SEC Rebuked for Failing to Explain Why It Declined to Regulate a Financial Product
The SEC's loss highlights a bigger problem with legislation that calls for sharing jurisdiction with the CFTC over financial products.
On July 28, 2023, a three-judge panel of the United States Court of Appeals for the District of Columbia granted a petition from a registered futures exchange challenging a 2020 Securities and Exchange Commission ("SEC") order treating SPIKES index futures ("SPIKES") as futures rather than as security futures ("Order"). The court vacated the Order on Administrative Procedure Act grounds, concluding that the SEC did not adequately explain why SPIKES must be regulated as futures, rather than as security futures, to promote competition with VIX futures. VIX futures are listed on the petitioner's exchange. The court provided a three-month grace period for market participants to close out their existing SPIKES before the vacatur takes effect.
A "security future" is defined by the Securities Exchange Act and the Commodity Exchange Act as a "contract of sale for future delivery of a single security or of a narrow-based security index, including any interest therein or based on the value thereof," with certain exceptions. Security futures are regulated jointly by the Commodity Futures Trading Commission ("CFTC") and the SEC. By contrast, futures contracts based on broad-based security indexes are regulated solely by the CFTC. Due in part to the burdensome joint regulatory structure, security futures are no longer traded in the United States.
Having shared jurisdiction over security futures products for nearly 25 years, one would think that the two agencies could agree by now on who does what to whom. Not so. As this case demonstrates, the SEC could not properly articulate its rationale for declining to regulate a product that it initially viewed as within its ambit alongside the CFTC. It seems that the SEC moved quickly to do so, then thought better of it—although it did not think clearly enough to meet the court's sensible standard. Regulatory uncertainty certainly affected interest in the product.
Nature abhors a vacuum; financial markets abhor uncertainty. Joint SEC and CFTC regulation was plainly a source of uncertainty in this case. More broadly, security futures products are lawful in the United States, yet they do not trade on any market—largely because the jointly administered rules are complex and difficult to apply. Indeed, years after those rules were finalized, the two regulators continue to squabble—as they did here—over what products are in scope.
This is a cautionary tale for the future development of mixed swaps and for Congress in drafting legislation to govern cryptocurrency, stablecoins, and digital assets.
