One Small Step Toward Executive Order 6102 Part 2

Remember when Over the Counter gold and silver transactions were banned and everyone made a fuss thinking they’d be unable to purchase physical? It happened over the Summer of 2011, just before gold skyrocketed to nearly $2,000 an ounce. And so, here we have the CFTC using new regulation to interfere with a free market. What I am curious in is how were these companies marketing these products to the customers? If they were well-aware of the structure, then the CFTC is being meddlesome here, as so many of us know.

The interpretation of this law, on behalf of the CFTC’s action, stems from Section 742(a) of the Dodd-Frank act which “prohibits any person [which again includes companies]from entering into, or offering to enter into, a transaction in any commodity with a person that is not an eligible contract participant or an eligible commercial entity, on a leveraged or margined basis.” The language of the ruling exempts a transaction if it results in actual delivery within 28 days or such otherlonger period as the Commission may determine by rule or regulation based upon the typical commercial practice in cash or spot markets for the commodity involved;”

What is absolutely significant in this move by the CFTC today is its symbolic nature. One year ago the CFTC issued a Consumer Fraud Advisory regarding precious metals fraud, saying that it had seen an increase in the number of companies offering customers the opportunity to buy or invest in precious metals.  This month, the one year anniversary, might be a significant month in the view of the CFTC in their pursuit of precious metals regulation.

The CFTC posted a press release today about their enforcing the relatively new law:

CFTC Charges Four Florida-based Precious Metals Firms and Three Individuals for Engaging in Illegal Retail Off-Exchange Transactions in Precious Metals

CFTC Orders Bar Secured Precious Metals International, Inc., Secured Precious Metals Management, Inc., Barclay Metals, Inc., Universal Clearing, LLC, Linda Laramie, Sean Stropp, and Sylvia Williams from commodities industry for five-years

Washington DC – The U.S. Commodity Futures Trading Commission (CFTC) today issued two Orders filing and settling charges against two Fort Lauderdale, Fla. companies, Secured Precious Metals International, Inc. and Secured Precious Metals Management, Inc., and their sole owner and principal, Linda Laramie (collectively SPM), as well as two West Palm Beach, Fla. companies, Barclay Metals, Inc. and Universal Clearing, LLC, and their owners and principals, Sean Stropp and Sylvia Williams (collectively Barclay), all for engaging in illegal off-exchange financed transactions in precious metals with retail customers.

The Illegal Transactions

The CFTC Orders find that from July 2011 through June 2012, SPM and Barclay solicited retail customers, generally by telephone or through their websites, to buy and sell physical precious metals, such as gold and silver, in off-exchange leverage transactions. According to the Orders, customers paid as little as 20 percent of the purchase price for the metals, and SPM and Barclay purportedly financed the remainder of the purchase price, while charging the customers interest on the amount borrowed. The CFTC Orders state that financed off-exchange transactions with retail customers have been illegal since July 16, 2011, when certain amendments of the Dodd-Frank Wall Street and Consumer Protection Act of 2010 became effective. As explained in the Orders, financed transactions in commodities with retail customers like those engaged in by SPM and Barclay must be executed on, or subject to, the rules of a board of trade that has been approved by the CFTC. Since SPM and Barclay’s transactions were done off-exchange with customers who were not eligible contract participants, they were illegal, the Orders find.

The CFTC Orders also state that SPM and Barclay acted as dealers for Hunter Wise Commodities, LLC (Hunter Wise), a metals merchant. The CFTC filed suit in federal court in Florida against Hunter Wise on December 5, 2012 (see CFTC Release 6447-12). However, as alleged in the CFTC complaint against Hunter Wise and according to the orders entered against SPM and Barclay, neither SPM, Barclay, nor Hunter Wise purchased physical commodities on the customers’ behalf, disbursed any funds to finance the remaining portion of the purchase price, or stored any physical commodities for customers. The Orders find that SPM and Barclay’s customers thus never owned, possessed, or received title to the physical commodities that they believed they purchased.

The CFTC Orders require SPM and Barclay to cease and desist from violating Section 4(a) of the Commodity Exchange Act, as charged, and prohibit them for a five-year period from trading on or pursuant to the rules of any registered entity. The Orders also require SPM and Barclay to comply with certain undertakings, including cooperating fully and expeditiously with the CFTC in related matters. The Orders, which do not impose civil monetary penalties, acknowledge the substantial cooperation of SPM and Barclay.

CFTC’s Precious Metals Fraud Advisory

In January 2012, the CFTC issued a Consumer Fraud Advisory regarding precious metals fraud, saying that it had seen an increase in the number of companies offering customers the opportunity to buy or invest in precious metals (see the Advisory). The CFTC’s Precious Metals Consumer Fraud Advisory specifically warns that frequently companies do not purchase any physical metals for the customer, instead simply keeping the customer’s funds. The Advisory further cautions consumers that leveraged commodity transactions are unlawful unless executed on a regulated exchange.

CFTC Division of Enforcement staff responsible for this matter: David Terrell, Joy McCormack, Jennifer Chapin, Steve Turley, Jeff Le Riche, Elizabeth M. Streit, Scott R. Williamson, Rosemary Hollinger, Rick Glaser, and Richard Wagner.

Forex made the post available in July 2011. Here is what it said:

 

Important Account Notice Re: Metals Trading
We wanted to make you aware of some upcoming changes to FOREX.com’s product offering. As a result of the Dodd-Frank Act enacted by US Congress, a new regulation prohibiting US residents from trading over the counter precious metals, including gold and silver, will go into effect on Friday, July 15, 2011.

In conjunction with this new regulation, FOREX.com must discontinue metals trading for US residents on Friday, July 15, 2011 at the close of trading at 5pm ET. As a result, all open metals positions must be closed by July 15, 2011 at 5pm ET.

We encourage you to wind down your trading activity in these products over the next month in anticipation of the new rule, as any open XAU or XAG positions that remain open prior to July 15, 2011 at approximately 5:00 pm ET will be automatically liquidated.

We sincerely regret any inconvenience complying with the new U.S. regulation may cause you. Should you have any questions, please feel free to contact our customer service team.

Sincerely,
The Team at FOREX.com

Some prehistory from Hedge Fund Law Blog:

The Dodd-Frank Wall Street Reform and Consumer Protection Act
(“Act”) has changed a number of laws in all of the securities acts
including the Commodity Exchange Act.  Two specific changes deal with
certain transactions in commodities on the spot market.  Specifically,
Section 742 of the Act deals with retail commodity transactions.  In
this section, the text of the Commodity Exchange Act is amended to
include new Section 2(c)(2)(D) (dealing with retail commodity
transactions) and new Section 2(c)(2)(E) (prohibiting trading in spot
forex with retail investors unless the trader is subject to regulations
by a Federal regulatory agency, i.e. CFTC, SEC, etc.).  According to a congressional rulemaking spreadsheet, these are effective 180 days from the date of enactment.

We provide an overview of the new sections and have reprinted them in full below.

New CEA Section 2(c)(2)(D) – Concerning Spot Commodities (Metals)

The central import of new CEA Section 2(c)(2)(D) is to broaden the
CFTC’s power with respect to retail commodity transactions.  Essentially
any spot commodities transaction (i.e. spot metals) will be subject to
CFTC jurisdiction and rulemaking authority.  There is an exemption for
commodities which are actually delivered within 28 days.  While the CFTC
wanted an exemption in which commodities would need to be delivered
within 2 days, various coin collectors were able to lobby congress for a
longer delivery period (see here).

It is likely we will see the CFTC propose regulations under this new
section and we will keep you updated on any regulatory pronouncements
with respect to this new section.

New CEA Section 2(c)(2)(E) – Concerning Spot Forex

The central import of new CEA Section 2(c)(2)(E) is to regulate the
spot forex markets.  While the section requires the CFTC to finalize
regulations with respect to spot forex (which were proposed earlier in
January), it also, interestingly, provides  oversight of the markets to
other federal regulatory agencies such as the CFTC.  This means that in
the future, different market participants may be subject to different
regulatory regimes with respect to trading in same underlying
instruments.  A Wall Street Journal article
discusses the impact of this with respect to firms which engage in
other activities in addition to retail forex transactions.  The CFTC’s
proposed rules establish certain compliance parameters for retail forex
transactions, requires registration of retail forex managers and requires such managers to pass a new regulatory exam called the Series 34 exam.
We do not yet know whether the other regulatory agencies will adopt
rules similar to the CFTC or if they will write rules from scratch.

Next, from Henderson & Lyman:

The prohibition of Section 742(a) does not apply, however, if such a
transaction results in actual delivery within 28 days, or creates an
enforceable obligation to deliver between a seller and a buyer that have
the ability to deliver, and accept delivery of, the commodity in
connection with their lines of business. This may be problematic as in
most spot metals trading virtually all contracts fail to meet these
requirements. As a result, although the courts’ interpretation of
Section 742(a) is unknown, Section 742(a) is likely to have a
significantly negative impact on the OTC cash precious metals industry.
Here too, it is essential that those who offer to be a counterparty to
OTC metals transactions seek professional help to discuss possible
operational and regulatory contingency plans.

 

More here:

Elimination of OTC Forex

Effective 90 days
from its inception, the Dodd-Frank Act bans most retail OTC forex
transactions. Section 742(c) of the Act states as follows:

…A person [which includes companies]
shall not offer to, or enter into with, a person that is not an
eligible contract participant, any agreement, contract, or transaction
in foreign currency except pursuant to a rule or regulation of a Federal
regulatory agency allowing the agreement, contract, or transaction
under such terms and conditions as the Federal regulatory agency shall
prescribe…

This provision will not come
into effect, however, if the CFTC or another eligible federal body
issues guidelines relating to the regulation of foreign currency within
90 days of its enactment. Registrants and the public are currently being
encouraged by the CFTC to provide insight into how the Act should be
enforced. See CFTC Rulemakings regarding OTC Derivatives located at the following website address,
under Section XX – Foreign Currency (Retail Off Exchange). It is
essential that OTC forex participants seek professional help to discuss
possible operational and regulatory contingency plans.

Elimination of OTC Metals

As
for OTC precious metals such as gold or silver, Section 742(a) of the
Act prohibits any person [which again includes companies]from entering
into, or offering to enter into, a transaction in any commodity with a
person that is not an eligible contract participant or an eligible
commercial entity, on a leveraged or margined basis. This provision
intends to expand the narrow so called “Zelener fix” in the Farm
Bill previously ratified by congress in 2008. The Farm Bill empowered
the CFTC to pursue anti-fraud actions involving rolling spot
transactions and/or other leveraged forex transactions without the need
to prove that they are futures contracts. The Dodd-Frank Act now expands
this authority to include virtually all retail cash commodity market
products that involve leverage or margin – in other words OTC precious
metals.

The prohibition of Section 742(a) does not apply,
however, if such a transaction results in actual delivery within 28
days, or creates an enforceable obligation to deliver between a seller
and a buyer that have the ability to deliver, and accept delivery of,
the commodity in connection with their lines of business. This may be
problematic as in most spot metals trading virtually all contracts fail
to meet these requirements. As a result, although the courts’
interpretation of Section 742(a) is unknown, Section 742(a) is likely to
have a significantly negative impact on the OTC cash precious metals
industry. Here too, it is essential that those who offer to be a
counterparty to OTC metals transactions seek professional help to
discuss possible operational and regulatory contingency plans.

Small Pool Exemption Eliminated

Pursuant to Section 403 of Act, the “privateadviser” exemption, namelySection 203(b)(3) of the Investment Advisers Act of 1940 (“Advisers Act”), will be eliminated within one year of the Act’s effective date (July 21, 2011). Historically, many unregistered U.S. fund managers had relied on this exemption to avoid registration where they:

(1) had fewer than 15 clients in the past 12 months;

(2) do not hold themselves out generally to the public as investment advisers; and

(3) do not act as investment advisers to a registered investment company or business development company.

At present, advisers can treat the unregistered funds that they advise, rather than the investors in those funds, as their clients for purposes of
this exemption. A common practice has thus evolved whereby certain
advisers manage up to 14 unregistered funds without having to register
under the Advisers Act. Accordingly, the removal of this
exemption represents a significant shift in the regulatory landscape, as
this practice will no longer be allowable in approximately one year.

Also
an important consideration, the Dodd-Frank Act mandates new federal
registration and regulation thresholds based on the amount of assets a
manager has under management (“AUM”). Although not yet underway, it is
possible that various states may enact legislation designed to create a
similar registration framework for managers whose AUM fall beneath the
new federal levels.

Accredited Investor Qualifications

Section
413(a) of the Act alters the financial qualifications of who can be
considered an accredited investor, and thus a qualified as eligible
participant (“QEP”). Specifically, the revised accredited investor
standard includes only the following types of individuals:

1) A natural person whose individual net worth, or joint net worth with spouse, is at least $1,000,000, excluding the value of such investor’s primary residence;

2) A
natural person who had individual income in excess of $200,000 in each
of the two most recent years or joint income with spouse in excess of
$300,000 in each of those years and a reasonable expectation of reaching
the same income level in the current year; or

3) A
director, executive officer, or general partner of the issuer of the
securities being offered or sold, or a director, executive officer, or
general partner of a general partner of that issuer.

Based on
this language, it is important to note that the revised accredited
investor standard only applies to new investors and does not cover
existing investors. However, additional subscriptions from existing
investors are generally treated as requiring confirmation of continuing
investor eligibility.

On July 27th, 2010, the SEC
provided additional clarity regarding the valuation of an individual’s
primary residence when calculating net worth. In particular, the SEC has
interpreted this provision as follows:

Section
413(a) of the Dodd-Frank Act does not define the term “value,” nor does
it address the treatment of mortgage and other indebtedness secured by
the residence for purposes of the net worth calculation…Pending
implementation of the changes to the Commission’s rules required by the
Act, the related amount of indebtedness secured by the primary residence
up to its fair market value may also be excluded. Indebtedness secured
by the residence in excess of the value of the home should be considered
a liability and deducted from the investor’s net worth.