Jul 28, 2022 By: Turnkey Trading Partners On July 19, 2022 the Commodity Futures Trading Commission (“CFTC”) and CME Group (“CME”) issued a potential precedent setting order. Within the order they settled charges involving Powerline Petroleum, LLC (“Powerline”) and its principals. Of particular interest to Turnkey and the commodity interest space is the charge that Powerline failed to register as a Commodity Trading Advisor (“CTA”) and thus also failed to make required disclosures to its customers. Order Summary The order found that Powerline had defrauded clients by failing to adequately disclose they had been acting as counterparty to certain of its customers transactions – in other words they were not acting merely as a broker. In so doing Powerline also failed to adequately disclose that it charged clients a markup over the cost at which Powerline was able to acquire certain fuel hedging strategies in the marketplace. These were violations of Powerline’s duty to disclose to clients all fees and conflicts of interest. The order also concluded that although Powerline was properly registered as an independent introducing broker (“IIB”), the firm acted in the capacity of a CTA by offering clients fuel hedging strategies but had not registered in such capacity. Reason for Concern This action may not appear to be all that interesting to the casual observer. However, to compliance and legal professionals it raises a number of potentially troubling concerns. The first indication that this case may have gone too far is that CFTC Commissioner Summer K. Mersinger issued a public dissent related to the order. Turnkey encourages our readers to carefully review this dissent as, in our experience, they are exceedingly rare. Within Mersinger’s dissent several very critical points are raised related to the Powerline order: Powerline is a small business. During its operating history the dissent shares that the firm never employed more than 10 employees at any point. Powerline had also been doing business for 20 years as an IIB and had no previous regulatory history prior to the order. During the firm’s operating history, it was also reviewed by National Futures Association (“NFA”) on multiple occasions. NFA never noted the firms need to register as a CTA. The CFTC’s order never implies that Powerline had done anything wrong as an IIB. The dissent agrees that Powerline may at times have undertaken activities which extended beyond those of a traditional IB. That some of these activities may have in fact met the standards of the commodity exchange act (“CEA”) in considering the definition of a CTA and its activities. Importantly the dissent highlights that industry rules provide registered IB’s an “exemption” from registering as a CTA if its trading advice to its customers is solely in connection with its business as an introducing broker. The dissent shares that Powerline introduced and executed trades through an FCM, much of Powerline’s revenue received from trade mark ups occurred on only two specific dates, and Powerline’s revenues from CTA related activity did not account for more than 50% of total revenues. The dissent shares the percentages were under 5% of revenue. Ultimately, Mersinger arrives at the conclusion that as an IIB Powerline did not have an obligation to register as a CTA. The dissent infers NFA shared this view as this was never a finding during the years the firm was reviewed. Mersinger also points to another order nearly identical to Powerline’s; Angus Energy where the CFTC did not apply the same standards. The dissent states specifically in this regard “To treat the Powerline settlement so differently from the Angus settlement is fundamentally unfair.” Precedent Setting? Turnkey has been working within the commodity interest space as an award-winning consulting firm for more than 15 years. Certain of our staff have been in the industry for a significantly longer period of time. Our industry relationships and connections run deep. On that basis, to the best of our recollection, never has a CFTC order raised so much concern throughout the industry. It is Turnkey’s view, as well as the view of other legal and compliance professionals in the space, that Mersinger’s dissent is spot on. Powerline, like many other industry participants, should have been entitled to the so called “IB Exemption” from registration as a CTA if the information in Mersinger’s dissent is correct. The CFTC’s Powerline order is now reverberating throughout the industry. It has many IBs and FCMs in a panic and rightfully so. Firms that have for years relied on the IB exemption from CTA registration to provide consultative hedging advice are concerned. Many of Turnkey’s industry relationships and customers have been operating for years relying on the IB exemption precedent. They are wondering “Does Powerline require us to become a CTA?”. While the answer to this question remains somewhat unclear it would be wise for IBs and FCMs to review the Powerline Order and Dissent with a compliance consulting professional or counsel. An inventory of day-to-day behaviors should be made to best determine if CTA registration may or may not be the right pathway forward. At a minimum, consideration of fee disclosures, conflicts of interest, and documentation of customer relationships should be reevaluated in light of Powerline. Regulators need to provide clarity on this matter urgently. Until they do, it would be wise to be proactive.