October 16, 2019
by Katherine Cooper

            This past Thursday, October 10, 2019, at the Yahoo! Finance All Markets Summit in New York, Commodity Futures Trading Commission Chairman Heath Tarbert declared the virtual currency ether to be a “commodity.”  He said:

It is my view as Chairman of the CFTC that ether is a commodity, and therefore it will be regulated under the CEA.

The thing is, it isn’t.  At least, not right now.

            Handily, the Commodity Exchange Act provides a definition for the term “commodity.”  After enumerating some thirty-odd categories of agricultural products, the definition continues on to read in relevant part:

and all other goods and articles, . . . and all services, rights, and interests . . .  in which contracts for future delivery are presently or in the future dealt in.[1]

Whether ether is a “good or article” or a “service, right or interest,” there are no futures contracts currently being traded on ether, and therefore it cannot be a “commodity” as that term is defined in the CEA.

            The definition of the term “commodity” in the CEA stems from the Commodity Futures Trading Commission Act of 1974 (the “1974 Act”)[2] which worked “a sweeping overhaul” of the CEA.[3] It created the CFTC and granted it extensive authority over commodity futures markets not then regulated by the CFTC’s predecessor, the Commodity Exchange Authority, a division of the Department of Agriculture.  Prior to 1974, the CEA and its predecessor statutes, the Futures Trading Act of 1921[4] and Grain Futures Act of 1922,[5] specifically enumerated commodities subject regulation. As the number of commodities with futures contracts trading on them increased, Congress repeatedly amended the statute to have the new markets regulated. When Congress amended the Grain Futures Act in 1936, renaming it the Commodity Exchange Act, it extended the law’s regulatory authority to cover cotton and other specified commodities. Amendments to the CEA in 1968 added more specifically enumerated commodities under the regulatory purview of the law such as livestock, livestock products, and frozen concentrated orange juice.

            By 1974, it had become clear that the strategy of naming specific commodities in the CEA’s definition could not keep up with the growth of the futures markets, which were expanding to cover additional goods and services:

While the futures markets in a number of agricultural commodities had been regulated to varying degrees since 1922, many large and important futures markets were completely unregulated by the federal government prior to 1974.  These included such agricultural and forestry commodities as coffee, sugar, cocoa, lumber and plywood plus various metals including the highly sensitive silver market and markets in a number of foreign currencies.  

A person trading in one of the then unregulated futures markets needed the same protection afforded to those trading in the regulated markets. . . . [6]

So Congress came up with a “Plan B.”  Congress determined to use two broad classes of products to define the commodities subject to the jurisdiction of the CEA. These included the phrases “all other goods and articles” to cover tangible commodities in addition to the specifically enumerated agricultural commodities, and “all services, rights, and interests” to cover the intangible commodities such as home mortgages, futures on which seemed just over the horizon to Congress in 1974.[7]

            But Congress did not give the CFTC jurisdiction over all “goods or articles” and “services, rights or interests.”  Rather, it limited the definition of the term “commodity” to only include such products “in which contracts for future delivery are presently or in the future dealt in.”[8]  That the “dealt in” language creating the futures trading requirement was jurisdictional in nature stretches back to the very beginning of Congressional deliberations to amend the CEA in September 1973.  On September 25, 1973, Frederick Uhlmann, Chairman of the Board of the Chicago Board of Trade, testified before a sub-committee of the House Small Business Committee, and presented proposed legislation to define “commodity” to be everything deliverable on a futures contract.[9]   He emphasized the importance of giving the as-yet unnamed

commodity regulatory agency exclusive jurisdiction over futures trading. This would prevent any possible conflicts over jurisdiction over futures trading. This would prevent any possible conflicts over jurisdiction.[10]

            After follow-on hearings before the House Agriculture Committee in October 1973,[11] W.R. “Bob” Poage, Chairman of the House Agriculture Committee, introduced H.R. 11955 on December 13, 1973.  That bill included the “dealt in” phrase.  Poage explained that, under his proposed legislation, “[a]ll commodities trading in futures will be brought within federal regulation under the aegis of the new Commission.” [12]

            In a series of speaking orders starting in 2015, the CFTC has asserted that “[b]itcoin and other virtual currencies are encompassed in the definition and properly defined as commodities.”[13]  None of these speaking orders involved transactions in a virtual currency other than bitcoin.[14]  None of them also explain how the “dealt in” requirement was met as they predated the launch of bitcoin futures by the Chicago Mercantile Exchange and the CBOE Futures Exchange in December of 2017.

            Notwithstanding its press releases heralding victory,[15] the CFTC’s attempts to assert its jurisdiction in federal court over fraud in the virtual currency cash markets has resulted in something of a mixed bag for the agency.  In CFTC v. McDonnell,[16] the CFTC alleged that Patrick McDonnell and related entities fraudulently induced individuals to send them Bitcoin and Litecoin for McDonnell to trade on their behalf.  In granting a preliminary injunction against McDonnell, Judge Jack Weinstein concluded that virtual currencies were “commodities,” but rested that conclusion on the “dealt in” clause: “Where a futures market exists for a good, service, right, or interest, it may be regulated by CFTC as a commodity, without regard to whether the dispute involves futures contracts.”[17]  At the time the McDonnell complaint was filed, there were futures contracts trading on Bitcoin on the CBOE Futures Exchange and the Chicago Mercantile Exchange, and Bitcoin binary options listed on the Cantor Fitzgerald Futures Exchange. Moreover, Bitcoin swaps and Bitcoin binary options had been available for trading on TeraExchange and NADEX, respectively, since 2014.[18]  It is not clear what Judge Weinstein’s thinking was over the CFTC’s jurisdiction over the Litecoin involved in McDonnell’s alleged fraud.  It may also be worth noting that McDonnell, a non-lawyer, proceeded in the action pro se.

            In CFTC v. My Big Coin Pay, Inc,.[19]  the only virtual currency involved in the case was “My Big Coin.”  The defendants moved to dismiss the amended complaint on the ground that because no futures contracts are traded on My Big Coin, the virtual currency was not a “commodity” – the “dealt in” requirement was plainly not satisfied.  In denying the motion to dismiss, Judge Rya Zobel rested her decision on three grounds.  First, she concluded that because the CEA: 

classifies “livestock” as a commodity without enumerating which particular species . . . . signals an intent [by Congress] that courts [should] focus on categories – not specific items – when determining whether the”dealt in” requirement is met.[20]

 

Second, quoting the Supreme Court’s decision in SEC v. Zandford,[21] Judge Zobel reasoned, given the antifraud context in which the court was being asked to construe the meaning of the term “commodity,” it was appropriate to “’construe[] [the CEA] ‘not technically and restrictively, but flexibly to effectuate [the CEA’s] remedial purposes’”[22]

            Third, although conceding that the caselaw on the question was “scant,” Judge Zobel stated that a series of cases involving natural gas[23] “repeatedly rejected arguments that a particular type of natural gas was not a commodity because that specific type was not the subject of a futures contract.”[24] Based on these three grounds, Judge Zobel ruled that because My Big Coin was a virtual currency and futures contracts trade on virtual currency, “[t]hat is sufficient, especially at the pleading stage, for plaintiff to allege that My Big Coin is a ‘commodity’.”[25]  In a footnote, the court elaborated that “[c]ontrary to defendants’ arguments, the amended complaint alleges that My Big Coin and Bitcoin are sufficiently related so as to justify this categorical treatment.”[26]

            At least two of the three grounds that Judge Zobel cited as supporting the conclusion that My Big Coin is a “commodity” are questionable.  First, the fact that the CEA states that “livestock” is a commodity without stating which species of livestock are commodities is irrelevant.  Congress added “livestock” to the definition in 1968 when it was still trying to set the CEA’s reach by specifically naming types of things that were commodities.  By 1974, however, Congress realized that it had to come up with a new approach to ensure that all futures contracts trading in the United States were regulated under the CEA.  Thus, Congress came up with the phraseology of “all goods or articles . . . or services, rights or interests in which contracts for future delivery are . . . dealt in” to make certain that all futures contracts trading in the United States were regulated under the CEA.  It is unclear how the use of categories for “goods or articles” and “services, rights or interests” advances Congress’s purpose in 1974 that all futures contracts in the United States be subject to the CEA.

            Second, the court’s assertion that the natural gas cases it cited stand for the principle that different “types” of natural gas were commodities even though they were not the “type” of natural gas on which the NYMEX Henry Hub futures trade is a misreading of those cases.[27]  None of those cases involved different “types” of natural gas.  In those cases, defendants argued that the natural gas involved was not a “commodity” because the gas there was to be delivered at a delivery point in the interstate pipeline system other than the delivery point – the Henry Hub in Louisiana – where the NYMEX futures contract calls for natural gas to be delivered.  For instance, the court in United States v. Brooks reasoned 

it would be peculiar that natural gas at another hub is not a commodity, but suddenly becomes a commodity solely on the basis that it passes through Henry Hub, and ceases to be a commodity once it moves onto some other locale.[28]

            In United States v. Futch, another case cited by the court, a Fifth Circuit panel rejected the defendant’s argument that the natural gas involved there was not a “commodity” because it was to be delivered at “Transco Zone 6” instead of the Henry Hub.[29]  Finally, the third decision Judge Zobel relied upon, United States v. Valencia, specifically noted that “natural gas is fungible” and found that “natural gas for delivery on the West Coast or otherwise, is a commodity” even if that is a different delivery point than the one used for the NYMEX contract.[30]   

            All three of these cases stand for the principle that a product that has a futures contract trading on it does not stop being a commodity simply because the transaction at issue involves a delivery point other than the delivery point specified in the futures contract. They do not support a conclusion that different types of products within a broad category are all commodities if a futures contract is traded on one of them. As the Valencia court noted, natural gas on the West Coast was fungible with natural gas at Henry Hub in Louisiana.[31]  In My Big Coin, the CFTC did not allege that My Big Coin was fungible with Bitcoin – only that it had some similar characteristics.

            Chairman Taubert did not explain the CFTC’s rationale for declaring ether to be a “commodity” subject to regulation under the CEA. Presumably, the agency is adopting the “categorical” approach endorsed by Judge Zobel.  But as explained above, there is no basis for taking a categorical approach for any product other than one of the specifically enumerated agricultural products.  To do so is at odds with the Congress’s purpose in enacting the 1974 Act.  Even if the agency is adopting the “categorical” approach taken in the natural gas cases, it is plain that ether is not fungible with bitcoin like the natural gas delivered at TRANSCO 6 is fungible with the natural gas delivered at Henry Hub. 

            Mr. Chairman, until a futures contract is listed on ether, ether is not a “commodity.”

 

[1] 7 U.S.C. § 1a(9) (emphasis added).

[2] Pub. L. No. 93-463, 88 Stat. 1389 (1974).

[3] T. Snider & R. Bartlett, Chapter 10: United States Jurisdiction published in The Regulation of the Commodities Futures and Options Markets 2d ed. (McGraw-Hill Cos. 1995) § 10.01.

[4] Pub. Law No. 67-66, 42 Stat. 187 (1921). The ill-fated Futures Trading Act of 1921 was Congress’s first attempt to regulate futures trading. It was meant to address speculative excesses on the grain exchanges following World War I. It based its regulatory authority on the taxing power under the Federal Constitution and was declared unconstitutional for that reason in Hill v. Wallace, 259 U.S. 44 (1922).

[5] Pub. Law No. 67-331, 42 Stat. 998 (1922).

[6] S. Rep. 850, 95th Cong., 2d Sess. 1978; 1978 U.S.C.C.A.N. 2087, 2097 (“1978 Senate Report”); H.R. Rep. 93-975, Commodity Futures Trading Commission Act of 1974 (Apr. 4, 1974) at 44.

[7] H.R. Rep. 93-975 at 31-32.

[8] 1974 Act § 201, now codified at 7 U.S.C. § 1a(9).

[9] Hearings before the Subcommittee on Special Small Business Problems of the House Permanent Select Committee on Small Business on Problems Involved in the Marketing of Grain and Other Commodities 93rd Cong. 1st Sess. July 25, 26: Sept 18, 25, 26; Oct 2, 3 and 4, 1973 at 144.

[10] Id. at 163.

[11] Review of Commodity Exchange Act and Discussions of Possible Changes, Hearings Before the House Agriculture Committee, 93rd Cong. 1st Sess. Oct. 16, 17, 18 and 24, 1973.

[12] 119 Congressional Record 41331, 41334 (House Dec. 13, 1973).

[13]In re Coinflip Inc., d/b/a Derivabit, and Francisco Riordan, CFTC Docket No. 15-29 (Sept. 17, 2015) (emphasis supplied). Available at: https://www.cftc.gov/sites/default/files/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfcoinfliprorder09172015.pdf

[14] See In re BFXNA Inc., d/b/a Bitfinex, CFTC Docket No. 16-19 (2016). Available at: https://www.cftc.gov/sites/default/files/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfbfxnaorder060216.pdf

[15] Court Denies Defendants’ Motion to Dismiss in Commodity Fraud Case Involving the Virtual Currency My Big Coin (CFTC Oct. 3, 2018) available at: https://cftc.gov/PressRoom/PressReleases/7820-18; Court Orders Defendants to Pay over $1.1 Million in Penalties and Restitution in Connection with the “Vicious Defrauding of Customers” (Aug. 24, 2018) available at: https://cftc.gov/PressRoom/PressReleases/7774-18.

[16] CFTC v. McDonnell, Docket No. 18-cv-00361 (E.D.N.Y.).

[17] CFTC v. McDonnell, 287 F. Supp. 3d at 213, 227 (EDNY 2018) 

[18] CFTC Backgrounder at 2 nn. 9 & 10.

[19] CFTC v. My Big Coin Pay, Inc., Docket No. 18-cv-10077RWZ (D. Mass.).

[20] CFTC v. My Big Coin Pay, Inc. et al., 334 F.Supp.3d 492, 497 (D. Mass. 2018).

[21] 535 U.S. 813 (2002).

[22] 334 F.Supp.3d at 497 quoting 535 U.S.at 819.

[23] Citing United States v. Brooks, 681 F.3d 678 (5th Cir. 2012); United States v. Futch, 278 F. App'x 387, 395 (5th Cir. 2008); United States v. Valencia, No. CR.A. H-03-024, 2003 WL 23174749, at *8 (S.D. Tex. Aug. 25, 2003), order vacated in part on reconsideration, No. CRIM.A. H-03-024, 2003 WL 23675402 (S.D. Tex. Nov. 13, 2003), rev'd and remanded on other grounds, 394 F.3d 352 (5th Cir. 2004).

[24] 334 F.Supp.3d at 497 (emphasis added). 

[25] Id. at 498.

[26] Id. at n.8.

[27] United States v. Brooks, 681 F.3d 678 (5th Cir. 2012); United States v. Futch, 278 F. App'x 387, 395 (5th Cir. 2008); United States v. Valencia, No. CR.A. H-03-024, 2003 WL 23174749, at *8 (S.D. Tex. Aug. 25, 2003), order vacated in part on reconsideration, No. CRIM.A. H-03-024, 2003 WL 23675402 (S.D. Tex. Nov. 13, 2003), rev'd and remanded on other grounds, 394 F.3d 352 (5th Cir. 2004).

[28] 681 F.3d 678, 694-95 (5th Cir. 2012).

[29] 278 F. App'x at 395.

[30] Valencia, 2003 WL 23174749 at *8

[31] Of course, there are not different “types” of natural gas in the interstate pipeline system.  Under the Federal Power Commission, “pipeline quality gas” standards were set to ensure the fungibility of the natural gas in the interstate pipeline network. M.M. Foss, Interstate Natural Gas—Quality Specifications & Interchangeability at 11 (Univ of Texas 2004)    (under the Federal Power Commission, “’Pipeline quality’ gas came to be defined as natural gas (1) within + / - 5 percent of the heating value of pure methane, or 1,010 Btu per cubic foot under standard atmospheric conditions, and (2) free of water and toxic or corrosive contaminants”).  Available at: http://www.beg.utexas.edu/files/energyecon/global-gas-and-lng/CEE_Interstate_Natural_Gas_Quality_Specifications_and_Interchangeability.pdf; see also POLICY STATEMENT ON PROVISIONS GOVERNING NATURAL GAS QUALITY AND INTERCHANGEABILITY IN INTERSTATE NATURAL GAS PIPELINE COMPANY TARIFFS at 12 (FERC June 15, 2006) (only FERC authorized pipeline tariff standards may be enforced).  Available at: https://www.ferc.gov/whats-new/comm-meet/061506/G-1.pdf

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