Reed Smith Client Alerts

The Ninth Circuit decided CFTC v. Monex Credit Company on July 25, 2019. The Monex decision (1) clarifies what constitutes “actual delivery” of a precious metal (i.e., a commodity), and (2) whether the CFTC must allege both fraud and manipulation of the markets for purposes of section 6(c)(1) of the CEA. This client alert discusses the significant implications that the Monex decision will have on metal traders, physical commodity traders, and participants in the cryptocurrency and retail forex markets.

Authors: Peter Y. Malyshev Christine Parker Justin J. Mirabal Joseph M. Motto

On July 25, 2019, in CFTC v. Monex Credit Company,1 the U.S. Court of Appeals for the Ninth Circuit reversed the district court’s dismissal of the U.S. Commodity Futures Trading Commission’s (CFTC) enforcement action against Monex Credit Company for alleged fraud in precious metals sales. The Monex court addressed two fundamental issues: (1) what constitutes “actual” delivery of a precious metal (that is, a commodity) and (2) whether, for purposes of section 6(c)(1) of the Commodity Exchange Act (CEA),2 the CFTC must allege both fraud and manipulation or whether fraudulently deceptive activity without manipulation of the markets is sufficient. The Monex decision has significant implications not only for metal traders, but also for physical commodity traders as well as those in the cryptocurrency and retail forex markets.3

In summary, the likely broad implications of the Monex decision are:

  • Custodians of commodities must take greater care to ensure that “actual delivery” has occurred for purposes of the 28-day exception – a mere book entry is not sufficient;
    Owners of commodities must have at least some minimal control over the asset to satisfy “actual delivery”;
  • It remains to be seen how the Monex decision will apply to “actual delivery” for crypto-assets, given the CFTC’s prior interpretations;4
  • The CFTC will probably follow the Securities and Exchange Commission’s (the SEC) body of law under section 10(b) of the Securities Exchange Act (the Exchange Act),5 and interpret CEA section 6(c)(1) to prohibit manipulative and fraudulent conduct as separate offenses; and
  • The CFTC will likely pursue manipulation or fraud claims under CEA section 6(c)(1) not only with respect to derivatives (futures, swaps, and options) but also with respect to commodities.

The facts of the case

Monex Credit Company (Monex) is a California-based trader in precious metals with a long history of litigation with the CFTC. As explained by the Ninth Circuit, under its Atlas program, Monex allowed its retail customers to purchase precious metals, such as gold, silver, platinum, and palladium, on a leveraged or margined basis, where the customer paid only a small portion of the actual cost of a given quantity of the precious metal (for example, 25 percent) and the remainder of the cost (that is, 75 percent) was financed by Monex. Any change in the value of the precious metal was amplified by the margin, and as a result, it was possible that Monex’s customers could owe Monex considerably more than they deposited to open their accounts if the price of the precious metal decreased over the life of the contract (if the customer opened a long position) or if the price of precious metal increased (if the customer opened a short position).

Upon deposit of margin, Monex did not deliver precious metal to its customers; instead, Monex deposited customers’ precious metal in depositories with which it had direct contractual relationships. Monex’s customers would only receive physical precious metal if the customer had paid the full price for their precious metal (that is, if the customer had repaid the full margin in addition to the initial deposit and all applicable fees and service charges which in aggregate will equal to 100 percent or more of the current price of the metal) and arranged for a special delivery of the metal. Furthermore, Monex had absolute control over customers’ accounts and could liquidate a customer’s position at any time, even if the customer’s position was “in the money” (in other words, if the strike price was above the market price of the prevailing market value).