.35;

* no trade practice rules, 17 C.F.R. 1.38, 1.39,

Part 155;

* no ban on manipulation, 7 U.S.C. §§ 7(d), 9;

* no CFTC registration requirements, 7 U.S.C.

§ 6d; 17 C.F.R. Part 3.

In short, adoption of petitioners’ position would pre-

clude all forms of CEA trading regulation for non-ex-

change options trading in the listed commodities.

Ill. PETITIONERS ARE CORRECT THAT OPTIONS

AND FUTURES SHOULD BE TREATED SIMI-

LARLY UNDER THE CEA BUT THAT REQUIRES

HOLDING THAT THE CEA COVERS OFF-EX-

CHANGE FOREIGN CURRENCY OPTIONS.

Petitioners (Pet. Br. 14) and all their supporting amici

admit that options contracts and futures contracts are

very similar both in form and purpose and must be

treated in a similar manner by the CEA. However, the

construction of the Treasury Amendment advanced by

petitioners and one of the two groups of amici in fact

would mandate a sharp distinction in the CEA’s coverage

of options and futures involving the commodities listed

in the Amendment. The other group of amici takes a

position which is inconsistent with petitioners’ in an

unsuccessful effort to escape the self-contradiction peti-

tioners’ position entails.

Petitioners and amici Credit Lyonnais, Bank Julius

Baer & Co. Ltd., Chase Manhattan Bank, N.A. and

Societe General argue that options on foreign currencies

16

are outside the coverage of the CEA. But this means that

options on foreign currencies would be treated entirely

differently from futures on foreign currencies. Futures

are generally covered by the CEA no matter how “trans-

actions in” is interpreted because of the Treasury

Amendment’s “unless” clause. The “unless” clause unde-

niably excludes from the exclusion any transaction which

involves the sale of a futures contract on a “board of

trade.” “Board of trade” is very broadly defined in the

CEA as “any exchange or association . . . of persons who

shall be engaged in the business of buying or selling com-

modity....” 7 U.S.C. § 1la(1). Thus, it is clear that if

petitioners had been selling foreign currency futures

their activities would have been covered by the CEA.‘ By

arguing that they should escape CEA coverage, petition-

ers are claiming the CEA treats foreign currency options

differently from foreign currency futures.

Amici Foreign Currency Exchange Committee, New

York Clearing House Association, Futures Industry Asso-

ciation, Managed Funds Association, and Public Securi-

* In CFTC v. Co Petro Marketing Group Inc., 680 F.2d 573,

581 (9th Cir. 1982), it was held that “board of trade” as de-

fined by the CEA was broad enough to include a corporation

that was trading gasoline futures in an unregulated market.

The CFTC has consistently taken the same broad approach in

applying the definition of “board of trade.” It has held that a

sole proprietor operating a bucket shop could be a board of

trade. In re Stovall, [1977-1980 Transfer Binder) Comm. Fut.

L. Rep. (CCH) 4 20,941 at 23,781 (CFTC 1979). See also CFTC

v. National Coal Exchange, Inc., {1980-1982 Transfer Binder)

Comm. Fut. L. Rep. (CCH) 4 21,424 at 26,053 (W.D. Tenn.

1982) (company operated “as a kind of board of trade”); CFTC

\aterpretive Letter No. 77-12, [1977-1980 Transfer Binder]

Comm. Fut. L. Rep. (CCH) 9 20,467 at 21,911-912 (Aug. 17,

1977) (government securities dealers may be a board of trade).

17

ties Association apparently recognize that they cannot

without self-contradiction claim both that options and

futures are treated similarly by the CEA and that op-

tions on foreign currency are outside the CEA given that

futures on foreign currency are certainly covered by the

CEA if they are traded on a “board of trade.” These trade

association amici attempt to avoid their dilemma by

claiming that both options and futures in the listed com-

modities fall under the Treasury Amendment and that

both options and futures are subject to the “unless”

clause (Foreign Exchange Committee et al. Brief at 22 n.

18). Consistent with this position, the trade association

amici ask the Court to remand to the district court for a

determination of whether petitioners’ conduct involved

transactions on a “board of trade.”

However, the “unless” clause simply does not mention

options, and the trade association amici’s attempt to

make it cover options has no basis in the text of the

Treasury Amendment or the CEA. Moreover, adoption by

the Court of the position taken by the trade association

amici would not help petitioners or amici. It is clear that,

given the very broad statutory definition of “board of

trade,” the activities of both petitioners and amici are

subject to the CEA if options contracts are subject to the

“unless” clause.

In fact, to reach the (correct) result that the CEA

treats options contracts the same as futures contracts, it

is necessary to hold that options transactions are not

“transactions in” the underlying commodity. The Trea-

sury Amendment excludes CEA coverage of contracts

contemplating actual delivery of the underlying commodi-

ties but does not exclude coverage of either futures con-

18

tracts or options contracts. This is entirely consistent

with the statutory language.

Finally, the argument made by petitioners that the

Second Circuit’s treatment of CEA jurisdiction over op-

tions is unreasonable or unworkable (Pet. Br. 14-15) is

totally without merit. The Second Circuit’s holding that

foreign currency option contracts are subject to CEA jur-

isdiction does not require anyone to guess at the time of

entering the option contract whether the option will be

exercised to determine whether the option is subject to

CEA jurisdiction. Under the CEA and the ruling by the

Court below, option contracts on commodities are always

subject to CEA jurisdiction whether they are ultimately

exercised or not. In the exceptional case, in which the

option is exercised, the exercise of the option would not

retroactively remove CEA jurisdiction over the option

contract.°

IV. THE 1982 AND 1992 AMENDMENTS TO THE CEA

SUPPORT CEA COVERAGE OF FOREIGN CURREN-

CY FUTURES AND OPTIONS.

It is evidence that a statutory interpretation is correct

that the interpretation has been brought to the attention

of Congress and Congress has not sought to alter it while

amending the statute in other respects. See Atkins v.

Rivera, 477 U.S. 154, 166 n.10 (1986); North Haven

Board of Education v. Bell, 456 U.S. 512, 535 (1982):

° The treatment by the Court below of option contracts under

the CEA is identical to the established treatment of futures.

Futures contracts are subject to the CEA at the time they are

made whether or not delivery is subsequently made under the

contract.

19

Zipes v. Trans World Airlines, Inc., 455 U.S. 385, 394-95

(1982). Congress has twice considered practical problems

allegedly created by narrow interpretations of the Trea-

sury Amendment which resulted in broad CEA coverage

of futures and options. In both cases, Congress carefully

amended the law to address the problems that it found

actually existed without amending the Treasury Amend-

ment to exempt off-exchange options trading.

In 1982, legislation was enacted in response to the

holding of Board of Trade v. SEC, 677 F.2d 1137, that

the Treasury Amendment did not apply to options but

only to transactions in the underlying commodities. Al-

though it was dissatisfied with some of the practical re-

sults of the Seventh Circuit’s holding, Congress did not

tamper with the Seventh Circuit’s interpretation of the

Treasury Amendment. H. Rep. No. 97-626, 97th Cong.,

2d Sess., Part I at 7-8. Instead Congress excluded from

the CEA options on government securities (7 U.S.C.

§ 2a(i)) and options on foreign currencies if traded on a

national securities exchange (7 U.S.C. § 6c(f)). The leg-

islative history of the 1982 Amendments shows that Con-

gress recognized that this would allow the CFTC to con-

tinue to regulate foreign currency options traded on com-

modities markets. H. Rep. No. 97-626, 97th Cong., 2d

Sess., Part II at 12. Given the unaltered Seventh Circuit

holding on the meaning of the Treasury Amendment, off-

exchange foreign-currency options also remained subject

to the CEA and CFTC regulation.

In 1992, in granting the CFTC authority to exempt

specific instruments from the exchange-trading require-

ment, 7 U.S.C. § 6(c), Congress plainly acted with the

understanding that prior to that amendment all futures

contracts and almost all options were required to be

20

traded on CFTC-designated contract markets. If the

Treasury Amendment had removed broad categories of

options and futures products from the CEA and CFTC

jurisdiction, Congress in 1992 would have cited that ex-

clusion in determining whether the exchange-trading re-

quirement was too rigid. Instead, the legislative history

of the 1992 amendment to the exchange-trading require-

ment demonstrates the exact opposite. The 1992 amend-

ment was designed to allow the CFTC to address in a

careful and limited fashion some of the concerns of banks

and other market participants which petitioners claim

Congress addressed in a blunderbuss fashion with the

Treasury Amendment. See S. Rep. No. 102-22, 102d

Cong., 2d Sess. 17, 59-62 (1992); H.R. Conf. Rep. No.

102-978, 102d Cong., 2d Sess. 76-83 (1992).

The 1992 amendment also eliminated any basis for

genuine concern that, absent a broad construction of the

Treasury Amendment, the 1974 expansion of the CEA

and CFTC jurisdiction could disrupt markets for foreign

currency and other financial instruments already regu-

lated by other federal agencies. To the extent that such

markets actually involve the trading of options or futures

contracts rather than only spot and forward contracts,

the CFTC now has the power to exempt a market from

any or all CEA regulation and even limit that exemption

to those instruments that are subject to regulation by

other federal agencies. In fact, in its hybrid exemption

(17 C.F.R. Part 34), the CFTC only exempted those in-

struments that would be subject to regulation under fed-

eral securities or banking laws.

In sum, through its 1992 grant of exemptive authority

to the CFTC, Congress established a specific mechanism

that allows the CFTC to determine what level of regula-

21

tion, if any, is appropriate for non-exchange futures trad-

ing. Adoption of petitioners’ position would strip the

CFTC of that power for foreign currency and government

security options. That result is out of step with Congress’

recent actions and should be rejected.

V. THE FOURTH CIRCUIT ERRED BY HOLDING IN

SALOMON FOREX THAT THE TREASURY AMEND-

MENT EXCLUDES CATEGORIES OF TRADERS

FROM THE CEA.

The Fourth Circuit in Salomon Forex erred in holding

that options and futures contracts on foreign currency

and other commodities mentioned in the Treasury

Amendment are excluded from CEA coverage. Salomon

Forex did not help matters by attempting to fix the huge

regulatory hole its holding implied by suggesting that the

CEA would still somehow protect small unsophisticated

investors in foreign currency options when the language

of the Treasury Amendment supplies no basis for Sa/lo-

mon Forex’s distinction in coverage between the sophisti-

cated and novices.

In Salomon Forex the Fourth Circuit reasoned that be-

cause futures are mentioned in the “unless” clause that

they must be covered by the Treasury Amendment and,

because options are economically similar to futures,

options too should be excluded for the CEA.*° Salomon

® The Fourth Circuit's reasoning based on the “unless” clause

is flawed. Transactions in foreign currency (i.e., cash and

forward transactions) that are complex can involve a futures

transaction and thereby be covered by the “unless” clause. The

“unless” clause, then, excludes a subset of cash and forward

transactions from the Treasury Amendment.

(continued...)

22

Forex was emphatic that there is “no principled reason”

to distinguish between foreign currency options and

futures. 8 F.3d at 974-76. The Fourth Circuit apparently

overlooked the fact that the “unless” clause dictates that

futures contracts in the commodities listed in the Trea-

sury Amendment are generally covered by the CEA.

Thus, if there is “no principled reason” to distinguish for-

eign currency options and futures, options should also be

covered by the CEA.

® (...continued)

The Fourth Circuit also believed that the Treasury Amend-

ment was not limited in its reach to spot and forward con-

tracts because that would cause it to be unnecessary in that

it would overlap in part with the forward or “cash commodity”

exclusion provided at 7 U.S.C. § 2. 8 F.3d at 975. But the 1922

enactment of the forward exclusion greatly predates that of

the Treasury Amendment. Congress frequently passes pro-

visions which are redundant of earlier enacted statutes, Con-

necticut Nat'l Bank v. Germain, 503 U.S. 249, 253 (1992) (“re-

dundancies across statutes are not unusual events in draft-

ing”), and it is hardly surprising that the Treasury Amend-

ment was enacted even if it was somewhat unnecessary. The

Treasury Department may well have not been aware that its

concerns were unjustified given the forward exclusion. See

Stein, 41 Vand. L. Rev. at 493. Further, it is not unusual for

Congress to enact statutory provisions to prevent the courts

from holding that an activity is covered by a law even when

there is no particular reason to believe the courts will so in-

terpret the law. For example, in the Soft Drink Interbrand

Competition Act, 15 U.S.C. § 3501 et seg., Congress precluded

the courts from construing the Sherman Act to hold vertical

territorial restraints in soft drink distribution per se illegal al-

though this Court had held that vertical territorial restraints

are not per se illegal in Continental T.V. Inc. v. GTE Sylvania,

Inc., 433 U.S. 36 (1977), before the Soft Drink Act was

enacted. See also 15 U.S.C. § 4302.

23

Further, Salomon Forex overemphasized the vague lan-

guage of the Treasury Department letter to the point of

discarding the expressed will of Congress in the statute

itself. Admittedly the legislative history of the Treasury

Amendment reflects considerable confusion on the part

of the Treasury Department.’ However, the text of the

Treasury Amendment, the text of the CEA generally, and

the clear goals stated by Congress in passing the 1974

CEA Amendments all support holding that the Treasury

Amendment excludes spot and forward contracts from

CEA coverage unless the spot and forward contracts are

involved in a futures transaction on a board of trade.

Salomon Forex was wrong to hold that the CEA does

not cover foreign currency futures and options but also

was wrong to attempt an ad hoc solution to some of the

problems its holding created. The language of the Trea-

sury Amendment makes no distinctions based upon the

knowledge, financial sophistication, or other traits of the

persons entering into the contracts in question.

Moreover, Salomon Forex’s approach to CEA coverage

would require case-by-case judicial findings concerning

the knowledge and sophistication of the participants in

a transaction to determine whether the Treasury Amend-

ment applies. It would also lead to the anomaly of other-

wise identical transactions being subject to disparate reg-

ulatory treatment depending upon the identity of some

of the counterparties. For instance, currency contracts

sold by a dealer to certain importers could be excluded

? This confusion undoubtedly resulted in part from the regu-

latory revolution that the 1974 CEA Amendments caused by

expanding from traditional agricultural commodities to the

new financial futures.

24

from the CEA, while identical contracts sold by the same

dealer to other importers would be subject to the CEA.

That kind of legislative line-drawing may be appropriate

in the context of the CFTC’s exemptive powers, which

are regulations of general applicability where agency spe-

cificity may lessen legal uncertainty. But trying to read

a fact-specific legal test into a statutory provision that

never even mentions the identity of the parties to ex-

cluded transactions would be a recipe for heightened

legal uncertainty that could curtail legitimate business

transactions.* The approach adopted by the Fourth Cir-

cuit must be rejected as unprincipled and unworkable.

The Fourth Circuit’s decision in Salomon Forex was in-

fluenced by the fears expressed by banks and others that

a narrow interpretation of the Treasury Amendment

threatened to undermine multibillion-dollar world-wide

currency markets. 8 F.3d at 976. That Court was told

that if the full scope of CFTC regulation was applied to

those markets (the feared outcome of a narrow construc-

tion), U.S. banks and institutions would not be able to

participate in those important currency markets. No one

supports that result, but there is no reason to fear that

* Some courts and commentators have suggested that the

Treasury Amendment excludes only “otherwise regulated”

futures and options, but that reading is unsupportable and

unworkable. Nothing in the Treasury Amendment’s language

suggests that Congress contemplated excluding “otherwise

regulated” futures and options from the CEA. Moreover,

asking market participants and, ultimately, courts to deter-

mine whether various transactions are subject to various un-

known statutes, both state and federal, and then determining

whether those laws constitute sufficient regulation to make a

transaction eligible for exclusion from the CEA would be a

daunting and largely counter-productive task.

25

result given the 1992 amendment. If any transactions

need to be carved out of any aspect of the CEA’s regula-

tory structure, this Court should allow the CFTC to

apply its exemptive scalpel to those transactions rather

than adopt a meat-axe approach.

CONCLUSION

Adoption by the Court of petitioners’ interpretation of

the Treasury Amendment would have the potentially

catastrophic result of allowing traders in over-the-

counter options involving foreign currencies and the

other instruments listed in the Treasury Amendment to

avoid all regulation. This result is the opposite of what

Congress sought to accomplish in 1974 when it extended

the scope of the CEA and the jurisdiction of the CFTC.

Therefore, the Chicago Mercantile Exchange asks the

Court to affirm the decision below.

Respectfully submitted,

JERROLD E. SALZMAN

(Counsel of Record)

JAMES T. MALYSIAK

ALBERT F. ETTINGER

FREEMAN, FREEMAN

& SALZMAN, P.C.

401 North Michigan Avenue

Suite 3200

j , Illinois 60611

(312) -5100

Counsel for the

Chicago Mercantile Exchange

Dated: August 30, 1996