The Dodd-Frank Wall Street Reform Act (“Act”) amends the Commodity Exchange Act (“CEA”) by adding multiple provisions that place additional restrictions on commodity transactions. Section 742(a)(2)(D) within Title VII of the Act specifically addresses margined or leveraged retail commodity transactions. The new provisions
“shall apply to any agreement, contract, or transaction in any commodity that is—entered into with, or offered to, a person that is not an eligible contract participant or eligible commercial entity; and entered into, or offered, on a leveraged or margined basis, or financed by the offeror, the counterparty, or a person acting in concert with the offeror or counterparty on a similar basis.” [emphasis added]
However, this Section contains an exception for contracts of sale that either “result in actual delivery within 28 days...” or “create an enforceable obligation to deliver between a seller and a buyer that have the ability to deliver and accept delivery, respectively, in connection with the line of business of the seller and the buyer.”
Arguably, this means that the Act prohibits most people from entering into, or offering to enter into, a transaction in any commodity with a person that is not an eligible party on a leveraged or margined basis in the absence of actual delivery within 28 days. This expands the “Zelener fix” in the 2008 Farm Bill, that authorizes the CFTC to pursue anti-fraud enforcement actions for transactions conducted on margin or leverage basis. Notably, there is nothing in the Act, the CEA, nor legislative history that defines the terms “seller”, “buyer”, or “actual delivery” within the meaning of this provision. As such, a look the Model State Commodity Code (“Model Code”) may be shed some light onto these new restrictions.
MODEL STATE COMMODITY CODE
The Model Code was originally drafted to provide a guide for state jurisdiction over generic commodities-themed transactions and contains language similar to that found in the Act. Similar language specific to the prohibition of margin and leverage account transactions appears in Section 1.02 as follows:
“no person shall sell or purchase or offer to sell or purchase any commodity under any commodity contract or under any commodity option or offer to enter into as seller or purchaser any commodity contract or any commodity option.”
Under the Model Code, the definition of a “commodity contract” includes margin contracts and leverage contracts.
Like the Act, the Model Code creates an exemption for margin and leverage contract commodity transactions, but the exemption only specifically applies to precious metals transactions. The exemption is available if the purchaser receives physical delivery of the precious metals within seven days from payment of any portion of the purchase price. Only the amount paid for, not the entire purchase amount, is required to be delivered within seven days. Additionally, “physical delivery” is satisfied when the precious metals have been delivered for storage to a financial institution or an approved depository that issues a confirmation and is not also the seller.
WHAT HAPPENS NEXT
The new federal regulations will become effective in July 2011. They will likely pre-empt the state requirements of margin and leverage contract commodities transactions. Unfortunately, many of the key terms in the federal exemption are left undefined. It is unknown how the courts or the CFTC, if at all, will define “seller”, “buyer”, or “actual delivery”. Additionally, because the new provision does not include any language regarding storage requirements for margin and leverage contracts, it is possible that the new legislation will prohibit individual consumers from purchasing precious metals on margin and then storing their precious metals with an approved depository or financial institution.
However, the legislature’s primary concern in enacting Title VII was to deal with unregulated swaps and foreign currency transactions. Therefore, because OTC precious metals transactions were not the key target of this legislation, it is conceivable that an exemption similar to that found in the Model Code, which is specific to precious metals purchases and prescribes “actual delivery” requirements, could result as opposed to the broad exemption that currently applies to all margin and leverage commodity contracts.
The bottom line (for now): the retail commodity market for over-the-counter precious metals transactions sold on margin or through leverage is uncertain. Those who participate in this market should understand the existence of two concurrent, but conflicting, standards for these types of transactions.