No Fair Notice, but a Fair Outcome: Fifth Circuit Rules Against CFTC for "Rulemaking by Enforcement"
On January 9, 2024, the U.S. Court of Appeals for the Fifth Circuit reversed a 2022 jury verdict for the Commodity Futures Trading Commission ("CFTC") against EOX Holdings LLC and a former broker, Andrew Gizienski, holding "that the Defendants lacked fair notice of the CFTC's unprecedented interpretation of this thirty-nine-year-old Rule," and as such, "Rule 155.4(b)(2)(i), as written, does not apply to the Defendants' actions."
The rule prohibits commodity brokers from "knowingly tak[ing], directly or indirectly, the other side of any order of another person," with the key issue on appeal being what "taking the other side of an order" means. The defendants argued it meant "becoming a counterparty with a financial interest and the possibility of profit or loss." Under this interpretation, brokers who exercise discretion over customer accounts would be excluded from the rule. The CFTC argued that "taking the other side of an order" included a broker "making the decision to trade opposite the order and executing the trade opposite the order."
The Fifth Circuit ruled against the CFTC, explaining that the CFTC never publicly stated that it interpreted Rule 155.4(b)(2)(i) to mean that "taking the other side of an order" included a broker's trading for a discretionary account without himself having financial interest in that account. In fact, this action was the first time the CFTC—in its "thirty-nine years of regulatory silence"—proffered any guidance, including this interpretation.
The doctrine of fair notice dictates that agencies may not impose civil or criminal liability on parties where the disputed regulation is not sufficiently clear to warn them as to the prohibited conduct. Here, the Fifth Circuit emphasized that this doctrine is an appropriate tool to address a common theme among agencies: the failure to provide interpretive guidance to the market.
Rewriting a rule on the fly, as opposed to revising a rule to have broader application or issuing public guidance indicating a more liberal interpretation going forward, is no way to police for market misconduct. This case provides a reminder that traditional legal principles—such as the requirement of fair notice—may prove powerful as agencies seek to adopt broad and novel interpretations of existing regulations. As they do so, defendants should remain on high alert as to whether sufficient notice of the prohibited conduct was provided. While settlement agreements may remain an attractive option, defendants may wish to consider availing themselves of traditional legal remedies either through litigation or in settlement discussions where the conduct in question is subject to an agency's novel interpretation.
