STATE SECURITIES REGULATORS AT ANNUAL CONFERENCE LIST PRECIOUS METALS SALES AS ENFORCEMENT PRIORITY

Members of this firm, financial industry members, and SEC and FINRA staff joined state securities and commodities regulators at their annual conference this week. As always, the conference agenda was relentless—filled with impressive panels discussing trends and developments on the broker-dealer and investment advisory side, State, Federal and SRO enforcement actions and compliance audits, as well as commodities regulation and international financial market policy. When NASAA's Enforcement Section met during the conference, its leaders listed precious metals retail sales as one of their primary concerns and enforcement priorities. The discussion, however, focused on margin sales, with an additional dose of skepticism about precious metals depository services. Notably, many interpret language in the Dood-Frank Act to preclude most transactions that combine the use of margin and storage, although the precious metals industry still awaits belated CFTC rule-making in this area.

In the interest of full disclosure, Cosgrove Law, LLC is a member of the ICTA and provides compliance services to members of the precious metals industry. Is also, however, represents investors defrauded by the less reputable members of an industry arguably vindicated by years of market appreciation. Indeed, today's Wall Street Journal published one of dozens of articles regarding the role of gold and other metals in the personal finances and portfolios of Americans struggling through another year of economic malaise and equity market volatility. To read this full article, please click here.

CFTC Tries On New Dodd-Frank Authority for Size

The Commodity Futures Trading Commission has recently filed over a dozen enforcement actions against entities allegedly involved in illegally soliciting foreign currency (forex) transactions or engaging in unregistered forex transactions. Thirteen of these actions were filed simultaneously across the country in what the CFTC has dubbed a nationwide sweep. The most recent action was filed on February 18, 2011 against a St. Peters, Missouri resident and three of his Missouri-based business entities for $2.8 Million.

These actions represent the CFTC’s first use of its new authority pursuant to Section 742 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Under this Section, entities that participate in the forex market must register with the CFTC and abide by new investor protection rules, such as maintaining certain capital requirements. These additional requirements are purportedly to increase transparency and reduce risk.

As previously forecasted on the Cosgrove Law, LLC blog, Section 742 could potentially expand the “Zelener fix” in the 2008 Farm Bill. The “Zelener Fix” authorizes the CFTC to pursue anti-fraud enforcement actions for transactions conducted on a margin or leveraged basis, especially in the retail forex market. Indeed the CFTC interprets the language in Section 742 as expanding on its enforcement authority, citing that it is taking this opportunity to aggressively pursue enforcement in this sector after the Zelener decision effectively quashed the agency’s efforts in 2004 and the 2008 Farm Bill did little to bolster its enforcement position. The CFTC hopes that this sweep will warn unregistered or noncompliant firms to “shape up or be sued.”

In addition to regulating forex transactions, Section 742 also specifically addresses margined or leveraged retail commodity transactions. 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.” This language loosely tracks state commodity regulation language which exempts certain precious metals contracts, but there are some key differences in term usage. The CFTC has yet to define the distinct terms within this Section. However, none of the actions filed so far pursuant to Section 742 have involved retail commodities dealers, but rather have focused on firms engaging in forex transactions. This is consistent with the Legislature’s primary concern in enacting this portion of Dodd-Frank—to deal with unregulated swaps and foreign currency transactions. Regardless, precious metals firms operating in this area should tread carefully until the CFTC fully defines the scope of this exception.

The Murky Waters of State Commodity Laws

State commodity laws are notoriously antiquated and hard to follow. For many precious metals dealers, it can be difficult to navigate the applicable state laws in the various states where they do business.

This difficulty arises for several reasons. First, the Model State Commodity Code (“Model Code”) was drafted in the early 1980s, and it has not been updated since its inception to account for changes in technology that affect the way legitimate precious metals dealers do business. Second, the Model Code has only been enacted as it was written by a handful of states, so there is a lack of uniformity from state to state. Third, some states, like Arizona and Montana for example, have adopted substantive provisions of the Model Code, but these provisions have been incorporated into the state securities laws, instead of a separate Chapter or Act. Finally, there are states that have chosen not to regulate commodity transactions at all or that have decided to regulate them using a different approach than that set out in the Model Code.

The Model Code originally was drafted to provide state jurisdiction over generic commodities-themed frauds because the state securities acts were inadequate to address such schemes. As a result, the Model Code devised the concept of a “commodity contract”, which is defined as “a contract for the purchase or sale of commodities, primarily for speculative or investment purposes, and not for use or consumption by the offeree or purchaser.” Therefore, this new concept was intended to provide a better means of jurisdiction over only certain commodity transactions.

Unfortunately, for precious metals dealers, the two most common schemes at the time the Model Code was drafted were centered around the sale of precious metals that were never delivered or promises to store precious metals that were subsequently never purchased. Accordingly, there are stringent provisions defining and regulating the purchase of precious metals. However, the Model Code drafters included an exemption for transactions involving the purchase of precious metals if certain very specific requirements were met. One of those requirements is that delivery must be completed within 28 days, purportedly making it easier for retailers to avoid and regulators to identify unregistered futures contracts.

Essentially, the Model Code should have streamlined the process for determining whether illegal transactions have taken place. But though the Model Code may seem straightforward on its face, the inconsistency in adoption between the states and nuances among those states that have adopted the Model Code has created a veritable trap for unwary precious metals dealers and necessitates the need for experienced counsel who are aware of the these subtle differences.

The attorneys of Cosgrove Law, LLC have a unique knowledge and understanding of state and federal commodity regulations and exemptions, with an emphasis in the area of precious metals. Our firm is a member of the Industry Council for Tangible Assets that has compiled a 500-page, nationally recognized 50 state commodities survey. Our attorneys regularly provide advice to commodity dealers about relevant state and federal regulations and assist in internal review of company procedures. As part of our firm’s compliance services, we are also available to conduct audits or assist in developing an audit program to ensure ongoing compliance.