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Full text of "Review of Commodity Futures Trading Commission's discretion to exempt certain transactions from antifraud provisions of the Commodity Exchange Act : hearings before the Subcommittee on Environment, Credit, and Rural Development of the Committee on Agriculture, House of Representatives, One Hundred Third Congress, first session, on H.R. 2374 ... April 28 and June 30, 1993"

REVIEW OF THE COMMODITY FUTURES TRADING COMMISSION'S 
DISCRETION TO EXEMPT CERTAIN TRANSACTIONS FROM 
ANTIFRAUD PROVISIONS OF THE COMMODITY EXCHANGE 
ACT 



Y 4. AG 8/1:103-13 



Revieu of the Connodity Futures Tri... 

xxx^nRINGS 

BEFORE THE 

SUBCOMMITTEE ON ENVIRONMENT, CREDIT, 
AND RURAL DEVELOPMENT 

OF THE 

COMMITTEE ON AGRICULTURE 
HOUSE OF REPRESENTATIVES 

ONE HUNDRED THIRD CONGRESS 

FIRST SESSION 
ON 

H.R. 2374 

TO AMEND THE COMMODITY EXCHANGE ACT TO ENSURE THE CONTIN- 
UED APPLICATION OF THE ACT'S ANTIFRAUD AND 
ANTIMANIPULATION PROTECTIONS 



APRIL 28 AND JUNE 30, 1993 



Serial No. 103-13 










Printed for the use of the Committee on Agriculture 



U.S. GOVERNMENT PRINTING OFFICE 
72-584 WASHINGTON : 1993 

For sale by the U.S. Govemment Printing Office 
Superintendent of Documents. Congressional Sales Office, Washington. DC 20402 
ISBN 0-16-041700-7 



REVIEW OF THE COMMODIH FUTURES TRADING COMMISSION'S 
DISCRETION TO EXEMPT CERTAIN TRANSACTIONS FROM 
ANTIFRAUD PROVISIONS OF THE COMMODITY EXCHANGE 
ACT 



Y 4. AS 8/1:103-13 

Revieu of the Connodity Futures Tra. 



,riRINGS 



BEFORE THE 

SUBCOMMITTEE ON ENVIRONMENT, CREDIT, 
AND RURAL DEVELOPMENT 

OF THE 

COMMITTEE ON AGRICULTURE 
HOUSE OF REPRESENTATIVES 

ONE HUNDRED THIRD CONGRESS 

FIRST SESSION 
ON 

H.R. 2374 

TO AMEND THE COMMODITY EXCHANGE ACT TO ENSURE THE CONTIN- 
UED APPLICATION OF THE ACT'S ANTIFRAUD AND 
ANTIMANIPULATION PROTECTIONS 



APRIL 28 AND JUNE 30, 1993 



Serial No. 103-13/^,^^, 







139^ 






Printed for the use of the Committee on Agriculture 



U.S. GOVERNMENT PRINTING OFFICE 
72-584 WASHINGTON : 1993 

For sale by the U.S. Government Printing OlTice 
Superintendent of Documents, Congressional Sales Office. Washington. DC 20402 
ISBN 0-16-041700-7 



COMMITTEE ON AGRICULTURE 



E (KIKA) DE 

GEORGE E. BROWN, Jr., California, 

Vice Chairman 
CHARLIE ROSE, North Carolina 
GLENN ENGLISH, Oklahoma 
DAN GLICKMAN, Kansas 
CHARLES W. STENHOLM, Texas 
HAROLD L. VOLKMER, Missouri 
TIMOTHY J. PENNY, Minnesota 
TIM JOHNSON, South Dakota 
BILL SARPALIUS, Texas 
JILL L. LONG, Indiana 
GARY A. CONDIT, California 
COLLIN C. PETERSON, Minnesota 
CALVIN M. DOOLEY, California 
EVA M. CLAYTON, North Carolina 
DAVID MINGE, Minnesota 
EARL F. HILLIARD, Alabama 
JAY INSLEE, Washington 
THOMAS J. BARLOW III, Kentucky 
EARL POMEROY, North Dakota 
TIM HOLDEN, Pennsylvania 
CYNTHIA A. McKINNEY, Georgia 
SCOTTY BAESLER, Kentucky 
KAREN L. THURMAN, Florida 
SANFORD D. BISHOP, Jr., Georgia 
BENNIE G. THOMPSON, Mississippi 
SAM FARR, California 
PAT WILLIAMS, Montana 
BLANCHE M. LAMBERT, Arkansas 



LA GARZA, Texas, Chairman 

PAT ROBERTS, Kansas, 

Ranking Minority Member 
BILL EMERSON, Missouri 
STEVE GUNDERSON, Wisconsin 
TOM LEWIS, Florida 
ROBERT F. (BOB) SMITH, Oregon 
LARRY COMBEST, Texas 
WAYNE ALLARD, Colorado 
BILL BARRETT, Nebraska 
JIM NUSSLE, Iowa 
JOHN A. BOEHNER, Ohio 
THOMAS W. EWING, Ilhnois 
JOHN T. DOOLITTLE, California 
JACK KINGSTON, Georgia 
BOB GOODLATTE, Virginia 
JAY DICKEY, Arkansas 
RICHARD W. POMBO, California 
CHARLES T. CANADY, Florida 
NICK SMITH, Michigan 
TERRY EVERETT, Alabama 



Professional Staff 

DiANNE Powell, Staff Director 

Vernie Hubert, Chief Counsel and Legislative Director 

Gary R. Mitchell, Minority Staff Director 

James A. Davis, Press Secretary 



Subcommittee on Environment, Credit, and Rural Development 



GLENN ENGLISH, 
TIM JOHNSON, South Dakota. 

Vice Chairman 
JILL L. LONG, Indiana 
EVA M. CLAYTON, North Carolina 
DAVID MINGE, Minnesota 
THOMAS J. BARLOW III, Kentucky 
EARL POMEROY, North Dakota 
TIM HOLDEN, Pennsylvania 
CYNTHIA A. McKINNEY, Georgia 
KAREN L. THURMAN, Florida 
TIMOTHY J. PENNY, Minnesota 
BILL SARPALIUS, Texas 
COLLIN C. PETERSON, Minnesota 
EARL F. HILLIARD, Alabama 
JAY INSLEE, Washington 
SCOTTY BAESLER, Kentucky 
BENNIE G. THOMPSON, Mississippi 
SAM FARR, CaUfomia 



Oklahoma, Chairman 

LARRY COMBEST, Texas 
STEVE GUNDERSON, Wisconsin 
WAYNE ALLARD, Colorado 
BILL BARRETT, Nebraska 
JIM NUSSLE, Iowa 
THOMAS W. EWING, Illinois 
JAY DICKEY, Arkansas 
RICHARD W. POMBO, CaUfomia 
NICK SMITH, Michigan 



(ID 



CONTENTS 



April 28, 1993 

Page 

Combest, Hon. Larry, a Representative in Congress from the State of Texas, 
opening statement 9 

English, Hon. Glenn, a Representative in Congress from the State of Okla- 
homa, opening statement 1 

Prepared statement 4 

Witnesses 

Albrecht, William P., Acting Chairman, Commodity Futures Trading Commis- 
sion 9 

Prepared statement 46 

Bair, Sheila C, Commissioner, Commodity Futures Trading Commission 11 

Prepared statement 67 

Dial, Joseph B., Commissioner, Commodity Futures Trading Commission 15 

Prepared statement 80 

Submitted Material 

Corcoran, Andrea M., Division of Trading and Markets, Commodity Futures 

Trading Commission, memorandum of April 9, 1993 85 

Implementation of the Futures Trading Practices Act of 1992 87 

June 30, 1993 

H.R. 2374, a bill to amend the Commodity Exchange Act to ensure the 
continued application of the act's antifraud and antimanipulation protec- 
tions 94 

Report from Commodity Futures Trading Commission 96 

Combest, Hon. Larry, a Representative in Congress from the State of Texas, 
prepared statement 92 

English, Hon. Glenn, a Representative in Congress from the State of Okla- 
homa, opening statement 89 

Farr, Hon. Sam, a Representative in Congress from the State of California, 
prepared statement 91 

Witnesses 

Arbor, Patrick H., chairman, Chicago Board of Trade 110 

Prepared statement 134 

Klein, R. Wayne, chief, securities bureau. State of Idaho, on behalf of the 

North American Securities Administrators Association, Inc 113 

Prepared statement 143 

Raisler, Kenneth M., attorney, on behalf of the Energy Group 121 

Prepared statement 165 

Submitted Material 

Albrecht, William P., acting chairman, Commodity Futures Trading Commis- 
sion, statement 97 

Bair, Sheila C, Commissioner, Commodity Futures Trading Commission, 
statement 102 

Bauman, Joseph, chairman. International Swaps and Derivatives Association, 
letter of June 30, 1993 177 

Dial, Joseph B., Commissioner, Commodity Futures Trading Commission, 
statement 106 

Redel, Donna, chairman. Commodity Exchange, Inc., letter of June 28, 1993 .. 180 

(III) 



REVIEW OF THE COMMODITY FUTURES 
TRADING COMMISSION'S DISCRETION TO 
EXEMPT CERTAIN TRANSACTIONS FROM 
ANTIFRAUD PROVISIONS OF THE COMMOD- 
ITY EXCHANGE ACT 



WEDNESDAY, APRIL 28, 1993 

House of Representatives, 
Subcommittee on Environment, Credit, 

AND Rural Development, 
Committee on Agriculture, 

Washington, DC. 
The subcommittee met, pursuant to notice, at 10:05 a.m., in room 
1300, Longworth House Office Building, Hon. Glenn English (chair- 
man of the subcommittee) presiding. 

Present: Representatives Long, Barlow, Holden, Combest, Gun- 
derson, Allard, Nussle, and Ewing. 

Also present: Representative E (Kika) de la Garza, chairman of 
the committee. 

Staff present: Vemie Hubert, chief counsel and legislative direc- 
tor; Fred J. Clark, deputy chief counsel; John E. Hogan, minority 
counsel; Glenda L. Temple, clerk; Benjamin L Baker, James E. 
McDonald, James A. Davis, John Riley, and David Ebersole. 

OPENING STATEMENT OF HON. GLENN ENGLISH, A REP- 
RESENTATIVE IN CONGRESS FROM THE STATE OF OKLA- 
HOMA 

Mr. English. The hearing will now come to order. 

Last year with the reauthorization of the Commodity Futures 
Trading Commission, the Congress wrestled with a very difficult 
issue of what we do pertaining to the so-called "derivatives." Our 
concern was that this was an issue in which we were not prepared 
to make a decision, and as such, we had requested that studies be 
done — studies that paralleled a study already underway by the 
General Accounting Office. 

We requested the Securities and Exchange Commission, as well 
as the Federal Reserve and CFTC, to carry out studies pertaining 
to these derivatives, and we also pointed out that we did not want 
any action taken beyond maintaining the status quo. This was a 
decision that the Congress was reserving for itself, as to what 
should be done. The Congress has not yet reached that point, or 
reached that decision. 

In maintaining that status quo, the Congress did grant authority 
to the CFTC to make sure that the courts did not act in preempt- 

(1) 



ing this decision, but it was made very clear that this was the deci- 
sion to maintain the status quo only, not go beyond that point. 

And at the time, I believe, I made the statement to the con- 
ference that as far as I was concerned, should action go beyond 
maintaining the status quo, that those who were involved would 
have the opportunity to explain their decision to this subcommittee, 
and it appears that that's where we are. 

The so-called Brent Oil decision was the judgment that we recog- 
nized needed to be addressed. We recognized that there was the 
danger of the courts acting, and that it would also cause difficulty 
as far as the oil markets are concerned. We had, in fact, instructed 
the CFTC to take whatever actions necessary to maintain the sta- 
tus quo at that time. 

There was a request made in November, with regard to exemp- 
tions. Those requests were considered by the CFTC, and from what 
I understand — if I'm in error, we'll let the Commission correct me — 
that the former chairman then provided to the Federal Register a 

Eroposal for a rule that had not even been considered or looked at 
y the other Commissioners, from what I understand. 

It is disturbing then that earlier this month, we found newspaper 
headlines which told us that the former chairman, shortly after the 
publishing of that proposal in the Federal Register, joined one of 
the very companies, who in November came before the Commis- 
sion. 

It is my understanding then that the action taken by the Com- 
mission earlier this month was along those lines, and went beyond 
simply maintaining the status quo. 

For the first time, we have a regulatory body that exempts those 
that they're regulating from fi*aud statutes, and while there is an 
inclusion of antimanipulation, there's a question as to whether or 
not it applies to the instruments that are being considered, since 
under the law — particular provisions under the law for manipula- 
tion apply to futures contracts. 

We also find that this is a Commission that does not have a full 
compliment of members, and this was a two to one decision. I did 
note with interest that the only attorney on the Commission voted 
against it. I also have taken note of the fact that we have a memo- 
randum to the files dated April 8 of this year, from the Director 
of the Division of Trading and Marketing, voicing concerns about 
this particular provision, and particularly the antifi'aud provisions. 

We also have another memo to the Director of the Economic Divi- 
sion — fi*om the Director of the Division on Enforcement — who 
voiced his concerns with regard to this action. It was noted by all 
three of those who I mentioned — the Director of Trading and Mar- 
keting, the Director of the Division on Economic Analysis, as well 
as the Commissioner — that the purpose of the legislation last year 
was to take us beyond an "all or nothing" position to not require 
the Commission to view each decision on that basis, and that this 
exceeded and went beyond what was intended, and I don't think 
there's any question about that. 

At no time during the discussion of the reauthorization of the 
CFTC — certainly in the House, and I don't believe, in the other 
body — did we ever have any Member who raised the question or 
the wisdom of excluding any contract fi*om fi-aud statutes of the 



Federal Government or the regulatory body involved, and as was 
pointed out by the Director of the Division of Trading and Market- 
ing, "To my knowledge, the Commission has never before exempted 
transactions in products subject to its jurisdiction from the anti- 
fraud provisions of the act, unless another regulatory regime clear- 
ly applied to such transactions." 

What is more disturbing is that this action by the Commission 
may go beyond simply Federal law, and again, I quote the Director 
in pointing out that, "In this case, the energy contracts exempted 
from the CEA would also be exempt from State antibucketing laws, 
and to the extent that they are not investment contracts or securi- 
ties, or can be so designed, it would be exempt from security laws 
as well." 

I know that we will be provided with an explanation as to why 
it was necessary to take this action, and I have to say that I, for 
one, have been Einxiously looking forward to the explanation. 

[The prepared statement of Mr. English follows:] 



STATEMENT OF CONGRESSMAN GLENN ENGLISH, CHAIRMAN 
SUBCOMMITTEE ON ENVIRONMENT, CREDIT AND RURAL DEVELOPMENT 

OVERSIGHT HEARING ON AN ORDER OF THE 
THE COMMODITY FUTURES TRADING COMMISSION 
EXEMPTING CERTAIN ENERGY CONTRACT FROM 
PROVISIONS OF THE COMMODITY EXCHANGE ACT 

April 28, 1993 

Today the Subcommittee is holding an oversight hearing to 
review an order issued by the Commodity Futures Trading 
Commission on April 13, 1993, that exempted certain energy 
contracts from most of the provisions of the Commodity Exchange 
Act, including the Act's anti-fraud provisions. 

The Commission's order was issued under an amendment to the 
Act enacted in, the Futures Trading Practices Act of 1992 that 
added an new section 4(c). Section 4(c) authorizes the 
Commission to "exempt any agreement, contract, or 
transaction. . .either unconditionally or on stated terms or 
conditions. .. from any of the requirements of ... subsection (a), or 
from any other provision of the Act... if the Commission 
determines that exemption would be consistent with the public 
interest. " 

The exemptive authority was granted to the Commission to 
enable it to provide legal certainty to a number of existing 
categories of instruments that have elements of futures contracts 
but do not trade on the regulated futures exchanges . The legal 
status of some of these contracts, including the 15-day Brent Oil 



contract, was questionable in light of various court decisions. 
Congress in granting the authority cautioned that the Commission 
should use this exemptive authority sparingly until Congress has 
had an opportunity to consider the results of various on-going 
studies of the fast-growing market in derivative instruments. 
However, the Conferees did recognize the need for the 
Commission to act promptly in four areas — hybrids, swaps, 
forwards, and deposits. The Commission previously granted 
exemptions applicable to hybrids, swaps, and deposits. 

As previously noted, the Commission, prior to granting an 
exemption, is specifically required to find that the exemption is 
consistent with the public interest. The Conference report on 
the 1992 legislation make it clear that the public interest test 
includes the national public interests as noted in the Act, the 
prevention of fraud, and the financial integrity of the markets. 

I believe that the report makes it quite clear that Congress 
did not expect the Commission to exempt instruments and contracts 
from the Act's anti-fraud provisions, unless there were extra- 
ordinary reasons for doing so. Today's witnesses will be given 
the opportunity to explain what the Commission believed those 
extra-ordinary reasons may be in the case of the exempted energy 
contracts — especially since the heads of the Commission's 
Division of Enforcement and Division of Trading and Markets 
advised against exempting such contracts from the Act's anti- 
fraud provisions. 



^vSTMo, 




COMMODITY FUTURES TRADING COMMISSION 

2033 K Sireel. NW . Washingion, DC 20581 

(202) 254-7424 

(202) 254 - 3534 Facsimile 



DIVISION OF 
ENFORCEMENT 



MEMORANDDM 



April 8, 1993 



TO: Gerry Gay, Director, 

Division of Economic Anal 

FROM: Dennis Klejna, Director,, 
Division of Enforcement 



RE: 



Exemption for Certain 




tracts Involving Energy Products 



This memorandum reiterates particular Division of 
Enforcement observations concerning the draft Commission order 
exempting certain energy contracts from most provisions of the 
Act.^ 

The primary focus of our observations is on the absence of 
retained anti- fraud jurisdiction under either Section 4b or 
Section 4o. The new exempt ive authority granted by Congress 
frees the Commission from having to make the all or nothing 
jurisdictional decisions faced in the past. In this connection, 
we are not aware of any Securities and Exchange Commission 
exemption that excludes securities products from anti- fraud 
jurisdiction. See , e.g. . Preliminary Note 1 to Regulation D, 17 
C.F.R. § 230.501 et. seq . (1992) (registration exemption for 
limited offerings); Preliminary Note 1 to Rule 144A, 17 C.F.R. § 
230.144A (1992) (registration exemption for certain private 
institutional resales) ; Preliminary Note 1 to Regulation S, 17 
C.F.R. § 230.901 et. seq . (1992) (registration exemption for 
offers and sales outside the U.S.). 

The lack of fraud jurisdiction over exempt contracts may 
become significant in two areas. First, the exemption will allow 
for indirect public participation through otherwise qu§.lified 
pools, trusts, or partnerships. The Commission's own experience 
shows that it is difficult to predict the effect on retail 
customers of Commission relief granted primarily to institutions. 
In 1985, the Office of General Counsel issued Interpretative 
Letter 85-2 to a regulated bank. The letter opined that 
transactions entered into by the bank and retail metals dealers 



■'■ The Division was consulted by the Division of Economic 
Analysis on the text of the order and the acconpanying preamble, 
and some, but not all. Division comments were incorporated in 
that process. 



were not futures, options, or leverage contracts. While the 
opinion appears legally correct, the result was the birth and 
proliferation of fraudulent sales operations that caused millions 
of dollars in retail customer losses and led to Congressional 
hearings.^ Moreover, there is a nearly limitless variety of 
partnerships, trusts, or other business entities that could be 
formed to engage in exempt energy contracts, and it would not be 
difficult to structure such an entity to avoid securities laws.-^ 
We have not fully examined the myriad legal issues associated 
with applying federal securities laws or state blue sky laws to 
investment vehicles that could trade in exempt contracts, and 
Section 12(e) of the Act may prevent the application of state 
securities laws. It is also unclear how the Model State 
Commodity Code would be applied to vehicles for indirect public 
participation in the energy contract market. 

In addition, the exemption would permit small businesses to 
qualify for participation in the energy contract market, which 
may raise policy issues about where the Commission wants to draw 
the line between large entities presumably capable of protecting 
themselves and smaller, albeit still "commercial," entities who 
may lack the acumen to judge complex derivative instruments.'' 
The Commission already has seen one example of precious metals 
contracts marketed to small businesses in a scheme that 
ultimately resulted in retail customer losses and allegations of 
fraud. See Krommenhoek v. A-Mark Precious Metals. Inc. . No. 90- 
35604 (9th Cir. Sept. 27, 1991). 

As I have noted in past discussions, there may be legal 
obstacles to applying Section 4b to the contracts described in 
the draft exemption. By its terms. Section 4b applies only to 
futures contracts, and energy contracts would be subject to 
Section 4b only if it could be proved that they were futures 
contracts. Therefore, a court may not find those energy 
contracts that fall within the scope of the Brent Interp. to be 
futures contracts in light of the Brent Interp. 's unqualified 
nature. However, the draft exemption goes beyond the Brent 
Interp. -- indeed, the applicants have stated that it is their 
intention to expand on the Brent Interp. -- and it could be less 
difficult to apply Section 4b to those transactions that fall 



^ See "The Scourge of Telemarketing Fraud: What Can be Done 
Against It?" H.R. Rep. 102-421 (I02d Cong. 1st Sess. 1991) . 

^ The SEC's problems in combatting "gold in the ground" 
schemes shows that commodity investments can be packaged to avoid 
SEC jurisdiction. See SEC v. Belmont Reid & Co. . 794 F.2d 1388 
(9th Cir. (1986) . 

^ In this regard, the Commission's "trade option 
exemption," which does apply to small businesses, does not exempt 
the subject transactions from fraud jurisdiction. See 17 C.F.R. 
§ 32.4 (1992) . 



8 



outside of the Brent Interp. but remain within the scope of the 
draft exemption. 

Also, I understand that some have suggested that the "for or 
on behalf of" phrase in Section 4b could be construed to create a 
litigation obstacle to applying Section 4b to the type of 
principal to principal transaction primarily contemplated in the 
exemption. However, in many Commission enforcement actions, 
courts have readily applied Section 4b in off-exchange cases 
where boiler-rooms have sold their illegal contracts directly to 
customers. In any event, the draft exemption now specifically 
permits brokers or agents to facilitate energy contracts, the 
very type of brokerage activity that Section 4b appears intended 
to encompass. 

Aside from the policy issues raised by not retaining anti- 
fraud jurisdiction over the contracts, a decision not to retain 
section 4o jurisdiction explicitly in the exemptive order could 
raise practical issues concerning the Commission's jurisdiction 
over pooled investment vehicles that engage in both exempted 
energy contracts and regulated futures or commodity options.^ 
Where such persons or entities engage in fraud, the Commission 
may face the argument that it lacks jurisdiction to prosecute 
because the fraud is attributable in part or in whole to the 
CPO's or CTA's conduct in connection with an exempted energy 
contract. Thus, the Commission may face higher litigation costs 
in pursuing fraud, even where it appears that the fraud pervades 
an entire pool offering (for example, where false track record 
information distributed to all customers of a pool that engages 
in a variety of energy contracts is false because it conceals 
losses solely on exempted contracts, would 4o jurisdiction 
exist?) . 



^ A footnote in the preamble to the order addresses this 
issue, but the effect of the footnote in the face of unambiguous 
language in the order itself is questionable. 



Mr. English. Mr. Combest. 

OPENING STATEMENT OF HON. LARRY COMBEST, A 
REPRESENTATIVE IN CONGRESS FROM THE STATE OF TEXAS 

Mr. Combest. Thank you, Mr. Chairman. Mr. Chairman, as you, 
possibly more than anyone else know, the Congress spent an inor- 
dinate amount of time debating and agonizing over the finer points 
of issues concerning the grant of certain exemptive authority to the 
Commodity Futures Trading Commission. 

Frankly, I thought we'd put these issues aside, at least until var- 
ious studies, reports, and papers had been published. We were 
waiting for these experts on all sides to make their cases concern- 
ing many unanswered questions. 

These questions include what these many derivative products 
are, who should or should not be regulating them, and what is the 
risk to the world's financial and trading systems should the Con- 
gress decide to maintain the status quo? 

I, too, am concerned that we not allow the Commission to get too 
far off the reservation on these matters that last year's conference 
committee agreed are difficult policy issues. They also may have 
unknown real world implications far beyond the politics of split 
regulatory and congressional jurisdictions. 

Since last year's reauthorization granted the Commission the au- 
thority to make such exemptions, our subcommittee should show 
our concern for market integrity, while being careful not to second 
guess every decision made by the Commissioners within their au- 
thority. 

Having said that though, I will reserve my judgment about 
whether or not the Commission made the correct decision in ex- 
empting participants from the antifraud provisions of section 4b of 
the Commodity Exchange Act. 

I look forward to hearing the Commissioners' reasoning this 
morning. Thank you, Mr. Chairman. 

Mr. English. Mr. Gunderson. 

Mr. Gunderson. No statement, Mr. Chairman. 

Mr. English. Today we will have a panel of witnesses, the three 
remaining members of the Commission — the three that partici- 
pated in this decision. We will have the Honorable William 
Albrecht, who is the Acting Chairman, the Honorable Sheila Bair, 
who is a Commissioner, and the Honorable Joseph Dial, who is a 
Commissioner. 

Mr. Albrecht, we'll let you begin with your testimony if you 
would, please. 

STATEMENT OF WILLIAM P. ALBRECHT, ACTING CHAIRMAN, 
COMMODITY FUTURES TRADING COMMISSION 

Mr. Albrecht. Thank you. My written statement, which I sub- 
mit for the record, discusses in some detail the statutory back- 
ground, the nature of the energy exemption, and the rationale be- 
hind it. 

In my remarks today, I will concentrate on two questions: Should 
the Commission have reserved the antifraud authority of section 4b 
of the Commodity Exchange Act, and how does our action fit into 



10 

the broader mosaic of issues currently affecting United States and 
world financial markets. 

Let me start with a few facts. On October 28, 1992, the Futures 
Trading Practices Act, or FTPA, gave the CFTC the authority to 
exempt given types of agreements from almost all of the require- 
ments of the Commodity Exchange Act, including section 4b. 

Neither the FTPA nor the accompanying conference report in- 
cludes any separate discussion of 4b. The conference report does, 
however, specifically direct the Commission to consider the exemp- 
tion under discussion today. 

Consistent with that legislative direction, on January 19, 1993, 
the Commission voted to publish for comment the proposed order 
granting this exemption. The proposed order did not seek to retain 
4b jurisdiction. 

When this proposed order was published in the Federal Register 
on January 27, we specifically asked for comment on whether we 
should reserve the applicability of section 4b. Sixteen comment let- 
ters were received. None of them explicitly supported reserving 4b, 
and most argued against it. 

On March 8, the Federal Register provided notice that the Com- 
mission would meet on April 6 to vote on a final order. 

On April 1, the Federal Register provided notice that this meet- 
ing had been postponed until April 13. 

On April 13, the Commission approved a filnal order that was 
much the same as the original proposal, and, in all respects, iden- 
tical concerning section 4b. 

In approving this order, I'm quite confident that we followed not 
only the letter of the law, but the spirit as well — the spirit of 
change embodied in our new exemptive authority. 

The world of financial services has changed dramatically since 
the CFTC was established nearly 20 years ago. At that time, fu- 
tures markets dealt primarily with agricultural products. The U.S. 
futures industry clearly dominated the world marketplace. There 
was no significant competition from over-the-counter products. It 
was easy to tell the difference between a "future" and a "forward." 
It was easy to tell the difference between a "future" and a "secu- 
rity." The distinctions among products were clear and meaningful. 

Today, none of these conditions hold true. Financial markets 
have evolved at a breathtaking pace, and that evolution continues. 

Last year, Mr. Chairman, under your leadership. Congress faced 
up to the realities of today's global marketplace. It recognized that 
a regulatory regime, based on the world of 20 years ago, was caus- 
ing serious problems for derivative markets in the United States, 
and that it was hurting our international competitiveness. 

Congress addressed this situation by passing the FTPA, and giv- 
ing the CFTC the exemptive authority it so badly needed. The ge- 
nius of this authority is that it frees us fi-om the increasingly 
meaningless debate over whether something is a future or not. In- 
stead, we can concentrate on designing the appropriate regulatory 
scheme for products that have futures-like characteristics. 

We can consider how much regulation by the CFTC is needed 
based upon the characteristics of the market, such as the customer 
base, the market's purpose, the potential for fraud, and the avail- 
ability of other governmental oversight. 



11 

For some products, such as the energy contracts under discussion 
today, this may mean almost no oversight by the CFTC. For others, 
such as swaps, we've decided to maintain more oversight. This au- 
thority also means that we can fashion different regulatory 
schemes for futures exchanges if that is appropriate. 

As I stated in my recent remarks at the annual meeting of the 
Futures Industry Association, I believe that changes in technology, 
customers, and competition mean that we can lighten the regu- 
latory burden on exchange traded products that are limited to ap- 
propriate persons, and offered through an electronic trading facil- 
ity. This would be an important step for achieving the fair competi- 
tion between exchanges and nonexchanges that Congress envi- 
sioned when it enacted the FTPA. 

In the case of energy transactions, we have fashioned an exemp- 
tion for a fundamentally commercial market, whose purpose is to 
move energy products in the stream of commerce. This market has 
been in operation for over a century, and has gotten along just fine 
without CFTC oversight. Its participants are large commercial enti- 
ties, well aware of their contractual rights and legal remedies. 

I am concerned that maintaining section 4b authority over this 
market would provide little, if any, benefit, and perhaps cause very 
real harm. If section 4b remains an issue, some international com- 
mercial participants will continue to refuse to do business with 
U.S. energy firms, and some U.S. firms will set up off-shore 
branches. 

In short, retaining 4b authority will damage U.S. international 
competitiveness. 

Let me emphasize, however, that the Commission's action does 
not signal any abandonment of the principles of section 4b. There 
has been no lessening of the CFTC's commitment to detect, deter, 
and punish fraudulent activities. We have simply made an in- 
formed judgment to devote our resources to those markets where 
they are most needed and most likely to be effective. 

Last October, Congress gave the CFTC the power to change an 
outdated regulatory system. In November, the voters chose a new 
President, the President elected on the platform of change — a 
President whose campaign theme song was "Don't Stop Thinking 
About Tomorrow." 

If America's financial services industry is to be an effective inter- 
national competitor, if the CFTC is to be an effective regulator, we 
must let go of the past. We must forget about outdated jurisdic- 
tional battles and outdated regulatory schemes, and start thinking 
about tomorrow. 

I believe that in adopting this energy exemption, the Commission 
has done exactly that. 

[The prepared statement of Mr. Albrecht appears at the conclu- 
sion of the hearing.] 

Mr. English. Thank you. 

Ms. Bair. 

STATEMENT OF SHEILA C. BAIR, COMMISSIONER, COMMODITY 
FUTURES TRADING COMMISSION 

Ms. Bair. Thank you, Mr. Chairman, members of the subcommit- 
tee. Thank you for the opportunity to appear before you today to 



12 

discuss the Commission's order of April 13 exempting certain en- 
ergy contracts from the Commodity Exchange Act. I voted against 
this order. 

As you know, it fails to retain the general antifraud provisions 
contained in sections 4b and 4o of the Commodity Exchange Act. 
I believe that exempting such transactions from statutory provi- 
sions so basic and central to our regulatory scheme is a serious 
misapplication of our new exemptive authority, and does set a dan- 
gerous precedent. 

At the outset, let me emphasize that I do not challenge the Com- 
mission's legal authority to have granted energy contracts this ex- 
emption, as ill-advised as I feel that action was, nor do I oppose 
in concept an appropriately tailored exemption for the Brent Oil 
market. 

As the members of this subcommittee are aware, in September 
1990, the Commission issued a statutory interpretation determin- 
ing Brent crude oil contracts were forward contracts excluded from 
the act. The Commission's action was prompted by a Federal dis- 
trict court holding in the Transnor case that Brent contracts were 
futures contracts subject to the CEA. 

As former Commissioner Fowler West pointed out in his dissent, 
the statutory interpretation went far beyond generally accepted cri- 
teria in defining Brent contracts as forwards. Regrettably, the 
Commission had little choice but to take such an approach because 
then, unlike now, it lacked the authority to exempt futures con- 
tracts from the act. 

Because the Brent statutory interpretation was such a departure 
from the traditional view of forwards, it left open the possibility 
that a court could disagree with it, and still find the Brent con- 
tracts were futures. Thus, it failed to provide the legal certainty 
which Brent market participants sought. 

As result, I believe it would have been completely appropriate for 
the Commission to use its new exemptive authority to grant an ex- 
emption for the Brent Oil market, while retaining antifraud and 
antimanipulation authority. Unfortunately, the exemptive order ap- 
proved by the Commission went far beyond what was necessary, 
and significantly expands the Commission's 1990 Brent Oil statu- 
tory interpretation. 

For instance, the statutory interpretation was crafted to address 
contracts for delivery in the Brent Oil market where a single cargo 
consists of 500,000 barrels with a current market value in excess 
of $10 million. The exemptive order, on the other hand, encom- 
passes any contract for crude oil, as well as condensates, natural 
gas, natural gas liquids, or any of their derivatives, regardless of 
the size of the transaction. 

The exemptive order also significantly expands the tj^es of offset 
arrangements that are covered. The statutory interpretation de- 
scribed arrangements requiring parties to negotiate offset arrange- 
ments subsequent to entering into a Brent contract. Thus, they re- 
tain significant delivery risk. 

The exemptive order, on the other hand, recognizes master 
agreements where the presumption is that the parties will offset 
their transactions. Parties using these agreements can net all 



13 

transactions in a particular month with no intention to take deHv- 
ery of any amount of the underlying commodity. 

In addition, the kinds of entities eligible under the exemptive 
order are significantly broader than those described in the statu- 
tory interpretation. The statutory interpretation described eligible 
participants as producers, processors, refiners, and merchandisers 
of petroleum products, and other entities that buy and sell petro- 
leum in connection with a line of business. 

Entities eligible to participate under the exemptive order, how- 
ever, include, among others, banks and governmental entities, as 
well as business entities with a net worth exceeding $1 million, or 
total assets exceeding $5 million. It is unnecessary for a business 
to meet even these relatively low financial requirements if it can 
secure a guarantee or letter of credit from a number of enumerated 
entities, including a bank, savings and loan, broker-dealer, FCM — 
even a floor broker or floor trader. 

A footnote to the exemptive order also makes clear that specula- 
tive investment vehicles, such as commodity pools, can qualify. 

Finally, the exemptive order dilutes the commerciality require- 
ment of the statutory interpretation to such an extent as to make 
it almost nonexistent. The statutory interpretation emphasized 
that transactions in Brent contracts are entered into for commer- 
cial purposes in normal commercial channels, and must be related 
to the business of the party. 

The exemptive order, on the other hand, simply requires that en- 
ergy contracts be entered into bj'^ "commercial participants who, in 
connection with their business activities, incur risk, in addition to 
price risk, related to the underljdng physical commodities." 

This sounds impressive, but a publicly offered commodity pool or 
a floor broker with a partial interest in a single oil well could, in 
good faith, claim that it has met the risk portion of this test. 

Indeed, it can be argued that an entity becomes a commercial 
participant for purposes of the exemption, simply by entering into 
an exempt transaction. This is because the terms of an exempt en- 
ergy contract expose the parties to the contract to the risk of own- 
ing the commodity. 

In my view, the April 13 order is sufficiently broad as to easily 
extend to transactions traditionally viewed as illegal, off-exchange 
futures contracts under criteria applied by the Commission and the 
courts. 

Given that fact, I believe it was important to the integrity of our 
enforcement program for the Commission to retain antifraud au- 
thority, and can see no valid policy reason for the Commission's re- 
fusal to do so. 

One of the primary arguments that has been advanced for grant- 
ing an exemption to the antifraud provisions of the act is that the 
participants in exempt energy transactions are sophisticated insti- 
tutional users, or entities of high net worth, who do not need the 
antifraud protections of the act. 

At the outset, I would note that if we are to rationalize exemp- 
tions from antifraud £ind other components of our regulatory 
scheme on the basis of the sophistication of market users, we might 
as well close our doors tomorrow because approximately 98 percent 



14 

of users of regulated exchange traded futures are also sophisticated 
institutional users or entities of high net worth. 

Additionally, we all know that large firms are defrauded. The 
Commission has brought or assisted in a number of actions where 
the victims have been so called, institutional or sophisticated inves- 
tors. 

Further, the Commission's exemptive order permits participation 
in exempt energy transactions by comparatively low net worth indi- 
viduals or small businesses through the $1 million net worth 
threshold for corporations and proprietorships and the sweeping 
guarantee provisions. The participation of such entities not only 
undermines the sophisticated institution argument for an exemp- 
tion from the antifraud provisions, it also increases the likelihood 
of exempt energy boilerrooms that target small business. 

In addition, the order contemplates indirect public participation 
in exempt transactions through a footnote permitting collective in- 
vestment vehicles such as commodity pools, but because the order 
fails to expressly retain section 4o authority, it is unclear if the 
Commission has the authority to sue a registered commodity pool 
operator for fraudulent representations to prospective pool inves- 
tors concerning exempt energy transactions. 

Another argument against retaining the antifraud provisions of 
the act is that it would place an onerous burden on the energy 
markets. 

In response, I would first note that if the antifraud provisions of 
the act were retained, they would only apply to fraudulent trans- 
actions, which could also be shown to be futures contracts, other- 
wise subject to our jurisdiction under the act. 

In addition, basic CEA antifraud protections apply no more of a 
burden on these markets than do State antifraud laws. Indeed, 
given conflicts in State law, providing Federal forums and remedies 
in connection with these transactions is, if anything, less onerous 
in forcing participants, many of which are not U.S. companies, to 
resolve their disputes under State law. 

It should also be noted that at least some of the energy contracts 
exempted by the Commission are also already subject to regulation, 
including antifraud requirements, in the United Kingdom without 
any apparent chilling effect on market participation. 

The Commission, I believe, has set a dangerous precedent by not 
retaining antifraud protections in this energy exemption. To my 
knowledge, it is unprecedented for the Commission to provide relief 
from antifraud protections for transactions that are not subject to 
the jurisdiction of another regulator. 

The Commission retained antifraud authority for swap trans- 
actions which, like energy contracts, are principal-to-principal ar- 
rangements in which brokers are permitted to facilitate treins- 
actions. 

What's more, the financial thresholds for eligible swap partici- 
pants under the Commission's swaps rule are significantly higher 
than those required of eligible energy contract participants. Thus, 
the energy order, if anything, would seem to present a stronger 
case for retaining antifraud protections than the swaps rule. 

Commission rules governing trade options, which are options of- 
fered to commercials in connection with their business, are also 



15 

subject to an antifraud provision, and of course, retention of anti- 
fraud jurisdiction is standard in exemptions granted by the SEC. 

By deviating from all of these precedents, my fear is that the 
Commission has raised the expectations of other potential appli- 
cants for exemptive relief, that they as well will be able to escape 
sections 4b and 4o. 

The primary reason the CFTC sought general exemptive author- 
ity in its reauthorization was to have the flexibility to craft appro- 
priately tailored exemptive relief based on public policy consider- 
ations, instead of continuing to deal vdth the "all or nothing" juris- 
dictional decisions forced upon us in the past. 

In my view, we should have used our new exemptive authority 
to clean up the confusion regarding forward contracts created by 
the Brent Oil statutory interpretation, and I have no doubt that we 
could have designed an exemptive order sufficient to meet the 
needs of the Brent Oil market without compromising core provi- 
sions of the CEA. 

Unfortunately, we have continued to follow the "all or nothing" 
approach, instead of weighing individual aspects of our regulatory 
structure and making a reasoned determination as to which re- 
quirements should apply. 

That concludes my statement. Thank you, Mr. Chairman. 

[The prepared statement of Ms. Bair appears at the conclusion 
of the hearing.] 

Mr. English. Thank you very much. 

Mr. Dial. 

STATEMENT OF JOSEPH B. DIAL, COMMISSIONER, 
COMMODITY FUTURES TRADING COMMISSION 

Mr. Dial. Thank you, Mr. Chairman, members of the subcommit- 
tee. As I stated in my concurring opinion to the exemptive order 
relating to certain energy contracts issued by the Commission on 
April 13, 1993, I believe that this exemption was unique, given its 
factual and legal background. 

In my comments on the 13th, I expressed the belief that Con- 
gress intended to allow existing energy contract practices in these 
markets to continue to perform a useful function in the inter- 
national marketplace. 

I noted my belief then, and I respectfully submit to you today 
that the Commission was exercising its exemptive authority in a 
manner consistent with congression^ intent. 

From November 16, 1992, until April 13, 1993, I rehed on the 
plain language of the Futures Trading Practices Act and the con- 
ferees' report as my guide in reaching a decision on the energy pro- 
posal. 

There are seven factors explicitly stated in the statute and con- 
ference report that I referred to from time to time, again and again: 

First, the conference report to the Futures Trading Practices Act 
of 1992, in a paragraph in the exemptive authority section entitled 
"Forwards," specifically provided that "[Tjhe conferees encourage 
the Commission to review the situation and these contracts to de- 
termine whether exemptive or other action should be taken." We 
did that. 



16 

Second, the conferees indicated that the exemptive authority 
should be used to "create legal certainty for a number of existing 
categories of instruments, which trade today, outside of the forum 
of a designated contract market." We took that into consideration 
as it was written. 

Third, the conferees further stated that the Commission should 
use the exemptive authority promptly in the "areas where signifi- 
cant concerns of legal uncertainty have arisen," including among 
others, forwards. We acted promptly. 

Fourth, the conferees specifically did not express a view regard- 
ing the applicability of the Commission's Brent interpretation. 

Fifth, the conferees expressly stated that the exercise of this ex- 
emptive authority would not "require any determination before- 
hand that the agreement, instrument, or transaction for which an 
exemption is sought is subject to the act." 

Sixth, the FTPA provides that the Commission may exempt an 
agreement, contract, or transaction from section 4(a) of the Act "or 
from any other provision of this act, except section 2(a)(1)(b), if the 
Commission determines that the exemption would be consistent 
with the public interest." We acted in accordance with those in- 
structions. 

Seventh, the conferees stated that the public interest test should 
"include the national public interest noted in the act, the preven- 
tion of fraud, and the preservation of the financial integrity of mar- 
kets, as well as the promotion of responsible economic or financial 
innovation and fair competition." We also tried to find proper bal- 
ance in compl3dng with these instructions. 

Given each of these factors, it remains my determination that the 
exemptive order, as approved by the Commission, was appropriate. 
The conferees chose to allow our prior statutory interpretation con- 
cerning forward transactions to stand. 

Furthermore, the language of the conference report clearly states 
that CFTC does not have to find a contract within our jurisdiction 
in order to exempt it. 

Accordingly, I voted to provide the requested relief to existing 
forwards-like markets, which could arguably come imder the pe- 
numbra of the Brent interpretation, believing we should treat these 
more "as excluded forwards" than as "exempted futures." As such, 
I made the decision that the application of section 4b to these con- 
tracts was inapposite. 

I base this decision, in part, on my understanding of the legisla- 
tive intent regarding regulation of forwards contracts. The section 
2(a)(1) exclusion for such contracts was grounded on the premise 
that "the act's regulatory scheme for futures trading simply should 
not apply to private, commercial merchandizing transactions which 
created enforceable obligations to deliver, but in which delivery is 
deferred for reasons of commercial convenience or necessity." 

That interpretation described the Commission's determination as 
to what commercial-to-commercial transactions involving commod- 
ities it considers to be within the scope of the section 2(a)(1) exclu- 
sion. 

Included within that scope of exclusions are "transactions which 
create specific delivery obligations, * * * [which] create substan- 
tial economic risk of a commercial nature to the parties * * *." 



17 

I believe that the contracts, which were the subject of the April 
13, 1993 exemptive order, were sufficiently within the penumbra of 
the Brent interpretation, so as to warrant similar treatment. These 
contracts are restricted to commercial entities and create delivery 
obligations that entail market risk. 

Even though the parties may enter subsequent contracts to dis- 
charge the obligations, this does not nullify the market risk attend- 
ant to these transactions. 

Similarly, even though the parties may satisfy the capacity re- 
quirement of the exemption by executing bona fide contracts for 
services such as production, refining, or storage, this still requires 
the ability to bear market risk involved with the transactions. 

Accordingly, I believe that the exemptive authority sufficiently 
delimited the relief to existing markets, which come within the 
general categories specified in the conference report paragraph 
noted above, entitled "Forwards." 

This, I believe, indicates that the fraud protection available to 
current participants in the forwards market is sufficient for con- 
tracts included in the exemptive order, and renders the application 
of section 4b inappropriate, 

I took this into account in reviewing the various components of 
the public interest test, and I came to the decision to support the 
energy exemption order as it was approved, after carefully review- 
ing the nature of the relief requested, the existing markets, the 
above-mentioned directives of the conference report, and the stat- 
ute. 

Thank you, sir, 

[The prepared statement of Mr. Dial appears at the conclusion of 
the hearing.] 

Mr. English. Thank you, Mr. Dial. 

The very purpose for the existence for the Commodity Futures 
Trading Commission or any other Government regulatory agency is 
to protect the public interest. 

Mr. Albrecht, can you explain to me how opening the door to 
fraud protects the public interest? 

Mr. Albrecht. I think that we should first be clear on a couple 
of facts: That essentially, what we have done is to maintain the 
status quo in exercising our exemptive authority. We've attempted 
to write a rule which leaves a market free from CFTC's jurisdic- 
tion, which is currently free fi-om that jurisdiction. 

The question is, should the specific antifi*aud prohibitions of the 
Commodity Exchange Act, as enforced by the CFTC, apply to this 
market? 

There are lots of markets in which there is no oversight by the 
CFTC, nor by any other governmental regulatory agency. There is, 
however, a Department of Justice, which enforces Federal anti- 
fi*aud statutes, there are State laws which enforce State antifraud 
statutes, and there are civil remedies available for fraud. 

The question is not, are we condoning fraud? The question is not, 
are we repealing antifraud statutes? We're simply saying, here is 
a market in which there are laws against fraud. The CFTC has 
never overseen this market. 



18 

We do not think that it would be in the pubHc interest to extend 
our antifraud jurisdiction to that market for the reasons that I've 
outlined — I'd be happv to go through again. 

Mr. English. Mr. Albrecht, that was not the question. The ques- 
tion I asked you goes to the very core of the existence of the CFTC. 

It was not your decision to make, nor were you a party to the 
creation of the CFTC or the need for it, and certainly, it is not up 
to you to make the decisions with regard to whether it needs to 
exist. 

It does exist because it has been determined by the people who 
have the responsibility to make the laws of this country, there's a 
need for it, not that some other governmental body can do it, and 
we don't need it. 

The bottom line question, again, is, given the requirements 
under the law to meet the interest of the public — a public interest 
test — how can you justify opening the door to fraud in these mar- 
kets? 

Mr. Albrecht. I simply have to take serious exception to the 
way the question is stated. I do not believe that we have opened 
the door to serious fraud. That simply is not true. 

Mr. English. Mr. Albrecht, I don't see how it can be looked at 
in any other way. Whenever you take it upon yourselves to exempt 
a market from the fraud requirements of the agency, that opens 
the door to fraud. There can be no other interpretation. 

Now, we may argue as to whether or not there should or should 
not be a CFTC, or whether there should or should not be any kind 
of governmental agency overseeing particular markets, but the fact 
of the matter is that unless you have — any time that you have been 
charged with the responsibility of carrying out the laws and pro- 
tecting the public interest, I see no way in which you can justify 
lifting the requirements of the law exempting a market from the 
fraud requirements of that agency. That is not in the public inter- 
est. 

Mr. Albrecht. Let me repeat one point that I made earlier 

Mr. English. I'm not asking you to repeat the point, I'm asking 
you to answer the question. 

Mr. Albrecht. I m trying to answer your question, sir. I believe 
. this is responsive to your question. 

I do not believe that we have lifted fraud requirements from the 
market. The market is subject to no more and no less fraud over- 
sight on April 14 than it was on April 12, but let me address the — 
perhaps, this will help answer the question. 

Mr. English. Well, let's follow-up on that part right there. You're 
sa5ring that it is subject to no more applications under the law on 
April 14 than it was on April 12? 

Mr. Albrecht. Yes, sir. 

Mr. English. In what way? 

Mr. Albrecht. On April 12, the CFTC did not have jurisdiction 
over these energy contracts — they never exerted that. On April 13, 
we voted to maintain that position. 

Mr. English. Well, explain to me then, Mr. Albrecht, how in the 
world a Government agency — how you, as a regulator, can exempt 
someone over which you have no jurisdiction, if that is your posi- 
tion. 



19 

Mr. Albrecht. I believe that is the heart and soul of this exemp- 
tive authority. Some people have said the CFTC may have jurisdic- 
tion over tins market — some people have said, "These may be 
futures 

Mr. English. Are you talking about people, or are you talking 
about courts? 

Mr. Albrecht. People — courts 

Mr. English. Yes — they're all the same, in your opinion? 

Mr. Albrecht. Well, judges are people, but — if the court- 



Mr. English. Well, let's use — ^yes. The court has decided. 

Mr. Albrecht. The court has said so, and 

Mr. English. And you disagree? 

Mr. Albrecht. A court said that 

Mr. English. Do you disagree with that court? 

Mr. Albrecht. Yes. 

Mr. English. So you do not believe that the courts are correct. 

Mr. Albrecht. I believe, in that particular case, that particular 
court made an incorrect decision. 

Mr. English. And you have chosen to overrule the court, is that 
correct? 

Mr. Albrecht. It's not in my power to overrule the court. 

Mr. English. It is also not in your power to exempt from the 
statutes, an entity over which you have no regulatory authority. Is 
that not correct? 

Mr. Albrecht. As I understand 

Mr. English. Will you answer my question, please? 

Mr. Albrecht. I'm trying to answer your question. 

Mr. English. Well, either yes or no. Do you have the authority 
to exempt from the statutes, an entity over which you have no reg- 
ulatory authority? 

Mr. Albrecht. Congress granted us the authority to exempt 
markets without making the determination as to whether they 
were subject to our authority, so the answer is yes. 

Mr. English. So you have the authority to exempt — are you an 
attorney, Mr. Albrecht? 

Mr. Albrecht. I am not an attorney. I work with a lot of attor- 
neys. I've received a lot of advice on this question from attorneys. 

Mr. English. Ms. Bair, you are an attorney? 

Ms. Bair. Yes, sir. 

Mr. English. Mr. Dial, you're not an attorney? 

Mr. Dial. No, sir. I am not. 

Mr. English. Ms. Bair, under the law — I'm not an attorney ei- 
ther. Maybe you could help us with a little legal work here then. 

Under the law, is it possible for someone to exempt from the 
statutes, if they have no authority over that entity? 

Ms. Bair. No, sir. I don't believe it is, and to the extent we are 
exempting things that are futures contracts, and therefore, are oth- 
erwise subject to the Commodity Exchange. 

Mr. English. So if these are not ftitures contracts, there's no au- 
thority. 

Ms. Bair. That's right. We cannot exempt something that's not 
within our jurisdiction in the first place. 

Mr. English. OK. 

Ms. Bair. In my view. 



20 

Mr. English. Mr. Albrecht, that brings us back to the point. We 
have the attorney here — your counsel on the Commission — who ad- 
vises you that you can't exempt something that is not, in fact, cov- 
ered under your jurisdiction. 

Mr. Albrecht, Commissioner Bair is not my counsel. I have 
counsel who advise me otherwise. 

Mr. English. Oh, you get your own lawyer's advice. You get your 
own counsel then, is that right? 

Mr. Albrecht. As I think you well know, each Commissioner has 
legal staff assigned to him. We have a number of attorneys within 
the Commission. I rely upon them for advice. 

I believe that they have told me that the conference report and 
Commissioner Bair's statement are inconsistent. 

Mr. English. You also had recommendations or views being ex- 
pressed by both the Director of Enforcement and the Director of the 
Division of Trading and Markets, is that right — on this issue? 

Mr. Albrecht. Yes. But those were documents which were not 
sent to the Commission. We forwarded them to you because we 
wanted to send as much material as we could on this. 

Mr. English. You're telling me then that these people did not 
advise you of their views? 

Mr. Albrecht. They did advise us of their views. 

Mr. English. So you were aware of these views. 

Mr. Albrecht. I was aware of these views. 

Mr. English. And both had advised you of problems that they 
saw with taking this action, is that correct? 

Mr. Albrecht. I think it would be useful to 

Mr. English. Well, just answer the question, Mr. Albrecht. Is 
that right or not? Yes or no? 

Mr. Albrecht. Yes. 

Mr. English. So you had both the Director of Enforcement of the 
Division of Enforcement and the Director on the Division of Trad- 
ing and Marketing, who advised you that they saw problems with 
regard to this matter, and even under the provisions of the law — 
the basic responsibility that you have to protect the public inter- 
est — you saw fit to move ahead, even over the reservations and 
concerns being expressed by the only attorney sitting on the Com- 
mission itself? 

Mr. Albrecht. Well, that's an incorrect statement. They are 
not 

Mr. English. Tell me who in the Commission was recommending 
that — ^who, with regard to the staff in the Commission, was 

Mr. Albrecht. "Hie General Counsel, which is an office fiill of at- 
torneys. The General Counsel herself is also an attorney. 

Mr, English, I thought the General Counsel's place was to ad- 
vise you what was legal and what's not. Is it also the General 
Counsel's position to advise you what's good policy and what's 
not — what's in the public interest and what's not? 

Mr. Albrecht. The purpose of every division Director is to give 
the full Commission their views on issues before us. 

Mr. English. Whether they have any expertise or not. 

Mr. Albrecht. Does who have any expertise? 

Mr. English. Whether the division has any expertise or 

Mr. Albrecht. They all have expertise, and 



21 

Mr. English. They all have expertise in every field that is within 
the Commission, is that correct? 

Mr. Albrecht. On most issues 

Mr. English. Does your legal counsel have that kind of expertise 
to what, in fact, is a problem from an enforcement standpoint, or 
what, in fact, is good policy? 

Mr. Albrecht. I believe so. I believe that — if I may be permitted, 
sir — I believe that each division Director has expertise over a wide 
range of issues. 

Now each division Director is most particularly concerned about 
a particular aspect of Commission policy — but they are staff. 

They are, by and large, career bureaucrats. They don't have to 
make the policy decisions. 

They make the recommendations, and we make the policy deci- 
sions. They make the recommendations from their perspective. 

As it turns out, of the four major division Directors, two sup- 
ported what we did, two would have preferred that we keep section 
4b in. 

I should also note that those 

Mr. English. Well, who are the two? You've mentioned your 
legal counsel — is that your personal legal counsel? Is that a head 
of a department or — what? 

Mr. Albrecht. The General Counsel, who is a head of a division, 
and 

Mr. English. Is that your personal counsel? 

Mr. Albrecht. No, sir. 

Mr. English. How many lawyers do you have over there? 

Mr. Albrecht. On the Commission staff? 

Mr. English. Advising you personally. 

Mr. Albrecht. I have two lawyers on my own staff 

Mr. English. And then you have a division of lawyers? 

Mr. Albrecht. We have a lot of lawyers. We probably have 
about 125 lawyers at the Commission. 

Mr. English. Well, that may be part of the problem right there. 

Mr. Albrecht. I've been known to say that. [Laughter.] 

Mr. English. Well, you may have been right. [Laughter.] 

Who's this other division head that was supporting — who didn't 
feel we needed any fraud statutes? 

Mr. Albrecht. That's our Chief Economist. 

Mr. English. So you have the economist and your head lawyer, 
who have said that they thought this was a great idea — "We don't 
need any fraud statutes." 

You have the head of the Division of Enforcement, and the head 
of Trading and Markets, who say they think it's a bad idea. 

Mr. Albrecht. That's right. 

Mr. English. And you've decided the lawyers know more about 
trading and marketing, and know more about enforcement than 
those folks that are running those jobs, is that right? 

Mr. Albrecht. I had the policy decision to make based upon all 
of the factors in front of me, including the advice of everybody that 
I talked to on the staff — which is a lot of people — including indirect 
discussions with my two colleagues here. The Commissioners are 
not really able to talk directly to each other because any two of us 
together is a quorum. 



22 

I am confident that these ideas were fully discussed, and vetted. 
If I pride myself on Einything as the Acting Chairman of this Com- 
mission, I pride myself in the fact that I have brought more open- 
ness to the process in the Commission than was there previously. 

I have included my two fellow Commissioners at the very early 
stages of every decision, I have encouraged the staff to make inde- 
pendent decisions, and I encouraged the staff, in fact, to write 
those memorandums if they disagreed with me because I wanted 
them to get these ideas out in public and have them debated. 

I think that leads to much better decisionmaking, but one of the 
consequences of that is that you do have public disagreement about 
issues. I think that's healthy. 

I take full responsibility for being part of that process. 

Mr. English. I think that's fine, but what you're going to have 
to take full responsibility for are the consequences of the acts, and 
this is going to be one that you're going to have to take the full 
consequences for. 

Mr. Dial, you're in favor of opening up the door for fraud, I see. 
Can you tell me — explain to me how this is in the public interest? 

Mr. Dial. Mr. Chairman, I'm not in favor of opening the door for 
fraud. 

Mr. English. Well, that's what you've done. 

Mr. Dl\l. Mr. Chairman, my background is somewhat similar to 
yours, in that we both come from an environment of values where 
straight talk and tough enforcement are very important. The last 
thing that I would do, sir, is act to open the door to fraud. 

Mr. English. Mr. Dial, let me stop you right there, because there 
is no question, that's what you've done. 

Whether you intended to or not, or whether you recognized and 
understood what you're doing or not, that's exactly what you've 
done, and as I said — and as your Director on Trading and Markets 
pointed out in her memo to the file — the Commission has never be- 
fore exempted any transactions, subject to its jurisdiction in these 
areas, from these antifraud statutes. 

Now, never before have you done that. I have never, quite frank- 
ly, heard of any other Federal agency — quite frankly, I consider 
this to be outrageous. 

And talking about straight talk — I'm giving it to you. You want 
it, you're getting it. That's what it's all about. 

And you say you're all for enforcement. Well, that's fine, but we 
have to have something to enforce first of all. 

If we wipe the laws off the books, then you don't have to worry 
about enforcement, do you? Maybe that makes it a lot easier, but 
the fact of the matter is, your action opened up the door to fraud 
in this area. 

Now there may be reasons — and I've heard, "Well, these are big 
boys. Let them take care of themselves." 

I would suggest to you, before this thing is done, as a con- 
sequence of your actions, there are going to be some little people 
that are going to get hurt, too. They may be big in our part of the 
country, but they're little in this world, and it seems like, that any 
time when the big people get hurt, they have to fall someplace, and 
they fall on an awful lot of little people. The little folks end up 
bearing a good deal of this burden. 



23 

Now if you want to go out and take off on some economic the- 
ory — if you want to be a purist in economics and say, "By golly, we 
believe in the free markets. Let's open it up all the way," then I 
assume that you would be for wiping the fraud statutes off the 
books of the States as well, but as Ms. Bair pointed out, this stat- 
ute has no more of a burden than do the State statutes. 

This would have no more of an impact than what we find taking 
place in the States today, and — I just, quite frankly, have found the 
action to be outrageous. 

Mr. Albrecht made the point that we had a comment period. 

What did you say — you have a dozen people writing in or some- 
thing like that? 

We got into the swaps issue, and you were going to do the same 
thing on this, and I believe you got a call from me on that, didn't 
you? 

Mr. Albrecht. I didn't, but I believe the Commission did, yes. 

Mr. English. Yes, they certainly did. And I made my views 
known. Did I get logged in as commenting — with regard to the mat- 
ter of fraud? 

I — didn't put it down? 

Mr. Albrecht. I beheve that 

Mr. English. Members of Congress don't get their views re- 
corded? 

Mr. Albrecht. I was not in the Chairman's office at that time, 
and I don't know exactly how that happened. It may or may not 
have entered the official file. 

It's my understanding that it came in fairly late, fairly well past 
the closing of the comment period, but in general, it's our policy 
that if a letter comes in, the letter will go in the comment file. 

The phone call would not go into the comment file, because it's 
a phone call, it's not a letter. One wouldn't want to possibly mis- 
represent what a person 

Mr. English. So because of the fact that I called the Chairman 
of the CFTC to express my — quite frankly, grave concerns — is the 
way I put it at that time — that the Commission was getting ready 
to act with regard to swaps, and you were going to exempt fraud 
in that area. You all were looking at doing it on swaps, too. 

Mr. Albrecht. It was certainly under discussion. 

Mr. English. It certainly was. It was barreling down the track 
about 90 miles an hour. 

I expressed some grave concerns about that, and then you de- 
cided, "Well, as long as it applies to futures, we'll go ahead and in- 
clude it." 

But swaps are not futures contracts in your view — are they, Mr. 
Albrecht? 

Mr. Albrecht. I think that the 

Mr. English. Is a swap a future? 

Mr. Albrecht. I could say yes, I could say no. My main point 
is it doesn't matter. 

Mr. English. Well, either it is or it isn't. 

Mr. Albrecht. It doesn't matter. 

Mr. English. I would disagree with you, because you all agreed 
to a ruling down there on this exemption with regard to swaps and 
the swaps fraud provisions, and I believe the manipulation provi- 



24 

sions on swaps, and I believe the same thing is true with regard 
to this particular contract. It applies only as it does under the fu- 
tures provisions of the law. 
Is that right, Ms. Bair? 

Ms. Bair. Well, that's right. Congress did not require us to make 
a determination in advance that contracts that met the specific re- 
quirements of the exemption were or were not futures, but clearly, 
again, in my view, you cannot exempt something that's not within 
your jurisdiction, which is a futures contract. 

Both the swaps rule and this rule, I believe, are sufficiently 
broad to include things we've traditionally viewed as futures con- 
tracts. 

Mr. English. But if you're viewing it the way Mr. Albrecht's 
counsel is — well, that's fine. We can go ahead and put that on the 
books because we don't view that as being a futures contract any- 
way; therefore, we have no regulatory authority anyway — right? 

Ms. Bair. If that's the analysis, we didn't need exemptive author- 
ity because, again, it would be 

Mr. English. But am I correct in the way that — the trail that 
that follows? 

Ms. Bair. Yes. I agree. 

Mr. English. So if you're Mr. Albrecht, well, you don't recognize 
any of it — "It doesn't matter whether it's on the books or not be- 
cause I choose not to view that to be a futures contract." 

Is there any such thing, Mr. Albrecht, as a futures contract if it's 
not traded on an exchange? Does it have to be traded on an ex- 
change to be a futures contract, or not? 

Mr. Albrecht. I think that is a question that we no longer have 
to answer. The question is, if something has futures-like 
characteristics 

Mr. English. I'm asking your personal point of view, Mr. 
Albrecht. You're the Chairman. You've been sitting down there on 
the Commission. 

You're the ones that make the judgment call. I'm trying to figure 
out whether we have anjrthing covered by fi*aud statutes. Maybe 
you don't view the stuff on the exchanges being futures anymore, 
for all I know. 

Mr. Albrecht. I believe they are futures. 

Mr. English. So everything on an exchange is a futures contract, 
is that right? 

Mr. Albrecht. If it's traded on a futures exchange, I believe it's 
a futures contract. 

Mr. English. Is there anything that's not traded on a futures ex- 
change that is a futures contract? 

Mr. Albrecht. There can be illegal off-exchange futures con- 
tracts. 

Mr. English. Do you know of any? 

Mr. Albrecht. Not at the moment. We would have shut them 
down if we had. 

Mr. English. So therefore, if you haven't shut them down and 
they're not traded on the futures exchange by your very definition, 
they are not a futures contract. 

Mr. Albrecht. Mr. Chairman, I do not think it is useful to spend 
a lot of time worrying about whether some of these instruments 



25 

with futures-like characteristics are futures contracts. We have 
wasted an awful lot of time over the past 20 years doing that. 

Mr. English. Mr. Albrecht, let me just point out to you, it is up 
to this subcommittee and this committee and this Congress to 
make that decision, not you, and that's exactly what the problem 
is here today, Mr. Albrecht, because I think you have taken it on 
yourself to make these decisions. 

You have taken it out of the hands of Congress, and as Commis- 
sioner Bair pointed out in her statement — and I assume, Commis- 
sioner Bair, you made that point to the other Commissioners — that 
in fact, you're going beyond what was the intent of the law, and 
certainly the intent of the exemption. 

Mr. Albrecht. It was not my intent to do that. I believed, and 
I still believe that what I did was consistent with the law, consist- 
ent with the conference report, and I thought it was consistent 
with the intent of Congress. 

Perhaps I'm mistaken, but I thought it was. 

Mr. English. You have a lot of folks that told you it wasn't, so — 
we'll take another round on this in just a little bit, but I'm sure 
Mr. Combest has a few questions. 

Mr. Combest. Thank you, Mr. Chairman, 

The whole issue of dealing in futures is an area which is not 
something that all of us have a personal awareness of. It is some- 
what of a unique business, and given the fact that we're dealing 
with this in terms of legal questions — I'm not an attorney either — 
let me see if my understanding of the questions is correct. Please, 
make any changes in my scenario of what has happened here — 
any of you, that you would see — because I want to make sure that 
I'm understanding this correctly. 

The question of jurisdiction in enforcing fraud provisions that 
were granted to the Commodity Futures Trading Commission had 
to do with whether or not the type of transaction fell within your 
jurisdiction. If the transaction did not fall under your jurisdiction, 
laws you are given to prevent fraud would not be applicable. As I 
believe, Mr. Dial mentioned in his testimony, there are statutes on 
the books to deal with fraud, if, in fact, fraud is found. On this 
question, your legal counsel, had differing opinions on the 
interpretiation and the intent of the Re-authorization Act as grant- 
ed by Congress last year. You all considered the counsels' advice, 
you had a difference of opinion as to the type of transaction this 
particular thing was, and based upon what each of you viewed and 
looked at differently, you came to different conclusions. 

Mr. Albrecht. If I could stop 

Mr. Combest. Please do. 

Mr. Albrecht. I think that's true as far as it goes. I think that 
we all continue to struggle with this issue of how to interpret the 
exemptive authority. 

Some people still use the futures/forward dichotomy and try to 
stick it into one of those. I, myself, view that as not terribly produc- 
tive, and I've tried to view it in terms of, "Here's something we 
might have jurisdiction over. What's the appropriate sort of regu- 
latory policy to follow?" But, I think we all agree that we could 
have come down differently on this, and the potential for different 
outcomes is substantial. 



26 

I do think that most of the transactions at issue are forward con- 
tracts. They're well beyond the reach of the Commodity Exchange 
Act. 

It's possible that some of the contracts that are at issue here, 
under various readings of the Commodity Exchange Act, could be 
considered subject to our authority. 

The question then is, should we exert our authority over those 
contracts? 

I think there are two issues: One, what are these things? Then 
the other is, once we've somehow sorted through what they are, 
what we should do about them. 

Mr. COMBEST. At that point. Commissioner Bair or Mr. Dial, do 
you have a comment. 

Ms. Bair. Yes. Again, I agree. I think this energy exemption is 
sufficiently broad to include things that are traditionally viewed as 
futures contracts. I also think it's sufficiently broad to be able to 
be misused by those who might want to set up fraudulent activi- 
ties — boilerrooms targeted to small businesses — along the lines of 
what we've seen in the past. 

Because we have not retained antifraud authority, we have re- 
moved our capability to prosecute those types of cases, should they 
occur. I think it's very easy to construct something that would fall 
within the parameters of the exemptive authority, and we just sim- 
ply would not now have the antifraud — residual antifraud author- 
ity to do it — to go after these folks, so that's my concern. 

My personal view as a policy matter — I think, whenever we're 
using 4(c) to grant exemptions to things that would otherwise fall 
within our jurisdiction, we should retain antifraud authority. I 
think it's just very basic and central to the Commodity Exchange 
Act. 

The only exception I can see is, for instance, the hybrid area 
where you have either an SEC regulatory scheme or banking regu- 
latory scheme with very extensive financial regulatory provisions 
against fraud that would apply to these instruments, so I think it 
was justified there, but otherwise, I don't think we should ever do 
it. 

Mr. COMBEST. Mr. Dial. 

Mr. Dial. Yes. 

Mr. COMBEST. You had some comments about my premise? 

Mr. Dial. Yes, sir. I agree with your premise, and once again, as 
I stated in my comments, I went to the language of FTPA and to 
the conferees report, the conferees did not "require any determina- 
tion beforeh£ind that the agreement, instrument, or transaction for 
which an exemption is sought is subject to the act." 

Also, the conferees allowed the status quo to be maintained with 
regard to the Brent interpretation. 

Given those two factors, we — forwards are excluded from our ju- 
risdiction. 

In order for us to include the 4b antifraud provision in the en- 
ergy exemptive order, we would have to have jurisdiction over 
these transactions. 

My interpretation, and that of the legal counsel whose advice I 
sought, made it very clear that Congress recognized that we did not 
have jurisdiction over forwards, and these energy contracts are for- 



27 

wards, and therefore, we did not have the legal authority to include 
4b in this exemptive order. 

Mr. COMBEST. I can understand how people can look at the same 
information and obviously come to different conclusions. We do that 
every day here. We have the same information provided to us, and 
many of us come to many different conclusions. 

Even though there was not — or would not be — the potential for 
the Commission to bring fraud charges if this exemption was grant- 
ed, there would still be other means by which an individual who 
felt defrauded under this transaction could go through the legal 
system and claim fraud. 

Mr. Dial. Yes. Let me 

Mr. COMBEST. Commissioner Bair started to respond — excuse me. 

Ms. Bair. I would say — ^yes. The argument has been made that 
State antifraud laws — regular old common law antifraud provisions 
could apply to these transactions. 

I think, though, you need to go back to the whole reason why the 
CFTC was created, and the SEC, and our whole Federal system of 
financial regulation, which was a recognition of the inadequacy of 
State remedies for these very complex, frequently cross-border, fi- 
nancial or fraudulent transactions. 

I mean, if you carry that argument to its logical conclusion — 
again, you don't need a CFTC — even if there weren't a CFTC, if 
there were frauds being committed on exchanges, you could always 
go back and use State common law fraud, so I don't really see that 
that is an adequate basis for which — for us to give up our antifraud 
authority. 

Mr. COMBEST, Yes. And I'm not trying to argue that you should. 
I would just 

Ms. Bair. Yes. But, that is the- 



Mr. CoMBEST. Again, for my own perspective 

Ms. Bair, That is the argument. 

Mr. COMBEST. But let me carry that a step further. Generally, 
you would expect then — or it would be common practice that if 
someone felt defrauded, they would bring legal action under the 
fraud statutes given to the Commission or to another authority — 
be it SEC, CFTC, or whomever — that would be governing the ex- 
change under which it was dealt? 

Ms. Bair. I think the question here is whether the CFTC can 
bring the action, not whether a private party can. And 4b applies 
to actions brought by the CFTC. 

Mr. CoMBEST. Right. 

Ms. Bair, And again, frequently you see — with these boilerroom 
operations — many people being ripped-off, with various levels of 
economic resources of sophistication to bring the action themselves. 

Again, I think that's why you have a Federal agency taking the 
lead with the expertise and with the resources to close these kind 
of operations down. 

Mr. COMBEST, Yes, sir? I didn't mean to cut you off. She just 
started to respond. 

Mr. Albrecht. All right. Thank you. First of all, we should rec- 
ognize the fact of what 4b is and what 4b isn't; 4b is designed to 
protect customers. It's designed to protect people who are being 



28 

sold something by a broker, being defrauded by a floor trader, or 
something Hke that. 

It is not designed to protect people in a principal-to-principal 
market. Most of these transactions we're talking about are beyond 
the reach of 4b, so to even say we're maintaining 4b — to say that 
does much would be illusory. 

There's a lot of illusion that goes on about regulation, so I think 
it would be very foolish and dangerous, in fact, for us to say we're 
regulating a market when we do not have the authority to do 
that — when that regulation wouldn't do anything. 

Now, I think we also must not lose sight of the fact that if people 
breach the terms of this exemption, they are subject to the Com- 
modity Exchange Act. The type of activity that we've typically 
seen— boilerrooms — they're not covered by this exemption. That's 
illegal activity under the terms of this exemption, and we would try 
to stop it. 

We have the authority to investigate all charges of boilerroom op- 
eration, and we have the authority to see if people are abiding by 
the term. . 

It's only people that abide by the terms of this exemption, which 
is for a principal-to-principal market — a commercial market— peo- 
ple that meet the various standards with appropriate "personhood" 
that are contained in this statute and our exemption, so I think we 
have to understand that— one, it doesn't — 4b doesn't reach most of 
the transactions we're talking about here — the types of boilerrooms 
and illegal bucket shops, and so forth. Those are going to get 
caught up by us anyway. 

Ms. Bair. Could I please respond to that? 

Mr. COMBEST. Yes. 

Ms. Bair. First, on the principal-to-principal argument, this is 
something I've heard before— that 4b won't apply to principal-to- 
principal transactions. We have brought cases— boilerrooms are 
typically set up as principal-to-principal transactions. 

Mr. Klejna's memo, that the Chairman referenced earlier, ad- 
dresses this point specifically, and says we have successfully pros- 
ecuted these types of cases where the scams are set up that way, 
and it has not become an issue before, and I don't think it should 
be. I think you want to have fraud applying to principal-to-prin- 
cipal transactions as much as you do to broker transactions. 

Also, I cannot more vigorously disagree with the statement that 
we can still go after boilerrooms. That's the whole point. This is an 
exemption from our jurisdiction. 

Even if our Enforcement Division could go in and prove that it's 
a futures contract — and would otherwise be subject to the CEA — 
if the promoter of whatever the fraudulent scam is has successfully 
constructed the fraudulent activity in a way that fits the param- 
eters of this very broad exemption, we do not have jurisdiction any- 
more to go in and shut these things down. 

Mr. COMBEST. So what you're saying is, that if a transaction was 
crafted in such a way as to create an exemption 

Ms. Bair. If any— that's right. Any transaction that falls within 
the parameters of this exemption 

Mr. COMBEST. Yes. 

Ms. Bair. We do not have jurisdiction to prosecute. 



29 

Mr. COMBEST. Right. 

Mr. Chairman, in the interest of other members, I'll wait for the 
next round. I have some more questions. 

Mr. English. Mr. Barlow. 

Mr. Barlow. Thank you, Mr. Chairman. I want to associate my- 
self with the gentleman who has very serious concerns about 
boilerroom operations, and we need to stay on top of this situation 
for the sake of investors across the country, but let me just take 
a little bit different tact — and bear with me, I'm learning my way 
here. 

We're talking about contracts here that are hybrid, swaps, de- 
rivatives — is derivative a generic name for this whole area in terms 
of a brokerage or a trader putting together a number of different 
types of vehicles — investment vehicles — and then selling them as 
one unit — this whole derivative area — are we talking about this? 

Ms. Bair. Well, derivatives is kind of a broad, generic term that 
can include anything, including regulated futures and options. I 
think what we're mainly focused on here are off-exchange deriva- 
tive products that look like — if not, in fact, are — futures contracts, 
as those that have traditionally been defined by the courts, but to 
go under this specific order, we're talking about energy contracts. 

Mr. Barlow. Well, now is it possible that you could have a trad- 
er or a floor trader manying in derivative oil futures, as well as 
wheat futures and com futures and so forth, as one vehicle? 

Ms. Bair. Do you mean in boilerroom contracts — there would 
be 

Mr. Barlow. I'm moving beyond the boilerroom. I have a concern 
with the whole way the derivatives process is developing in — not 
just our Nation, but in the world, with billions and tens of billions 
and trillions out there on the line, and I'm very sensitive to the fact 
that the regulatory authorities are trying to reach out to make sure 
there's not fraud, and just generally shoddy practices going on that 
can lead to — down the line — a disaster, and I'm very concerned 
fi-om the standpoint of our jurisdiction about the grains, and even 
in the oil area. 

We have in our area of the country, a river transport industry 
that carries a lot of crude, and I would not like to see a situation — 
an emergency situation blow up that involved the unraveling — be- 
cause of fraud — of a number of contracts, and the oil is in the proc- 
ess of being transported by a barge line, and all of a sudden this 
barge line is in receivership because of fraud, so I would like to see 
the broad reach of fraud be kept. 

I think everybody feels that we have an industry here that's ex- 
ploding in all directions — ^hopefully, most of which is constructive, 
but if it's not policed properly, we can see fraud come up in agri- 
culture to the extent that it's involved or wound into these deriva- 
tive swaps in the futures area, and even the oil energy area can 
be severely impacted. 

Does anybody want to respond to that in general terms? It's more 
a statement than a question, but — Mr. Albrecht? 

Mr. Albrecht. I certainly agree that this is an industry or a 
market or a set of markets that's expanding dramatically in a vari- 
ety of derivative products — products whose value is based on the 
value of some underl3dng products. 



72-584 0-93-2 



30 

An interest rate future is a derivative because its value is de- 
rived from the value of the interest rate. An oil future is a deriva- 
tive because its value is derived from that, and they are increas- 
ingly complex. It's a very difficult task to put together the appro- 
priate regulatory scheme for any of those. How much should we 
rely upon regulation, how much should we rely upon State law, 
regular Federal law, and how much should we rely upon private in- 
centives. 

All of us at the Commission, whether we agree or not on a par- 
ticular outcome, are very much concerned about that, and are doing 
our level best to try to do what we can within the statute that 
we've been given. It's something we have been instructed to report 
to Congress on, and we will do so by the end of October of this 
year, and I'm sure it's something Congress will revisit from time 
to time, both in our area, and in many other areas. 

Mr. Barlow. So even though we're focused here on a particular 
law suit involving a Brent Oil contract, under these swaps and de- 
rivatives, other futures could be wound into a package here, and 
that might involve wheat futures or other things. It all depends 
upon the imagination of the trader, right? 

Ms. Bair. Could I just make one point of clarification? 

Mr. Barlow. Yes. 

Ms. Bair. This order — and this is a very important point, I 
think— this order is not confined to the Brent Oil market. This 
order is not confined to any particular identifiable energy market. 

Mr. Barlow. Right. 

Ms. Bair. This order extends to a broad range of energy trans- 
actions based on oil, natural gas, their derivatives, and conden- 
sates, so I think — to the extent your specific concern is with regard 
to off-exchange oil markets, you may very well have a concern with 
the Commission's failure to retain antifraud authority with regard 
to this energy exemptive authority. 

Mr. Barlow. Yes. 

Ms. Bair. It does encompass all those markets, not just Brent 
Oil. 

Mr. Barlow. Right. So oil — and to the extent that people are get- 
ting into derivatives that marry other futures contracts, a default 
in an oil contract could have repercussions into wheat and com and 
so forth, no? 

Mr. Albrecht. This exemption is limited to energy. I think we 
have to be very clear about that. There is no expansion of this par- 
ticular exemption beyond the field of energy. 

Now the Brent interpretation by contrast, while designed to deal 
specifically with the problem rising out of the Transnor case, is 
much broader than our exemption because it talks about delivery 
of physical commodities in general, and it is not specifically limited 
to oil, even though it was designed in response to a problem in the 
oil market. 

Mr. Barlow. Well, you might have a trader in oil who takes an 
extreme position in the oil futures market, and he's now outside 
the fraud provisions and he moves into unwise transactions — alleg- 
edly fraud — but he may lay off his exposure in the wheat market 
or the com market or the cotton market or a number of other mar- 
kets. If he defaults, it's going to have impacts there, right? 



31 

Mr. Albrecht. You really need more details, I think, to- 



Ms. Bair. This order does not apply to agricultural derivatives. 

Mr. Barlow. No. That's true, but if he defaults 

Ms. Bair. Indirectly, there could be an impact. 

Mr. Barlow. If he defaults in the oil area because you've re- 
leased him from surveillance, it will have impacts in these other 
areas, right? As those futures have to be unwound quickly or 

Ms. Bair. I can't say that it wouldn't. I think, also, farmers and 
agricultural co-ops, to the extent — they are energy users and may 
have inventories of fuel on the premises. They could very well qual- 
ify as qualified participants for these exempt energy contracts, and 
be some of the small businesses that might be the victims of fraud 
in operations that would meet the requirements of this exemption, 
yes. 

Mr. Barlow. That's true. 

Mr. Dial. Congressman Barlow, if I might make an observation. 
At any point in time, that an instrument is a futures instrument 
or the transaction is one that is traded on a multilateral exchange 
facility, then it comes under our jurisdiction, so even though some- 
one might design some derivative hybrid-type product that would 
involve energy and the ag commodities, or even a financial instru- 
ment once a ftitures transaction becomes a part of that, that aspect 
of that derivative product comes under our jurisdiction, and it is 
subject to 4b. 

Mr. Barlow. Even if energ/s included? 

Mr. Dial. If it is outside of this exemption that we're talking 
about, and is futures, then it comes under our jurisdiction. 

And as a point of clarification — in as much as I see the direction 
that your question is headed in — let me call to your attention, re- 
spectfully, that in this exemptive order it says, "And whereas this 
order is limited to commercial participants who, in connection with 
their business activities" — it lists several things — but No. 4 says, 
"Commercial participants who, in connection with their business 
activities, are not formed solely for the specific purpose of constitut- 
ing an eligible entity pursuant to this order." 

In other words, if someone forms a pool and they use that as a 
fraudulent vehicle, it does not come under this exemptive order, 
and we do have the opportunity to investigate that fraudulent, 
volatile conduct. 

Ms. Bair. I would have to register a disagreement with my col- 
league on that point. That particular provision applies only to enti- 
ties that were solely formed for the specific purpose of qualifying 
as a participant for an exempt transaction, so I think commodity 
pools, FCM's, floor traders, floor brokers — if they have minimal 
participation in regulated futures markets, they haven't been 
formed solely for the purpose of qualifying to be a qualified partici- 
pant for an exempt transaction. 

Similarly, a boilerroom could simply have a partial interest in an 
oil well, and also fall outside the bounds of that requirement. I 
think, because of those qualifiers, it's a very limited use. 

Mr. Dial. But they also would have to meet all of the other re- 
quirements to be a qualified participant. 

Mr. Barlow. Yes. 



32 

Mr. Chairman, I'm just concerned that the farmers are being ex- 
posed here, and I'd like to see the fraudulent provisions kept as 
broad as possible. 

Mr. English. Thank you very much, Mr. Barlow. 

Mr. Allard. 

Mr. Allard. Thank you, Mr. Chairman. I was on the conference 
committee last year, and what I remember is that the committee 
wrestled a lot with the definition of these derivatives or swaps or 
hybrids or whatever, and there was some discussion about impact 
on international markets and how you define them and enforce- 
ability, and it seems to me like the results of a lot of that, as we 
decided at that conference committee, were that we set up a mech- 
anism to monitor and gather information on how provisions of the 
bill worked in the form of a study, and determine if more regula- 
tion oversight is necessary. 

Are you aware of any fraud, now going on, with these particular 
oil 

Mr. Albrecht. No. I'm aware of one case in a court in New York 
or Connecticut, in which a firm has been prosecuted for fi-audulent 
arrangements with a bank. This was a firm that was in the market 
that has been taken care of by Federal authorities. 

Mr. Allard. But it's been enforced, and as far as you know, as 
a result of your action here, you haven't — there hasn't been — and 
I guess there haven't as many times, but there hasn't been any 

Mr. Albrecht. There hasn't been any time 

Mr. Allard. Anything that's come up yet? 

Mr. Albrecht. It still has not gone into effect yet. 

Mr. Allard. So again, we're sort of back where we were in the 
conference committee, where some of the decisions that we maybe 
made in the legislation — we haven't had enough time yet to see 
how the enforcement is going to be applied and whether it's going 
to have a real impact or not, and one of the things that we wrestled 
with in the conference committee is that we can talk about boiler- 
rooms, and all of us think in terms of a domestic company dealing 
with American citizens. 

Then we get into the international market, and then how does 
that get applied with the international trade? I guess that's kind 
of where I'm thinking — we have businesses that deal internation- 
ally — at least, I can visualize that — for example, airline companies 
and fuel purchasers and whatnot. 

In your opinion, how would we enforce — if we were to go ahead 
with what the chairman has suggested — how would we enforce that 
on a — or how would that interact with a foreign customer? 

Mr. Albrecht. It gets difficult. We have, over the past few years, 
worked fairly close with authorities in other countries and we have 
established memorandums of understanding and so forth with 
them. We share information £ind we help one another in enforce- 
ment efforts. 

Once fraud goes international, it becomes a little bit more dif- 
ficult to catch and work with, but we continue to try to do that in 
all areas that are under our jurisdiction. 

It's a resource-intensive effort. It takes a lot of time, it takes a 
lot of money, but we continue to do that. 



33 

Mr. Allard. We could have a foreign customer that could file 
suit in U.S. courts against a domestic company? Is that possible? 

Mr. Dial. Sure. 

Ms. Bair. We have that now. 

Mr. Albrecht. Yes. That's the situation. 

Mr. Allard. That's possible? 

Mr. Dial. Yes. 

Mr. Allard. Is it possible for a domestic company to file suit 
against that foreign customer in U.S. courts? And if he's not a citi- 
zen of the United States, how would our laws apply to him? 

Ms. Bair. Well, if he's doing — I'm not an international law ex- 
pert. I believe if he's doing business in the United States, though, 
that you usually can 

Mr. Allard. So what I'm wrestling with is how do we make 
United States law apply to foreigners who aren't citizens. 

Ms. Bair. Right. Could I back up just for a minute? 

Mr. Allard. Yes. 

Ms. Bair. A couple of points, I think, need to be made. Again, 
this order is not confined to the Brent Oil market. This order is not 
confined to international markets. 

This order applies to any "energy transaction which meets the re- 
quirements." That could be a completely domestic transaction. 

Mr. Allard. Or it could be international. 

Ms. Bair. Or it could be international. 

There are also, plenty of examples of fraudulent activity in 
boilerroom operations that come to our attention involving energy 
products, so I think that point needs to be made, too. 

Also, I would reemphasize, as I did in my statement — my written 
testimony — the U.K. does — even in the international Brent Oil 
market, the U.K., which is frequently pointed to as a "good regu- 
lator," in terms of fostering international competitiveness of U.K. 
businesses — they have antifi*aud requirements that apply to the 
Brent Oil market. 

Mr. Albrecht. Could I respond to that? 

Mr. Allard. Yes. 

Mr. Albrecht. Specifically, the question of the U.K. and its reg- 
ulatory regime has come up, and I think it's worth talking about. 

First of all, I think we all should understand that the U.K. sys- 
tem and the U.S. system are very different. No one would probably 
want to transplant their system here, and they wouldn't want to 
take ours. 

In general, their system is a much less regulatory system than 
ours — a much lighter hand. To the extent there's a comparable 
agency to us and the SEC, it's the SIB. It has much less power 
than either the CFTC or the SEC. They rely much more heavily 
upon self-regulation than we do. 

Now what Commissioner Bair is referring is the oil market code 
of conduct, which is put forth by the Securities and Investments 
Board. The Securities and Investments Board issues this code of 
conduct to publish information and give advice. 

Among that advice, market participants are reminded that, "A 
market participant should not attempt to improperly mislead its 
counter-parties or dishonestly conceal material facts from them. 
Market participants are reminded that activity of this kind may 



34 

amount to a criminal offense" — for example, under section 47.1 of 
the Financial Services Act. That means that the SIB would refer 
that to the appropriate national regulatory agency, much as we 
would do under our exemption if we found evidence of fraud. 

We would refer it to the Department of Justice or the appro- 
priate State authority, and I think we would probably say some- 
thing more than "this may amount to a criminal offense." 

This code goes on — "A market participant should not attempt to 
improperly manipulate the market. Activity of this kind may 
amount to an offense," and again, to be referred to another author- 
ity- 

We would maintain manipulation authority within the CFTC 

under this exemption, so I think that a careful reading of the dis- 
tinctions between the two countries makes it pretty clear that we 
haven't done anything particularly less-regulatory than in the U.K. 

Mr. Allard. Ms. Bair. 

Ms. Bair. I would have to disagree with that. I think that, not 
only do antifraud provisions apply — it is true that the oil market 
code of conduct provides regulatory guidance, but section 47 of the 
Financial Services Act says that violations of the oil market code 
of conduct could be deemed to be in violation of the Financial Serv- 
ices Act. 

The fact that the SIB— the enforcement structures such as the 
SIB must refer criminal actions to another enforcement body. It's 
just the way they are set up. 

On the criminal side, we also have to — even things that we've re- 
tained jurisdiction over — ^we've had to refer to the Justice Depart- 
ment. We only had civil enforcement authority. 

I would also add that not only do antifraud requirements apply 
under the oil market code of conduct and the Financial Services 
Act, but there are others that Brent Oil— 15-day Brent Oil con- 
tracts are deemed investment contracts, which is the category that 
also includes futures under the U.K.'s financial regulatory scheme, 
and there were other requirements that — other regulations that 
apply, too, with regard to disclosure, capital requirements — even 
more than antifraud. 

Mr. Allard. One thing I'd like to get back to, Ms. Bair, is, do 
you agree that if a boilerroom operation was reported to your agen- 
cy, that could be referred to the Department of Justice and referred 
to the appropriate State authorities, and action could be taken 
against that operation? 

Ms. Bair. Well, it would depend on whether— since there's no — 
assuming that it falls within the terms of the exemption, there 
would be no violation of the Commodity Exchange Act, so we could 
refer it to the Justice Department if we could show— you'd have to 
show mail or water fraud, or you'd have to show State common law 
fraud. 

Mr. Allard. But if that would get pointed out to the CFTC, that 
could be — I mean, there's no — I can't imagine just saying, "Well, 
we're just going to ignore it. It doesn't fall under our jurisdiction." 
If they would look for a suitable 

Ms. Bair. I think, and I would hope we would do what we could 
by giving it to — bringing it to the attention of other enforcement 



35 

bodies. I think the important point is, we are set up to prosecute 
those types of cases, and we couldn't do it now 

Mr. Allard. So it's a jurisdictional 

Ms. Bair. Because we don't have jurisdiction anymore. 

Mr. Allard. So it's a jurisdictional issue with you? 

Ms. Bair. It's a jurisdictional issue. It's a matter of whether we 
can fulfill our mandate to enforce the Commodity Exchange Act, in- 
cluding antifraud provisions, to the types of transactions where we 
traditionally have done so. 

Mr. Allard. But what I've heard in testimony here is that the 
Department of Justice and State laws can go aJiead and address 
the problem with the boilerrooms. It doesn't necessarily have to be 
the CFTC. 

Ms. Bair. Again, that is not what the Justice Department is set 
up to do. I don't know if we can get 

Mr. Allard. No. That's — I mean 

Ms. Bair. Yes. I understand. 

Mr. Allard. They can do that? 

Ms. Bair. Yes. They could do that. 

Mr. Allard. So we're getting into sort of a jurisdictional percep- 
tion. You'd like to see most of that power in CFTC, but if it's not 
there, it is in the Justice Department or it's also under State juris- 
diction in some cases. 

Ms. Bair, I think that's a fundamental issue that this sub- 
committee, as our oversight subcommittee, needs to look at and 
deal with. Do you want a CFTC? Do you want us to enforce anti- 
fraud laws as they apply to these types of scam operations, the way 
we traditionally have done? 

Mr. Allard. Yes. 

Ms. Bair. There is always mail and wire fraud that you can 
refer — you can try to plug that in and refer it to the Justice De- 
partment or State common law fraud, but in terms of enforcement 
bodies specifically set up to prosecute these types of fraudulent 
transactions, that's what I thought the CFTC was supposed to do. 

Mr. Allard. Yes. You know, we were wrestling with this legisla- 
tion, as to how you go ahead and define all these hybrid instru- 
ments and forwards and whatnots, and I don't want to disrupt the 
international market. 

I want to see us go ahead, but on the other hand, we don't want 
to open the door for fraud or anj^hing, and I think a lot of us are 
just waiting to see what's going to happen. I'd hate to see us jump 
prematurely if there isn't any actual problem going on. 

Mr. Albrecht. 

Mr. Albrecht. Let me just make a couple of points, if I may. 
One is that I think we have drawn this line in a responsible way. 
It's difficult, of course, to draw the line as to what you permit and 
what you don't permit. I don't think we're going to permit boiler- 
rooms. 

If things become full-fledged, run-of-the-mill boiler operations, 
such as Commissioner Bair is talking about, I am convinced they 
will run afoul of the exemption. I don't think you're going to find 
those under the exemption. 

If it turns out that I'm wrong, it would be very easy for the Com- 
mission to address this issue — to revisit it, and change those lines. 



36 

What we have tried to do is draw a line around this market, 
which permits the existing market to continue to exist. We tried to 
draw a Kne around the market, such that it will not permit the 
type of boilerroom operations that Commissioner Bair is talking 
about to exist. 

In truth, those two lines are probably not exactly the same line. 
Whatever line you draw will probably exclude a few people from 
the market whom you would like in the market. It also has the po- 
tential of letting some activity go on that you prefer not. 

I think we've examined this issue very carefully, and drawn the 
line in a very responsible way. If, as you point out, experience 
proves us wrong, we may want to expand that line, and we may 
want to contract it. 

Mr. Dial. I'd also like to make an observation in that regard. In 
the first place, once again, in my opinion, what we're talking about 
are forwards, and forwards have a history of nearly a century of 
being used in commerce — domestic commerce and international 
commerce. 

Those that commented on this particular proposal did not make 
any mention of problems with fraud, either in today's markets or 
in markets that are past, so there is no strong evidence to indicate 
that fraud is rampant in these energy contracts. 

In addition to that, in enacting the 1992 act. Congress explicitly 
authorized exemptions from all provisions of the act, except section 
2(a)(1)(b), and simultaneously enacted a conforming amendment to 
section 12(e)(2), explicitly acknowledging that State antifraud stat- 
utes of general applicability would continue to apply to exempted 
transactions, so 

Mr. Allard. Mr. Chairman, I'm ready to wind up, if I could just 
have one more question with Ms. Bair. 

You had replied to one of the chairman's questions that the law 
can apply when they're exempted. Did I understand that 

Ms. Bair. Under the terms of this 

Mr. Allard. Our understanding is correct. Then on your testi- 
mony — you see, in your written testimony, you said, "Let me state 
that I do not oppose in concept, some type of exemption from the 
act from the Brent's crude oil contracts," which just all seems to 
center around that, and it almost sounded to me like there was sort 
of a contradiction here in the way you are responding in this, and 
if you'd highlight that and- 



Ms. Bair. No. I was referring to 

Mr. Allard. Talk a little more. 

Ms. Bair. I also go on to say, "But I think we should retain anti- 
fraud and antimanipulation authority." Yes, I support an exemp- 
tion from virtually — for the Brent Oil market for virtually all other 
regulatory requirements of the Commodity Exchange Act. 

And 4b, the general antifraud provision, and 4o, our antifraud 
provision that applies to commodity pools, I think are very fun- 
damental and basic, and we should not have banned an exemption 
there. 

Mr. Allard. So we can take 

Ms. Bair. We have in this order. 

Mr. Allard. All right. 



37 

Ms. Bair. And again, this order is not limited to the Brent Oil 
market. It is much, broader than that. 

Mr. Allard. Thank you. 

Thank you, Mr. Chairman. 

Mr. English. Thank you very much, Mr. Allard. 

I also want to make a point. This, Commissioner Bair, if I'm not 
mistaken, does, as you point out, goes beyond the Brent Oil deci- 
sion. 

Ms. Bair. Absolutely. 

Mr. English. And this expands on the authority that existed 
prior to the enactment of the reauthorization bill last year. 

Ms. Bair. I think, to the extent that the intent behind that was 
for us to use exemptive authority only to address the issues per- 
taining to existing markets, yes. I think it goes beyond that. 

With regard to — I know Chairman Albrecht may have a different 
view — I think this order is much broader than the Brent Oil statu- 
tory interp. I would note that the people who applied — the energy 
group that applied for exemptive relief said in their application 
that they need broader guidance, more comprehensive guidance in 
meetings held with Commission staff — notes of which you have. 

Again, they said it's not enough to just have the Brent statutory 
interp. We need more relief that applies to a broader range of en- 
ergy markets. There is no doubt in my mind that this order is sig- 
nificantly broader than the Brent Oil statutory interp. 

Mr. English. And certainly goes way beyond the status quo un- 
derstanding that was reached between the members of the con- 
ference last year. 

Ms. Bair. Again, I was not privy to that. I can only go by what 
was in the conference report. 

My interpretation of the conference report was that — yes, you 
wanted us to use this authority very judiciously and stick — yes, 
provide additional clarification with regard to existing markets 
where issues have arisen. 

I think, clearly, with regard to the Brent Oil market, that is the 
case, and it would have been appropriate and consistent with your 
legislative intent, as I understood it — give relief to Brent Oil — but 
we went beyond that. 

Mr. English. As Mr. Allard pointed out, he was a member of the 
conference, and if you recall last year, that was the understanding 
that we reached — that there would not be — we would maintain the 
status quo, and that was exactly what the purpose of these provi- 
sions we put in the law were for, 

Mr. Allard. Yes. Mr. Chairman, did Mr. Albrecht say that actu- 
ally — your decision continued the status quo? 

Mr. English. Well, he may say it, but that isn't what it does. 
That's the whole point. 

Mr. Allard. So there's a difference of agreement whether we 
continued with status quo or 

Mr. English. No. There isn't a difference of agreement at all. I 
don't think you're going to find any lawyer that isn't sitting on that 
Commission that's going to give you that opinion. 

If I could continue on this — Mr. Albrecht, you also made the 
statement that — with regard to the terms of the exemption — the 
terms of the exemption that are granted to anyone who falls under 



38 

that category — if someone commits fraud, they are not violating the 
terms of the exemption, are they? 

Mr. Albrecht. Not by that act. 

Mr. English. So the exemption that you have granted — a person 
could go out and go so far as committing fraud, and they would not 
be violating any terms of the exemption granted by the CFTC, and 
the action of committing fraud would not be sufficient to have that 
exemption revoked. 

Mr. Albrecht. I think that if we found fraud 

Mr. English. I'm just asking you, under the terms of the exemp- 
tion. Under the terms of the exemption 

Mr. Albrecht. Under the terms of the exemption, a person could 
defraud a bank, defraud a customer, could lie to Congress, lie to 
the CFTC — that would not violate the terms of the exemption. It 
would violate other things, but it wouldn't violate the terms of the 
exemption. 

Mr. English. Also, I was curious — under the terms of the exemp- 
tion, we also have broker dealers and, of course, futures commis- 
sions merchants that are subject to the antifraud provisions of the 
law on traditional futures contracts. Why is there a different treat- 
ment in this area? Why shouldn't antifraud apply to broker dealers 
and futures commission merchants who are in this area, as op- 
posed to those who are dealing with the traditional futures con- 
tracts? 

Mr. Albrecht, It would apply, of course, to their activities deal- 
ing with customers in traditional futures contracts. 

I've tried to get this in a couple of times, and I think it would 
help if I could do it sooner rather than later because 

Mr. English. I'd like for you — if you would answer my question, 
please. The question I asked you is, why is there a different appli- 
cation to broker dealers and futures commission merchants under 
traditional futures contracts, as opposed to under these contracts? 

Mr. Albrecht. For the very reasons that we gave the exemption. 
This is a commercial-to-commercial market. It's a principals mar- 
ket. 

It's not the general public. It's a fairly closed group of a fairly 
small number of people that know each other 

Mr. English. How do you know that? 

Mr. Albrecht. Know the credit worthiness of one another, and 
there's no reason to subject somebody to a particular law, just be- 
cause he happens to be an FCM, for that particular type of trans- 
action. 

If it spilled over in any way to their regulated activity, it would 
be subject to our law. In any event, we still have the authority to 
use our risk assessment to determine whether there were any fi- 
nancial integrity issues raised by this activity. They still have that 
authority. 

Mr. English. Now as I understand it, the CFTC supposedly still 
has a study underway to determine exactly what we're talking 
about in the derivative markets, and what is involved in the deriv- 
ative markets, and every bit of testimony we've received — every in- 
dication we've received from people who have been involved in this, 
particularly within the General Accounting Office — no one knows 



39 

for sure, so I'm intrigued, Mr. Albrecht, with the finding that you 
have. 

This is a fairiy small group of people, all of whom know each 
other, all of whom are financially — I don't know what that means — 
what was the term you used? Financially secure? Financially well 
off? What does that mean? 

Mr. Albrecht. I'm not — that's not in the order I used it. I used 
it rather imprecisely. We have specific net worth and asset tests 
and so forth in the exemption. 

Mr. English. But how do you know that? 

Mr. Albrecht. Well, of course, one doesn't know exactly in every 
transaction 

Mr. English. So you, with regard to the individuals that will be 
involved in this market — and as Commissioner Bair pointed out, 
this is not just the Brent Oil folks, this is an energy exemption — 
and you're telling me that you personally know who all these indi- 
viduals are, you personally are aware of the transactions that they 
carry out, and personally aware of their financial situation, and 
you know that this is not going to have an impact on the public, 
is that right? 

Mr. Albrecht. Well, of course, I don't know that. 

Mr. English. Well then, why did you make that statement? 

Mr. Albrecht. I don't believe that I said that I know these peo- 
ple. 

Mr. English. Well, who does? 

Mr. Albrecht. First of all, if they do not meet these standards, 
they have violated the terms of the exemption and they are subject 
to our oversight. 

Mr. English. Who is canying out the investigation as to wheth- 
er or not they've met the terms of the exemption? 

Mr, Albrecht. Somebody would have to complain to us, and we 
would carry out the investigation. We would have to have people 
carry out the investigation 

Mr. English. Only after the fact, do you determine whether or 
not someone was truly eligible under whatever it is you have in 
your mind — the criteria the people should have to meet this exemp- 
tion? 

It's an after-the-fact determination as to whether or not they 
were exempt, but before that fact, unless someone brings it to your 
attention, unless someone complains, unless there is some reason, 
which I suppose would have to be a complaint for an investigation 
by the CFTC, and there would have to be a finding, I suppose, be- 
fore you carried out that investigation, then you have no idea who's 
getting this exemption, you have no knowledge with regard to their 
financial circumstances, and you know absolutely nothing about 
the people that are being covered by a blanket exemption, which 
takes on, quite fi'ankly, the characteristics of an exclusion rather 
than an exemption. 

Mr. Albrecht, The fact of the matter is that — one, virtually 
every time fraud occurs, we find out about it after it has occurred, 
and we go in and investigate if we have a complaint 

Mr. English. Well, Mr. 

Mr. Albrecht. May I please finish? 



40 

Mr. English. Well, the thing that troubles me is you're not an- 
swering my question. 

The question I asked you, Mr. Albrecht, is how you responded to 
my question, with regard to the differences as to why someone who 
is a broker/dealer or a futures commission merchant should be re- 
quired to be under that act if they're trading under traditional fu- 
tures contracts — but in this case, they should not. 

What I was looking for was the justification as to what is the jus- 
tification for making this difference between the two under — and 
granting one an exemption, and not the other, and you responded 
by saying, "This is a very small number of people. These are people 
who are well-known with each other. They're financially secure 
people." 

Then I asked you, "Well, then do you personally know them?" 
You said you do not know them personally. 

Then I tried to determine — "Well, what is" — ^what do you know 
about them, and evidently you don't know anything about them, so 
you don't know whether it's a small group of people, a big group 
of people — you don't know whether they're broke on their tail 
today, but you've granted the exemption under the illusion, I sup- 
pose, that these are the kind of folks that deal in this market — be- 
cause somebody told you so. 

Is that all you know about it? Is that right, Mr. Albrecht? Is that 
the only knowledge that you have — it's because somebody told you 
that's the way it was? 

Mr. Albrecht. We have representations in the applications 
about the nature of this market. We have reason to believe those 
representations are accurate. 

Mr. English. Well, who are these people? That's what I'm trying 
to find out. How do you determine the credibility of these people? 

Mr. Albrecht. I think they're listed in the energy exemption. 
The names are there. 

The big oil companies, the big gasoline companies are the major 
people that 

Mr. English. Are they the only ones trading in this area? 

Mr. Albrecht. They are the major people that are in this mar- 
ket today. 

Mr. English. How do you know that? 

Mr. Albrecht. I have been told that. 

Mr. English. Who told you that? 

Mr. Albrecht. We were told that in comment letters, we were 
told that in 

Mr. English. You got 12 comment letters, I believe you said. 

Mr. Albrecht. We were told that in comment letters, we were 
told that by the people that applied for the exemption. 

Mr. English. So the people who want to be exempt are the peo- 
ple who have given you the information that you're relying on to 
base this decision before the3^re ever exempt. Is that right? 

Mr. Albrecht. And as I've indicated, if people do not adhere to 
the terms of the exemption, then they are subject to our jurisdic- 
tion. 

Mr. English. So they can go out and commit fraud, and not vio- 
late the terms of the exemption, they can — as long as they don't get 
caught, they can continue the exemption. 



41 

What are the terms of the exemption? In what possible way could 
they violate the terms of the exemption? 

Mr. Albrecht. If a firm does not meet the standards set forth 
in that exemption 

Mr. English. What are the standards? 

Mr. Albrecht. The standards are: They have to be commercials, 
they have to be involved in the business in one way or another, 
they have to assume risk other than price risk — they have to meet 
one of the various standards of being an appropriate person. 

Mr. English. An appropriate person? 

Mr. Albrecht. Appropriate person. That's the language that I 
believe is in the legislation. 

Mr. English. So as long as they meet that general criteria — how 
in the world could they violate that criteria? I mean, how could 
they not be exempt? That's a better question. 

Mr. Albrecht. If you were in that market, you would violate it. 
I don't think you're in the terms of the — perhaps I don't 

Mr. English. I don't know that I would, because you'd have to 
catch me first, Mr. Albrecht, and I don't know that you can catch 
me. 

Tell me about the detection system that you have set up to go 
in and identify those people who are violating the agreement. What 
kind of detection system does the CFTC have set up to determine 
whether or not someone is, in fact, violating the agreement? 

Mr. Albrecht. We would have to get complaints. 

Mr. English. You'd have to get what? 

Mr. Albrecht. Complaints. 

Mr. English. So if nobody complains, it's a blind eye from the 
CFTC — "You guys go do whatever you want to. Commit fraud, do 
anything you want to, just don't tell us about it" — is that right? 

Mr. Ajlbrecht. That's the way we catch all fraud — almost all off- 
exchange fraud. We have monitoring systems on exchanges. We 
don't have monitoring systems elsewhere. 

Mr. English. But in this case 

Mr. Albrecht. We have 570 people- 



Mr. English. In this case, Mr. Albrecht, there's a difference. In 
the other cases you're mentioning, we have laws, we have rules, we 
have statutes, and we have a regulatory body that has the respon- 
sibility to deal with that. 

In this case, you've exempted them. If they're exempt, the/re ex- 
empt. If you get complaints of fraud, you've exempted them from 
fraud. 

How in the world can you take any action against someone you 
have exempted from fraud? They can go out and just cheat people 
blind, and there's not a blooming thing you can do about it. 

The very agency that we have put our trust into — if you can't 
deal with fraud, Mr. Albrecht, there is no reason for you to be here. 

Mr. Albrecht. We deal with — we would 

Mr. English. By the way, when does your term expire, Mr. 
Albrecht? 

Mr. Albrecht. It has expired. 

Mr. English. It has? So you're a lameduck. 

Mr. Albrecht. I'm very lame. 

Mr. English. And this was a lameduck decision. 



42 

Mr. Albrecht. This was not a lameduck decision. I guess it 
would have been easier to duck this decision, but I made it because 
I thought we needed to keep moving. 

Markets don't wait for Presidents to make appointments. Mar- 
kets continue to move. We needed to do something. 

If I could just say 

Mr. English. Well, let me just say, I wish to God you had. I 
think the public — this country would have been better off if you 
had. 

Mr. Albrecht. We regulate this the same way we regulate fraud 
in forward markets. We have no jurisdiction over forward markets. 
The only way we would find out if the law was being violated is 
if somebody were to tell us, "Hey, this isn't really a forward mar- 
ket," then we would take a look at it. 

Mr. English. But in this particular case, you've been handed 
special authority by the Congress — special authority to maintain 
the status quo until the Congress can make a decision — until we 
can make a judgment as to how to deal with these kinds of instru- 
ments with the derivatives — only to maintain the status quo, not 
to produce an end. 

But you saw fit to take that responsibility beyond the status quo, 
and now you tell us that you have no way of determining whether 
or not the criteria that you have set out to qualify for the exemp- 
tion is even being met, isn't that right? 

Mr. Albrecht. I'm sorry. The question specifically is? 

Mr. English. The question is specifically, you have no way of de- 
termining whether or not the criteria that you have set out under 
the very special authority that has been granted by the Congress 
to deal with some very special problems — you have no way of deter- 
mining whether or not that criteria is being met. 

You cannot assure the public, you cannot assure the Congress, 
you cannot assure this Nation that, in fact, the criteria that you 
have set out for this exemption from fi'aud is being met. 

Mr. Albrecht. We can tell, anj^ime we look at a situation, as 
to whether it is being met, so we do have a way. 

Mr. English. How can you do that? 

Mr. Albrecht. We look at the participants, and we see if they 
meet the criteria 

Mr. English. You don't even know who they are, Mr. Albrecht. 
We don't know who they are. 

Mr. Albrecht. If we had a situation to look at, we could do 
that — we would do that. We would look at this market and say, 
"Who are the participants? What are they doing?" 

Anytime we want, we can go in and look at a market — of course, 
we can do that. 

Mr. English. You have 

Mr. Albrecht. We would if we had any reason to believe that 
we should. 

Mr. English. If you had any reason to believe that you should. 

Mr. Albrecht. Which is much the way we conduct all of our in- 
vestigations right now. 

Mr. English. You have no way of knowing — when you grant that 
exemption, you're not granting it to individuals, you're blanket-ex- 



43 

empting. Anyone and everyone who's involved in this business is 
exempt from fraud. 

Isn't that what it says? 

Mr. Albrecht. I don't beUeve that's what it says at all. 

Mr. English. Commissioner Bair, is that your interpretation? 

Ms. Bair. Again, my interpretation of the exemptive order is, if 
it meets the terms of the exemption, yes. It's completely off our 

Mr. English. And we'd have no way of knowing what the terms 
of the — whether they're meeting the terms of the exemption or not, 
do we? 

Ms. Bair. I think that's a good point. I think — and I believe that 
was specifically referenced in the legislation — that perhaps there 
should be some monitoring system to determine — not only just this 
area, but swaps and hybrids as well — whether the terms of the ex- 
emption are being met. That is not in existence now, that I know 
of. 

Mr. English. So under the ruling by the Commission — Mr. 
Albrecht and Mr. Dial — they have decided that we shouldn't do 
that. They've made the decision under this ruling that we \yill have 
no check whatsoever to determine whether or not the individuals, 
who are being exempted, meet the criteria under the exemption. 

We have no way of determining whether or not the people that 
we are providing this trust are the biggest thieves in the world — 
maybe some of the biggest thieves in the world — and we're turning 
them loose — loose from all fraud requirements of the CFTC — of the 
very regulatory body that is supposed to be looking out for the pub- 
lic. Is that correct. Commissioner Bair? 

Ms. Bair. I don't want to speak for my colleagues, but that is 

Mr. English. I'm just asking your opinion. 

Ms. Bair. Yes. In my opinion, that is what has happened — that 
it is a very broad exemption, and if folks — whoever wants to — has 
the creative mind to do it, can meet the terms of the exemptions. 
I think it's very easy to do. 

They are exempt from everything, including our antifraud re- 
quirements, and we can't do an3rthing about it. 

Mr. English. Let me go back then, Mr. Albrecht. Do you have 
any way of identifjdng who the individuals are that you're granting 
this exemption to? 

Mr. Albrecht. We know who some of them are. We don't know 
who all of them are. 

Mr. English. Can you even say you know who most of them are? 

Mr. Albrecht. Personally, no. 

Mr. English. Does the CFTC know who most of them are? 

Mr. Albrecht. Probably not. 

Mr. English. So you don't know who the individuals are that 
we're granting the exemption to. Let me take the next step then — 
do you have any mechanism, as was recommended in the legisla- 
tion — do you have any mechanism to determine and see if, in fact, 
the people who are receiving these exemptions meet the criteria? 

Mr. Albrecht. We have two mechanisms. One is that 

Mr. English. I'm talking about before the exemption is granted. 

Mr. Albrecht. Well, the primary mechanism, of course, is to re- 
spond to allegations that something wrong is going on. I would ex- 
pect that the Commission would continue to keep an eye on this 



44 

market— to revisit it, to look at it, to make sure the terms of the 
exemption are being met, 

Mr. English. Is there any mechanism that you have set up in 
this ruHng to do that? 

Mr. Albrecht. We have not done that. 

Mr. English. So there is no assurance to the pubHc that that cri- 
teria is being checked. It's not being checked before the exemption's 
given. There's no mechanism in the criteria to check it afterwards. 

The only thing that the public can hope for is that if we have 
any people who are committing fraud, that those people — somebody 
blows the whistle on them at some time. That's the best we can 
hope for. 

Mr. Albrecht. That will happen. 

Mr. English. That will happen? 

Mr. Albrecht. If there is any serious amount of fraud, people 
will blow the whistle. 

Mr. English. If there is any serious amount of fraud. 

Mr. Albrecht. There can be an isolated instance where someone 
gets cheated out of a nickel or a dime, but I mean, if there is 

Mr. English. Well, we're talking about billions and billions of 
dollars being traded here, Mr. Albrecht. We're not talking about 
nickels and dimes, we're talking about billions on international 
markets that, according to the president of the Federal Reserve in 
New York, can have an impact on the very economy of this country. 
Isn't that correct? 

Mr. Albrecht. If there's any fraud of any significance, it will be 
found out about. The person who is defrauded will complain. 

Mr. English. Mr. Albrecht, I'm going to tell you, that's a very 
naive way of thinking. We have crimes committed in this country 
that are not reported. 

We have a lot of crime, and a lot of people that are victims of 
crime that are not reported, and it may go on for some time before 
it's reported, much less the individuals being caught. 

If you're simply assuming that every crime that is committed is 
going to be reported to the CFTC, I think you have a very naive 
view of the world. It doesn't happen that way in real life. 

If you aren't aggressively — if that is the case, why in the world 
do we bother to have people looking at the futures exchanges? Why 
don't we just sit back and say, "Well, if there's a problem some- 
place, somebody will give us a call" — why did we bother to have the 
FBI, and of course, that raises the question — maybe we now are 
seeing it— why it took the FBI and the U.S. Attorney in Chicago 
to put undercover people in place. 

It brings us down to the real question of "What in God's name 
is the CFTC all about?" If it's not— if we can't even count on the 
CFTC to protect the public from fraud, if we can't depend on the 
CFTC not to give away the store, from the standpoint of giving 
blanket — not exemptions, exclusions — that's an outrage. I mean, 
you're not worth your salt if you can't do that, Mr. Albrecht. 

I have defended the CFTC for the last 4 years. I fought for in- 
creasing the budgets of the CFTC for the past 4 years. I've fought 
to prevent incursions on the jurisdiction of the CFTC for the last 
4 years, but I have to tell you, today I'm asking myself, "Why, in 
God's name, did I do it?" 



45 

I think your actions have raised serious questions as to whether 
or not the CFTC can be entrusted with this responsibiHty. I can 
certainly agree and understand differences of opinion, but when it 
comes down to opening the door to fraud, that's simply going too 
far. That's not deregulation, that's just blatant irresponsibility. 

I would encourage the Commissioners to reconsider their decision 
in this area. I would encourage the CFTC to consider, any time 
they're granting any exemption, a provision in which any crimes of 
fraud or manipulation — that that be applied in general and not just 
under the specific futures provisions of the CFTC — that the CFTC 
retain the right, regardless of whether on any responsibility that 
they might have, regardless of whether it is or is not defined a fu- 
tures contract, to act in dealing with fraud and manipulation. 

I would encourage the CFTC to look at private rights of action. 
If you want somebody to come tell you about fraud, that's the way 
to do it, Mr. Albrecht — give them that right — give them some kind 
of recourse. 

And to simply dump it back and assume that the States are 
going to be able to handle this is just an outrage, when you've 
taken away part of the authority that the States have had. 

I have to say, in the 18 years that I've been in Congress, this is 
the most irresponsible decision I've come across. 

Mr. Allard, do you have any other statements or comments you'd 
like to make? 

Mr. Allard, No, Mr. Chairman. 

Mr. English. I said, I urge the Commission to reconsider this de- 
cision. 

With that, we'll recess, subject to the call of the Chair. 

[Whereupon, at 12:10 p.m., the subcommittee adjourned, to re- 
convene, subject to the call of the Chair.] 

[Material submitted for inclusion in the record follows:] 



46 



statement of Dr. William P. Albrecht 

Acting Chairman 
Commodity Futures Trading Commission 
Before the Subcommittee on Conservation, Credit 
and Rural Development of the 
House Committee on Agriculture 
April 28, 1993 

Good Morning, Mr. Chairman and members of the Committee. Six 
months ago today, the President signed into law the Futures Trading 
Practices Act of 1992 ("1992 Act") . Since then the Commission has 
been working diligently to implement the statutory reforms and new 
authorities which you and this Committee helped originate. For 
your information, I have attached a summary of actions the 
Commission has taken in response to the 1992 Act. 

Today, I welcome this opportunity to discuss one of our most 
recent steps: exempting from regulation under the Commodity 
Exchange Act ("CEA") certain contracts for the deferred purchase or 
sale of specified energy products. 

Statutory Background 

Prior to the 1992 Act, any instrument classified as a futures 
contract could lawfully trade only on a CFTC-designated exchange. 
Other instruments such as forward contracts were completely 
excluded from CFTC authority. This all or nothing approach worked 
fairly well for more than fifty years. However in recent years we 
saw the advent of new financial and commodity products which 



47 



2 

contain both futures and non-futures elements. Clearly, the 
financial and commodity markets were evolving in ways never 
contemplated when the CEA was originally drafted. The Commission 
found itself spending more and more time studying these new off- 
exchange instruments, trying to fit them into the right statutory 
pigeon hole. The CEA's inflexible requirements also impeded the 
introduction of economically useful new products which might fall 
on the futures side of the line, but were not suited for exchange 
trading because of contract size, limited interest or other 
factors. 

After studying these issues, Congress wisely recognized the 
need to give the Commission greater flexibility in dealing with 
innovative products. Thus, the 1992 Act added Section 4(c) to the 
CEA, This provision gave the CFTC authority to exempt any 
agreement from the exchange-trading and most other requirements of 
the CEA contingent upon certain conditions. Those conditions 
include: a Commission determination that the exemption is in the 
public interest; the agreement is between appropriate persons (such 
as institutional participants) ; and the agreement does not have a 
material adverse effect on the ability of the Commission or any 
exchange to discharge its regulatory or self -regulatory duties. 
The Conference Committee explained that the Commission was granted 
this exemptive authority in order to provide "certainty and 
stability to existing and emerging markets so that financial 
innovation and market development can proceed in an effective and 
competitive manner." The Conferees specifically stated that they 



48 



3 
"expect and strongly encourage the Commission to use its new 
exemptive powers promptly upon enactment [of the 1992 Act] in four 
areas where significant legal uncertainty have arisen...." These 
areas included swaps and hybrids, where the Commission acted in 
January, and forwards, which are the subject of the Commission's 
recent energy contract exemption. 

The Energy Contracts 

The classification of energy transactions as futures or 
forwards had become a crucial issue in 1990, when one court found 
certain transactions in the Brent crude oil market to be futures 
contracts. See Transnor (Bermuda) Limited v. BP North America 
Petroleum . 738 F. Supp. 1472 (S.D.N.Y.). These transactions had 
never before been considered futures contracts. Now, they could be 
void as off -exchange futures contracts. This decision stunned the 
international energy markets. Technically, this aspect of the case 
applied only to Brent market transactions. However, the facts in 
Transnor involved individuals, firms and transactions on four 
continents and the language of the decision brought into question 
trading practices throughout the international and domestic energy 
markets. Clearly, the sophisticated international energy and 
trading firms that made up this market should not be permitted to 
walk away from losing transactions by simply declaring their 
contracts void as off-exchange futures contracts. 

The Commission's response was to issue a statutory 
interpretation stating that it did not view these transactions as 



49 



4 
futures, but rather as cash forward contracts, and thus excluded 
from regulation under the CEA. Unfortunately, this action did not 
completely resolve the problem. Legal uncertainty continued and 
was reportedly sufficient to deter some international firms from 
entering into transactions with U.S. firms. 

Congress was aware of this and specifically mentioned the 
Transnor case in the Conference Report on the 1992 Act. The 
Conferees encouraged the Commission to review the situation to 
determine whether exemptive or other action should be taken. The 
Conferees noted the international scope of these markets and also 
that, since foreign participants were free of restraints imposed by 
the CEA, competitive disadvantages for the U.S. could result. 

Commission Response 

Last November — just three weeks after the 1992 Act became 
law — the Commission received an application for exemptive relief 
for these contracts. In January, in response to this application, 
we published a proposal to exempt certain contracts for the 
deferred purchase or sale of specified energy products from 
Commission jurisdiction. The Commission limited its proposal to 
existing practices in the energy markets, as described in the 
application. Since the Commission was not regulating this market, 
the proposal essentially maintained our existing jurisdiction. 

The Commission received sixteen comments on the proposal, all 
but one of the which generally supported the proposed exemption. 
After carefully considering the views of the commenters, the 



50 



5 

Commission granted the exemption, limiting its order to those 
general types of commercial participants identified in the 
application. The Commission made some technical changes in the 
final exemption, such as including "condensates" as an underlying 
commodity, and tightened the exemption to eliminate provisions that 
would have allowed qualifying firms to act as fiduciaries on behalf 
of customers. Beyond that, the exemption was largely adopted as 
originally proposed. 

I believe the Commission made the right decision. The 
exemption covers large commercial participants in of f -exchange, 
energy based transactions. These transactions compose a large 
ongoing market for energy products — a market that is vitally 
important to U.S. and international commerce — that has existed 
for aany years, continually growing in size, importance and 
complexity. The Commission has never regulated nor sought to 
regulate this market. I am aware of no reason sufficient to 
justify Commission regulation now. Indeed, this market, its 
transactions and participants are clearly within the scope Congress 
intended for the exercise of the Commission's new exempt ive 
authority. 

Section 4b of the CEA 

Questions have arisen, however, as to whether the Commission 
should have reserved the applicability of the anti-fraud provisions 
of section 4b of the CEA in granting this exemption. We 
specifically requested comment on this issue in the Notice of 



51 



6 

Proposed Rulemaking. No coimnenter advanced any arguments 
supporting Commission retention of anti-fraud jurisdiction and most 
of the commenters affirmatively opposed it. They cited the 
commercial nature of these transactions and the fact that the 
proposal was limited to commercial participants and other 
"appropriate persons" — sophisticated entities quite able to look 
out for their own interests. A majority of the Commission agreed. 
They voted not to retain Section 4b to whatever extent it might 
apply to these transactions. 

Some have urged that the Commission should have retained 
section 4b, as it did in the case of its swaps exemption. Indeed, 
I have even heard it said that the Commission cannot legally exempt 
these energy contracts from section 4b. While one may reasonably 
disagree with the merits of our decision, as a natter of law the 
exemption is clearly within the CFTC's statutory authority: the 
exemptive power runs to all provisions of the CEA with the sole 
exception of section 2(a)(1)(B). 

As a matter of policy, I fully support the decision not to 
apply 4b to these exempt energy transactions. One of the most 
valuable aspects of our exemptive authority is that it allows the 
Commission to proceed on a case-by-case basis — an exemption for 
one product can retain some regulatory controls while another 
exemption can retain more, or none at all. 

In the case of swaps, for example, the Commission did agree to 
reserve section 4b, as suggested by several of the commenters on 
that proposal. I think that too was the right decision. Section 



52 



7 
4b covers fraud committed by one person acting for or on behalf of 
another: an agent acting for its principal, if you will. The swaps 
exemption specifically permits some eligible participants to act on 
behalf of other eligible participants in entering into swaps 
transactions. Thus, the principal-agent aspect of section 4b could 
have relevance if a given swap agreement was found to be a futures 
contract. 

This is not the case with the energy exemption. These energy 
contracts are entered into between principals. The exemption 
applies only to "bilateral contracts between two parties acting as 
principals", thus it does not allow one participant in this market 
to act for or on behalf of another. Accordingly, any relevance of 
section 4b on its face to these transactions is highly 
questionable. 

Furthermore, in the Commission's 1990 statutory 
interpretation, we took the position that generally these were not 
futures contracts, but rather forward contracts. By law, section 
4b does not cover forward contracts. Thus, any attempt to actually 
take an enforcement action based on 4b would face substantial 
jurisdictional hurdles. 

In these circumstances, rather than providing a potential 
benefit, retaining section 4b would create legal uncertainty. 
Having gone to great lengths to assure foreign energy firms that 
they may engage in normal pre- Transnor business practices with U.S. 
firms, the presence of 4b may say to some that the futures issue is 
not over. To some of these firms the presence of 4b would indicate 



53 



8 
that the CFTC is exerting some jurisdiction over them and that more 
may follow. Further, it would inject the illusion of Commission 
supervision into a market where there is none. In that regard, 
some may take comfort from the coverage of 4b, but it would be cold 
comfort indeed without the benefits of any ongoing regulation. 
After all, the Commission just does not have the resources 
necessary to adequately regulate these markets. In short, the 
benefits of extending the coverage of 4b to this market are not 
apparent. 

While it is correct that the Commission has exempted these 
transactions from Commission regulation generally, and in 
particular from Section 4b of the CEA, that does not mean that 
these transactions are above the law, or that fraud is somehow 
permitted. While problems can occur, as evidenced by Iransnor's 
refusal to pay and take delivery of Brent oil, these are generally 
private contractual disputes that typically do not involve public 
concern about fraud or market integrity. To the extent there are 
concerns about the ability of these firms to perform their 
contractual obligations, these large commercial institutions do not 
appear to need or desire the assistance of the Commission to police 
their market to assure performance of contractual obligations. 
Nevertheless, to the extent this activity occurs in firms related 
to a futures commission merchant ("FCM"), the Commission can use 
its risk assessment authority to monitor risk to the FCM. 

While fraud remains a possibility, even in a market consisting 
of sophisticated large commercial firms, existing civil and 



54 



9 

criminal remedies exist and the extension of the Commission's law 
enforcement authority into this market appears unwarranted. The 
participants have not found existing remedies insufficient, nor 
have they asked the Commission for additional protection. 

Finally, I would point out that should the practices within 
this market change to the detriment of its participants, or the 
public, or should these transactions take on more characteristics 
of futures contracts, the Commission can always revisit both the 
wisdom and the scope of its exemption. For instance, we could 
tighten the restrictions on who can engage in these transactions. 
Or, if unforseen events warrant, we could extend 4b coverage to 
this market after all. Unlike prior law, our exemptive authority 
under section 4(c) is a flexible statutory tool which can quickly 
be used to accommodate change. In this regard, I would like to 
conclude with a few words about the changing marketplace. 

Section 4 (c) and the Changing Marketplace 

As I have noted, Congress gave the CFTC broad exemptive powers 
as a means of providing certainty and stability to existing and 
emerging markets. Congress understood that 1992 is not 1922 or 
even 1972. The regulatory schemes of the past are being stretched 
by technological changes almost on a daily basis. New statutory 
approaches and tailored regulations are more appropriate than a 
single set of rules for diverse instruments and markets. 
Furthermore, the institutional traders that now dominate the 
financial markets simply do not need as much protection as 



55 



10 
individual customers. 

Some of our foreign competitors have recognized this. In the 
U.K., for example, firms dealing with sophisticated investors are 
subject to less stringent rules — among other things, less 
elaborate risk disclosures and the ability to have customers decide 
whether their funds will be segregated. This produces cost savings 
for both government and those regulated. 

Unless we in the U.S. also recognize these regulatory 
realities, we will inevitably lose the battle of international 
competitiveness in financial services. The CFTC is keenly aware of 
these issues and has done a lot in recent years to address them. 
New section 4(c) now gives us the opportunity to do more and we 
hope to do so as Congress intended. Mr. Chairman, we trust we will 
have your support as we proceed. 

I will be happy to answer any questions you may have. 



i 



56 



COMMODITY FUTURES TRADING 
COMMISSION 

Exemption for Certain Contracts 
Involving Energy Products 

AGENCY: Commodity Futures Trading 

Commission. 

ACTION: Final order. 

SUMMARY: In response to an application 
for exemptive relief, the Commodity 
Futures Trading Commission 
("Commission") proposed to issue an 
order exempting from regulation under 
the Commodity Exchange Act, 7 U.S.C. 
1 et seq. ("Act"), certain contracts for 
the deferred purchase or sale of certain 
specified energy products. 58 FR 6250 
(January 27, 1993). This exemptive 
order is being issued pursuant to the 
exemptive authority recently granted to 
the Commission In the Futures Trading 
Practices Act of 1992. The 
Commission's Order is intended to 
provide greater legal certainty regarding 
trading in these products. 
EFFECTIVE DATE: May 20, 1993. 
FOR FURTHER INFORMATION CONTACT: 
Paul M. Architzel, Chief Counsel or 
Joseph B. Storer, Economist, Division of 
Economic Analysis, Telephone: (202) 
254-6990 or 254-7303, respectively, or 
David R. Merrill, Deputy General 
Counsel, Office of the Genbral Counsel, 
Telephone: (202) 254-9880, Commodity 



57 



federal Register / Vol. 58, No. 74 / 1 ucsaay. ApiU 10, lyyj / Notices 



^i^oi 



Futur«s Trading Commission, 2033 K 
Street. ^4W.. Washington. DC 20581. 

SOPPtCMENTARY MFOfttUTION: 

I. Background 

A. Statutory Framework 

As the Commission noted in the 
Notice Proposing Issuance of an Order, 
58 FR at 6250. section 2(a)(1)(A) of the 
Act grants the Commission exclusive 
jurisdiction over accounts, agreements 
and transactions commonly known as 
options, and transactions involving 
contracts of sale of a commodity for 
future delivery traded or executed on a 
contract market or any other board of 
trade, exchange, or market. 7 U.S.C. 2. 
The Act and Commission rules require 
that transactions in commodity Futures 
contracts and commodity option 
contracts, with narrowly deHned 
exceptions, occur on or subject to the 
rules of contract markets designated by 
the Commission.' 

The recently enacted Futures Trading 
Practices Act of 1992. Public Law No. 
102-564 {"1992 Act'*), added new 
subsections (c) and (d) to section 4 of 
the Act. New section 4(c)(1) authorizes 
the Commission, by rule, regulation, or 
order, to exempt any agreement, 
contract or transaction, or class thereof, 
from tae exchange-trading requirements 
of section 4(a) or any other requirement 
of the Act other than section 2(a)(1)(B).* 
New section 4(c)(2) provides that the 
Commission may not grant an 
exemption ftom the exchange-trading 
requirement of the Act unless, inter alia. 



' SflcUoQB «(*). 4c(bl and 4c(c) of Iho Ad. 7 U S C 
6(a). 6c(b). BdcJ. Sechon 4(a) of Ihfl CEA 
specifically provfdes. inter alio, thai It Is unlawful 
lo eotar lolo ■ commodity futures contraci thai is 
oot made oo or sub^ to the mlu of a tXMxd of 
trada which hu bean daaignaled by lb* 
CommissloQ as « "cootr*cl mariet" tor such 
commodity. 7 US C a(a). This prohlNlioa does not 
apply to futures coolracts made oo or subject lo the 
rules of a foreign board of trade, exchange or 
markrt 7 US C ft(a). 

'SpeciflcAlly. wction ♦{cMl). 7 U S C e(cKl), 
provides: 

"lo order to promote responsible economic or 
financial lonovalloD and fall competition, the 
Commlsiioo by rule, regulatloo. or order, after 
notice and opportunity for bearing, may (oo its own 
Initiative or oo application of any pervoo, Including 
any board of trade designated as a cootrvct market 
tot transactions for Future delivery in any 
commodity under secUoD 5 of this Act)exempl any 
agreement, contract, or transadion (or class thereof) 
that Is otherwise subject to subsectloo (a) (iixJudlng 
any person or class of persons offerinft, eolering 
into, rendering advice or rendering other services 
with respect to, the agreement, contract, or 
transactioD), either unconditionally or oo slated 
lenns or conditions or for stated periods and either 
retroactively or prospectively, or both, bxtm any of 
the requlremenis of suhsaclioo (a), or from any 
other provtsloo of this Act (except section 
2(aXl)(BH. tf the Commission determines thai the 
exemption would be consistent with the public 
tntereat." 



the agreement, contract or transaction 
will be entered into solely between 
"appropriate persons", a term defined 
in new section 4(c)(3). ^ In granting 
exemptions, the CommissioD must also 
determine specifically that the exchange 
trading requirements of section 4(a) 
should not be applied, that the 
agreement, contract or transaction in 
question will not have a material 
adverse effeci on the ability of the 
Commission or any contract market to 
discharge its regulatory or self- 
rogulatory duties under the Act and that 
the exemption would be consistent with 
the public interest and the purposes of 
the Act.* 



' SecUoD 4(c). 7 U S.C e(cH3). provides that: 

"* * * the term 'approprlale person' shall be 
limited lo the following pardons or classes thereof: 

"(A) A bank or trust company (acting in an 
individual or Tiduciary capably). 

"(B) A savings association. 

"(C) An Insurance company. 

"(D) An invesimenl company subbed to 
regulation under ihe Inveslmenl Company Act of 
1940(15 use 80*-l etseq). 

"(E) A commodity pool formed or operated by a 
porvin subject lo regulation under this Act. 

"(F) A corporalion. pa;tnership. proprietorship. 
organiLfition. trust, or other business enlily with a 
net worth exceoding Sl,(XX).0O0 or total as»els 
exceeding S5.000,000. or Ihe obligations of which 
under the agreemeat, contract or Iraasactlon are 
guaranteed oi 'Otherwise supported by a lettor of 
credit or keepwell support, or other agreement by 
any such entity or by an entity referred to io 
subparagraph (A|. (B). (C). (H). (I), or (K) of this 
paragraph. 

"(C) An employee tMnefil plan with assets 
exceeding $1,000,000 or whose investment 
decisions are made by a bank, trust company, 
insurance company, inveslmenl adviser registered 
under the Investment Advisers Ad of 1940 (IS 
use SOft-1 el seq.). or • commoditv trading 
advisor subject to regulalioo under this Ad. 

"(H) Any governmental enlily (including the 
United Stales, any stale, or any foreign govnrmnent) 
or political subdivision thereof, or any 
mullinational or supranational entity or any 
Instnimeotality, agency, or department of any of the 
foregoing. 

"(I) A tiroker- dealer subfecl lo regulation undv 
the SecuriUes Exchange Ad of 19J4 (15 US C 78a 
et seq ) Ktingon Its own l)ehairor oo tmhalfof 
another appropriate person. 

"(J) A fut\ires commission merchant, floor broker, 
or floor trader rutted to regulalioo under this Act 
•ding oo Its own behalf or on behalf of another 
appropriate person." 

* Specifically, section 4(c)(2). 7 U S.C 6(c)(2). 
suias: 

"The Commission shall oot grant any exemption 
■ * * from any of the requirements of sub&edkia 
(a) unless the Commission determines that (A) the 
requirement should not be applied to the 
■greemenL conlrad, or transadion for which lh« 
exemptloo Is sought and thai the exemption would 
be consistent with the public Interest and Ihe 
purpoees of this Act, and (B) the agreement, 
contract or transadion — 

"(i) WiU be entered Into solely t>elween 
appropriate persons: and 

"(ii) Will Dol have a material adverse effed oo the 
ability of the Commission or any contrad market to 
discharge its regulatory or self-regulatory duties 
under this Act" 

As Is frequently the case when Congress giants a 
regulatory agency authority to ad in a manner 



B. The Proposed Order 

The Commission, on January 27. 
1993. published for public comment tho 
proposed order. The Commission 
proposed this order in response to an 
application for exemptive relief 
("application") filed oy a group of 
entities (the "Energy Group") which 
represented that each is a producer, 
processor and/or merchandiser of crude 
oil, natural gas and/or other crude oil or 
natural gas product, or is otherwise 
engaged in a commercial business in 
these commodities.' 

The application, submitted pursuant 
to Section 4(c) of the Act. is for an order 
exempting ^m regulation transactions 
for the purchase and sale of certain 
energy products through contracts that 
meet specified criteria. As noted In the 
Notice Proposing Issuance of an Order. 
the applicants based their request for an 
exemption both on the nature of the 
participants in, and on various 
representations regarding the usage and 
form of, these transactions.* 



consistent with "the public interact sod the 
purposes of* its enabling statute, little statutory 
etaboralion Is given As commonly uodertlood. 
however, an agency, such as the Commlssloo, is to 
apply this standard against the template of Its 
regulatory scheme. In this regard, the Conference 
Report states that the "nublic Interesl" under 
section 4(c] includes "Ute national public InteresU 
noted lo the jAd). the prevention of fraud and the 
preservation of the financial int(>grlly of markets. aJ 
well as the promotion of responsible economic or 
finandal innovation and fair competition." H R. 
Rep No. 97&, 102d Cong.. 2d 5^ess. 7a The 
Conference Report goes on to s.ete that "(t|he 
Conferees Intend (or this reference lo the 'purposes 
of Ihe Ad' to underscore their expectation thai the 
Commission will assess the impact of a proposed 
exemption on the maintenance of the Integrity and 
soundness of markots and market pa/lldpanls." 
H R- Rep No 97«. I02d Cong , 2d Ses*. 78. 
However, the Conference Report on the 1992 Ad 
also stales that: 

"TtM Conferees do not Intend for this provisioa 
to allow an exchange or any other existing DUrkel 
lo oppose the exemption of a new produd solely 
on grounds that it may compete with or draw 
market share away from the existing market" — H.IL 
Rep. No. 170. 102dCoog.. 3d Sees. 70(1092). 

'The submission represents that each of the 
memtien of the Elner^ Group is an adlve 
participant In the prindpal domestic aod 
international markets for crude oil and/or iiatural 
gas and the produds and by-products thereof, 
which regularly engages lo the purchase of such 
commodities for use in Its business operations, the 
sale of such commodities for use by end-users aztd 
the transport of such cocnmodilles through pipelioe, 
vessel or tnick detlveriea. 

* Specifically, as staled In the apptlcaiion. see SS 
FR at 0251. the exempUoa would: 

"' * * preclude participation * • * by memben 
of the gerveral public and * ' * Umll lb« * • ' 
{relief} to those appropriate persons who. In the 
context of their business edivitlea. incur risks 
related to the underlying physical commodities, to 
addition, ^e exemptloo %inll require thai e*ch 
* * * Contrad (covered by the relief would) 
Impose binding delivery oollgallons on the panies 
(with the exception of those covered liy * * ' [a 
speciHed] proviso * ' *) and that it not provide 

Conli»u9d 



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The appIicanU further reuoned that 
the exemption wai needed to provide 
legal clanly and certainty reg£^ding the 
trading of theae product*. In this regard, 
at noted In the Federal Re^er notice. 
58 FR at 62S1. the applicants contended 
that the requested exemption should 
"recognized the ability of commercial 
entities to settle • • * Contracts 
through the full ran^ of commercially 
■vailanle forms of settlement," and 
should "allow commercial entities to 
conduct their necessary business 
activities in the domestk: and foreign oil 
and gas eoarkets * * * with the 
requisite degree of legal certainty and 
comfort" 

In addition, the application also 
addresaed the public interest to be 
served by the Commiseion's issuance of 
an order granting this request for an 
sxempllon. The Comnussioa Included 
this analysis in the Notice for comment, 
quoting extensively from it. See, 58 FR 
01 6251. In this regard, as noted in the 
Federal Register notice, the applicant 
reasoned that the exemption would be 
in the public interest because "Itlhose 
entities which satisfy * * * the 
proposed exemption are sufficiently 
sophisticated and knowledgeable to 
protect their own interest in connection 
with • • • Contracts, regardless of 
whether the regulatory protections 
afforded under the Act are available 

* * '/'because "the exemptive relief 

* * * is necessary in order to permit 
commercial commodity markets to 
function effectively * * *;" because 
"the financial integrity of the markets 
for such* * * Contracts will be 
adequately addressed by the limitation 
of appropriate persons and the measures 
adopted by each market participant 



atfhar party wfA Ihe unnatoral right to reqiilre itj 
counterparty lo ofTs«t the contract by caih 
Mttlement The Contracts witl therefore expose the 
pertiea to eubetanttal ecooomk risk of ■ coimnercia) 
Battire. Further, the Contnicti will be entered into 
lietweeB two parties each of whtcb acts as principal, 
and the material economic terms, including credit 
terms of the tMHsactioo will ha subject to 
individual negotiation betweeo the partiea." 

The sppBcation further explained that the 
requested ax eai pHo p: 

"* ' * focnses on (ha comnercia] nature of the 
parties and the {act that the * * * ContrBcts impose 
binding delivery obligatlofU, thereby establishing a 
*Vight line" test The exemption recognizes that- 
regardless of the purposes for which the parlies 
enter Into a* • • Contract, they may be required 
by their counterparty to make or receive delivery 
pursuant ID the terms of (he ContraoL This will 
permit commercial entities to enter into ' • • 
Contracts lor hedgjag, risk ukanagement, pridog or 
other conM * e i c i al purpose*, ptorided that (he (emu 
of the sgivemeets hspose biading delivery 
obligatiooi. the parties are legally pemilned to 
make ai>d receive delivBry ar>d ere capable of doing 
se In this reeped as wril.theexflnplion win 
fadliutetheiueof ■ * * CoatracU fer legitimate 
and necessary basli>ess purposes." (CMetions 
omitted.) 



* * *;" and because "such Contracts 
lack the degree of standardization and 
fungibility required In order to permit 
them to be traded on an exchange." Id. 

Finally, the Commission included 
seven issues on which It particularly 
sought public comment. These included 
the list of eligible "appropriate 
persons," the CUimmission's description 
of the commodities covered by the 
exemption, its description of the cash 
market, including the use of brokers and 
of netting arrangements, the possible 
effect on cxmtract markets from granting 
the exemption, and whether section 4b 
of the Act should be applicable to these 
transactions. 

C. Comments Heceived 

The comment period closed on 
February 26, 1993. Sixteen comments 
were received; including eight from 
active participants in the energy <ash or 
forward markets or entities representing 
such participtmts, three from futures 
exchanges, three from futures industry 
associations, one from a bar association 
committee and one from an attorney. All 
but one of the commeaters generally 
supported issuance by the Commission 
of the proposed order. 

Most commenters confirmed the 
accuracy of the Commission's 
description of applicable of applicable 
cash market practices. Several, however, 
suggested changes to the Commission's 
description, including in particular, 
clarifications with regard to the degree 
of standardization, or individual 
negotiation, of these contracts. Several 
further recommended that the 
Commission clarify additional aspects 
of the proposed order, including in 
particular, the applicability of the order 
to various other types of instruments 
and other of the Commission's rules and 
Interpretations. 

Others recommended that the 
commission modify certain aspects of 
the proposed order. ITiese 
recommendations included modifying 
the persons proposed to be eligible for 
this relief, the breadth of commodities 
covered under the proposed order, and 
the effective date oT the exemption. The 
opposing commenler, the Chicago Board 
of Trade ("CBT"), questioned the 
Commission's statutory authority for 
Issuing the order as proposed, the 
rationality and fairness of the proposed 
order and whether the Commission has 
provided a meaningful opportunity for 
comment on the statutorllyrequired 
determinations regarding the public 
interest which it roust make in issuing 
this order. 



n. The Final Order 

Based upon Its careful consideration 
of the application for exemption, the 
comments received, and Its independent 
analysis, the Commission is issuing an 
order under its authority In section iid 
of the Act to exempt specified 
transactions from Commission 
regulation. The final order, and in 
particular, the modifications made to it 
hora the proposal, are discussed below. 

A. Statutory and Beguhtory Basis of the 
Order 

In proposing to issue this order under 
sedion 4(c) of the Act, the Commission 
made clear that It did "not intend to 
determine whether Energy Contracts are 
subject to the Act," nor to "affect the 
applicability to Energy Contracts of 
exemptions or interpretations 
previously Issued by the Commission or 
its staff, including the Stalutoiy 
Interpretation Concerning Forward 
Transactions. * ' * or the forward 
contract exclusion set forth in section 
2(a)(1) of the Act * * V" 58FRat 6253. 
n.l8. The C3T, the sole commenter 
opposing Issuance of the proposed 
order, maintained that Issuance of this 
order, pursuant to section 4(c) of the 
Act. was inconsistent with prior actions 
of the Commission and with the CBTs 
reading of the scope of the Act's section 
4(c) exemplive authority. 

■The Congress, however, did not 
Intend such a restrictive reading of the 
Commission's 4(c) exemplive authority. 
On the contrary, the Conferees stated 
that: 

"lo granting exemplive authority to the 
Commission under new section 4(c). the 
Conferees recognize (he need to create legal 
certainty for a numlier of existing categories 
of Instruments whicli trade today outside of 
the forum of a designated conlrBCt market. 

"The provision included in the (inference 
substitute Is designed to give the Clommission 
broad flexibility in addressing these products 

"In this respect, the Conferees expect and 
strongly encourage the Commission lo use Its 
new exemplive power promptly upon 
enactment of this legislation In four areaa 
where significaot concerns of le^ 
uncertainty have arisen: (1) hybrids. (2) 
swaps, (3) forwards, and (4) bank deposits 
and acxounts." 

H R. Rep. No. 978, 102d Cong. 2d Sets. 
(1992|al«0-ai. 

The conferees further stated that they 
did 

"not intend thai the exercise of exemplive 
authority by the Commission would require 
any delenuinatlon before hand that the 
agreement. Instrument, or tra n saction for 
which en exemptioa It sought it tubject to 
the Act Rather. Ihii provitlon ptovldat 
flexibility for the Commission to provide 
legal certainty (o novel instnimenlt wh«t« 



59 



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21289 



the d«termiDatioD «5 to Jurisdiction Is not 
•trslghlforwimJ. Rather than making a finding 
•< to whether ■ product 1» or Is not a futures 
contract, the Ck)minlsslon In appropriate 
cwet may proceed directly to Issuing an 
exemption." 

H.R. Rep. No. 978, 102d Cong, 2d Sess., 
(1992) at 82-83.' 

Separately, several commenters 
recommended modifications to the 
proposed order on the grounds that 
relief under the order was not as far- 
reaching as the relief recently granted by 
the Commission with regard to hybrid 
instruments or to swap agreements. 
Thus, one commenter argued that the 
Commission should make this 
exemption applicable to any cash- 
settled energy contract because such 
transactions arguably would be exempt 
from regulation under the Commission's 
Exemption for Certain Swap 
Agreements. See. 58 FR 5587 (January 
22, 1993). A second commenler 
suggested that the Commission reiterate 
that this relief was not intended to 
vitiate the continued vitality of the 
Commission's Statutory Interpretation 
Concerning Forward Contracts, 55 FR 
39188 (Sept. 25, 1990). Finally, a third 
commenter requested that the 
Commission clarify that this exemplive 
order was not intended to supersede any 
other Commission rule or interpretation 
regarding those transactions which have 
been characterized as forward or trade 
option transactions. 

In proposing this order, the 
Commission made clear that It did not 
intend to supersede or vitiate any other 
of its rules or interpretations, in 
particular those relating to the section 
2(a)(1) exclusion of the Act. 58 FR 6253, 
n. 18. Rather, this order was proposed 
in response to a particular application 
for relief, and was intended to provide 
legal clarity with regard to certain 
transactions as described therein in 
specified commodities. Thus, the 
Commission is limiting the order to 
existing practices in these markets, as 
represented in the application. Nor does 
the Commission believe that the order 



'In any event, the commenter maJDIains that 
■■CEA i 4(c) compel! the CFTC, at the least, to 
detenntne that every Instruoienl it exemplj could 
be a futures contract." In this regard, the 
CocnmUsion [wtes thai the le^ uncertainty which 
thlj axeniptlve order addresses was occasioned by 
the tMlief ol some observers thai some of the 
Inj^umants at issue are Indeed futures cootrects. 
See. e-g., Ti%insnor (Bcnnuda} v. BP North America 
Pttrvltum. 7J» F Supp 1472 (S D N.Y. 1990). 
Thiis, regardless of the Commission's position on 
the appropriate charactertzatloo for specific types of 
transections, the status of some of these transactions 
under the Act appears likely lo be subject to 
continued dispute, and this potential for 
uncertainly provides a suffldenl basis for the 
exatdae of exemptlve authority as lo these 
transACtlona. 



should go beyond the representations in 
the application with regard to practices 
in these markets to practices whic^ may 
be permillod luider other Commission 
rules, such as the exemption for swaps 
in pari 35 of its rules. Finally, by 
confining its order to these transactions, 
the Commission is not thereby making 
a determination regarding, or otherwise 
determining the legality or status of, any 
other type of transaction or superseding 
any other rule or interpretation.* 

B Commodities Eligible for the 
Exemption 

Several commenters suggested that 
the Commission not limit this order for 
exemption to Energy Contracts, but 
rather extend it to all commtjdities. One 
commenter suggested that an exemption 
limited to energy contracts increases 
uncertainty regarding forward contract 
markets in other commodities, thus 
requiring that the Commission expand 
this exemption to cover transactions in 
all commodities. A second commenter 
argued that there was no legal basis to 
distinguish energy products from other 
commodities. 

As discussed above, however, the 
Cximmission, in proposing this 
exemptive order, was responding to a 
particular application for relief The 
record before the Commission, and the 
representations in the application, are 
limited lo trading practices in the 
markets relating to energy products. See. 
58 FR 6251 , n 8. Moreover, the Congress 
specifically directed the Cximmission to 
consider the appropriateness of 
exemplive relief for the crude oil 
market. H.R. Rep. No. 978, 102d Cong., 
2d Sess. at 81-82 (1992). 

Based upon the intent of the Congress 
in enacting this exemplive authority, 
and upon the limited focus of the 
application for exemption and the 
corresponding record, the Commission 
is of the view that this final order is 
appropriately limited to transactions in 
Energy Contracts. Of course, as the 
Commission noted previously, this 
exemption in general, and its limitation 
to Energy Contracts in particular, does 
not affect the applicability or vitality of 
existing Commission policies or 
interpretations regarding transactions in 
these, or any other, commodities. 

Several commenters also requested 
that the Commission make technical 
amendments to its enumeration of 



• In this regard, the Commission reiteraros that the 
exemption granled here does not alTact the 
applicability lo Eoer^ Contracts of the 
Commission's Statutory Interpretation Concerning 
Forward Transactions. 55 FR 3918* (Seplember 25, 
1990). Any transaction that has been or will be 
wlered Into coiuislent with that Interpretation 
remains excluded from regulalion under die Act. 



commodities included within the 
meaning of the term "Energy Contract." 
The Commission defined this term In Its 
Notice Proposing Issuance of an Order 
as. "contracts for the purchase and sale 
of crude oil. natural gas. natural gas 
liquids or other energy products, 
Including products derived from crude 
oil. naluralgas or natural gas liquids, 
and used primarily as an energy source 
• • •."58FR6251. 

In particular, one commenter 
recommended that "condensates" 
should be explicitly included within the 
commodities enumerated. The 
Commission agrees. Other comments 
reflected confusion over whether a 
product must actually be used as an 
energy source in order to be included 
within the exemption. The Commission 
did not Intend that inclusion of a 
particular product within the exemption 
rest upon a sub)ective test of Intent as 
to its use as an energy source. For 
example, a particular company may 
purchase cargoes of crude oil for use in 
various commercial activities. The 
Commission did not mean to exempt 
only transactions for those specific 
shipments of the specified products 
which are used as an energy source. 
Rather, the enumerated products — crude 
oil, condensates, natural gas and natural 
gas liquids, which can be used In their 
natural stale for energy— are included 
within the exemption regardless of 
whether the actual or ultimate use of 
these commodities is as an energy 
sourc». 

Derivatives of these products are 
included to the extent that the 
derivative product is used primarily as 
an energy source. Again, however, it is 
the derivative product itself, such as 
gasoline, heating oil, or diesel fuel, and 
not the use made of particular lots of a 
fungible product, which is included 
under the exemption. The Commission, 
therefore, in its final order, la clarifying 
the description of the commodities 
included in the exemption. 

C. Entities Eligible for the Exemption 

The Commission, in its Notice, 
specifically requested comment 
regarding its enumeration of the entities 
which would ]>e eligible for exemptive 
relief. This request elicited diverse 
opinions which raised several Issues. As 
proposed, the exemptive order would 
have been applicable to "commercial 
participants who. in connection with 
their business activities, incur risks 
related to the underlying physical 
commodities, have the capacity to make 
or lake delivery under the terms of ihe 
contracts, and are also eligible 
'appropriate persons.' " The 



60 



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Federal Register / Vol 58. Ng 74 / Tuesday. April 20. 1993 / Notices 



CommUstoD birther deOoed "eligible 
eppropriate persons" u: 

"(1) A tiuik or tnut cxxnpluy (acting Id an 
Individual or fiduciaiy capacity) which U 
le^lly penBitted and otherwise authorizad to 
engage In such traiuactiona; (2) a 
corporatioo, partDanMp, proprietorship, 
organization, trust, or other business entity 
with a net worth exceeding $1,000,000 or 
total assets exceeding {5,000,000, or the 
obligations of which under the agreement, 
contract or transaction are guaranteed or 
otherwise inpparted by a letter of credit or 
keepwell aupport, or other agreement by any 
sucn entity or by an entity reierTsd to in 
subsections (H), (I) or (J) of Section •«(c)(3); 
(3) any govommenta! entity (including the 
United States, any state, or any foreign 
government! or political subdivision thereof, 
or any rauhir>ational or supranational entity 
or any insuumentaiity, agency, or 
departmeol of any of the foregoing; (4) a 
broker-dealer subject to regulation under the 
Securitiea Exchange Act of 1934 (1 S US.C. 
78a et seq.) acting on its own behalf or oa 
behalf of another appropriate person (as set 
forth herein); and (5) a futures commission 
merchant subject to regulation under the Act 
acting on Its own behalf or on behalf of 
another appropriate peraon (as set forth 
herein).'* 
58 FR 6257. 

Several commentars opined that the 
entities eligible Tor this relief should be 
extended to include not only 
"commercial participants • • • who 
incur risVs related to the underlying 
physical commodities, land] have the 
capacity to male or take delivery 
* • *," but also to include any 
appropriate person which is legally 
authorizad to make or take delivery of 
the physical commodity. These 
commentert further suggested that an 
entity could so qualify "by contracting 
out its obligations to a person or entity 
that provides such services as storage or 
transportation of the underlying 
commodity,** 

In addition to the above revision to 
eligibility, several commenters also 
supported the inclusion oF commodity 
pools within the list of "eligible 
appropriate person," These commenters 
supported this revision by reasoning 
that, "because there is no basis to 
distinguish between them (commodity 
pools) for purposes of exemptive relief 
under section 4(c)," commodity pools 
should be included within the terms of 
thii exemption "on the same terms as 
swap transactions.** 

Other commenters disagreed with Oiis 
view. One such commenter, a futures 
exchange, contended that permitting 
commodity pools to be covered by the 
exemption was contrary to the proposed 
order's stated rationale, reasoning that; 

"Itlhe purpose of the IVt^nsed OnleT Is 
ostensibly to permit tiansarllrws which are 



entered Into Cor legUtmale oomB>eTcial 
purposes * * *. To treat a speculative 
commodity pool * * * as the equivalent of 
an entity engaged In the business of being a 
producer, processor and/or merchandiser of 
energy products, is contavy to the Proposed 
Order's ol^ectlve of facilitating commercial 
activities free of unnecessary regulatory 
burdens * • *." 

Based upon the above reasoning 
amphasinng the commercial nature of 
the eligible entities, the commenter 
further recommended that the 
Ckimmission state explicitly that eligible 
parties under the exemption must have, 
"as part of the routine course of their 
business activities. • • • the physical 
capacity to produce, refine, store, 
transport or otherwise tangibly control 
the commodity." and questioned the 
need for conditions related to net worth 
and total assets. The commenter noted 
that by limiting the exemption to 
commercials, it would apply only to 
sophisticated entities and that the net 
worth and total asset conditions were 
therefore unnecessary, potentially 
excluding unnecessarily "small or start- 
up commercial entities * * *." 

After carefully considering the views 
of the commenters, the tx)mmission is 
limiting the final order to those types of 
commercial participants identified in 
the proposeo order. The Commission is 
persuaded that this is appropriate in 
light of the limited nature of the 
application, and In li^ of its 
understanding of the nature of the 
transactions and the participant** 
currently in these markets. 

Consistent with this determination, 
the Commission is tnaking clear that 
this exemption remains applicable to 
transactions that result in risks relating 
to making or taking delivery of the 
underlying physical commodities. 
Accordingly, the category of eligible 
appropriate persons for this exemption 
must have a demonstrable capacity or 
ability to make or take delivery. As the 
Commission explained in the Notice 
Proposing Issuance of an Order, at page 
6252. "such capacity entails the ability 
to produce, refine, store, transport or 
otherwise tangibly control the physical 
commodity." This can be fulfilled, 
however, by bona fide contractual 
arrangements for these services. 

Moreover, despite some merit in the 
observation that certain smaller, or start- 
up commercial firms may be excluded 
unnecessarily from eligibility for this 
exemption by the net worth and total 
assets conditions set (orth in section 
(A)(ii) of the Order. Ui light of the 
general nature of the current 
participants in the markets, the 
Commission believes that smaller 
commercial fimu, which cannot meet 



these financial criteria, should not be 
included. In this legard, size Is a 
relevant proxy for measuring the 
expertise of, and participation In these 
types of markets, and for an enlHy*! 
capability of making or taking delivery 
in these markets. Moreover, the 
Commission notes that even smaller or 
start up firms should be able to meet 
these financial requirements through the 
use of various types of permitted 
guarantees, and thereby qualify for this 
exemption.* 

On a separate issue, one commenter 
requested that the final order also 
exempt "any person or class of persons 
offering, entering into, rendering advice, 
or rendering other services with respect 
to such Energy Contracts, in connection 
with such activity," The commenter 
reasoned that extension of relief to those 
advising or rendering advice or other 
such services in connection with these 
transactions, which was included in the 
exemption for swap and hybrid 
instruments, is equally applicable to 
this proposed exemption. 

Consistent with sectrtm 1(c)(1) of the 
Act end the Commission's exemptions 
for swap and hybrid instruments, the 
Commission is providing that persons 
offering, entering into, rendering advice, 
or rendering other services with respect 
to such Energy Contracts are eligible for 
this exemption.'® 



*ln Ihif regard, although ttie Commission has nol 
provided that ouDisodtly pools or oOwc coHectiva 
invmbrenl vehidM. including rnTestmeiil 
cooipafues. or Ooor brokan and floor tjadflrs 
separately coostilule daises of "appropriate 
persons." to the extent that such enbties qualify for 
exemplioji as an eligible aality under another 
category of "appropriate persoa." they will oot tie 
excluded from the exemption. Accordingly, such 
entities may qualify as appropriate persoru If. In 
connection with their tntstness aclivitiea. they tnciir 
riski. In addj tion to price risk, related to tl>e 
imdertyiBg physical conunoditie&, have a 
demonstrable capadty or ability, directly or IhrtHigh 
separate bono fide contractual arraDgements. to 
make or take tielivery ondei the terms of the 
contracts, are not prxsKibited by law er regulation 
from entering into such contracts, and otherwise 
meet the qualtlrcatioos set (orth in one of the 
enumerated categories of appropriate persons. 
However, any collective investment vehide formed 
solely for the purpose of entering into Energy 
Contrects will iu>t tjuelify for the exemp<iv« relief 
provided under the Commission's Onler. Of oourse. 
a (xmiDodity pool operator will cmtiiuie to be 
subject to Section 4o of the Ad in ccuurection with 
iu solicitatiofu or other adivibas es a CPO evan 
though it may purchase or direct the patzhate ot 
Energy Contracts that are suhfed to the 
Commijaion's Order. 

x> As the CommtsskM ootad in the Notice 
Proposing Usuaisca at an Ordec it did "not tBland 
that the proposed coiutiUosi that an Eisergy Cootiect 
be a priridpal-to-priaclpftl tr«B*actM0 preclude the 
tsj* of brokWi Of other agents in cennectieii with 
the negotiation oC ar the perfonnanoe or aetlleoMist 
of the obligariOBS ur>der. a contrect * * "- $• Fit 
6232, n.t1 The fijul onlar m^m dear that M 
eocom passes agenu readarlag sedh mrwUjm. 
including advisory services, for those aotivitiea. 



61 



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21291 



However. M explained lo connection 
with the exemption (or swap 
trajMaction*. the application of tbii 
exemption to such persons 

"engagod Id activity otherwlM sub^xrt to the 
Act would DcM fa« oxempt Cor fvxJl activity, 
even If II ware cooiMctod to tiwlr 
exempted • • • (Enelgy Conlracil activity. 
Also in this regard, the Commiuion wi&hes 
to malie dear that the exemption d< >&» ool 
appTy to any financial, recordkeeping, 
reporting or o<heT requirements Imposed on 
any pereon in coaD«ction with their activities 
that reniala subject to regulation under the 
Act. Thus, for axampla, hitures commijaion 
merchants omst oootioua to account for any 
liabilities arising out ot any * * •(Energy) 
agreement Ln meeting ihe net capital 
requirements ofCommisslon Rule 1 17 just as 
they do in the case of other financial 
instruments not regulated under the Act. 
Similarly, tbe risk assessment recordkeeping 
and reportfrtg requirements imposed on 
futures commission merchants by Dew 
section 4flc) of the Act apply ' • •." 
58 FR at 5580. 

Finally, several commenlers suggested 
that (he Commiasion clarify the rote of 
written representations in forming a 
reasonable basis for the belief tliat a 
counterparty qualiSes as eligiblu for this 
exeoiplion. A second cotnmenler 
requested that the Commission also 
clarify that a reasonable belief is 
required as to the counterparty's 
eligibility with respect to Doth its 
capacity for delivery and its inclusion as 
an eligiole appropriate person. 

These determinations, that there is a 
reasonable basis to believe that a 
counterparty is eligible to enter into the 
transaction both with regard to its 
capacity and as an appropriate person, 
are lo be made at the inception of the 
transaction. Moreover, an eligible entity 
that has a reasonable basis to believe its 
counterparty is also an eligible entity 
when entering into a master agreement 
may rely on such representations 
continuing, absent information lo tbe 
contrary." Compare, 58 FR at 5589. 

D. Description of Exempt Transactions 
In general, commenters agreed with 
the accuracy of the Commission's 
description of the operation of these 
markets In energy products. However, 
the entitle* which Tiled the application 
for this exemption, sought, in their 
comment tetter, to distinguish the 
relativs degree of individual negotiation 
over particular categories of the 
contract'i economic terms. In particular, 
this commenter pointed out that the 



terms of the transactions regarding 
quality and location lo many of thesa 
markets, because they Involve "a single 
supply location," "are Gxed and not tbe 
subject of individual negotiation." 

The Commission U aware that the 
terms regarding tbe quality and location 
of Energy Contracts, as well as other 
conventions surrounding their trading 
are standardized- Novertbeless, these 
transactions can be distinguished by the 
fact that, because their credit terms ar^ 
Individual to the counterparties, they 
are not fungible and are created through 
the direct negotiation of the parties lo 
the transaction. Compare, S8 FR at 5591. 

Several commenters also requested 
that the Commission confirm that the 
requirement for binding delivery on the 
contracts is not affected by inclusion in 
the contract of a termination right which 
is triggered by an event of default, such 
as the insolvency of a counterparty. The 
Commission concurs that bona fide 
terminations occurring under the terms 
of a contract, for contingencies such as 
default or insolveitcy that are not 
expected by the parties at the time tbe 
contract is entered into, will not 
invalidate application of the exemption 
to the transaction, bi this regard, 
however, the Commission cautions that 
the inclusion of such provisions, end 
their use, must be bono fide and not for 
the purpose of evading the terms of this 
exemption. 

Finally, one commonter argued that 
the proposed order is arbitrary because 
it would have exempted only contracts 
which were bilateral and not subject lo 
a mutual risk clearing system." The 
CBT concluded that this is contrary to 
the public interest because those 
methods which are included wilhin the 
exemptive relief are, in its view, inferior 
lo a true clearing system, which is not 
included within the scope of this order. 
As the Commission has noted elsewhere 
in this release, however, this order is 
responsive to the appHcation for relief 
and is tailored to current practices in 
these markets. Accordingly, the order is 
limited in scope to bilateral, 
individually negotiated instruments, 
which is the common practice in these 
markets. 



"As under the Put 33 rules, where a 
counterpwly has ceased to be eGgible for this 
exemp4ioQ. an eligible eoUty aevertheleu may eiUar 
Into a "dosing Uansactloo" with Iha counts/party 
to tenninele aJI obllgaboaj berwean them. See. Sa 
FRatssas. n. ia 



"As the Commission noted in the Notice 
Proposing an Order 

"The reqiiirefneal that Energy Contracts be 
bilateral and sub)ect lo individual negotiatloa la 
Intended to assure that the IrHnsaclioru >v ould not 
be subjocl lo a clearing system where the aedil risJi 
of individual panicipants of the system lo each 
other, with respect to a transaction to which each 
is a counterparty, would eftedively be eliminated 
and replaced by a * ' * system of muluJixed risk 
of toss that binds members generally whether or ool 
they are counterparties to the original 
transect ion.'— 58 fH at 6J53. il 1 1. 



B. Breadth of Exemplht Relief 

Tbe Commission requested coaiment 
on whether it should reserve aotl-fraud 
jurisdiction under section 4b of the Ad, 
7 U.S C 6b. over these instruments. No 
commenler explicitly supported the 
retention by the Commission of anti- 
fraud jurisdiction. To the contrary, 
almost all of the commenters opposed 
reservation of this authority. Most 
agreed with the views expressed by one 
commenter that: 

"ICtiven the commercial characteristics ol 
those transadiona and the significaat 
requirements to he 'commercial participants' 
and 'appropriate persons.' the (commentar) 
* * * does not believe that soclion 4(b) (ale) 
of the Ad (anti-fraudi should t>e applied to 
Energy (xm tracts," 

In this particular instance, the 
Commission concurs with the 
commenters that it need not retain 
section 4b authority, lo whatever extent 
that section of the Act would otherwise 
be applicable to these transactions." 
However, sections 2(aUl)(B) of the Act 
end the provisions of sections 6(c), Gc. 
6(d) and 9(a)(2) of the Act. to the extent 
that these provisions prohibit 
manipulation of the market price of any 
commodity in interstate commerce or 
for future delivery on or subject lo the 
rules of any contract market, will 
continue to apply.** 

Finally, several commenlers requested 
that the Commission broaden the 
exemption by making its application 
retroactive. As proposed, the 
Commission's order would have been 
effective upon publication for all 
executory transactions. Various 
commenters objected. One reasoned 
that: 

■■|l|t the CTTC determines that issuing the 
proposed exemption is consistent with tbe 
public interest, its determination should 
eliminate any legal uncertainties with respect 
to Energy (Contracts entered into before as 
well as after the effective date of the 
exemption. The CFTC's final rules exempting 



"Of course, that is not to say tiiat the 
Commission's decision ool lo reserve Sactlob 4b 
anIl-fratKl jurisdiction will leave market 
paxticipanis without legal recourse for fraud Id 
connection with these l/ansacUoni. Market 
parlicipanis will continue to b«ve available those 
slate and comaioa tew remedies whlctk have bean 
applicable to these markets from Iheir loceplloA. 

<* Moreover, as the Commlssloo noted lo Its 
Notice f^posing Usuaisce of an Order, al Sa FK 
e2S3. n.19. this order "would not aflsd lb* 
appllcebillty or proiectioos of stale law (other IfaaD 
gaming or "bucket shop" lawsj. or aiUifnud statutaa 
of general appUcabtllly. to the exempted Qsaqor 
(Contracts or any other prolectlons provided try 
other applicable tedetaj laws. Congress sped/loally 
Ikoted that, la axampHog an Instrument bom the 
Ad. the Commlssioa caoaot exempt It froa 
applicable sacurlUee and bairiUng Laws and 
regulations " H-R. Rap. No. «7a, UM Coof.. Id 
SessBl (19921. 



72-584 0-93-3 



62 



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Federal Register / Vol. 58, No. 74 / Tuesday, April 20, 1993 / Notices 



certain iwap and hybrid tranaactlont apply 
retroactively, and • • • |iho commenlorl 
seea no reason why the proposed exemption 
should not alio apply to existing Energy 
Contracts." 

In light of the Commission's objective 
in issuing this order — to provide greater 
legal certainty regarding the trading of 
these instruments — ana the uniform 
opinion of the commenters that the 
retroactivity of the order is an important 
component of providing that certainty, 
the Commission has determined that 
upon the order's effective dale, it will 
apply retroactively, to all such 
Ironsaclions entered into on or alter 
October 23, 1974. This is consistent 
with the Commission's recent 
promulgation of rules exempting certain 
swap transactions, 58 FR 5587, and 
certain hybrid instruments, 58 FR 5580 
(January 22, 1993). 

F. Public Interest and Purposes of the 
Act Determinations 

1. Publiclnlerest 

In determining that its actions are 
consistent with "the public interest and 
the purposes of its enabling statute, an 
agency, such as the Commission, 
applies the standard against the 
template of its overall regulatory 
scheme. In this regard, the Conference 
report stales that the "public interest" 
under section 4(c) includes the 
"national public interests noled in the 
jAcll, the prevention of fraud and the 
preservation of the financial integrity of 
the markets, as well as the promotion of 
responsible economic or Rnancial 
innovation and fair competition." H R. 
Rep. No. 978, 102d Cong., 2d Sess. 78 
(1992). '• The Conference Report goes on 
to slate that "lljhe Conferees intend for 
this reference to the 'purposes of the 
Act' to underscore their expectation that 
the Commission will assess the impact 
of a proposed exemption on the 
maintenance of the integrity and 
soundness of the markets and market 
participants." Id. 

Energy Contracts are used by certain 
commercial entities that are engaged in 
the production, refining, processing or 
merchandising of crude oil, 
condensates, natural gas, natural gas 
liquids, or their derivatives which are 



*'OiHi commenter. a fururea exchange. In Its letter 
notes tlut Id addrBSslng certain elemenli of the 
public InterMt for futures trading. Congress has 
indicated that contract mariet designation and 
ragutaliDa under the Act is necassary to avoid 
creating an undue tmrden on couunerce Sm 
Section 3 of tlie Act. Seventy years after the 
eoactment of Section 3. however. Congress enacted 
Section 4(c] authorizing exemptions from Section 
4(a) of the Ad, for certain products, because 
"traditiooal futures regulation * ' • may create an 
inappropriate burden on commerce." H.R. Rep. No. 
97«. 102d Cong., 2d Sess 80 (1992) 



used primarily as an energy source. 
Energy Contracts are used by these 
entitles and other commercial entities In 
the conduct of their businesses. 
Reportedly, these markets have been 
chilled by the legal uncertainly 
surrounding these transactions. The 
Order should reduce uncertainty, thus 
allowing participants to nsgoliale and 
structure Energy Contracts In ways that 
most effectively address their economic 
needs, and thereby enhancing the global 
competitive position of U.S. businesses. 
As noted by one commenter, 

"Congress, when considering passage of 
the IFulures Trading Practices of 19921, 
acknowledged that the mandatory exchange- 
trading requirement, if applied to every 
commodity transaction having the indicia of 
a futures contract, may cause foreign market 
participants to engage in such transactions 
outside of the United States, creating 
'competitive disadvantages for U.S. 
participants.' " 

2. Material Adverse Effect on Regulatory 
or Self-Regulatory Responsibilities 

In mailing this determination. 
Congress indicated that the Commission 
is lo consider such regulatory concerns 
as "market surveillance, financial 
integrity of participants prolection of 
customers and trade practice 
enforcement." '" 

The record before the Commission 
does not support a conclusion that the 
purpose of the Ad or the Commission's 
regulatory efforts thereunder have been 
adversely affected by the use of Energy 
C)ontracts or will be so by the issuance 
of the order Energy Contracts have been 
entered into by commercial participants 
in the energy markets for a number of 
years, without any apparent adverse 
impact on market surveillance, financial 
integrity of participants, protection of 
customers and trade practice 
enforcement of regulated markets. 

Specifically, the Commission has 
addressed concerns regarding financial 
integrity and customer prolection 
through the requirement that Energy 
Contracts may only be entered into and/ 
or only be transacted on behalf of 
"appropriate persons", as defined 
above. This approach ensures that such 
transactions involving Energy Contracts 
will be limited to sophisticated entities 
engaged in the businesses described 
above and who are financially able to 
bear risks associated with such 
transactions." 



The Commission also noted that (be 
existence of Eneivy Contracts to data 
has not affected the ability of futures 
exchanges to fulfill their self-regulatory 
duties." In this regard, commenters 
have asserted that the futures market 
and the Energy Contract markets are 
linked, with many of ihe same 
commercial entities using Energy 
Contracts also using the energy futures 
markets for hedging purposes. By 
creating a more certain legal 
environment for Energy Contracts, the 
potential for systemic risk due to 
disaffirmance of sutJi contracts as 
invalid under the Act is reduced, and 
there is no reason to conclude thai the 
exchanges' self-regulatory 
responsibilities will be adversely 
affected by permitting transactions 
under Energy Contracts to continue on 
this basis." 

3. Anticompetitive Considerations 
Section 15 of the Act provides, in 
relevant part, that the Ciimmission must 
consider the public interest to be 
protecled by the antitrust laws and 
endeavor lo take the least 
anticompetilive means of achieving the 
objectives, policies, and purposes of the 
Act in adopting any rule, regulation, or 
exemption under section 4(c). '° Thus, a 
formal analysis under the antitrust laws 
is not, by ilself, dispositive of Ihe issues 
raised by a Commission action."' As a 
result, the Commission is not compelled 
by section 15 lo lake the least 
anticompetitive course of action. Rather, 
where alternatives with varying degrees 
of regulatory benefit exist, the 



'"H.R. No 97«. 102dCong. 2d Sess. 79(1992) 
"In enacting the 1992 Act. Congress explicitly 
authorized exemptioru from alt provisions of the 
Act (except section 2(aKlKB)) and simultaneously 
enacted a " conforming amendment" to section 
12(e|(2) explicitly acknowledging that State 
antifraud statutes of general applicability would 
continue lo apply lo exempted transactions. 



'•In this respect, neither of the two futures 
exchanges commenting on Ihe proposal indicated 
that the proposed order will adversely afTect ibeir 
self-regulatory responsibilities. 

'"The Commission is uruwareof any Energy 
Contracts that provide for settlement by leitiettn% 
an exchange-created delivery instrument, such as 
an exchange-approved depositary or depository 
receipt or shipping certificates, ttiat is specified in 
the r\iles of any designated contract market Energy 
Contracts which did specify such delivery 
Instruments could have an effect on certificated 
supplies for settlement of designated futures or 
option contracts and. accordingly, the rreabon of 
Energy Cjantracls specifying such delivery 
instnimenls should only occur after consuitatioQ 
with IheCommissiorL 

"* Specifically, section 15. as amended by section 
S02(b) of the 1992 Act. provides: 

"The O^mmissiOD stull take Into considaratioD 
the public interest to be protected by the antitrust 
laws and endeavor to lake the least anticompetitive 
means of achieving the objectives of this Act. as 
well as the policies and purposes of this Act. in 
issuing any order or adopting any (!!otniiiissMO rule 
or regulation (including any exemption under 
sections 4(c) or 4c(b), or in requiring or approving 
any bylaw, rule, or regulation of a contrad mariet 
or registered Futures association estabiishwl 
pursuant to section 17 of this Act." 

» See Cordon v. New York Slock ExcAorife. 422 
U S 659. 69(V-e9l {it7l); Silver y. NtwYaik Slack 
Exchange. 37J U.S. 341 II963). 



63 



Federal Register / Vol. 58. Uo. 74 / Tuesday, April 20. 1993 / Notice* 



21293 



Commistion may adopl the approach 
that appears to Nb Iha raott likely to 
achieve the objective*. poUde*. and 
purpose* of the Act. even if that 
approach is not the least 
aiilicompetitive.'' 

Accordingly, section IS reouires the 
Oramissfon to balance the likely 
anticompetitive impact of its action 
against the objective, policy, or purpose 
of the Act which that action may 
further. And. although the Commission 
must consider the public interest in 
maintaining or promoting competition, 
it need not weigh this interest equally 
against an objective, policy or purpose 
of the Act being served in reaching its 
final determination. 

The Commission's consideration of 
the proposed order and its evaluation of 
the comments received in this regard 
has led it to conclude that any possible 
anticompetitive effects are clearly 
outweighed by the order's furtherance of 
the policies, purposes and objectives of 
the Act. First, the proposal does not 
appear to raise any significant 
competitive issues. As a number of 
commenters noted, the exemption, by 
improving the legal certainty o( Energy 
0>ntracts. will reduce the risk that the 
physicals market may be disrupted. 
Commenters also noted that grajiling the 
exemption could result in expanded 
participation by foreign and domestic 
energy companies. Accordingly, the 
exemption furthers a fundamental 
objective of section 4(c)(1) of the Act. 
i e.. promoting "responsible economic 
or financial innovation and fair 
competition." 

For the reasons explained above, the 
Commission, based upon the 
appropriate determinations made in 
accordance with the standards set forth 
In section 4(c) of the Ad. hereby issues 
the following Order 

Order of the Commodity Futarps 
Trading Commiirion Exempting From 
Regulation (Excapl as Specified) 
Certain Eoar^ Cootxacts 

Wherras, it is the Commission's 
understanding, based upon 
representations contained in an 
Application (or Exemption, dated 
November 16. 1992. that contrarts for 
the purchase and sale of crude oil. 
coadensale*. natural gas, natural gas 
liquids, or their derivatives which are 
u^d primarily as an energy source, by 
their terms. Impose binding delivery 
obligations on the parties ("Energy 
Contract*"). These &iergy Contracts do 



nol provide aUbsr party with the 
unilateral right to offset the contract or 
to discbarge its obligatioo under the 
contract by a cash payment, except 
pursuant to a bona fide term of the 
contract permitting the unilateral 
termination of the contract for force 
majeure, insolvency or bankruptcy of 
one of the parties, default or other 
inability to perform, unexpected at the 
time the contract is entered Into ("bono 
fide termination right"). Energy 
Ointracts thus expose the counterparties 
to the substantial economic risk of a 
commercial cash market transaction in 
which delivery of the product is 
required pursuant to the terms of the 
contract. Furtlier, Energy Contracts are 
entered into between principals, and 
their material economic terms 
(including, in particular credit terms) 
are subject to individual negotiation 
between the parties.'' 

The Commission further understands 
that parties to Energy Contracts satisfy 
or otherwise settle their obligations 
through several types of commercially 
acceptable arrangements, including the 
seller's passage of title and the 
purchaser's payment and acceptance of 
the commodity underlying the 
contract." Passage of title and 
acceptance of the commodity 
constitutes performance under a bona 
pde contract regardless of whether the 
buyer lifts or otherwise takes delivery of 
the cargo or receives pipeline delivery, 
or as part of a subsequent separate 
contract, passes title to another 
intermediate purchaser in a "chain", 
"siring " or "drcle" within a "chain." 

The physical delivery obligation 
spedfied in an Energy Conlrad entered 
into between two [)art)es can also be 
satisfied through various other 
arrangements between the parties. For 
example, in the case of crude oil and 
crude oil produds, the physical delivery 
obligation could be satisfied by 
exchanging one quality, grade or 
produd type for another quality, grade 
or produd type. Such transadions are 
referred to in the industry as "grade 
and/or quality swaps" or "exchangea." 
In addition, the obligation could be 
satisfied by location swaps. 

In addition, two parties to an Energy 
O^nlrsd may enter into a bilateral 
"netting" or other similar agreement. 



subsequent to the exscutiiiD of m 
Energy Ointract." Under (uch an 
agreement, the two partiw agree to 
"net" or "book out" the obligstioa* 
imposed under two or more Energy 
Contracts which provide for delivery of 
the same commodity at the same 
delivery location and during the same 
delivery period and thus cancel each 
other. Such a netting agreement can be 
entered into at the time that the 
canceling Energy Cxintrad is originated, 
or subsequently, through a different 
agreement, at a time prior to when 
performance on the contracts otherwise 
would bo due." 

The Commission further understand* 
that under current market practice, the 
parties to the original contrsd may enter 
into a subsequent agreement ( "second 
conlrad ") which provides for settlement 
in a manner other than by physical 
delivery. The second contrad, however, 
cannot stand alone as an independent 
transaction: it is inddenlal to a pi9- 
existing, bona fide Energy Contract. 
Moreover, the establishment of the 
second conlrad caruiot be made a pre- 
condition of the initial Energy Contrad: 
e g , one party cannot require its 
counterparty to agree in advance to the 
establishment of the secoiui contrad as 
a condition of acceptance of the Initial 
Energy Contract Accordingly, the 
second contrad is a separately 
negotiated agreement and, if the 
counterparty subsequently does not 
agree to the second contrad, the parties 
remain obligated in accordance with the 
binding delivery requirements imposed 
under the initial Energy Ck)ntract. 

Existing market practice also permits 
three or more parties, upon Tmding that 
they form a "chain", or a "string " or 
"drcle" within a "chain", to satisfy 
their obligations under an Energy 
Contract, whether or not title passes or 



"Sea. Ag.. BrSish Anwrkan Commcxlity Options 
C-jrp » Bofiley, Comm. Pol L F«p (CCH). »J<S 
•I 2I3MISD.N.Y. l«7e,). tffd In faxlajiditx'd in 
port. Ml ?.li *»1 (Id Or. 1977). cat denicrf. 4M 
US 93* (1977). 



'' Paxtias to Dloiq^ CoJitracIs mtj eslabtisli 
biUloral coJIaleral or other credit protect:ua 
arrangenientf. nich a5a letter of credit or uttier 
documaotarion of fuod) avaiUbility. (o aiMress 
aedil IsaoAS. 

'*Cash mafiel fraosadiona In crude oil, 
petroleuin producu. oabtra] gas aitd nati:ral gaa 
liquids, as welt as othar energy related commodHiea 
In which pky^cai deTivery is made, are pfTeded 
Ihrou^'h payinenl Irv the truys and transfer of Ulle 
try the seller to the Duyar. 



" In the energy maiketa, tlie terms "book out" 
(crude oil) and "book Irajufsr" (other petrvlewB 
pioducis) are cash aiarkel tensj that geoefafly lefar 
to ttie CAOceltabon or nettiog oApfaysicat delirery 
obligations lietween parties, the primary purpose ot 
which is to prevent ot fninlmize the urvecnoomjc 
movetseni of the pkyaica} cotRiDodity. 

""Rather than agreetog to Dst partioslar cancettng 
Ener^ Contracts, two frequent counterpanLas. for 
purposes of ease of admisistxalioe.may usaa 
"master."* or other form of bilaterat a^reameot to 
achieve the sanae result. This inas>er agreement, 
eslablistled prior to entry tnio tbe ta^rgj Coolracls. 
pitjvides that lb« two coualerpartres a^na to oM 
ener^' Contracts of the same coomuxlily at lh« 
same location and during the same delivery period. 
This agreement replaces the practice thai 
counterparties agree to net partkular cBBcebng 
Energy Cgnlncis. eitUer to rtia tuna the sacoiia 
coaliacl is entered Into, oe by a sapenla. 
tubsequast agreeoieol. with the onderstaAdlag Ibat 
all camrttcls between Umb wbrcb caocaJ earii otll« 
wilt b* netted, tmlaea tbay bave agreed not to appJy 
the prior netting agreamaot at Iba lime of entry into 
an Energy Contract. 



64 



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Federal Re^ster / Vol. 58, No. 74 / Tuesday, April 20, 1993 / Notices 



ii deemed to pan, through ■ 
subsequent, separate agreement, with 
unanimous consent of the parties, to 
"book out" and satisfy their obligations 
through separately negotiated bilateral 
cash payments or other mutually 
acceptable terms. It hat been 
represented to the Commission that 
such arrangements are common In the 
energy cash market." They are standard 
commercial practice to avoid and/or 
minimize transaction costs, non- 
economic payments and product 
movements, and for reducing the 
number of transactions necessary to 
perform all obligations between parties 
pursuant to the contracts which are 
"booked out." 
And whereas, this order is limited to 

(A) commercial participants who, in 
connection with their business 
activities: (1) incur risks, in addition to 
price risk, related to the underlying 
physical commodities; (2) have a 
demonstrable capacity or ability, 
directly or through separate bona fide 
contractual arrangements, to make or 
take deUvery under the terms of the 
contracts: (3) are not prohibited by law 
or regulation from entering into such 
Energy Contracts; (4) are not formed 
solely for the specific purpose of 
constituting an eligible entity pursuant 
to this Order; and (S) qualify as one of 
the following entities: 

(i) A bank or trust company; 

(11) A corporation, partnership, 
proprletorsnip, organization, trust, or 
other business entity with a net worth 
exceeding SI. 000,000 or total assets 
exceeding $5,000,000, or the obligations 
of which under the agreement, contract 
or transaction are guaranteed or 
otherwise supported by a letter of credit 
or keepwell support, or other agreement 
by any such entity or by an entity 
referred to in subsections (A), (B), (C), 
(H), (I) or (J) of section 4(c)(3); 

(lii) A broker-dealer subject to 
regulation under the Securities 
Exchange Act of »34 (15 U.S.C. 78a et 
seq.); 

(iv) A futures commission merchant 
subject to regulation under the Act; or 

(B) Any governmental entity 
(including the United States, any state, 
any municipality or any foreign 
government; or political subdivision 
thereof, or any multinational or 
supranational entity or any 



''TIm uMof farokfln. agantt or « Ihlrd-party lo 
IdenUfjr 111* «xU(eoc« of • "duiD" or lo faciltlAI* 
lb« l>ll4lonlly Mgotialed "book oul" oriTwuaclloiu 
forming ■ "chain" It oot doemed lo conitilule • 
clearing tystem. The Cocumluloo hu been advisod 
thai tbm tn ■ number of third-parly broker* and 
■geoU who provide thli lervice In ihe energy cash 
mark«l. 



instrumentality, agency, or department 
of any of Ihe foregoing; 

And whereas, this order also 
encompasses persons offering, entering 
into, rendering advice or rendering 
other services with respect lo the 
agreement, contract, or transaction 
which is the subject of this Order, for 
such activity; 

The Commission, pursuant to section 
4(c) of the Act. hereby exempts from all 
provisions of the Commodity Exchange 
Act, 7 U.S.C. 1 et seq., except sections 
2(a)(1)(B) of the Act and the provisions 
of sections 6(c), 6c, 6(d) and g(a)(2) of 
the Act. to the extent that these 
provisions prohibit manipulation of the 
market price of any commodity in 
interstate commerce or for future 
delivery on or subject to the rules of any 
contract market, the following 
transactions, entered Into on or after 
October 23, 1974: 

Contracts for the purchase and sale of 
crude oil, condensates, natural gas, 
natural gas liquids or their derivatives 
which are used primarily as an energy 
source, and which: 

(1) Are entered into by and between 
participants covered by this Order, having at 
initiation of the contract a reasonable basis to 
believe that its counterparty Is also within 
the terms of this Order. 

(2) Are bilateral contracts between two 
parties acting as principals, the material 
economic terms of which are subject lo 
individual negotiation by the parlies; and 

(3) Impose binding obligations on the 
parties to make and receive delivery of the 
underlying commodity or commodities, with 
no right of either party to effect a cash 
settleraent of their obligations without the 
consent of the other party (except pursuant 
lo a bona fide termination right), provided, 
however, that the parties may enter into a 
subsequent book out. book transfer, or other 
such contract which provides for setllemeDt 
of tiie obligation in a marmer other than by 
physical delivery of the commodity specined 
in the contract 

Issued in Washington, DC, this 13th day of 
April. 1993, by the Cxjmmlssion (Acting 
Chairman Albrecht and Commissioner Dial 
concurring, Commissioner Balr dissenting). 
)tto A. Webb. 
Secretary of the Commission. 

Concurring Opinion of Acting 
Chairman WUliam f. Albrecht 

Today we have before us an 
exemption for large commercial 
participants in off-exchange energy 
based transactions. These transactions 
compose a large ongoing maikel for 
eneigy products of importance to U.S. 
and international commerce. We are 
considering this exemption in response 
to a petition submitted by several 
market participants who seek further 
certainty that this market Is outside 
CFTC regulatory jurisdiction. 



This market for energy product* ha* 
been in existence for many years and 
over those years it has grown in size, 
importance and complexity. The 
Commission has never regulated this 
market, nor has it sought to regulate It. 
The market is characterized by principal 
to principal transactions between large 
sophisticated commercial entities. The 
Commission is not aware of fraudulent 
practices perpetrated against the general 
public by the participants in this 
market, nor Indeed have any of the 
commercial participants in this market 
complained to the Commission of 
fraudulent practices by other 
participants. Also, there generally do 
not appear to be any concerns about the 
ability of these market participants lo 
perform their obligations. Absent two 
events it is doubtful that the pelllloners 
would have brought their request to us. 

First, a vast number of transactions 
previously not considered to be within 
the scope of the Commodity Exchange 
Act were brought into question by a 
single court decision, Transnor 
(Bermuda) v. BP North America 
Petroleum, that applied the CEA lo a 
foreign market of mostly commercial to 
commercial trarsactions. The 
Commission did not believe these 
transactions were Ihe off-exchange 
"futures" contracts that Congress 
intended lo prohibit and the 
Commission Issued a statutory 
interpretation to that effect. Obviously, 
the parties in Ihe 15 day Brent Market- 
major international oil and trading 
companies — should not have been able 
to escape their contractual obligations in 
these transactions by claiming the 
transactions were void as illegal futures 
contracts. 

Second, the Commission's new 
exemptive authority granted by 
Congress in the Futures Trading 
Practices Act of 1992 frees the 
Commission from the constraints of the 
futures/forwards dichotomy. In this 
regard the exemptive authority allows 
the Commission to approach situations 
on a case by case basis. This freedom to 
try new approaches is the real value of 
the exemptive authority. The 
Commission is now able to review 
petitions or requests for exemption on a 
public policy basis In light of the 
seventy year history of regulating 
futures contracts as well as the current 
and expected needs of commerce. 

I believe that public policy dictates 
that the Commission exempt the market 
before us today from Commission 
regulation. There does not appear lo be 
any reason sufficient lo justify 
Commission regulation, nor any 
necessity for Ihe Commission lo Involve 
itself in this market. I view this market. 



65 



Federal Register / Vol. 58, No. 74 / Tuesday, April 20, 1093 / Notice* 



21295 



lu tianMctlooi, end peitidpanU u 
clearly within the tcope intended by 
CongreM for the exerdse of the 
Commlulon't new exemptive authority. 
Indeed, in enacting the exemptive 
•uthority Congress specifically directed 
us to address Uie crude oil market. 

Soma have ai^jued that the 
Commission should not exempt these 
markets from the anti-fraud 
requirements of section 4b of the CEA. 
I disagree. First, in this commercial to 
commercial market there has not been 
shown any need for the Commission to 
take any action to prevent fraud. 
Second, >s the Commission will not be 
Involved with ongoing regulation of this 
market, or even be more than generally 
knowledgeable of the activities in this 
market, it will not possess the 
information necesssry to enforce 
Section 4b. Third, the presence of 4b 
will be of little potential benefit and 
great potential harm. The terms of 4b 
limit its application to futures contracts 
entered into for or on behalf of a 
customer — serious limitations where the 
transactions are largely principal to 
principal and where the Individual 
transactions would have to be proved to 
be futures contracts. Further, If a party 
to one of those exempt transactions were 
to seek to base a complaint on Section 
4b, they would face the problem that the 
commission has also chosen to exempt 
this market from section 22 of the Act, 
thus they may not have any right to 
bring a private action under the CEA. 
The potential harm of maintaining 4b 
jurisdiction Is that such action on one 
Dand may hinder the development of 
this market, undermining the legal 
certainty we seek to assure today and on 
the other hand give some the illusion of 
federal supervision by the CFTC, when 
in fact the CFTC does not and can not 
supervise this market. 

Exemptive Order for Certain Energy 
Contracts, Concurring Opinion of 
Commissioner Joeeph B. Ola] 

AAer the enactment of the FTPA, we 
find ourselves In the peculiar situation 
of possessing an exemptive authority 
that does not require our determination 
that something Is a futures contract In 
order to exempt if bom out jurisdiction. 
At least that's what the conference 
report language tells u«. 

Accordingly, we have worked 
diligently to avoid steppiiig on the legal 
and policy land mine* Inherent In this 
authority. I have gone over the new law 
and the conference report, as well as the 
case law end Commission 
interpretations in the area of forward 
contract deBnition. in light of concerns 
regarding Section 4b of the Act and this 
exemption, and the differing 



Institutional opinions on this issue, I'd 
like to make clear how I view this 
exemption. 

First, It Is understandable that people 
ihake a comparison between the swaps 
and hybrids exemptive authority this 
commission exercised In January, and 
the exemptive authority we are 
approving today. We are new at this 
endeavor, and so have little background 
as an Institution in using this particular 
authority. Therefore, I think It Is 
Important to note some of the 
dilTerences I see between today's 
exercise and the exemptive action the 
Commission took on January 14, 1993. 

The forwards markets are understood 
to be fundamentally different from the 
swaps markets. In effectuating the 
swaps exemptive authority, we did not 
have the longstanding Institutional 
experience that we do with forwards 
markets and their evolution. Swaps are 
a relatively new field of complex 
financial transactions, and are still the 
object of intense study by the 
government and the private sector. 
Therefore, the Commission deemed it 
prudent to retain 4b so that, for 
example. If In the unlikely event an 
unscrupulous entity were to convolute a 
swaps transaction into a boilerroom- 
type futures transaction, we could act 
expeditiously against such conduct. 

Conversely, with the exercise of 
exemptive authority as to the energy 
contracts In current usage as described 
In this proposal, we have extensive legal 
and policy background relating to these 
well-known commercial markets. 

As my colleagues are aware, 1 take a 
strong pro-enforcement stance In the 
Investigation and prosecution of fraud 
In the markets we regulate. However, 
after reviewing the current request for 
exemption for existing markets, and In 
light of the Brent interpretation and the 
continuing evolution of these 
commercial transactions, I believe it 
more proper, from a policy and legal 
standpoint, not to retain 4b authority as 
to contracts described In this 
exemption. I came to this view after 
Interpreting the conference report 
language regarding the use of exemptive 
authority In this area to Indicate a need 
for clarincatlon of our Brent 
Interpretation. While I recognize that 
this exemption Is regarded as an 
expansion of Brent, I view our action 
here today to be in accordance with the 
Congressional directives In the FTPA. 
Therefore, I've concluded that 4b should 
not be retained regarding exemptive 
authority for existing practices In these 
energy contracts. 

If, after approval today, someone 
commits a fraudulent act relating lo 
what appears on the surface lo he an 



exempt ane;gy transaction within tUi 
proposal, but U proven latar to hia 
futures contract outside the paramalara 
of this proposal, then the COmmltsIon of 
course nas authority to prosecute that 
fraudulent conduct under 4b. 

This exemption Is unique, given Its 
factual and legal background. I believe 
that by approving it we are exercising 
our exemptive authority In a manner 
consistent with Congressional Intent 
We era allowing existing energy contract 
practices in these markets, whose 
historical record Is well-documented, to 
continue to perform a useful function lo 
the International marketplace. 

Dissenting Opinion of Commlnionar 
Sheila Bair 

Mr. Chairman. I have decided, albeit 
reluctantly, to vote against the final 
order before us today because of Ila 
failure to retain the general anti-fraud 
provisions contained in section 4b and 
4o of the commodity Exchange Act. Let 
me Just briefly summarize the policy 
reasons why I believe we should retain 
such authority in the energy exemptive 
order. 

In my view, the final order, by its 
terms, is not limited to forward 
contracts traditionally excluded from 
the jurisdiction of this agency. Rather, it 
goes slgnificanlly beyond the forward 
contract exclusion and extends to 
transactions which could very well meet 
the criteria for illegal off-exchange 
futures contracts traditionally applied 
by this agency and the courts. I Dellevs 
that exempting such transactions from 
statutory provisions as basic and central 
to our regulatory scheme as Sections 4b 
and 4o is a serious misapplication of our 
new exemptive authority, and sets • 
dangerous precedent. 

The Proposed Order Goes Beyond the 
Forward Contract Exclusion 

As I stated, the order, by Its terms, U 
not limited to forward contracts. 
Further, the fact that we are proceeding 
with an exemption from our 
Jurisdiction, as opposed to describing a 
class of excluded transactions, 
demonstrates ImpUdt recwnltlon that 
some of the transactions which we ara 
exempting could indeed be future*. 
Moreover, ^narkets which qualih fcr ' 
this exemption operate very diflerently 
from traditional lorward markets. Tha . 
contracts are standardized, there is a 
large amount of speculative activity, and 
the overwhelming majority of 
transactions do not result Id delivery, ^■ 
but are cash fettled. 

Indeed, tha only arguable 
distinguishing feature between exeinfrt * 
transactions under the order and tha 
typical gasoline boiler room operation it 



66 



:i298 



Federal RejMer I VoV. 58, No. 74 / Tuesday. April 20. 1993 / NoUce« 



the requirement that participants be 
commenHal entities. Yet. the 
"commeidalitr" requ lre ineirt in the 
order is by and large uodeGned. 
MoreoTer, the Commission, has nerer 
recognized an exemption to its 
jurisdiction based solely on the 
"commerciality" of the participants, nor 
can I see any policy reason why 
commercial firms engaging in futures 
transactions should not have the basic 
protection of our anti&aud provisions. 

The "SophistJcatios" of Market 
Participants is Not a Vahd Basis for 
Providing oa Anti-Fraud Exemption 

II has beoi argued that because the 
participants in exempt energy 
transactions are "sopnislicated" 
institutional users or entities of high net 
worth. Ihey don't "need" CFTC anti- 
fraud protections. 

At the outset. T would note that if we 
are to rationalize exemptions from anti- 
fraud and other components of our 
regulatory scheme on the basis of the 
"sophistication" of market users, we 
might as well close our doors tomorrow, 
because approximately 98% of users of 
regulated, exchange-traded futures meet 
the eligibility rquirements of our swaps 
rule, and, these financial requirements 
are much higher than those in the order. 
Moreover, large firms are defrauded — 
we have brought a number of 
enforcement actions where the victims 
have been so-called inslitutional or 
sophisticated investors. I would also 
add that this order does allow for 
indirect public participelion through 
collective investment vehicles, ana 
thro(4gh the guarantee provisions In 
paragraph il of the appropriate person 
portion of the order. 

The Existence of State Aati-Fraud 
Remedies is Irrelevant to the Issue at 
Hand 

In addition. I do not view the 
existence of state anti-fraud remedies as 
a valid policy basis for providing an 
exemption from the CEA's basic anli- 
fraud protections. State remedies are 
always available in the absence of 
federal protections. It Is Important to 
remember that it was the historical 
inadequacy of slate law protections, 
however, ual gave rise to federal 
regulation of flnancial markets in the 
first placa 

Retaining Sesklaal Anti-Fraud 
Authority Would Not Place An Onerous 
burden on the Uarket* 

I also do not believe It»t we would 
place an ODerous bnrden on the inailsU 
by retaining anti-fraud autiiority. 

If we retained 4b and 4o, Ihey would 
apply to those fraudnlent transactiom 



which we could demonstrate i 
futures contracts and thus otherwise 
subject to the CEA. In addition, since we 
are preserving the Brent Oil statutory 
interpretation, defendants would still be 
able to rely on that document as a shield 
against CfTX) actions. Moreover, 
participants in these markets have 
always run the risk that transactions 
which do not meet the statutory 
interpretation could be deemed 
"futures" and thus subject to the whole 
plethora of CEA requirements, not just 
anti-fraud prohibitions. That is precisely 
why we are moving forward witn this 
order. Is 11 really that much of a burden 
on market participants to retain a sliver 
of authority r^arding fraudulent 
activity? 

It should also be emphasized that 4b 
and 4o apply no more of an onerous 
burden on these markets than does slate 
anti-fraud law. Indeed, given conflicts 
in stale law. providing federal forums 
and remedies to these transactioas is. if 
anything, less onerous. 

Providing aa Anti-Fraud Exemption 
Would Set a Dangerous Precedent and 
Is Unnecessary Given Our New 
Exemptive Authority 

Finally, I think we are setting a 
dangerous precedent by not retaining 
anti-fraud authority. I can see no valid 
policy reason why to decide lo retain 
anti-fraud authority in our swaps rule, 
yet lo declirte lo do so here. My fear is 
that we win inevitably raise the 
expectations of other potential 
applicants for exemptive relief that they 
will also be able to escape Sections 4b 
and 4o. 

What Is especially frustratinig lo me is 
that we do aol oeea to paint ourselves 
into this comer. The scaia raasoo why 
the CFTC sought general examptiva 
authority in last year's reauthorization 
was so that we would have the 
flexibility to craft appropriately lailored 
exemptive relief based on public policy 
considerations, instead of having lo deal 
with the "all or nolhing" jurisdictiouil 
decisions we had to make in the past. 
Yet. we are still following this "all or 
nothing" approach, when in my view, 
we should be carefully weighing 
individual aspects of our tegulalnry 
striurlure and makiiig a raasooad 
determination as to which requirements 
shonld and should not ^ply loa 
particular class of IraasacUons. And, for 
the reasons 1 have stated, I do not 
believe the case has been made lor 
providing an exemption from basic anti- 
fraud provlsioni. 

IFR Doc 83-9037 Piled 4-19-93: 8:4S ami 
Bajj<o COM nsi-oi-a 



67 



statement of Sheila Bair 

Commissioner 
Commodity Futures Trading Commission 

Before the House of Representatives Committee on Agriculture 

Sulscommittee on Conservation, Credit 
and Rural Development 

April 28, 1993 

Mr. Chairman, members of the Subcommittee, thank you for the 
opportunity to appear before you today to discuss the Commission's 
recent order exempting certain energy contracts from the Commodity 
Exchange Act. I voted against the exemptive order because it did 
not retain the general anti-fraud provisions of the Act. I voted 
as I did because I think that exempting these transactions from 
statutory provisions as basic and central to our regulatory scheme 
as Sections 4b and 4o is a serious misapplication of our new 
exemptive authority, and sets a dangerous precedent. Before I 
discuss the specific policy reasons underlying my view that the 
Commission should retain such authority, I would like to discuss 
some general issues related to the energy exemption. 

At the outset, let me say that I believe that the Commission 
had the statutory authority to grant energy contracts an exemption 
from the provisions of the Commodity Exchange Act, including the 
antifraud provisions of Sections 4b and 4o. Section 4(c) of the 
Act, which was recently added, gives the Commission the authority 
to "exempt any agreement, contract or transaction . . . that is 
otherwise subject to subsection fa) . . . from any of the 
requirements of subsection (a) or from any other provision of the 
Act (except section 2(a)(1)(B)) if the Commission determines that 



68 



2 
the exemption would be consistent with the public interest." 
(emphasis added) . 

Subsection (a) of Section 4 of the Act, referred to in the 
Commission's exempt ive authority, requires that futures contracts 
be traded on contract markets designated by the Commission. Thus, 
under Section 4(c), the Commission has the authority to exempt 
futures contracts from the provisions of the Act. The legislative 
history to Section 4(c) makes it clear that Congress did not intend 
that the Commission needed to make a determination that a product 
is a futures contract before granting it an exemption from the Act. 
However, any exemption granted by the Commission is effective only 
to the extent that the product exempted is a futures contract 
subject to the Act. The Commission's exemptive order for energy 
contracts did not specify whether those contracts are futures. The 
Commission's exemptive order did leave that possibility open and 
is, in my view, effective to the extent that the energy contracts 
at issue are futures. 

Further, let me say that I did not oppose, in concept, some 
type of exemption from the Act for the Brent crude oil contracts. 
As the legislative history to Section 4(c) noted, one court in a 
decision in Transnor (Bermuda) Limited v. BP North America 
Petroleum , has found that these contracts are futures contracts. 
The legislative history to Section 4(c) encouraged the Commission 
to review the situation regarding Brent contracts and "to determine 
whether exemptive or other action should be taken." Conf. Rep. at 
82. 



69 



3 

I was amenable to a properly tailored exemption for the Brent 
market because I could see why uncertainty as to the legal status 
of this market persisted after the Commission's September 1990 
issuance of a Statutory Interpretation determining that Brent 
contracts were forward contracts excluded from the Act. As former 
Commissioner Fowler West's dissent to the Brent Statutory 
Interpretation correctly points out, the Brent Statutory 
Interpretation went far beyond generally accepted criteria in 
defining Brent contracts as forward contracts. In the Brent 
Statutory Interpretation, the Commission was forced to depart from 
the traditional requirement that the parties to a forward contract 
contemplate delivery and that delivery routinely occurs in order to 
avoid concluding that Brent market transactions were illegal off- 
exchange futures. The Commission had little choice but to take 
such an approach to defining forwards, because it lacked the 
authority to exempt futures contracts from the Act. 

The Brent Statutory Interpretation, however, did not provide 
the legal certainty that the Brent market participants sought. The 
Brent Statutory Interpretation was such a departure from the 
traditional view of forwards that it left open the possibility that 
a court could disagree and find that Brent contracts were futures 
contracts subject to the Act, in spite of the Commission's view 
that they were not. I believe that this is exactly the type of 
situation that the Commission's exemptive authority is meant to 
address. Legitimate, ongoing commercial activity was being 
threatened by uncertainty about the legal status of conducting such 



70 



4 

activity off an organized exchange. The Commission could end that 
uncertainty by granting an exemption from the Act. In such a case, 
I believe that the proper course was for the Commission to grant an 
exemption retaining, at the least, anti-fraud and anti-manipulation 
authority. I would have supported an exemption for the Brent 
market on these terms. 

Retention of anti-fraud and anti-manipulation authority is 
even more important to me in the context of the exemptive order 
issued by the Commission because this order grants relief 
significantly beyond the Brent market and the Brent Statutory 
Interpretation. The Brent Statutory Interpretation was crafted to 
address contracts for the delivery in the Brent oil market, where 
a single cargo consists of 500,000 barrels of oil with a current 
market value in excess of $10 million. The energy exemption, on 
the other hand, encompasses any contract for the purchase and sale 
of all types of crude oil as well as condensates, natural gas, 
natural gas liquids or the derivatives of these commodities, 
without regard to the size of the transaction. 

Further, expansion of the types of contracts granted relief 
necessitated expan^on of the types of offset arrangements 
permitted under the exemption in order to reflect the practices of 
markets other than the Brent market. The Brent Statutory 
Interpretation described several alternatives to delivery: strings, 
chains, loops and book-outs. These arrangements are all negotiated 
subsequent to entry into a Brent contract. Because there is no 
preexisting obligation to enter into such arrangements, parties to 



71 



5 

Brent contracts retain the risk that they will have to make or take 
delivery in the absence of counterparty willingness to offset the 
delivery requirement, and that someone, in fact, will always have 
to take delivery of each Brent cargo. 

The energy exemption permits these alternatives to delivery as 
well as the use of master agreements established prior to entry 
into an energy contract. Master agreements, used in some of the 
markets covered by the exemption, provide that the two 
counterparties agree to net energy contracts of the same commodity 
at the same location and during the same delivery period. The 
presumption under a master agreement is that all contracts between 
the counterparties which cancel each other will net, unless the 
parties agree not to apply the prior netting agreement at the time 
of entry into an energy contract. Participants in these markets 
that use master agreements can net all transactions in a particular 
month, with no intention to take delivery of any amount of oil, and 
no ultimate movement or change in ownership of the commodity . 

In addition, the scope of entities eligible for the energy 
exemption is significantly broader than those described in the 
Brent Statutory Interpretation. The Brent Statutory Interpretation 
described the participants in the Brent market as producers, 
processors, refiners and merchandisers of petroleum products and 
other entities that buy and sell petroleum in connection with a 
line of business. The entities eligible to participate in exempt 
energy contracts include, among others, banks, governmental 
entities, including municipalities, corporations, partnerships and 



72 



6 

proprietorships with a net worth exceeding $1 million or total 
assets exceeding $5 million or the obligations of which are 
guaranteed or supported by a line of credit from an eligible 
entity, including a bank, savings and loan, broker-dealer or 
futures commission merchant. A footnote to the exempt ive order 
makes clear that commodity pools and other collective investment 
vehicles as well as floor brokers and floor traders can be eligible 
participants in exempt energy contracts so long as they meet the 
net worth or guarantee requirements for business entities and 
qualify as "commercials" for purposes of the order. 

This expansion of eligible entities would not be so 
significant if the commerciality requirement of the Brent Statutory 
Interpretation had been preserved. However, this requirement has 
been loosened considerably. The Brent Statutory Interpretation 
emphasizes that transactions in Brent contracts are entered into 
for commercial purposes in normal commercial channels and are 
related to the business of the parties to the contract. These 
parties were subject to substantial economic risk, including risks 
related to delivery such as demurrage, damage, theft and 
deterioration . 

On the other hand, exempt energy contracts may be entered into 
by "commercial participants who, in connection with their business 
activities incur risks, in addition to price risk, related to the 
underlying physical commodities." This sounds impressive, but a 
publicly offered commodity pool or a floor broker with a partial 
interest in a single oil well could, in good faith, claim that it 



73 



7 
met the risk portion of the commerciality test. Indeed, it could 
be argued that an entity could become a "commercial participant" 
for purposes of the exemption simply by entering into an exempt 
transaction. This is because the terms of an exempt energy 
contract expose the parties to the contract to the risk of owning 
the commodity. This circularity essentially nullifies the 
commerciality requirement of the energy exempt ive order. 

Related to the definition of commerciality is the capacity to 
make or take delivery under the contract. In the Brent Statutory 
Interpretation, the participants in Brent contracts were described 
as having the capacity to actually make or take delivery of cargoes 
of Brent crude oil. On the other hand, the Commission's energy 
exemptive order permits participants to contract out for delivery 
capacity and permits business entities that do not meet the net 
worth requirements of the order to participate in exempt energy 
contracts though guarantees provided by other business entities 
which meet the net worth requirement, or by a bank, savings 
association, insurance company, broker-dealer, futures commission 
merchant which are not required to meet any net worth requirement. 
Taken together, these provisions of the energy exemptive order 
describe a system virtually identical to that used by traders who 
trade on futures contracts with the benefit of a performance 
guarantee provided by their carrying futures commission merchant. 

In my view. Brent contracts, as described in the Brent 
Statutory Interpretation, may well be futures contracts under the 
traditional criteria applied by the courts and the Commission. The 



74 



8 

Commission's energy exemption is an expansion of the Brent 
Statutory Interpretation in markets covered, delivery alternatives 
permitted, market participants deemed appropriate, level of 
commerciality required and the type of delivery capacity needed. 
As a result, it is quite probable that many of these exempt 
transactions are, in fact, futures contracts within the meaning of 
that term developed by the Commission and the courts. 

My conclusion that the energy order exempted futures contracts 
from the provisions of the Act reinforced my view that, as a 
general rule, the Commission should retain anti-fraud authority 
whenever it grants an exemption under Section 4(c). As I will 
explain, I was not convinced that, in the context of the energy 
exemptive order, the case had been made for making an exception to 
my strong preference that we retain anti-fraud authority in 
exemptions. As a result, I dissented from the Commission's order 
exempting energy transactions. 

One of the primary arguments advanced for granting an 
exemption to the anti-fraud provisions of the Act has been that the 
participants in exempt energy transactions are "sophisticated" 
institutional users or entities of high net worth who do not "need" 
the anti-fraud protections of the Act. At the outset, I would note 
that if we are to rationalize exemptions from anti-fraud and other 
components of our regulatory scheme on the basis of the 
"sophistication" of market users, we might as well close our doors 
tomorrow, because approximately 98% of users of regulated, 
exchange-traded futures are also "sophisticated" institutional 



75 



9 
users or entities of high net worth. Moreover, the Commission has 
never recognized an exception to its jurisdiction based solely on 
the "sophistication" of market participant, nor can I see any 
policy reason why sophisticated firms should not be covered by 
basic anti-fraud provisions. 

Additionally, we all know that large firms are defrauded. 
The Commission has brought or assisted in a number of actions where 
the victims have been so-called institutional or sophisticated 
investors. For example, with the Commission's assistance, the 
employee of a bank holding company was convicted of defrauding a 
number of banks in Pennsylvania in connection with their futures 
trading. Last summer, the Commission found that a regional 
brokerage firm had engaged in unauthorized trading of the account 
of a now-failed savings and loan with the assistance of an employee 
of the S&L. 

Further, as I have described, the Commission's exemptive order 
permits participation in exempt energy transactions by 
comparatively low net worth individuals or small businesses, 
through the footnote permitting collective investment vehicle 
participation, the $1 million net worth threshold for corporations 
and proprietorships and the sweeping guarantee provision. The 
participation of such entities not only undermines the 
sophisticated institution argument for an exemption from the anti- 
fraud provisions of the Act for energy transactions it also 
increases the likelihood of exempt energy boilerrooms that target 
small business. Finally, because the order fails to expressly 



76 



10 

retain Section 4o authority, it is unclear if the Commission has 
the authority to sue a registered commodity pool operator for 
fraudulent representations to prospective pool investors concerning 
the pool's participation in exempt energy transactions. 

For all of these reasons, I was unpersuaded that an exemption 
from the anti-fraud provisions of the Act could properly rest on 
the types of participants permitted to use exempt energy 
transactions . 

Another argument made to justify an exemption from the anti- 
fraud provisions of the Act is that retaining these provisions 
would place an onerous burden on the energy markets. First, I must 
emphasize that if the anti-fraud provisions of the Act had been 
retained, they would only apply to fraudulent transactions. In 
order to prevail, our Division of Enforcement would have to show 
both that fraud occurred and that the transaction in question was 
a "futures contract" subject to the jurisdiction of the Act. In 
addition, participants in Brent contracts would still be able to 
brandish the Brent Statutory Interpretation as a shield against 
CFTC enforcement action because the energy exemptive order 
preserved the viabilj.ty of that document. 

It should also be emphasized that 4b and 4o apply no more of 
an onerous burden on these markets than does state anti-fraud law. 
Indeed, given conflicts in state law, providing federal forums and 
remedies in connection with these transactions is, if anything, 
less onerous than forcing participants, many of which are not U.S. 
companies, to resolve their disputes under state law. 



77 



11 

Further, at least some of the energy contracts exempted by the 
Commission are subject to a foreign regulatory scheme that appears 
to be more onerous than retention of the anti-fraud provisions of 
the Act would be. For example, 15-day Brent contracts are 
considered "investment contracts" under the United Kingdom's 
Financial Services Act, a category of contracts that includes 
futures. The Financial Services Act contains limitations on the 
types of customers who can participate in non-exchange traded 
investment contracts, such as 15-day Brent contracts. The 
contracts are also subject to an Oil Market Code of Conduct 
promulgated by the Securities and Investment Board, a body which is 
empowered to enforce the Financial Services Act. The Oil Code of 
Conduct, among other things, prohibits the making of misleading 
statements and misleading conduct in connection with 15-day Brent 
contracts. The Oil Code of Conduct refers in this regard, to 
Section 47 of the Financial Services Act, violation of which 
constitutes a criminal offense punishable by up to 7 years 
imprisonment or a fine or both. 

In these circumstances, I did not see that it was much of a 
burden on market participants to retain the anti-fraud provisions 
of the Commodity Exchange Act. 

I have also heard the argument that federal anti-fraud 
remedies are unnecessary because state remedies remain available in 
the absence of the anti-fraud provisions of the Act. I simply do 
not view the existence of state anti-fraud remedies as a valid 
policy basis for providing an exemption, from the Act's basic anti- 



78 



12 

fraud protections. It is important to remember that it was the 
historical inadequacy of state law protections that gave rise to 
federal regulation of financial markets, including the Commodity 
Exchange Act and the CFTC, in the first place. In view of these 
concerns, I was not persuaded that state remedies provided an 
adequate alternative to the anti-fraud provisions of the Act. 

In addition, I could see no valid policy reason for 
distinguishing the Commission's retention of anti-fraud authority 
in the Commission's swaps rule from the failure to do so in the 
energy exemptive order. Both swaps and energy contracts are 
principal to principal contracts in which brokers are permitted to 
facilitate transactions. Both permit letters of credit and 
guarantees to substitute for net worth in determining the 
eligibility of some participants. In fact, the asset thresholds 
for eligible swap participants are significantly higher than those 
required of eligible energy contract participants. Because the 
energy exemptive order is broader than the swaps rule in allowing 
low net worth individuals and businesses qualify to participate in 
exempt transactions, the energy order would, if anything, seem to 
present an even stronger case for retaining anti-fraud protections 
than the swaps rule. 

I also think that the Commission set a dangerous precedent in 
not retaining the anti-fraud provisions of the Act in the energy 
exemption. To my knowledge, it is unprecedented for the Commission 
to provide relief from anti-fraud provisions for a transaction that 
is not subject to the jurisdiction of another regulator. Even 



79 



13 
Commission rules governing trade options, which are options offered 
to commercials in connection with commodities used in their 
business, are subject to an antifraud provision. Retention of 
anti-fraud jurisdiction is standard in exemptions granted by the 
Securities and Exchange Commission, even those that involve very 
high net worth investors. My fear is that the Commission has 
raised the expectations of other potential applicants for exempt ive 
relief, including the futures exchanges, that they will also be 
able to escape Sections 4b and 4o. Remember, approximately 98% of 
users of regulated, exchange-traded futures are sophisticated 
institutional users or entities of high net worth. 

Finally, I see the struggle over whether to retain anti-fraud 
authority over exempt energy contracts as a sign that the 
Commission is not yet taking full advantage of the flexibility 
provided by our broad exemptive authority. I find this very 
frustrating. The primary reason why the CFTC sought general 
exemptive authority during its reauthorization was to give us the 
flexibility to craft appropriately tailored exemptive relief based 
on public policy considerations, instead of continuing to deal with 
the "all or nothing" jurisdictional decisions that the Act required 
in the past. I see the energy exemptive order as evidence that we 
are still following this "all or nothing" approach when, in my 
view, we should be carefully weighing individual aspects of our 
regulatory structure and making a reasoned determination as to 
which requirements should and should not apply to a particular 
class of transactions. 

Thank you. 



80 



statement of Joseph B. Dial 

Commissioner 

Commodity Futures Trading Commission 

Before the 
Subcommittee on Environment, Credit and Rural Development 

April 28, 1993 

Concerning the exemptive order for certain energy contracts. 
Approved by the Commission April 13, 1993 

As I stated in my concurring opinion to the exemptive order 
relating to certain energy contracts, issued by the Commission on 
April 13, 1993, I believe that this exemption was unique, given its 
factual and legal background. In my comments on the 13th I 
expressed the belief that Congress intended to allow existing 
energy contract practices in these markets to continue to perform 
a useful function in the international marketplace. I noted my 
belief then, and respectfully submit to you today, that the 
Commission was exercising its exemptive authority in a manner 
consistent with Congressional intent. 

From November 16, 1992 to April 13, 1993, I relied on the 
plain language of the Futures Trading Practices Act and the 
conferees' report as my guide in reaching a decision on the energy 
proposal. There are seven factors explicitly stated in the statute 
and conference report that I referred to time and time again: 

1. The conference report to the Futures Trading Practices 
Act of 1992 (FTPA), in a paragraph in the exemptive authority 
section entitled "Forwards," specifically provided that "[T]he 
conferees encourage the Commission to review this situation and 
these contracts to determine whether exemptive or other action 
should be taken." (FTPA, at 82). 



81 



2. The conferees indicated that the exemptive authority 
should be used to "create legal certainty for a number of existing 
categories of instruments which trade today outside of the forum of 
a designated contract market." (FTPA, at 80) (emphasis added). 

3. The conferees further stated that the Commission should 
use the exemptive authority promptly in the "areas where 
significant concerns of legal uncertainty have arisen," including, 
among others, forwards. (FTPA, at 81). 

4. The conferees specifically did not express a view 
regarding the applicability of the Commission's Brent 
interpretation. (FTPA, at 82). 

5. The conferees expressly stated that the exercise of this 
exemptive authority would not "require any determination before 
hand that the agreement, instrument, or transaction for which an 
exemption is sought is subject to the Act." (FTPA, at 82, 83). 

6. The FTPA provides that the Commission may exempt an 
agreement, contract, or transaction from Section 4(a) of the Act, 
"or from any other provision of this Act (except section 
2(a)(1)(B)), if the Commission determines that the exemption would 
be consistent with the public interest." (FTPA, Section 
502 ) (emphasis added)*. 

7. The Conferees stated that the public interest test should 
"include the national public interests noted in the Act, the 
prevention of fraud and the preservation of the financial integrity 
of markets, as well as the promotion of responsible economic or 
financial innovation and fair competition." (FTPA, at 78). 



82 



Given each of these factors, it remains my determination that 
the exemptive order as approved by the Commission was appropriate. 
The conferees chose to allow our prior Statutory Interpretation 
Concerning Forward Transactions , [1990-1992 Transfer Binder] Comm. 
Fut. L. Rep. (CCH) § 24,925 (September 25, 1990 ) (hereinafter 
referred to as the Brent Interpretation) to stand. Furthermore, 
the language of the conference report clearly states that CFTC does 
not have to find a contract within our jurisdiction in order to 
exempt it. Accordingly, I voted to provide the requested relief to 
existing "forwards-like" markets which could arguably come under 
the penumbra of the Brent interpretation, believing we should treat 
these more as "excluded forwards" than as "exempted futures." As 
such, I made the decision that the application of Section 4b to 
these contracts was inapposite. 

I based this decision in part on my understanding of the 
legislative intent regarding regulation of forwards contracts. The 
Section 2(a)(1) exclusion for such contracts was grounded on the 
premise that "the Act's regulatory scheme for futures trading 
simply should not apply to private commercial merchandising 
transactions which create enforceable obligations to deliver but in 
which delivery is deferred for reasons of commercial convenience or 
necessity." (Brent Interpretation, at 37,367). That 
interpretation described the Commission's determination as to what 
"commercial-to-commercial transactions involving commodities it 
considers to be within the scope of the Section 2(a)(1) exclusion." 
(Brent Interpretation, at 37,368). Included within that scope of 



83 



exclusions are "transactions [which] create specific delivery 
obligations . . . [which] create substantial economic risk of a 
commercial nature to the parties . . . ." (Brent Interpretation, 
at 37,368) . 

I believe that the contracts which were the subject of the 
April 13, 1993 exemptive order were sufficiently within the 
penumbra of the Brent Interpretation so as to warrant similar 
treatment. These contracts are restricted to commercial entities, 
and create delivery obligations that entail market risk. Even 
though parties may enter subsequent contracts to discharge the 
obligations (for example, agreements akin to the cancellation 
agreements discussed in the Brent Interpretation), this does not 
nullify the market risks attendant to these transactions. 
Similarly, even though the parties may satisfy the capacity 
requirement of the exemption by executing bona fide contracts for 
services such as production, refining, or storage, this still 
requires the ability to bear market risks involved with the 
transactions . 

Accordingly, I believe that the exemptive authority 
sufficiently delimited the relief to existing markets which come 
within the general category specified in the conference report 
paragraph noted above, entitled "Forwards." This, I believe, 
indicates that the fraud protection available to current 
participants in the forwards market is sufficient for contracts 
included in the exemptive order, and renders the application of 
Section 4b inappropriate. I took this into account in reviewing 



84 



the various components of the public interest test, and I came to 
the decision to support the energy exemption order as it was 
approved after carefully reviewing the nature of the relief 
requested, the existing markets, the above-mentioned directives of 
the conference report and the statute. 



85 



April 9, 1993 



MEMORANDUM 



TO: Files 

FROM: Andrea M. Corcoran 

Division of Trading and Markets 

RE: Exemption for Certain Contracts in Energy Products 



This memorandum sets out reservations, which I have shared 
with each Commissioner, concerning the draft Order that exempts 
certain contracts from most provisions of the Commodity Exchange 
Act--in particular, the anti-fraud provisions.^ 

The new flexibility afforded the Commission by the Futures 
Trading Practices Act of 1992 provides welcome relief from the 
need to make "all or nothing" decisions on the legality of 
products subject to our jurisdiction. The opportuni*-y to reduce 
current restraints on commerce and to permit markets to evolve, 
however, does not alter the Commission's overriding 
responsibility to protect the public interest. 

As drafted, the exemption covers certain collective 
investment vehicles and permits speculative transactions as well 
as transactions based upon commercial need. The retail public 
who might participate in such entities would be unlikely, absent 
the blandishments of the salesman, to enter speculative 
transactions in energy prices. Similarly, small comjnercials 
would be unlikely to enter such transactions in the ordinary 
course of their businesses.^ 



''l have signed the draft as consulted on behalf of the 
Division of Trading and Markets, and many of ray suggestions have 
been incorporated. Ultimately, however, policy concerns are 
committed to Commission discretion. 

^Among the public policy implications of developments that 
the Commission is asked to specifically stxidy and report on to 
Congress at the end of fiscal 1993 are those resulting from the 
case of Krommenhoeck v. A-Mark Precious Metals, Inc . , 945 F.2d 
309 (9th Cir. 1991). That case, by reference to the so-called 
Brent Statutory Interpretation Concerning Forward Transactions 
(55 F.R. 39188) found certain contracts to be both futures and 
forward contracts and denied the relief sought with respect to 
substantial losses suffered by small commercial customers. 
Conference Report to accompany H.R. 707, H.R. Rep. No. 102-978, 
102 Cong. 2d Sess. at 83. 



86 



To my knowledge, the Commission has never before exempted 
transactions in products subject to its jurisdiction from the 
anti-fraud provisions of the Act unless another regulatory regime 
clearly applied to such transactions .■' In this case, energy 
contracts exempted from the CEA would also be exempt from state 
anti-bucketing laws and, to the extent that they are not 
investment contracts or securities, or can be so designed, they 
would be exempt from the securities laws as well. 

By way of comparison, transactions in exempt securities-- 
including transactions by sophisticated investors (such as 
qualified institutional participants with $100,000,000 
portfolios) are not exempt from the anti-fraud provisions of the 
federal securities laws. Further, in the United Kingdom, 
certain transactions in the Brent Oil market itself are subject 
to the criminal anti-fraud provisions of the Financial Services 
Act (Section 47 (1)) and small commercial counterparties are 
generally limited by law to transactions integral to their 
businesses .^ 

By retaining anti-fraud jurisdiction to the extent 
applicable, the Commission no more suggests that exempted energy 
contracts may be futures (rather than forward) contracts than it 
does by expressly acknowledging in the proposed release that the 
Commission is not making a determination that these contracts are 
not subject to the CEA or than the applicants have by requesting 
an exemptive order from the exchange trading requirement for 
futures .^ 



^Compare the treatment of swaps (anti-fraud provisions 
retained) with the treatment of hybrid securities or depository 
instruments (anti-fraud provisions relinquished in deference to 
applicable federal and state securities and banking laws) in the 
Commission's new Part 35 Rules. 

^See e.g. . Section 10b of the Securities and Exchange Act of 
1934 and Rule lOb-5; see also Preliminary Note i to Rule 144A) . 
Also, as the result of failures of certain secondary dealers, 
aspects of the government securities markets were regulated in 
1986 and further regulation is contemplated as a result of the 
alleged Salomon Brothers manipulation. 

^See Appendix 2, Oil Market Code of Conduct of the 
Securities and Futures Authority (SFA) Rule Book and SFA Conduct 
of Business Rule 5-5. 

^ See Division of Enforcement memorandum, dated April 8, 
1993, to Gerry Gay concerning the scope of Section 4b. I would 
make just one other point. Among the list of qualified 
counterparties are certain entities which meet a net worth 
($1,000,000) or a net assets ($5,000,000) test. The exemption 
makes clear however that a guarantee of no specified amount can 
be substituted for this minimum size and resources test and 
potentially for the capacity to deliver. To the extent this 
provision is included to permit participation by small 
commercials in energy-related businesses it is unnecessary - 
another provision does so. Separately, participation on organized 
futures exchanges is largely commercial, and intermediary 
guarantees and clearing guarantees substitute for the credit 
judgments made in private transactions betweeen counterparties as 
principals. 



87 



commodity Futures Trading Commission Implementation of 
The Futures Trading Practices Act of 1992 



SUBJECT 

1 . Exemptive Authority-Swaps 

2 . Exemptive Authority-Hybrids 

3. Exemptive Authority- 
Forwards 

4 . Dual Trading 

5 . Broker Associations 

6 . Floor Trader Registration 

7 . Ethics Training 

8. Reparations /Class Actions 

9 . Telemarketing 

10. Insider Trading 

11. Exchange Emergency Actions 

12. Margin 

13. Derivatives study 

14. Risk Assessment 

15. Suspension of Registrants 
Charged with Felonies 

16. Conflicts of Interest 

17. SRO Governing 
Boards/Disciplinary 
Committees 

18. Audit Trail 

19. Penalty Study 

20. Computerized Trading Study 

21. Competitiveness Study 

22. Oral Orders 



COMMISSION ACTION 

Final Rule (58 FR 5587, 1/22/93) 

Final Rule (58 FR 5580, 1/22/93) 

Final Order (58 FR 21286, 
4/20/93) 

Proposed Rules (58 FR 13025, 
3/9/93) 

Proposed Rules (57 FR 57116, 
12/3/92) 

Final Rules (58 FR 19575, 
4/15/93) 

Final Rules (58 FR 19575, 
4/15/93) 

Proposed Rules (58 FR 17369, 
4/2/93) 

NFA Rule 2-9 approved 1/19/93 



Final Rule adopted 4/26/93 

Federal Reserve Board delegation 
to CFTC 



Final Rules (58 FR 19575, 
4/15/93) 



Proposed Rules (58 FR 13565, 
3/12/93) 



Proposed Rules (57 FR 62244, 
12/30/92) 



TIMETABLE 
(Statutory) 

Promptly 

Promptly 

Promptly 

270 Days 

270 Days 

180 Days 

180 Days 

270 Days 

180 Days 
36 Days 
180 Days 
None 

One Year 
Two Years 
None 

None 
270 Days 

Two Years 
Two Years 
Two Years 
18 Months 
270 Days 



AMEND THE COMMODITY EXCHANGE ACT TO 
ENSURE THE CONTINUED APPLICATION OF 
THE ACT'S ANTIFRAUD AND ANTIMANIPU- 
LATION PROTECTIONS 



WEDNESDAY, JUNE 30, 1993 

House of Representatives, 
Subcommittee on Environment, Credit, 

AND Rural Development, 
Committee on Agriculture, 

Washington, DC. 

The subcommittee met, pursuant to call, at 10:15 a.m., in room 
1302, Longworth House Office Building, Hon. Glenn English (chair- 
man of the subcommittee) presiding. 

Present: Representatives Long, Clayton, Barlow, Holden, McKin- 
ney. Penny, Sarpalius, Peterson, Baesler, Farr, Gunderson, Allard, 
Nussle, and Smith of Michigan. 

Staff present: Vemie Hubert, chief counsel and legislative direc- 
tor; Fred Clark, deputy chief counsel; John E. Hogan, minority 
counsel; John Frank, deputy minority counsel; Glenda L. Temple, 
clerk; Benjamin I. Baker, James E. McDonald, James A. Davis, 
John Riley, and David Ebersole. 

OPENING STATEMENT OF HON. GLENN ENGLISH, A REP- 
RESENTATIVE IN CONGRESS FROM THE STATE OF OKLA- 
HOMA 

Mr. English. The hearing will come to order. A couple of months 
ago this subcommittee held a hearing with regard to action that 
was taken by the CFTC regarding the exemption of certain instru- 
ments from the antifraud and antimanipulation provisions of the 
Commodity Exchange Act. 

While there is a question that remains as to whether or not there 
is jurisdiction as far as the CFTC is concerned in some of these 
areas, we felt that it was questionable as to the wisdom of giving 
blanket exemptions on any authority that it may have. 

So with that in mind, we have a hearing today with regard to 
legislation to reinstate those provisions of antifraud and 
antimanipulation protection. The legislation before us is H.R. 2374 
and we have three witnesses today. We have Mr. Patrick Arbor, 
who is chairman of the Chicago Board of Trade. 

We would ask that he be our first witness today. 

Let me also ask, is there any member who has an opening state- 
ment that they would care to make this morning before we hear 
from our first witness? 

(89) 



90 

And for the record, although Mr. Donovan is well-known, we will 
let you introduce Mr. Donovan if he is accompanying you. 

Also, any prepared statements submitted by the members will 
appear at this point in the record. 

[The prepared statements of Mr. Farr, Mr. Combest, H.R. 2374, 
and report from the Commodity Futures Trading Commission fol- 
low:] 



91 



STATEMENT OF THE HONORABLE SAM PARR 

UPON THE HEARING AND CONSIDERATION OF H.R. 2374 

IN THE SUBCOMMITTEE ON ENVIRONMENT, CREDIT AND RURAL DEVELOPMENT 

JUNE 30, 1993 



Mr. Chairman and my fellow colleagues, it is a pleasure to join 
you today for my first hearing and business meeting as the newest 
member of the House Agriculture Subcommittee on Environment, Credit 
and Rural Development. I want to thank you for allowing me the 
opportunity to join you in working on issues of great importance to 
the American farm economy. 

The 17th District of California includes some of the most 
bountiful farmland in the country and one of the most beautiful coast 
lines in the world. My work in the California State Assembly included 
protection of that beautiful coastal environment. As I continue my 
work in this area, I look forward to my new tasks ahead as a federal 
representative serving the people who provide the largest economic 
base in my district, farmers. 

In a world of diminished resources, international trade 
agreements and banking reform, I know that the challenges the 
Subcommittee face are great. I look forward to working with each of 
you on formulating policy that benefits all farmers and Americans in 
this country. 

Thank you. 



92 



Statement of 

the Honorable Larry Combest, M.C. 

Subcommittee on Environment, Credit and Rural Development 

Committee on Agriculture 

June 30, 1993 



Mr. Chairman, the hearing we had on April 28th convinced me that the matter of CFTC 
exemptive authority was going to be a contentious issue. It was unfortunate, but not 
surprising, that the three committees of jurisdiction in the House could not resolve all the 
underlying issues last year during reauthorization of the Commission. 

I note that our Committee has now received letters from the other two committees 
concerned about H.R. 2374. Although I say this half in jest, I am beginning to think we 
might have caused less harm had we simply moved forward with your proposal to define a 
futures contract. Markets in exchange-traded and derivative products have become so 
intertwined that the current, confused regulatory scheme is truly baffling to all but a few 
commodity lawyers. I assume we are going to hear from some of them this morning. So I 
hope to be enlightened. 

While I understand your frustrations over this issue, Mr. Chairman, I did not hear April 
28th nor have I heard anything since then that convinces me that this energy contract 
exemption could cause the defrauding of an innocent public. I understand there are plenty 



93 



of innovative and unscrupulous people out there who may make me change my mind. But, 
even if such activity takes place the Commission's enforcement chief recognizes the obstacles 
the CFTC would face in bringing a case under the anti-fraud provisions of the Act. I assume 
when the CFTC deals with fraudulent boilerrooms, the Commission must first prove the 
contracts are illegal futures. 

We certainly need to resolve these issues, and I look forward to working with you in the 
months ahead once the various studies are in and we have heard from the experts. In the 
meantime, it would be helpful if we could get a full complement of Commissioners and a 
chairman that has the confidence of the current Administration and congressional 
committees of jurisdiction. 



72-584 0-93 



94 



103d congress 
1st Session 



H. R. 2374 



To amend the Commodity Exchange Act to ensure the continued appHeation 
of the Act's anti-fraud and anti-manipulation protections. 



IN THE HOUSE OF REPRESENTATIVES 

June 10, 1993 

Mr. English of Oklahoma introduced the following bill; which was referred 

to the Committee on Agriculture 



A BILL 

To amend the Commodity Exchange Act to ensure the con- 
tinued appUcation of the Act's anti-fraud and anti-ma- 
nipulation protections. 

1 Be it enacted hy the Senate and House of Representa- 

2 tives of the United States of America in Congress assembled, 

3 SECTION 1. FUTURES ANTI-FRAUD PROTECTIONS. 

4 The Commodity Exchange Act (7 U.S.C. 1, et seq.) 

5 is amended by adding at the end the following new section: 

6 "SEC. 23. RETENTION OF CERTAIN AUTHORITIES. 

7 "(a) In General. — Except as provided in subsection 

8 (b), to the extent that the Commission, by rule, regulation, 

9 or order grants, or has granted, any exemption under sec- 
10 tion 4(c)(1) for any agreement, contract, or transaction 



95 



2 

1 (or class thereof), including an exemption for any person 

2 or class of persons offering, entering into, rendering advice 

3 or rendering other services with respect to the agreement, 

4 contract or transaction, from any of the provisions of this 

5 Act, such exemption shall not apply to the anti-fraud or 

6 anti-manipulation provisions of this Act. 

7 "(b) Exception. — The proscription in subsection (a) 

8 with respect to the anti-fraud provisions of this Act shall 

9 not apply to an exemption for any agreement, contract, 

10 transaction, or person (or class thereof) to the extent that 

1 1 such agreement, contract, transaction, or person (or class 

12 thereof) is or will be subject to Federal securities or bank- 

13 ing laws that provide comparable anti-fraud protection, as 

14 determined by the Commission.". 

15 SEC. 2. REGULATIONS. 

16 The Commodity Futures Trading Commission shall 

17 issue interim final regulations to implement the amend- 

18 ments made by section 1 of this Act within sixty days fol- 

19 lowing the date of the enactment of this Act. Such interim 

20 final regulations shall include such amendments to any 

21 rule, regulation, or order previously issued by the Commis- 

22 sion as necessary to comply with the amendments made 

23 by this Act. 



HR 2374 IH 



96 




COMMODITY FUTURES TRADING COMMISSION 

2033 K Street, N. W.. Washington, DC 20581 

Williann P. Albrecht (202) 254 - 6970 

Acting Chairman August 12, 199 3 



The Honorable E (Kika) de la Garza 
Chairman, Committee on Agriculture 
U.S. House of Representatives 
1301 Longworth House Office Building 
Washington, D.C. 20515 

Dear Mr. Chairman: 

This is in response to your letter dated June 14, 1993 
requesting the Commission's views on H.R. 2374, a bill to amend 
the Commodity Exchange Act to ensure the continued application of 
the Act's anti-fraud and anti-manipulation protections to 
exemptions issued by the Commission under Section 4(c) of the 
Act. 

Please find attached the individual statements of myself and 
Commissioners Bair and Dial setting forth our views on this bill 
as presented to the Subcommittee on Environment, Credit and Rural 
Development at its markup on June 20, 1993. 

In your letter you ask us tok include the cost of enacting 
this legislation for the current and next five fiscal years. 
This is difficult to do without further indication of 
Congressional intent. The bill would require the Commission to 
reserve the antifraud and manipulation provisions of the Act in 
each exemptive order the Commission has issued and will issue in 
the future under section 4(c) of the Act. If the intent of the 
legislation is not to expand the Commission's pre-existing 
enforcement authority, we believe our existing enforcement 
capability would be adequate to deal with these cases and there 
should not be any significant cost increases in enacting this 
legislation. If, on the other hand, the intent of the bill is 
that the Commission develop an active oversight and surveillance 
presence in markets where none has previously existed, 
significant additional staff and resources will be required. 

We appreciate this opportunity to present our views to the 
Committee. 

Sincerely, 



William P. Albrecht 
Acting Chairman 



97 



Statement of Dr. William P. Albrecht 

Acting Chairman 

Commodity Futures Trading Commission 

Subcommittee on Environment, Credit and Rural Development 

Committee on Agriculture 

U.S. House of Representatives 

June 30, 1993 



Mr. Chairman, I welcome this opportunity to submit my views to you and members 
of the Subcommittee on H.R. 2374, a bill which would prohibit the Commodity Futures 
Trading Commission from exempting any transactions from the anti-fraud and anti- 
manipulation provisions of the Commodity Exchange Act ("CEA"), except where the 
exempted transactions were determined to be subject to comparable anti-fraud jurisdiction 
under the Federal securities or banking laws. While I support the goals of preventing fraud 
and manipulation, I cannot support this legislation which would restrict the flexibility just 
recently granted to the CFTC. The need for this legislation has not been shown. In my 
view, it would not significantly increase protection from fraud and manipulation. And, 
despite its worthy goals, it could actually cause harm. Therefore, I urge you to proceed 
cautiously so as to preserve the great strides made in the Futures Trading Practices Act of 
1992 ("FTP A") after years of consideration in Congress. 

Aiui-Fraud Need has Not Been Shown 

I continue to believe the Commission has exercised its exemptive authority prudently 
without exposing the public to increased risk of fraud or manipulation. Nevertheless, I 
recognize your disagreement with the Commission's decision to exempt certain energy 
contracts from the anti-fraud provisions of Section 4b of the CEA as you forcefully 
expressed at your April 28, 1993 Subcommittee hearing. Certainly, it is legitimate to express 
concerns about the possibility that the Commission's action opened the door to fraud; 
however, I do not believe that we have done so. Nevertheless, the possibility, prevention 
and prosecution of fraud are issues that should be addressed. 

With regard to the exempt energy contracts, the Commission carefully considered 
whether or not to exempt this market from the anti-fraud provisions of the CEA. Energy 
market participants had not asked the Commission for enforcement assistance before the 
exemption was granted, and I know of no problems since the exemption was granted. 

The possibility of fraud was not ignored. In fact, one of the reasons the energy 
exemption was limited to commercial, principal-to-principal transactions was to protect the 
pubhc from potential boiler rooms. It is hard to imagine any boiler room style operation 
dealing with the public which would not violate the terms of the exemption and thus be 
subject to the full coverage of the CEA, to the extent it applied, including its anti-fraud 
provisions and its prohibition against off-exchange trading. 



98 



In the unlikely event that some unanticipated fraudulent practices violating Section 
4b within the scope of the energy exemption occur, the Commission is not left without 
alternatives. Obviously, the Coimnission could amend the exemptive order to assert Section 
4b authority over the exempt transactions (again, to the extent it applied). Or even better, 
it could amend the exemptive order to leave the questionable transactions outside the scope 
of the exemption altogether. In such a case the Commission would not need to prove fraud, 
rather it need only show that the transactions were futures contracts not conducted on a 
designated exchange and are thus illegal. 

Finally, in addressing the need for CFTC anti-fraud jurisdiction, the alternative laws 
available to police a given market should be considered. Indeed, H.R. 2374 recognizes that 
CFTC fraud jurisdiction is not necessary when comparable securities or banking anti-fraud 
laws exist. In my view, given the apparent absence of fraud in these transactions, existing 
criminal and civil remedies are adequate to police these energy market transactions. 

No Significant Benefits from Additional Anti-Fraud Law 

Protecting market participants from fraud is of the highest importance to the CFTC, 
as it should be to any regulator. In the exempt energy contracts, there were significant legal 
and practical obstacles that more than offset any potential benefits of extending Section 4b 
coverage to those contracts. 

The initial obstacle to the application of Section 4b was that Section 4b applies only 
to futures contracts and the vast majority of the energy contracts in question appeared to 
be forward contracts under the Commission's 1990 Statutory Interpretation Concerning 
Forward Transactions . In addition, by its own terms, the coverage of Section 4b is limited 
to fraud committed by one person acting for or on behalf of another. Thus, Section 4b 
apparently does not apply to the principal-to-principal energy contracts in question. 

Besides the legal obstacles to the application of Section 4b there was the very real 
practical problem that retaining Section 4b would have injected an illusion of Commission 
supervision into a market where there was no ongoing regulation. Effective use of Section 
4b may require an ongoing CFTC regulatory presence which would have created other 
problems. After all, for the instruments it regulates the Commission maintains 
comprehensive regulatory programs utilizing not only regulations and direct enforcement, 
but also oversight of extensive programs of more than a dozen self-regulatory organizations 
(SROs). To credibly maintain anti-fraud jurisdiction over exempt transactions the 
Commission may believe that it is obligated to exert at least a modified regulatory presence. 
Finally, the Commission just does not have the resources necessary to extend its regulation 
to all these markets. 



99 

3 

Real Burdens 

In my April 28, 1993 testimony before this Subcommittee I expressed my concerns 
that retaining Section 4b would do more harm than good. Rather than providing a potential 
benefit, it would create legal uncertainty. I was concerned that, after having gone to great 
lengths to assure foreign energy firms that they may engage in the normal business practices 
that existed prior to the district court decision in Transnor (Bermuda) Limited v. BP North 
America Petroleum . 738 F. Supp. 1472 (S.D.N.Y.) (" Transnor "). the presence of Section 4b 
may say to some that the futures issue is not over. To some of these firms the mere 
presence of Section 4b would have indicated that the CFTC is exerting some jurisdiction 
over them and that more may follow. This was not an unreasonable view given that the 
Commission had never regulated, nor sought to regulate, this market and that the market 
was not then viewed as being within the scope of Section 4b. The legal uncertainty as to 
whether the CFTC would in some way regulate these energy markets was reported to inhibit 
the ability of U.S. firms to engage in international oil trading. 

Even if there is disagreement on whether the Commission has acted appropriately 
in a given situation, elimination of Commission flexibility would in itself have adverse 
consequences. Flexibility is needed to deal with the innovations and problems of tomorrow 
which we cannot predict today. It is that need for flexibility to enable the Commission to 
allow, even encourage future innovations, that was the driving force behind Congress' grant 
of exemptive authority just last year. 

Exemptive Authority 

In my view it is very important that H.R. 2374 be considered in the context of the 
grant of exemptive authority to the Commission in the hi FA. In my April 28, 1993 
statement submitted to you I noted the advent of new financial instruments in recent years 
which contain both futures and non-futures elements. Analysis of these new financial 
instruments placed the Commission in the jurisdictional dilemma of either forswearing any 
jurisdiction at all over the instrument in question or requiring that it be traded on a 
designated e.xchange. This dilemma faced by the Commission in turn caused great legal 
uncertainty for the parties to transactions referred to as "swaps", "hybrids", and "cash settled" 
forwards, and other commodity linked instruments which had futures-like characteristics. 

The threat of legal uncertainty was highlighted by the district court decision in 
Transnor : parties to transactions that had never before been considered futures contracts 
now faced the prospect of having their transactions ruled void as off-exchange futures 
contracts. The Commission responded to provide legal certainty to "Brent" market 
participants and to parties to similar transactions, regardless of location or underlying 
commodity, by issuing a statutory interpretation stating that the CFTC did not view these 
transactions as futures, but rather as cash forward contracts, and thus excluded from 
regulation under the CEA. Regretfully, this did not completely resolve the problem and 



100 



reportedly some international firms continued to refuse to do business with United States 
based firms. 

Fortunately, Congress was aware of the severe problems caused by the legal 
uncertainty facing not only Brent market participants, but all parties to these new financial 
instruments with futures-like characteristics. Congress recognized the need to provide 
flexibility in this area and in the FTPA authorized the Commission to exempt any agreement 
from the exchange-trading and most provisions of the CEA contingent upon certain 
conditions. Those conditions include Commission determinations that the exemption is in 
the public interest, that the agreement is between appropriate persons (such as institutional 
participants), and that the agreement does not have a material adverse effect on the ability 
of the Commission or any exchange to discharge its regulatory or self-regulatory duties. 
Granting the Commission this exemptive authority was one of the most significant 
amendments to the CEA by Congress in recent years. 

As you know, there is no statutory definition of a futures contract. The legal 
definitions relied on today largely come from Commission enforcement actions against 
boiler room operations. The problems caused by application of those same definitions to 
legitimate instruments with futures-like characteristics were one of the reasons exemptive 
authority was needed. 

One of the wisest decisions made by Congress in granting the Commission exemptive 
authority was that exemptions do not depend on a determination that exempt transactions 
are futures contracts. Some strongly disagree with the notion that the Commission can 
exempt transactions not within its jurisdiction. I appreciate the rationale of this position, 
but it ignores the history of why the exemption was necessary in the first place. The 
exemptive authority was necessary because a whole new generation of instruments has 
evolved that no longer clearly fit into the traditional regulatory categories. 

Swaps are an excellent example of the need for legal certainty and the need for a 
broad exemption. Swaps are limited to appropriate participants and serve the legitimate 
financial management needs of firms all over the world, and yet many would say that 
economically they are the equivalent of futures contracts traded on exchanges. Without 
Congress' actions in the FTPA and the Commission's exemption, this entire market could 
be upset by a future Transnor -like decision. Fortunately, Congress did not require the 
Commission to decide whether swaps generally, or whether any swaps in particular, were 
futures contracts before granting the exemption. As you consider H.R. 2374 I urge you to 
recognize the need to provide the Commission with exemptive authority which is sufficiently 
broad to foster the necessary degree of legal certainty for any particular market-including 
markets that cannot be anticipated today. Only by doing so will Congress foster innovation 
in the manner that I understood was the intent of the FTPA. 



101 

5 

Manipulation 

The concerns raised about eliminating Commission flexibility with regard to anti- 
fraud jurisdiction also apply to manipulation jurisdiction. There does not appear to be a 
need for retaining this authority, there will not be significant benefits gained by retaining 
it generally and there are very real burdens to be placed on the exempt markets. In the 
case of swaps, hybrids and energy contracts, the Commission retained limited anti- 
manipulation authority. For instance, under the swaps exemption the Commission can take 
action against a swaps dealer for using swaps contracts to manipulate the futures market, 
or the underlying cash market, but the Commission did not retain the authority to take 
action against a swaps dealer for manipulating the swaps market. After all, swaps are less 
susceptible to manipulation since they are cash settled without a common expiration. The 
Commission maintains an extensive surveillance and reporting program in conjunction wath 
the SROs designed to address manipulation problems well before they are allowed to 
develop. The Commission does not have such programs in place in the swaps market. 
Arguably some such program would be needed to exercise anti-manipulation authority in 
the swaps market itself. 

Overlapping Jurisdiction 

I appreciate the fact that one of the goals of H.R. 2374 is to coordinate the coverage 
of Federal commodities law with Federal securities law and Federal banking law. While I 
agree that the CFTC should consider comparable anti-fraud provisions in Federal securities 
and banking laws, those are not the only sources of anti-fraud laws. For example, criminal 
laws enforced by the Department of Justice, including wire and mail fraud statutes, are 
frequently used in commodities fraud cases, even where the CEA is also applicable. 
Additionally, state laws may in themselves be sufficient to police some markets. 

Before concluding, I would like to comment on the legitimate interest of the states 
in seeking to protect their citizens from fraud. I am confident that the Commission will 
continue to assist the states in their efforts to protect their citizens. Further, I look forward 
to continued dialogue with state regulators that will foster effective enforcement. 

In conclusion, while I cannot support H.R. 2374, I appreciate the opportunity to 
discuss my views. I trust that full consideration of this legislation will clarify Congressional 
intent on the scope of the Commission's exemptive authority. 



102 



statement of Sheila C. Bair 

Commissioner 

Commodity Futures Trading Commission 

Before the House of Representatives Committee on Agriculture 

Subcommittee on Environment, Credit 

and Rural Development 

June 30, 1993 



Mr. Chairman, members of the Subcommittee. Thank you for the 
opportunity to appear before you today to discuss H.R. 2374. I am 
pleased to express my support for this legislation, which is 
designed to ensure that the anti-fraud and anti-manipulation 
provisions of the Commodity Exchange Act will remain applicable to 
transactions exempted by the Commission from other provisions of 
the Act. I believe that the anti-fraud and anti-manipulation 
provisions of the Act are basic and central to our regulatory 
scheme. My views in this regard are set out in more detail in my 
testimony presented before this Subcommittee on April 28, 1993. I 
only regret that legislation which limits the Commission's 
exemptive authority appears to be necessary to maintain the 
applicability of these provisions of the Act. 

I agree with the approach of H.R. 2374 as to when the 
Commission should retain the anti-fraud and anti-manipulation 
provisions of the Act and when sound public policy considerations 
indicate that — in very limited circumstances — an exemption from 
the anti-fraud provisions of the Act is appropriate. Consistent 
with H.R. 2374, the only circumstance in which I believe that an 



103 



exemption from the anti-fraud provisions of the Act would be proper 
is when the transactions or persons exempted are subject to the 
jurisdiction of the SEC or the federal banking regulators. 

One issue which the Subcommittee may wish to consider is 
whether the bill should identify the specific sections of the Act 
that comprise the Act's anti-fraud and anti-manipulation 
provisions. The failure to specify which provisions of the Act the 
Commission must retain when it grants an exemption may lead to 
further misunderstandings between the Commission and the 
Subcommittee . 

Alternatively, the bill could direct the Commission to draft 
and adopt special anti-fraud and anti-manipulation rules of general 
applicability to all exempted instruments. This is the approach 
the Commission has followed under its plenary authority over 
options in retaining anti-fraud authority over exempted trade 
options. See, Commission Rule 32.9, 17 C.F.R. § 32.9. Such rules 
could apply across the board to all transactions exempted from the 
Act by the Commission. Such an approach would uniformly preserve 
the Commission's ability to put a stop to fraudulent activities 
involving futures transactions, regardless of whether the 
transactions fall within the parameters of an exemption the 
Commission has granted. 



104 



Adoption of general anti-fraud and anti-manipulation rules for 
exempted instruments and persons would put all applicants for an 
exemption on notice that these crucial requirements will not be 
waived. This approach would free the Commission to make a reasoned 
determination about which aspects of our regulatory structure 
should continue to apply to an instrument or activity for which an 
exemption is sought without wasting time and energy debating the 
advisability of preserving anti-fraud authority in a particular 
case. 

As previously stated, I think it is appropriate that the 
legislation gives the Commission the flexibility to grant 
exemptions from the anti-fraud provisions of the Act where it 
determines that the relevant transaction is subject to the Federal 
securities or banking laws. This is a determination that the 
Commission is competent to make. However, once the Commission has 
determined that a particular transaction is subject to a sister 
regulator's jurisdiction, this should be sufficient. It is 
unnecessary, to my mind, to further require a determination as to 
whether the other regulator's anti-fraud protections are 
"comparable." For this reason, I suggest that this concept be 
stricken from H.R. 2374. 

Although I have referenced a few technical concerns in my 
testimony which the Subcommittee may wish to consider, overall, I 
believe that H.R. 2374 will achieve the important goal of ensuring 



105 



that the anti-fraud and anti-manipulation protections of the Act 
continue to apply to transactions exempted by the Commission from 
other regulatory requirements. Preserving such authority in no way 
implies that particular types of exempted off -exchange transactions 
such as traditional swaps or 15 day Brent Oil contracts are in fact 
futures contracts subject to CFTC jurisdiction. On the contrary, 
it simply reflects the difficulties in crafting exemptive relief 
broad enough to accommodate the legitimate needs of existing OTC 
markets without providing a loophole for those who might try to use 
an exemption as a shield against CFTC enforcement actions. 
Preserving anti-fraud and anti-manipulation authority will ensure 
that the CFTC continues to have the tools it needs to protect the 
public interest. 



106 



statement of Joseph B. Dial 

Commissioner 
Commodity Futures Trading Commission 

Before the House of Representatives Committee on Agriculture 

Subcommittee on Environment, Credit, 
and Rural Development 

June 30, 1993 

Thank you for the opportunity to comment on H.R. 2374. I will 
not reprise my comments of April 28, 1993, on this subject, 
inasmuch as they are a matter of record and I have not altered my 
position . 

If Congress passes H.R. 2374, then I will do all that is 
within my power as a Commissioner to see to it that Commodity 
Futures Trading Commission (CFTC) complies with the provisions of 
this legislation. However, I respectfully submit my considered 
opinion on the consequences of passage of H.R. 2374. 

First, the intent of Congress in passing the Futures Trading 
Practices Act (FTPA) of 1992, as expressed by the conferees, is 
that, among other provisions, the Commission should use the 
exemptive authority promptly in the "areas where significant 
concerns of legal uncertainty have arisen," including, among 
others, forwards. (FTPA, at 81). 

If passed, H.R. 2374 will remove the legal certainty that the 
CFTC exemptive order provides, because H.R. 2374 will apply a 
futures antifraud provision to forward contract circumstances. If 
H.R. 2374 becomes law, the energy sector will be right back where 
they were after the court handed down the Transnor decision and 
CFTC subsequently issued its Brent Oil Interpretation. H.R. 2374 



107 



will put a cloud of legal uncertainty over the head of energy 
industry participants who wish to use these forward contracts 
without assuming the legal risks of trading legally ambiguous 
contracts which would expose them to an inappropriate regulatory 
scheme . 

If Congress decides to pass H. R. 2374 and do a 180-degree 
turn from the position it took in the 1992 FTPA, that is their 
prerogative. The members should know, before they make such a 
move, that their action will impact the free market characteristic 
of business participation based on economic incentive. As a 
result, the cost of doing business in energy products may well 
increase and ultimately the taxpayer will have to foot the bill for 
unnecessary government intervention. 

Forward contracts have been used in the normal course of 
commerce for a century. There is absolutely no historical evidence 
to prove that these transactional instruments have been a 
convenient ruse used by devious charlatans to defraud "mom and pop" 
retail customers. As of this date, no one has put forth a 
plausible scenario whereby the exempted energy contracts would 
subject the public interest to fraudulent schemes. 

Granted, there are those who ascribe to the theory that this 
exemption will allow for general public participation through the 
use of pools, trusts, or partnerships, and the CFTC would not be 
able to use the 4b fraud provision to prosecute fraudulent activity 
in these circumstances. That is not the case. 

In order for a collective investment vehicle to qualify for 



108 



this exemption, it must satisfy all of the appropriate person 
requirements. Also, it can't be formed solely for the purpose of 
qualifying for the exemption. If any of these requirements are not 
met, the exemption is not applicable, and Section 4b fraud 
authority could be available. In addition, the exemption provides 
that Section 4o will continue to apply to commodity pool operator 
fraud. 

It is important to understand that the appropriate person 
language in the CFTC energy exemption requires business proprietors 
to have a net worth of $1,000,000 or total assets exceeding 
$5,000,000, in order to become an eligible participant. 
Furthermore, only commercial entities are allowed to engage in the 
transactions covered by the energy exemption. As has always been 
the case, if any commercial entity, large or small, is victimized 
by fraudulent forward contract activity by its commercial 
counterparty, then the plaintiff may address such conduct through 
state law remedies. Accordingly, state fraud remedies clearly are 
available to participants involved in exempted energy transactions. 
Commodity Exchange Act (CEA) remedies are inappropriate, because 
Congress has excluded forward contract activity from CEA 
jurisdiction. 

As further evidence of this fact, consider that in the 1992 
FTPA, the conferees specifically did not express a view regarding 
the applicability of the Commission's Brent interpretation. (FTPA, 
at 82). Also, the conferees expressly stated that the exercise of 
this exemptive authority would not "require any determination 



109 



beforehand that the agreement, instrument, or transaction for which 
an exemption is sought is subject to the Act." (FTPA, at 82, 83). 
Taken together, these two actions continue to position the forwards 
markets in the same light as CFTC viewed them, i.e., as being 
excluded from the Commission's jurisdiction. Consequently, CFTC 
cannot apply 4b, a futures regulatory provision, to exempted energy 
forwards . 

If H.R. 2374 is enacted, then participants in exempted energy 
contracts will run the risk of a disgruntled counterparty having 
the option of reneging on its obligations by declaring an exempt 
forward transaction to be an illegal off-exchange futures contract, 
and having the panoply of futures market regulation applied to 
them. This clearly is not what Congress intended to happen when it 
passed the Futures Trading Practices Act of 1992. 



110 

STATEMENT OF PATRICK H. ARBOR, CHAIRMAN, CHICAGO 
BOARD OF TRADE, ACCOMPANIED BY THOMAS R. DONOVAN, 
PRESIDENT AND CHIEF EXECUTIVE OFFICER, AND MARK 
YOUNG, COUNSEL, KIRKLAND & ELLIS 

Mr. Arbor. Thank you, Mr. Chairman, and members of the sub- 
committee. My name is Patrick Arbor and I am the chairman of the 
Chicago Board of Trade. I am accompanied, as you noted, Mr. 
Chairman, by Thomas Donovan, the president and CEO of the Chi- 
cago Board of Trade, and Mark Young with the firm of Kirkland 
& ElHs, who is our legal counsel. 

Thank you for your invitation to present the views of the Chicago 
Board of Trade on H.R. 2374 and the exemptions the Commodity 
Futures Trading Commission has granted. As set out in my written 
testimony, the board of trade generally supports H.R. 2374. 

Antifraud and antimanipulation are core protections that should 
apply to every transaction under the Commodity Exchange Act. We 
have suggested certain technical changes to H.R. 2374 to strength- 
en its provisions, but I am a businessman, not a lawyer, and rather 
than discuss those technical issues today, I would be happy to 
make our staff available to the subcommittee. 

Mr. Chairman, like others, the board of trade could have just 
submitted our written views to you. We chose, however, to appear 
in person today to underscore our profound disappointment with 
the CFTC's exercise of its exemptive powers. 

The issue is very simple. In granting the CFTC exemptive pow- 
ers. Congress told the CFTC, "to promote fair competition." That is 
a quote from the statute. Congress told the CFTC to apply its ex- 
emptive powers in, "A fair and evenhanded manner to products and 
systems sponsored by the exchanges and nonexchanges alike." 

Congress told the CFTC to use, "The least anticompetitive means 
of exempting persons or transactions from the provisions of the 
act." These are all quotes from the act. 

Some 8 months have passed since the legislation became law. In 
that time, the CFTC has ignored those congressional mandates. 
The CFTC has refused to allow the exchanges to offer exempt in- 
struments, swaps, energy contracts, under the same class of ex- 
emptive relief it has willingly provided to the dealer markets. 

The result of these policies is the worst kind of unfair competi- 
tion. Over-the-counter dealer trading is exempt from regulation, 
but exchange trading is subject to ever increasing regulatory cost 
and restrictions. If the trend continues, exchanges will not survive. 
They will lose the competitive battle to the over-the-counter mar- 
kets and to foreign exchanges that enjoy nurturing relationships 
with their regulators. 

Indeed, we have done some work in Chicago and have discovered 
that a customer opening up an account in the United States may 
have to sign as many as 20 different documents, suitability require- 
ments, disclosure requirements. A same customer opening up an 
account in London or Paris may only have to sign two documents. 
The documentation, the compliance, is becoming just too onerous. 

But let me be clear, Mr. Chairman. The board of trade does not 
want the over-the-counter market to be regulated beyond the fraud 
and manipulation protections that your bill would impose. We are 
comfortable with that. That kind of regulation is quite adequate for 



Ill 

professional markets where the only traders are sophisticated par- 
ties who can protect themselves, but exchanges should have the op- 
portunity to offer exempt professional markets too. 

The CFTC to date has denied us that opportunity. The CFTC's 
policy also precludes clearing of exempt instruments, a process that 
we feel would strengthen the financial integrity of over-the-counter 
derivatives; indeed, many feel this. This is possibly the most bi- 
zarre aspect of the CFTC's policy. 

Consider this: Since 1976 the CFTC has found that clearing is 
essential for any new futures or options contract. Without clearing, 
the CFTC has said it would disapprove trading, "As contrary to the 
public interest." 

For exempt instruments, however, the CFTC has prohibited 
clearing and says that prohibition is, "Consistent with public inter- 
est." 

Now, maybe I haven't been in Washington long enough, Mr. 
Chairman, but I can't figure out how something can be contrary to 
and consistent with the public interest at the same time. That kind 
of logic escapes us. Yet that is exactly the policy the CFTC has 
adopted on clearing. 

Mr. Chairman, Will Rogers once wrote, everything is funny as 
long as it is happening to someone else. I guess the CFTC's incon- 
sistent and incoherent exemptive policies might be funny except for 
the fact they aren't happening to somebody else; they are happen- 
ing to us. 

The CFTC is denjdng futures exchanges the fair competition 
Congress intended, while also denying market users the benefits 
exempt exchange trading would offer, price transparency, liquid 
trading, low regulatory costs, and financial integrity through clear- 
ing. 

The CFTC, however, will have a chance soon to remedy this situ- 
ation. The board of trade has decided to file an exemptive applica- 
tion for professional trading markets. As proposed, a professional 
trading market would be exempt generally from CFTC regulation 
subject to four basic conditions. One, only professional traders, not 
small, retail customers would be allowed; two, the board of trade 
operating the market must notify the CFTC before the operations 
begin; three, fraud and manipulation prohibitions apply as well as 
private damage actions; and four, all trades must be submitted to 
a CFTC-approved clearing system. 

The professional trading market exemption would promote both 
responsible financial innovation and fair competition between ex- 
changes and over-the-counter markets, the very purpose Congress 
cited when it gave the CFTC exemptive powers. Therefore, we will 
ask the CFTC to approve this proposed exemption immediately. 

In conclusion, Mr. Chairman, the CFTC has thus far ignored the 
fair competitive mandate that you and others in Congress enacted. 
Our proposed professional trading market exemption affords the 
CFTC another chance to follow your mandate. 

In any legislation you adopt dealing with the CFTC exemptive 
authority, we urge you to reaffirm the agency's duty to promote fair 
competition and to do so in terms that the Commission may no 
longer ignore. 

Thank you, Mr. Chairman. 



112 

[The prepared statement of Mr. Arbor appears at the conclusion 
of the hearing.] 

Mr. English. Thank you very much, Mr. Arbor, I appreciate 
that. 

You mention that there were certain suggested changes that you 
would recommend pertaining to the language of the bill. Are those 
technical in nature that you are referring to or are they more sub- 
stantive? 

Mr. Arbor. They are technical in nature. 

Mr. English. So from a substantive standpoint, you have no sug- 
gestions with regard to change in the legislation; is that correct? 

Mr. Arbor. No. Generally we agree with the bill. 

Mr. English. Now, the point that again I want to stress here is 
that the purpose of this legislation is not to reach beyond the juris- 
diction the CFTC may have. That is, with regard to many of these 
instruments or decisions that will have to be made at a later time, 
but we do not want to send a signal that in any way a regulatory 
body of the U.S. Government is withdrawing from its dealings and 
responsibilities pertaining to fraud or antimanipulation. 

I think that would be the wrong signal to send to any market 
that may be under the jurisdiction of a Federal regulator. So I ap- 
preciate your testimony and recognize that the points that you 
were making in referring back to the reauthorization bill were well 
taken. I am hopeful that we will see the CFTC pursue a course of 
evenhandedness and fairness to all who may come under their ju- 
risdiction, and all of the various markets, whether they be on ex- 
change or off exchange. 

So I appreciate that very much. 

Mr. Allard. 

Mr. Allard. Thank you, Mr. Chairman. 

I am curious, from your perspective, do you think the CFTC has 
the resources and the expertise to adequately police the antifraud 
jurisdiction? 

Mr. Arbor. If they have the resources and the authority to do 
it for the exchanges, we think they certainly would have it for the 
over-the-counter market. 

Mr. Allard. Thank you. 

That is all I have, Mr. Chairman. 

Mr. English. Mr. Holden. 

Mr. Holden. No questions. 

Mr. English. Ms. McKinney. 

Ms. McKinney. No questions. 

Mr. English. Mrs. Clayton. 

Mrs. Clayton. No. 

Mr. English. Mr. Baesler. 

Mr. Baesler. No. 

Mr. English. Mr. Farr. 

Mr. Farr. No. 

Mr. English. Mr. Sarpalius. 

Mr. Sarpalius. No questions. 

Mr. English. You get off light today, gentlemen. Thank you very 
much, we appreciate your testimony. 

Our next witness is Mr. R. Wayne Klein, who is a securities bu- 
reau chief for the State of Idaho and he is representing the North 



113 

American Securities Administrators Association here in Washing- 
ton. 

Mr. Klein, we want to welcome you here today and would be 
happy to receive your testimony. 

STATEMENT OF R. WAYNE KLEIN, CHIEF, SECURITIES BU- 
REAU, STATE OF IDAHO, ON BEHALF OF THE NORTH AMER- 
ICAN SECURITIES ADMINISTRATORS ASSOCIATION, INC. 

Mr. Klein. Mr. Chairman, members of the subcommittee, good 
morning. My name is Wayne Klein. I am chief of the Idaho Securi- 
ties Bureau and a member of the board of directors of the North 
American Securities Administrators Association, NASAA, on whose 
behalf I appear this morning. 

In the United States, NASAA is the national voice of the 50 
State securities agencies responsible for investor protection and ef- 
ficient functioning of the capital markets at the grassroots level. 
NASAA and its members work closely with the Commodity Futures 
Trading Commission and the National Futures Association in com- 
batting commodity-related fraud. 

Mr. Chairman, members of the subcommittee, I appreciate the 
opportunity to appear here this morning in support of H.R. 2374, 
legislation now under consideration by the subcommittee which 
would amend the Commodity Exchange Act to ensure the contin- 
ued application of the act's antifraud and antimanipulation protec- 
tions, even in those instances where exemptions from regulatory 
oversight otherwise are granted. 

We commend the subcommittee for addressing this critically im- 
portant issue. We also would urge you to turn your attention to 
what we believe is a more general and disturbing trend at the 
CFTC: Abandonment and repudiation of its responsibility to protect 
the integrity of the commodity futures markets and those who in- 
vest there. 

The intolerable situation we find ourselves in today is a direct re- 
sult of the regulatory philosophy and actions of the Commission's 
leadership in recent years. It is not reflective of the work of the 
Commission's dedicated staff which deserves credit for its investor 
protection efforts. 

The CFTC's recent order with respect to exempting certain en- 
ergy contracts from regulatory oversight, including the antifraud 
and antimanipulation provisions of the Commodity Exchange Act is 
just the latest of what perhaps may be best characterized as the 
agency^s reluctance to regulate, even in the face of blatant threats 
to investors and to the integrity of the markets. 

Worse yet, the Commission has vigorously guarded what it be- 
lieves to be its turf, only to turn around and severely limit its own 
role in what would appear to be a philosophy of, we won't police 
the area, but we don't want anyone else to either. It is the hope 
of NASAA and its members that such an approach will not persist 
and instead Congress and the Clinton administration will use their 
considerable authority to reenergize the agency with a clear sense 
of its original mission and purpose. 

As a former enforcement attorney and a State securities commis- 
sioner, I have had personal experience observing the devastation 
that can occur in the lives of those who are particular victims of 



114 

fraudulent commodity schemes. I myself have heard the outrageous 
lies contained in their telephone solicitations. 

I have litigated with those companies offering programs that 
steal money from unsuspecting victims. In many cases the promot- 
ers were able to defraud the victims only because the victims — in- 
vestors believed that these investment vehicles were subject to sub- 
stantial Government oversight. 

Based on my experience and as detailed more fully in my written 
statement, I feel that the CFTC is not performing the supervisory 
and law enforcement task contemplated in the legislative history of 
the Commodities Exchange Act. This inaction contributes to the 
fraud that is already occurring. 

Mr. Chairman, members of the subcommittee, without active and 
vigorous oversight, the markets under CFTC exclusive jurisdiction 
will invite fraud and abusive trading. While the States are commit- 
ted to detecting and prosecuting fraudulent operators in this arena, 
our role under the Commodity Exchange Act is very limited. 

As a result, we respectfully would recommend that this sub- 
committee seriously consider the following six point action plan for 
reinvigorating the CFTC as an active and effective regulator of the 
commodity futures marketplace. 

First, Congress should immediately move to pass H.R. 2374. This 
bill is absolutely necessary to mandate preservation of antifraud 
and antimanipulation authority even in those instances where reg- 
ulatory exemptions otherwise are granted. The provisions of the 
bill should apply on a retroactive and prospective basis. 

Second, the CFTC should be directed to withdraw its counter- 
productive 1990 Brent statutory interpretation. In doing so, the 
regulatory scheme governing the futures markets would revert to 
the guidelines and criteria articulated by the Congress and by ear- 
lier court decisions. 

Third, Congress should consider requiring the CFTC to provide 
a reasonable scheduled review of this latest energy related exemp- 
tion, then require each entity seeking use of the exemption to make 
a separate, publicly available application for exemption. 

Each application should be accompanied by an explanation as to 
how the participant and the contemplated transactions satisfy the 
criteria set forth in the Futures Trading Practices Act. 

Fourth, the CFTC should be directed to take great care in grant- 
ing exemptions on a broad, generic basis without knowing who will 
be taking advantage of the exemptions. This may help reduce the 
potential for the exemptions to be used by crooks. It also would 
provide information to the CFTC about off-exchange trading with 
which to evaluate the effects of the exemption. Moreover, it makes 
publicly available such economic factors as the volume of, the price 
of, and parties engaged in, such trading. 

Fifth, Congress should require the CFTC to embrace the policies 
set forth in the FTPA conference report accompanying the Com- 
modity Futures Practice Act with respect to distinction between fu- 
tures and forward contracts, the continued validity of prior case 
law establishing the futures contract definition and the jurisdiction 
of other regulators. 

And sixth. Congress should consider prohibiting the CFTC from 
granting any exemption from its oversight for transactions which 



115 

are similar in nature to those currently traded on the regulated ex- 
changes. This may help reduce the migration of trading away from 
the exchanges, a trend which NASAA believes is contrary to the in- 
terests of the economy and the integrity of those vital markets. 

Mr. Chairman, members of the subcommittee, the futures mar- 
kets today are recognized at home and abroad as a vital part of the 
financial services industry. It is critically important that these 
markets remain as free as possible from fraud and manipulation. 

As exclusive overseer of the futures markets, the CFTC alone has 
the authority to set the tone of regulation in this arena. If the 
CFTC fails to assert or exercise its jurisdiction, other regulators 
have only limited power to act and then may act only after viola- 
tions have occurred. 

NASAA and its members look forward to working with you and 
other Members of Congress to take the steps necessary to restore 
the CFTC to its original mission and purpose. 

I thank you for this opportunity to express the views of NASAA. 
I am happy to answer any questions you may have. 

[The prepared statement of Mr. Klein appears at the conclusion 
of the hearing.] 

Mr. English. Thank you very much, Mr. Klein. I appreciate your 
testimony. 

We were told when the CFTC appeared before us earlier in the 
discussion with regard to this exemption that as far as any fraud 
is concerned, that States have fi'aud laws, and so therefore there 
is really not any problem, that the States could simply use their 
fi*aud laws to deal with any violations that might occur, any in- 
stances of fraud that might occur with regard to this market. 

Could you give us your views with regard to that possibility? 

Mr. Klein. Mr. Chairman, we appreciate the CFTC being so gen- 
erous with providing work for us, but there are a number of rea- 
sons why we think that is a very inadequate solution. 

One is that the CFTC is the one who truly has the expertise in 
this area and to say the States can use their general common law 
fraud statutes to apply is not going to give us the ability to go after 
the kind of frauds we ought to. 

Also, the laws are not as specialized enabling us to go after par- 
ticular suitability or misrepresentations without proof of an intent 
to deceive. 

Second, only the CFTC has authority under the Commodity Ex- 
change Act to enforce the Commodity Exchange Act on a nation- 
wide basis. Yes, individual States can take action and can even 
shut down the fraud, but they will have to do it on a State-by-State 
basis, and we think it is inappropriate to require 30 or 50 States 
to take action in order to shut down a program operating nation- 
ally. 

In addition, they are relying on us, the States, to bring enforce- 
ment action to remedy problems that could more easily be rem- 
edied by some restrictive requirements on the trading beforehand 
that prevents the fraud from occurring rather than saying, yes, 
when you find the fraud, please go after the people who commit it 
and put them in jail because the investors have still lost money. 

Mr. English. I am not an attorney, but it is my understanding 
that under the Commodity Exchange Act the States are preempted 



116 

from the standpoint of any kind of State laws that might exist in 
dealing with violations under the Commodities Exchange Act. Is 
that correct? 

Mr. Klein. Mr. Chairman, for the most part, that is entirely cor- 
rect. Unlike the securities laws where the States have State's secu- 
rities laws and the securities laws exist at the Federal level, under 
the Commodity Exchange Act, the CFTC is granted exclusive juris- 
diction. 

As a result of the prevalence of fraud, in 1928, there were some 
amendments to the Commodities Exchange Act granting the States 
some limited authority to take action but our ability to act is very 
limited against — ^we can only act after the fact. We cannot take any 
action to license people, to require substantive standards to be met 
beforehand, and there are a number of people that we are still pre- 
cluded from taking action against. 

Mr. English. I guess the question that occurs to me, and again, 
not being an attorney, I certainly don't profess to have any legal 
expertise in this area, but given the fact that there is that exemp- 
tive situation as far as the Commodities Exchange Act is con- 
cerned, then the CFTC exempts a particular group of instruments 
from the antifraud and antimanipulation provisions under the 
Commodity Exchange Act. 

Does that raise a legal question as to whether the States even 
after that exemption, since it may come under the jurisdiction of 
the Commodity Exchange Act, will they even have authority to act 
against fraud that they may discover within their boundaries be- 
cause of the exemption and because of the application of the Com- 
modity Exchange Act? 

Mr. Klein. Absolutely, Mr. Chairman, because to the extent that 
the Commodity Exchange Act grants the States some limited au- 
thority to enforce the Commodity Exchange Act, to the extent the 
CFTC has granted an exemption and said that the Commodity Ex- 
change Act does not apply, not only has the CFTC denied itself ju- 
risdiction, they have precluded the States from using the Commod- 
ity Exchange Act to go after some of these operations. 

Mr. English. So that places us in a position where not only the 
CFTC has exempted itself from any kind of action against fraud or 
manipulation, they are also, in effect, exempting that kind of action 
by the States themselves. 

Mr. Klein. It is so pernicious because in essence the CFTC be- 
comes the protector of these operations, both the legitimate ones 
and the fraudulent ones. 

Mr. English. Mr. Allard. 

Mr. Allard. The States, and I am interested in following up a 
little more on the chairman's checking out the State's role in this, 
the States, under the securities act, for example, on energy con- 
tracts, which is one of the controversies that have come up in here, 
do the States have any ability under their State security exchange 
acts to regulate at all, anything? 

Mr. Klein. To the extent that the contracts could be construed 
as securities, yes, the States could use their securities laws. 

Mr. Allard. Most of those contracts fall under those securities? 
Can they be construed that way? 



117 

Mr. Klein. Congressman, I have not seen the way the contracts 
are structured. In my opinion, they probably would not because se- 
curities laws require that you will be making an investment now, 
relying on someone else to make a profit, to return that profit to 
you in the fiiture. 

Under the futures contract, it is generally fewer parties and they 
are making the contract now and they are relying on each other. 

Mr. Allard. Are you aware as to whether any of the energy 
States, those that produce oil and gas, have made any special effort 
in trjdng to regulate this area? 

Mr. Klein. Congressman, they have made efforts. To the extent 
that we find fraud in this area, and Texas has been particularly 
active as has Oklahoma, to the extent they find fraud in this area, 
they do everything they can to stop it and if they can somehow 
stretch the securities laws to apply, they will. 

Sometimes they will use the general and the common law fraud 
statutes. They are dedicated people who do everything they can to 
get money back for the victims and stop the frauds but the problem 
frankly is the laws do not address it well, particularly when the 
Federal law has granted exclusive jurisdiction over certain types of 
contracts. 

Mr. Allard. Currently does the CFTC or any Federal agency 
have individuals in these States that are trying to enforce Federal 
law or work with the States in enforcing these laws? 

Mr. Klein. Congressman, the CFTC does have several regional 
offices. However, to the extent that the CFTC has exempted these 
transactions or these parties, then the CFTC's regional offices will 
lack the authority to act, as well as having, I presume, instruction 
from the home office to ignore them. 

Mr. Allard. I see. Are there any other Federal regulations that 
deal with this area that you are aware of? 

Mr. Klein. Congressman, the only other one that I think would 
apply would be the general mail fraud statutes which would be ad- 
ministered by the postal inspectors as well as the FBI. 

But I don't think that they are without work to do and it is dif- 
ficult to use those statutes, although it was used successfully in, I 
believe, in some Chicago pit investigations. 

Mr. Allard. Thank you, Mr. Chairman. 

I yield back the balance of my time. 

Mr. English. Thank you very much. 

Ms. McKinney. 

Ms. McKinney. Thank you, Mr. Chairman. 

I just have one question and I don't know if it is for you or if 
it is for the chairman, but you make a recommendation in your tes- 
timony that the action that we take be retroactive. 

Let me see if I can find it, and I want to know, I don't see that 
that is specifically stated in the legislation, is it? 

Mr. English. No, it is not. There is not a provision for it to be — 
excuse me — counsel is pointing out to me, they are required to go 
back and amend their orders, but as far as retroactive action 
against people who may be violating it, which I think you are refer- 
ring to, any violations that have occurred since the order came out 
from the CFTC, they wouldn't. 



118 

But of course they are still in the process of implementing that 
order. So we are kind of in a twilight period here where both the 
CFTC is implementing the order that they have come down to at 
the same time that we may have it here. 

Of course rules and regulations have to be promulgated to deal 
with this law should it pass and be signed by the President. 

Ms. McKlNNEY. So to some extent it is retroactive. Is that what 
you are saying? 

Mr. English. Well, it is retroactive as far as the action that we 
are taking against what the CFTC has done in their ruling to ex- 
empt antifraud and antimanipulation. If you would be interested in 
offering an amendment along those lines, as has been rec- 
ommended, that might be appropriate once we open the bill up for 
amendment. 

Ms. McKlNNEY. Is that what you would recommend? 

Mr. Klein. Mr. Chairman, Congresswoman, yes. 

Because we have already had 2 months where the exemption has 
been in place and based on my experience, I can tell you that there 
are many fraudulent operations out there that are quickly going to 
the printers with new brochures and sales pitches and depending 
how much time elapses before this amendment can pass both 
Houses and be signed by the President. I think we need to close 
that gap. 

Ms. McKlNNEY. OK, Mr. Chairman, I would like to do that. 

Mr. English. Thank you very much. 

Mr. Smith. 

Mr. Smith. Mr. Chairman, thank you. 

I am just coming up to my learning curve on this, but I would 
be curious whether your jurisdiction to protect against fraud 
matches your technical and staff ability to do that or is there some- 
what of a false impression that we are sending out that you are 
really doing more than you are capable of doing? 

Mr. Klein. That is always a risk that we — the Government sends 
out when they say: Here are the things that we will do and we 
have taken the responsibility to protect the markets against fraud. 

And in a sense then, every time I bring an enforcement action, 
I am admitting a certain type of failure because I have only been 
able to act after the fact to put somebody in jail, to stop a fraud, 
to get money back for the victims. 

We can never do the kind of job that we wish we could. 

Having said that, however, I think that there is a tremendous 
amount of expertise and dedication at the State level in individual 
States and the States acting together, and with that expertise and 
those resources of combining efforts, the States have acted some- 
times individually and sometimes jointly with the Commodities Fu- 
tures Trading Commission to close down a number of large fraudu- 
lent operations, many of them nationwide. 

And as a result, I think the expertise and the resources are 
there, never as much as we would like, but enough that we can go 
after the worst crooks. 

Mr. Smith. So, Mr. Chairman, as a follow-up, do I understand 
you to say that, no, you don't think we are misleading anybody in 
terms of your ability to protect against that fraud? 



119 

Mr. Klein. Congressman, I think that there is a real danger that 
we are misleading the public about what the CFTC is doing to keep 
the markets free of fraud. I think the implication, which you want 
the public to have, if they go trade on regulated markets, it is going 
to be safe and fair and free of fraud or manipulation. 

I think that message is a false one, but I think that to the extent 
the States see fraud and can find any way to act, they will. 

Mr. Smith. Thank you, Mr. Chairman. That is all I have. 

Mr. English. Mrs. Clayton. 

Mrs. Clayton. Mr. Klein, the tone of your testimony is interest- 
ing as well as your written work. I am interested to know a little 
bit about the relationship between the States and the CFTC. 

Has it deteriorated or was there ever an area when you felt they 
weren't really performing their regulatory jurisdiction? Was there 
a time when they understood what their oversight responsibility 
was and had a good relationship protecting the public, or has some- 
thing occurred within the recent period of time that we need to ad- 
dress? 

Mr. Klein. Congresswoman, I would like to first make a distinc- 
tion between the policymakers on the Commission and the staff. In 
the midlevel, staff members, the Directors of the various divisions 
and their staff people have always gotten along very well with the 
States. 

But as far as the CFTC as an entity, it has been a roller coaster. 
Prior to 1982 the CFTC was very intent on protecting its exclusive 
jurisdiction, to the point that even in late 1979 or 1980, States had 
brought some action against fraudulent operations and the CFTC 
actually intervened in those lawsuits sa5dng the States had no au- 
thority, and that led to Congress adopting the amendment in 1982 
giving the States some limited authority, and things went very well 
until about 1985 when the CFTC adopted an exemption or essen- 
tially gave a no action position — opinion letter — for bank financed 
precious metals which spawned a whole new generation of fi'audu- 
lent operations where people would buy the metals. They put 20 
percent down. The metal would then be transferred to some other 
entity which would hold it, and the CFTC said that takes it out of 
the futures contract, and that then spawned many frauds. 

And then from there the branch statutory interpretation, the 
CFTC's action in connection with a lawsuit in A-Mark that is men- 
tioned in my testimony and now this exemption has strained rela- 
tions very much with the policymakers of the Commission although 
it remains fairly good with the senior staff. 

Mrs. Clayton. Is there, in your judgment, philosophically, a 
trend that we need to be conscious of that needs to be stopped? Ap- 
parently this policy, if they have exclusive jurisdiction, is that their 
interpretation or is that actual policy? 

Mr. Klein. Exclusive jurisdiction provided visions are contained 
in the Commodity Exchange Act and the statute grants them that 
jurisdiction. Yes, I think there is a trend and I think it is a dan- 
gerous trend. 

I think it perhaps can still be reversed, but they are not listening 
to the staff and unless things change soon, it is going to be too late 
to go back. 



120 

Mrs. Clayton. Do you have recommendations about that beyond 
your testimony? 

Mr. Klein. Congresswoman, the recommendations we would 
have are contained in my testimony and the attachments which are 
included and letters that have been submitted to the CFTC and to 
the President. 

Mrs. Clayton. Thank you very much. 

Thank you, Mr. Chairman. 

Mr. English. Mr. Gunderson. 

Mr. Gunderson. Thank you very much, Mr. Chairman. 

Mr. Klein, I want to read to you a statement from Commissioner 
Dial as a part of his testimony submitted to this subcommittee. 

"As of this date, no one has put forth a plausible scenario where- 
by the exempted energy contracts would subject the public interest 
to a fraudulent scheme. Granted, there are those who ascribe to the 
theory that this exemption will allow for general public participa- 
tion through the use of pools, trusts, or partnerships and the CFTC 
would not be able to use the 4(b) fraud provisions to prosecute 
fraudulent activity in these circumstances. That is not the case." 

Will you comment on that statement? 

Mr. Klein. Congressman, I deeply wish he were correct — wish I 
could agree with him. Unfortunately, I think that his own division 
of enforcement disagrees based on the memo that I have seen that 
they submitted to the chairman before this exemption was granted. 

In addition, some discussions I have had with people familiar 
with the CFTC, we have identified situations where it is possible 
that people are going to pool their money, it will be invested by 
someone else claiming to meet the minimum asset requirements 
contained in this exemption and, yet, they are not truly going to 
be the sophisticated investors that they appear to be. 

And the ones who are going to lose money are going to be the 
investors who participate in this pool and it is going to be an un- 
registered commodity pool, or it will be a company whose stock- 
holders are just investing, or it is going to be people who are going 
to find some other way around it, and as we saw in A-Mark unfor- 
tunately, the lawsuit that we brought as bankruptcy trustee, some 
courts at least are willing to say that a small dealer who works out 
of an old house and buys and sells used gold fillings and school 
rings qualifies as a commercial entity, and I think it is a mistake 
to say that those people are able to protect themselves against 
multibillion dollar companies. 

Mr. Gunderson. So you do not believe that the antifraud provi- 
sions under 4(b) are adequate to prosecute? 

Mr. Klein. Congressman, I do not. 

Mr. Gunderson. OK. 

Thank you, Mr. Chairman. 

Mr. English. Thank you. 

Ms. Long, 

Ms. Long. I have no questions. 

Mr. English. Well, thank you very much. I appreciate it, Mr. 
Klein, your testimony has been most helpful. 

Mr. Klein. Thank you, Mr. Chairman. 

Mr. English. Our last witness this morning is Mr. Kenneth 
Raisler, who is with the Energy Group from New York. 



121 

STATEMENT OF KENNETH M. RAISLER, ATTORNEY, ON 
BEHALF OF THE ENERGY GROUP 

Mr. Raisler. Thank you. Mr. Chairman, and members of the 
subcommittee, my name is Kenneth Raisler. I am an attorney with 
the law firm of Sullivan & Cromwell. I am appearing today on be- 
half of nine energy companies, each involved in commercial busi- 
ness relating to crude oil, natural gas or their products and by- 
products. 

I represented these energy companies in their application to the 
CFTC for an exemption that was the subject of this committee's 
earlier hearing and has been discussed today. I have submitted a 
written statement for the record which sets forth in detail our posi- 
tion on H.R. 2374. 

In my oral statement, I wish to make only a few brief points. 

First, as a personal matter, prior to joining Sullivan & Cromwell, 
I served in the U.S. Department of Justice, including a tour as a 
criminal prosecutor in the District of Columbia. I also served as the 
General Counsel of the Commodity Futures Trading Commission. 
In that capacity, one of my jobs was Chairman of the CFTC State 
advisory committee and I am pleased to say from Mr. Klein's testi- 
mony it was during the period of 1982 to 1985 when the roller 
coaster, at least he indicates, was at high level. 

From my personal perspective and the perspective of the group 
I represent, I am adamantly opposed to fraud in any market, in- 
cluding the market covered by the energy exemption. My view and 
the view of the group that I represent is that the bill is not an ef- 
fective way to address this issue. 

Instead, it may create false impressions and confusion that may 
deter important participation in these markets. 

Congress in the 1992 Futures Trading Practices Act directed the 
CFTC to address an exemption for forward contracts in order to re- 
solve what was legal uncertainty that came about as a result of one 
district court decision in New York. 

Forward transactions, it is very important to realize, are and al- 
ways have been excluded from all of the provisions of the Commod- 
ity Exchange Act and CFTC jurisdiction, not just antifraud, but 
they are outside the act in their entirety. 

Transactions described in the exemptive order are generally rec- 
ognized to be such forward contracts outside the CFTC's jurisdic- 
tion. The exemptive order seeks to clarify this very point. 

In our view, application of the CFTC's antifraud jurisdiction only 
confuses the picture. The CFTC has never overseen or been in- 
volved in policing these markets. I believe that is just a critically 
important point. Without the staff or the expertise, retaining anti- 
fraud jurisdiction could create a misleading impression about the 
CFTC's abilities. 

Moreover, CFTC authority is limited. The CFTC has to prove 
that these contracts are, in fact, futures contracts and in fact they 
are generally recognized instead to be forwards. Parenthetically, I 
would point out that that debate opens up court actions on what 
is a futures contract versus what is something that is not a futures 
contract, which is the very point that this committee and the Con- 
gress sought to avoid by giving the CFTC exemptive authority. 



122 

We are unaware of any evidence of fraud in these markets or any 
of the markets covered by the exemptive order. 

In fact, Mr. Klein made reference to fraudulent operators out 
there and going to the printer. We are unaware and we would be 
most interested in hearing about any such evidence. We are aware 
of none and to our knowledge we are not aware of any that have 
occurred in the past either. 

If problems arise in these markets, it is our view that both the 
participants and the authorities can seek recourse under applicable 
State and common law. In fact, the CFTC and every authority that 
I am aware of is on record that the goal, when there was fraud in- 
volved, is to bring criminal prosecutions. 

Criminal authority is free and available to the Federal Govern- 
ment using mail and wire fraud statutes and they have repeatedly 
used those in any kind of activity that involves fraud, as well as 
the States using their various statutes to bring to bear. 

It is important to recognize that the exemptive order does not 
permit activities that could be the cause of public fraud. The gen- 
eral public and individuals are not eligible for the exemption. Both 
parties to the energy exemption contracts must be commercial par- 
ticipants with substantial net worth or assets, at the $1 million 
level for net worth and $5 million for assets. 

Public marketing and sales, whether high pressure or not, are 
not permitted. Thus, if such activity, and I believe the activity that 
Mr. Klein described, were to occur, it is our strong belief that the 
exemptive order would not apply in any way and the CFTC would 
have available its full panoply of authority, not just its antifraud 
authority. 

The goal of legal certainty sought by the energy companies has 
been achieved by the CFTC's exemptive order. Foreign counter- 
parts, no longer confused about the applicability of the act and 
CFTC jurisdiction, are prepared to enter into energy contracts in 
the United States. 

This result provides important benefits to the U.S. energy compa- 
nies and energy consumers allowing greater certainty in the pricing 
and sourcing of energy. 

We endorse the goals of Congress in enacting the Futures Trad- 
ing Practices Act which provides the CFTC with important discre- 
tion. If an exemptive order like that issued for energy contracts is 
determined to have unintended effects, the CFTC can always re- 
visit it and tighten up its requirements or clarify its terms. 

In our view, in fact, that is the better approach because the 
CFTC antifraud authority on its own is insufficient. It would need, 
if it finds activities to go outside, to go beyond antifraud and look 
to other regulatory and other kinds of prohibitions and the way to 
do that, in our opinion, is to modify the exemptive order if prob- 
lems occur. 

We see no reason for problems to occur because the exemptive 
order is very carefully designed to avoid the public marketplace. 

For these reasons, we do not endorse the automatic application 
of the act's antifraud provisions. I appreciate the opportunity to ap- 
pear before the committee and would be happy to answer any ques- 
tions that the committee has. 

Thank you, Mr. Chairman. 



123 

[The prepared statement of Mr. Raisler appears at the conclusion 
of the hearing.] 

Mr. English. Thank you very much, Mr. Raisler, I appreciate 
that. 

As was pointed out by Mr. Klein, I was particulariy struck by the 
fact that this part;icular action, this exemption from fraud £ind ma- 
nipulation, £iny type of fraud and manipulation application of the 
Commodities Exchange Act, that that recommendation came from 
the economic division over CFTC, while being opposed, strongly op- 
posed, by the enforcement division. 

Now, it may be fine from an ivory tower economic theory stand- 
point to say, hey, we are opposed to all regulation. Let's deregulate, 
and if that is where we are, then we might as well do away with 
all our Government entities that have regulations as their respon- 
sibility. 

That is free trade, that is wide open, and I understand that 
many in our country would like that, many who are ivory tower- 
types. Then we have the other types. We have the fast buck boys 
and the fast buck boys are always looking for an edge and if you 
are going to open the door and say, the Federal Government is not 
interested in whether you create fraud, involved in fraud or manip- 
ulation of markets, I guarantee you they are going to be delighted 
to step in and take advantage of that situation. 

Now, I don't think that the people at the CFTC who voted for 
this two to one, that was what the margin was of the Commis- 
sioners, we have a lot of vacancies over there, don't we? 

Mr. Raisler. That is correct. 

Mr. English. Two to one. I don't believe those two who voted for 
this actually want to open this market up for fraud and manipula- 
tion. I believe that they listened to the ivory tower-types, but I 
think it would be very naive, as I told them before, to expect that 
is going to be the case. 

I would also make the point that where you are talking about 
being misunderstood, foreign counterparts might misunderstand, I 
have never been able to understand why people overseas would feel 
that it is somehow confusing that we are opposed to fraud and ma- 
nipulation. 

Most people, it seems to me, when they enter into a transaction, 
like to feel like they are going to be dealt with fairly, not some fast 
buck guy in there that is going to gouge him. And I can assure you, 
whether they are domestic or foreign, if we are going to turn our 
back as a Nation, those people are going to be present. They are 
in our society. 

It would be nice if it were not the case, but I have a very hard 
time buying your argument that somehow these people are going 
to feel that in some way it is burdensome to be protected from 
fraud and from manipulation. That is an interesting argument, but 
I simply don't think that exists. 

Now, I have also heard from some, well, these are the big boys. 
We shouldn't concern ourselves because these are the big boys. 
Well, the big boys fall too, and when they fall, they fall on a lot 
of little people. The little people get hurt when the big boys fall, 
and the big boys are just as subject to manipulation and fraud as 
anybody else, and perhaps we shouldn't concern ourselves when- 



124 

ever they get gouged or taken, but we have a lot of companies that 
these big boys represent, and when those big boys go down, when 
they go into banlaiiptcy, whenever they have problems, that rever- 
berates throughout the economy and a lot of little people get hurt. 

I think all the people of this country deserve to be protected from 
fraud. They deserve to be protected from those who would manipu- 
late, and quite frankly, I am astounded by the fact that you would 
come here before us saying that, golly, we shouldn't extend our 
laws dealing with fraud and manipulation to those who may come 
under the jurisdiction of the CFTC, and as I am sure you are well 
aware, this legislation of course applies only in those cases, to 
those instruments, that are not covered under the jurisdiction of 
some other regulator. 

So I don't have any questions, but I have to say, I felt compelled 
to make those points. 

Mr. Allard. 

Mr. Allard. From your perspective, do you feel that the anti- 
fraud and the rules and regulations that we have in place now pre- 
vent boilerroom operations, particularly in regard to the energy 
contracts that had come up as an issue with the CFTC? 

Mr. Raisler. I think there is very much a misimpression about 
this CFTC exemption and who it applies to. In our strong view, any 
boilerroom-type activity would not be eligible for this exemption. So 
the issue of the application of antifraud is irrelevant. The legisla- 
tion, therefore, is irrelevant. 

Our view is if somebody, in the chairman's words, the fast buck 
boys are out there selling this product to somebody, the CFTC ex- 
emption does not apply, and I don't want to send a signal to any- 
body out there that they should be able to take advantage of this 
exemption under those means. 

The fact is that it is very important, and I agree with the chair- 
man's comments, that everyone in this country and throughout the 
world deserves to be protected from fraud. The fact of the matter 
is that the CFTC's application of antifraud jurisdiction under this 
bill is a very narrow aspect and that the people who are out there 
marketing boilerrooms should understand that they have no oppor- 
tunity to get the benefits of the CFTC exemption, and if they try 
to rely on the exemption, it should be clear from the CFTC, and 
everybody else, that their business should be put to a halt, and 
that that exemption does not apply and all CFTC jurisdiction can 
be brought to bear to shut them down, and hopefully the States 
and the Federal criminal authorities are also at hand. 

Mr. Allard. In the early part of your testimony, you had begun 
to draw some distinctions between forwards and how these energy 
transactions may differ. 

Is there a significant difference between forwards and the energy 
contracts who have the exemption? 

Mr. Raisler. No. In our view, not at all. 

The fact of the matter is that this whole issue comes up because 
a district court in New York found that some of these contracts 
were, in fact, futures. 

Our position is that decision was wrong. The CFTC issued a stat- 
utory interpretation in effect saying that that decision was wrong. 
The exemptive authority gives us a way to put a belt with those 



125 

suspenders, if you will, to make it clear to everybody out there that 
this activity is forwards activity. In effect, this activity is outside 
of CFTC jurisdiction. 

That is the goal that we went to Congress and sought in the leg- 
islative history to the Futures Trading Practices Act and that is the 
goal we believe was achieved by the exemptive order. So I think 
that is important to recognize, we are not talking about deregula- 
tion in this market. 

That it is a forwards market; that the CFTC, since the Commod- 
ity Exchange Act was adopted in 1922, has never had jurisdiction 
over the buying and selling of goods which, in effect, is what this 
energy exemption seeks to clarify and affirm. 

Mr. Allard. In your view then, does the CFTC have the re- 
sources and the expertise to regulate the energy exemptions if we 
bring them back in under the fraud? 

Mr. Raisler. Our opinion is no. The fact is the CFTC has never 
regulated or overseen or policed the forward markets. The CFTC's 
resources are limited, as this committee well knows. 

The CFTC does not have any individuals stationed in any of the 
States that are energy producing or energy trading States. There 
are no CFTC employees in Texas, Oklahoma, or Louisiana, for ex- 
ample. To expect the CFTC, and this is where we are concerned 
about a misleading impression to the marketplace, to expect the 
CFTC to be policing fraud wherever it occurs in the country I be- 
lieve gives the public a misleading impression about that level of 
protection. If it is determined that protection is needed, a more 
radical step than giving CFTC antifraud jurisdiction should be the 
way to solve the problem. 

We don't believe that is necessary because the exemption is nar- 
rowly drawn to a marketplace that has never been regulated by 
any Federal regulator, including the CFTC. 

Mr. Allard. What has been your experience in dealing with the 
States? We had a previous witness who gave the State's perspective 
on the rules and regulations. 

And now representing those who are regulated or could be regu- 
lated, what is your perspective on the State's role in this area as 
far as regulation is concerned? 

Mr. Raisler. I think it is important to recognize that the States 
do have an important role to play. The CFTC, in fact, if I can go 
back a bit in time, in 1982, which is when Mr. Klein talks about 
the environment changing at the CFTC and there was a better re- 
lationship with the States. 

In 1982 this committee recommended and Congress adopted a 
change to the Commodity Exchange Act. Up until that time the 
CFTC was exercising exclusive jurisdiction over not just the mar- 
kets in which — the futures markets, the exchange traded futures 
markets, but also the cash markets and where commodity advice 
is being given. 

The CFTC recommended, and this committee endorsed, taking 
away that authority from the CFTC and giving the States very 
broad authority to develop their own laws. In fact, the States have 
moved forward with a model State commodity code to prohibit the 
boilerroom and bucketshop activity at the State level. 



72-584 0-93-5 



126 

This has been a very important initiative adopted by a number 
of States and strongly supported by the CFTC and I beheve the 
pubHc at large. The States have an important responsibility. They 
have worked closely with the CFTC over a number of years. It is 
important to recognize as these markets evolve that the States con- 
tinue to have a responsibility and that responsibility particularly 
is focused on the fraud level, particularly focused on the boilerroom 
level at the local — in the local areas. 

Mr. Allard. Madam Chairman, I tried to clear up in my mind 
sort of a chronology here 

Ms. Long [assumed chair]. Without objection. 

Mr. Allard. So we had a period of time there where there prob- 
ably wasn't much thought or concern about commodities or the fu- 
tures and swaps and those sort of gray contracts, that gray area, 
and then was there a period of time when we had the CFTC explic- 
itly prohibit the States, where they actually exempted the States 
and then went back into a period of time after that where then the 
States then were allowed this regulatory authority and they are in 
the process now of passing the CFTC acts that you referred to in 
your comments? 

Mr. Raisler. Right. If I can—prior to 1982, the CFTC effectively 
preempted the States from dealing with off exchange trading, that 
is, the trading that existed away from the futures markets. That 
changed in 1982. 

The States now have very broad authority and they have author- 
ity to adopt, at the State level, their own laws. There is the model 
State commodity code which each State is free to adopt and a sig- 
nificant number of States have adopted a form of model code. 

The intent of that model code is to prohibit commodity-related 
fraud at the State level and the CFTC has worked with the States 
to do that since 1982. In the last decade, enormous progress has 
been made and a lot more vigilance has been paid to the boilerroom 
activity. 

Let me just point out that from our point of view, the whole dis- 
cussion of fraud in the boilerroom context really does not apply to 
this energy exemption which we believe would not be available to 
a boilerroom-type purveyor, but my answer to your question stands 
with that caveat at the end. 

Mr. Allard. Thank you, Mr. Chairman. 

I see my time has run out. 

Mr. English [resuming chair]. Ms. McKinney. 

Ms. McKinney. No questions, Mr. Chairman. 

Mr. English. Mr. Penny. 

Mr. Penny. No. 

Mr. English. Ms. Long. 

Ms. Long. You have partially answered this, but I would simply 
say that if you think there is no fraud or abuse, then if you would 
just say specifically why you oppose the bill. 

Mr. Raisler. I think there are several reasons. The first is that 
by enacting this bill and giving the CFTC this antifraud authority, 
you are creating, I believe, the impression in the marketplace, one, 
that a variety of activities that we believe are not covered by the 
exemption may be permitted under the exemption and the CFTC 
should therefore use its antifraud authority to stop them. 



127 

Two, you are creating the impression that the CFTC will be able 
to stop fraud in these markets if such fraud were to occur when, 
in fact, the activity is basically outside the exemptive order. Both 
the States and the CFTC are able to proceed to stop that fraud now 
with the exemptive order in place and there is no reason to impose 
that. 

The last point is that bringing antifraud into the exemptive order 
creates confusion as to what is the CFTC's jurisdiction in this area. 
We have sought by the legislation in 1992 and the exemptive order, 
to clarify in essence that these are forward contract-like instru- 
ments which the CFTC has never had any jurisdiction over. 

We believe that is the right result and that is the result that is 
indicated by a pattern of activity, including an earlier statutory in- 
terpretation of the CFTC. Bringing antifraud in basically says, in 
effect, these things are futures-like and forces the CFTC, if it 
wants to proceed with a fraud case, to prove that contracts which 
we have tried to present to be forwards and not under CFTC's ju- 
risdiction are finding their way into the CFTC's jurisdiction again 
as futures, and that debate is one we thought we had avoided with 
the exemptive authority and with the 1992 legislation. 

Ms. Long. Thank you. 

I don't have any other questions, Mr. Chairman. 

Mr. English. Thank you very much. 

Mr. Smith. 

Mr. Smith. Help me understand what kinds of fraud might be an 
example of — that would take place that the lesser ability of the 
CFTC couldn't determine. 

Help me understand what kind of fraud might happen. 

Mr. Raisler. I think that if I understand your question and if 
I don't, please redirect this to me. 

Mr. Smith. I don't have an understanding what kind of fraud 
might happen in this energy contract. 

Mr, Raisler. There are really two kinds of frauds that people are 
talking about today as I hear it. One is the sort of purveying to the 
general public — this sort of boilerroom-type activity that has gone 
on in precious metals historically where people are getting on the 
phone and hawking a product. People are sending out literature 
saying, gold is going through the roof or whatever, and that kind 
of activity is not covered by this energy exemption at all. 

So in our view, the CFTC has full authority to stop that kind of 
boilerroom activity, as do the States under their various State stat- 
utes. 

The other kind of fraud 

Mr. Smith. Excuse me. Would there be more penalties, if you 
didn't have the exemption and it was discovered, would there be 
more penalties than just the prosecution under State statutes? 

Mr. Raisler. No. I would say it is apples and oranges. The 
exemption has nothing to do with that boilerroom business. That 
boilerroom business cannot rely on the energy exemption so there- 
fore that boilerroom business is thrown back into all of the provi- 
sions that make their conduct illegal. 

So there is no — the current energy exemption really has nothing 
to do with the boilerroom business. 



128 

Mr. Smith. But it has to do with some business. It might not oth- 
erwise be covered under the State statutes. 

Mr. Raisler. The kind of fraud one thinks about — the energy ex- 
emption appHes to when two over-the-counter parties, both com- 
mercial entities who are in the energy business, deal with each 
other, and it is certainly possible that in those dealings one could 
defraud the other — one could make — I mean, it is — one could not 
pay on its contract, one could misrepresent its assets, one could 
misrepresent that they had the oil when they hadn't yet bought it. 

Those are the kinds of disputes between two commercial parties 
that historically have, if they have existed and generally in this 
market we are not aware of them, but if they had existed, would 
be the subject of litigation between those two commercial 
counterparties where they could rely on a whole variety of common 
law and State fraud statutes as well as contract statutes and other 
legal remedies. 

Mr. Smith. Mr. Chairman, I don't want to take any more of the 
subcommittee's time. 

I will pursue this, my questions directly, but my experience is 
that the less our ability to determine that fraud and criminal activ- 
ity, sometimes the greater the penalty helps to act as a deterrent. 

Mr. English. Will the gentleman yield? 

Mr. Smith. Yes, sir. 

Mr. English. One statement you made I am having a great deal 
of trouble understanding, Mr. Raisler, how in the world, with re- 
gard to any kind of action taken, if CFTC has exempted itself, that 
is what is happening. They are totally exempt. They can't take ac- 
tion under any circumstances? 

Mr. Raisler. Just one quick point on that, Mr. Chairman, just 
to clarify. The CFTC has 

Mr. English. Isn't that correct? 

Mr. Raisler. Just one specific point. The CFTC is 

Mr. English, All I am asking is it true or not? 

Mr. Raisler. With one exemption. The CFTC has retained 
antimanipulation authority. 

Mr. English. That was another question I was going to ask you. 
Since they have retained that antimanipulation authority, and I 
believe you said in response that they don't have the capability to 
deal with any kind of antimanipulation or any manipulation that 
may take place, but they have the authority on price manipulation, 
don't they? 

How can you, in fact, have the capability to carry out the respon- 
sibilities on price manipulation, in fact, how can you have any ju- 
risdiction if you have the capability of taking action on price ma- 
nipulation, but you don't have it in any other area of manipulation? 

Mr. Raisler. I believe the CFTC has full authority in the manip- 
ulation area. 

My comment was directed to the fraud area. Manipulation is 
when you manipulate the price in the marketplace and the CFTC, 
through the futures markets in particular, has always been con- 
cerned about that. 

Mr. English. You said that they don't have jurisdiction. This is 
a forward contract. CFTC has no jurisdiction, therefore, CFTC can't 
get involved, can they? You either got it or you don't have it. 



129 

Mr. Raisler. CFTC always has jurisdiction over price manipula- 
tion. 

Mr. English. No matter whether it is a futures contract or not? 

Mr. Raisler. That is correct. 

Mr. English. That is not a futures contract, if it is something 
CFTC has no jurisdiction over, they in no way can take any kind 
of regulatory action against a security. That comes under the SEC. 

You can't take it against any other kind of instrument. The only 
jurisdiction they have is on a futures contract and the problem 
came about in this area because you had a court determine that 
these were futures contracts. 

Mr. Raisler. Mr. Chairman, on the issue specifically of manipu- 
lation, the CFTC has always had authority over the cash markets. 
Specifically in connection with the attempted manipulation of the 
silver market in 1980 by the Hunt family, the CFTC did 
proceed 

Mr. English. Those were on market, on exchange transactions, 

Mr. Raisler. The CFTC's proceeding was a manipulation of both 
the futures market and the cash market and its enforcement au- 
thority affected both the futures market and the cash market. 

Mr. English. The only authority they have is if that is deter- 
mined to be a futures contract and the way that the CFTC is deter- 
mining if it is a futures contract today is if it is traded on an ex- 
change. 

If it is not traded on an exchange, I don't believe you can name 
me a single instrument that is being traded off exchange that the 
CFTC has been making the determination they havie any kind of 
authority over it, doesn't matter what the court says. 

Mr. Raisler. CFTC continues to bring proceedings on off ex- 
change futures trading, including in the foreign exchange market. 

Mr. English. Name one. 

Mr. Raisler, There are two cases pending in the eastern district 
of New York involving foreign exchange trading. 

Mr. English. None of those contracts are being traded on ex- 
changes at all? 

Mr. Raisler. That is correct, 

Mr, English, Any exchange in this country, absolutely none? 

Mr. Raisler. If I understand the chairman's point, the people 
who sold those contracts were not trading them on an exchange. 

Mr. English. That isn't the point. The question is, are those in- 
struments being traded on an exchange? 

Mr. Raisler. If I understand the chairman's question 

Mr. English. You understood my question. Is it being traded on 
an exchange or is it not? 

Mr. Raisler. It is not. 

Mr. English. Absolutely. Nowhere in this coimtry on any ex- 
change that is regulated by the CFTC are any of those instruments 
being traded in any form? 

Mr. Raisler. The answer to that question is certainly yes. 

Mr. English. All right. That is my point. That is where the tie 
comes in. 

If these contracts are not being traded on exchanges, the CFTC, 
from a practical standpoint, has made the determination those are 
not futures contracts and they have no jurisdiction. If they are fa- 



130 

tures contracts, they are required to be traded on exchanges, aren't 
they? 

Mr. Raisler. Not pursuant to various exemptions the CFTC has 
granted and not pursuant to the 

Mr. English. I will come back. CFTC has made under the law, 
under the Commodity Exchange Act, if an instrument is deter- 
mined to be a futures contract, the CFTC says it has to be traded 
on exchanges. In fact, the law says it has to be traded on ex- 
changes; isn't that correct? 

Mr. Raisler. I agree that is what the law says, yes. 

Mr. English. All right. I know that you may not like the law, 
but that is what the law says. 

Mr. Raisler. But the CFTC is granted a variety of exemptions, 
including the recent swaps. 

Mr. English. That is exactly why we are here today. They have 
granted a variety of exemptions and that is exactly the problem. 
The CFTC is whiddling away at the law. 

In this case we have gone to the point where in fact they are 
willing to exempt fraud and manipulation. The question that is 
going to come down to and going to be determined by this Congress 
and by this legislation is whether or not this Congress is going to 
endorse that or not. 

We have carried the issue of deregulation to the point that a reg- 
ulatory agency says we are going to turn a blind eye to fraud and 
manipulation, even if it is in our jurisdiction, even, in fact, in light 
of the fact that this Congress, through its reauthorization, stated, 
we are going to determine whether off exchanged instruments are 
being traded, what they are and who they will be regulated by. 

We want status quo. Whenever you start exempting on the basis 
of fraud £md manipulation, that is not status quo, and that is what 
brings us here today. 

Mr. Nussle. 

Mr. Nussle. Thank you, Mr. Chairman, and just to make sure 
I understand the remedy that you are prescribing in the alter- 
native of passing this particular piece of legislation is the civil 
courts? 

Mr. Raisler. Two basic remedies is that the parties of course 
have — and the authorities have the criminal courts as well as the 
civil courts available, but to the extent that this exemption is found 
to raise the possibility of abuse in some area, the CFTC, because 
it is only an exemption, the CFTC can revisit it. 

And our position is that as the major players in these markets, 
we don't want fraud in these markets. We have no interest in pro- 
moting fraud in these markets and if there is a problem and we 
don't believe the way this is designed there will be, but if there is 
a problem, we will be the first to recommend the CFTC revise the 
exemption to clarify that certain participants should not be eligible 
for it, and that is in addition a very significant remedy that is 
available to the CFTC and to the public at large. 

Mr. Nussle. But having this in effect, doesn't that provide some 
deterrent effect? You are talking about closing the bam door after 
the horses are out. 

I am saying, is there a deterrent effect of having this kind of leg- 
islation on the books? 



131 

Mr. Raisler. The concern that we have is that there may be 
more confusion than deterrent by putting this on the books. 

Mr. NUSSLE. Sometimes confusion is a deterrent. 

Mr. Raisler. Well, the question though is whether that may 
deter legitimate players from participating in the market because 
they are concerned about the scope of the CFTC's jurisdiction in an 
area which is basically deemed to be forwards outside of CFTC ju- 
risdiction. 

That is the concern in terms of confusion. 

Mr. NusSLE. OK, but the bottom line though is that the real 
remedy that you are prescribing in the alternative of this legisla- 
tion is the civil courts. 

You are basically saying let the buyers beware, let the market 
beware, and you are on your own, you take care of it on your own. 
You have to investigate it, you have to uncover it, you have to be 
aware of it, and then you have to prosecute it. 

Mr. Raisler. And let me point out, as a general matter in this 
country the buying and selling of goods, whether they be energy or 
any other kind of product, find themselves with that remedy, yes. 

Mr. NusSLE. Usually on a lot less sophisticated scale. Bujdng a 
candy bar at a local convenience store is not the same as purchas- 
ing securities, forwards, futures, or whatever it might be. 

Mr. Raisler. We are not talking here about investment con- 
tracts. What we are talking here about is the buying and selling 
of cargoes of crude oil and pipeline delivery of natural gas, between 
the kind of people that are represented in the Energy Group. 

These are commercial contracts to move physical product across 
State lines for purposes of getting that oil to the powerplant or to 
the corporation that needs it. 

These are not candy bar purchases, these are not retail pur- 
chases, and these are not investment purchases. These are people 
who are trying to buy and sell crude oil, natural gas, and their 
products for their businesses. 

Mr. NusSLE. And the Government has no place regulating or 
monitoring that particular transaction, in your opinion? 

Mr. Raisler. The Government never has, and so we see no rea- 
son for them to start now. 

Mr. NussLE. Well, if the Government never has, why would they 
have granted an exemption? 

Mr. Raisler. The district court in the southern district of New 
York reached a conclusion which the CFTC disagreed with but was 
nonetheless on the books, creating confusion about whether some 
of those contracts might be futures imder the CFTC's jurisdiction. 

Our goal here was to clean that up. The CFTC statutory inter- 
pretation did that in part. This exemption was intending to make 
the rest of that clear, and that is the full extent of what we were 
trying to achieve here, no more. 

Mr. NusSLE. Thank you, Mr. Chairman. 

Mr. English. Thank you very much, Mr. Nussle. 

I would like to say, Mr. Raisler, before you leave, I think the im- 
pression is that since you are representing the Energy Group, that 
this is a few big oil companies that are involved in all this trading 
around back and forth, and those are the guys that are involved. 



132 

It is also my understanding the people who are involved in these 
kinds of contracts, the people who would be subject to any fraud 
or manipulation that may take place, also include municipalities 
that operate power facilities, rural electric cooperatives and other 
power suppliers, fleet operators, barge companies, railroads, air- 
lines. 

Wouldn't take but just a little manipulation, a little fraud to 
push some of these airlines in bankruptcy and goodness knows 
what impact that would have on our economy, other transport com- 
panies, fertilizer producers, blasting producers, aluminum, steel 
producers, and other energy dependent manufacturers, farmer sup- 
ply cooperatives, and home heating associations, just to name a 
few. 

Mr. Raisler. That is certainly correct, Mr. Chairman. 

Mr. English. And I don't hear any of them coming up here and 
sajdng, golly, gee, throw me in that briar patch with all that fraud 
and manipulation. We sure want to be manipulated. 

We sure want a little fraud, so be sure and don't pass any bill 
that is going to prevent us from being involved in all this fraud and 
manipulation here. 

Mr. Raisler. Mr. Chairman, the CFTC did put this exemptive 
order out for public comment. It got 16 comments back and no- 
body — and the CFTC specifically raised the antifraud issue. Nobody 
argued then. 

The State securities people did not come in, weigh in on the 
issue, nobody put forward on that record a request that the CFTC 
apply antifraud and in fact the vast bulk of the comments are spe- 
cifically recommended against it. 

So there has been an opportunity for people to weigh in on this 
specific point and the CFTC teed it up and nobody was prepared 
to hit it. 

Mr. English. Would you please name the members of the Energy 
Group so that we all know specifically who it is that is up here tes- 
tifying in favor of fraud and abuse, manipulation? 

Mr. Raisler. Mr. Chairman, I would be happy to name the mem- 
bers of the Energy Group. We should be making it clear that we 
are not testifying in any way in favor of fraud or any other 

Mr. English. I am happy to hear that. So you have no problem 
with the objective of the legislation? 

Mr. Raisler. We have no problem with deterring fraud in any 
market. 

Mr. English. I am happy to hear that. 

Mr. Raisler. If you wish, our written testimony includes the 
names of the companies and I will read them. This is only in alpha- 
betical order, so I am not 

Mr. English. You are not slighting anyone. 

Mr. Raisler. That is correct. BP Oil Company, Coastal Corpora- 
tion, Conoco Inc., Enron Gas Services Corporation, J. Aron & Com- 
pany, Koch Industries Inc., Mobil Sales and Supply Corporation, 
Phibro Energy Division of Solomon, Inc., Phillips Petroleum Com- 
pany. 

Those are the nine companies who comprise the Energy Group 
who submitted the application to the CFTC for the energy exemp- 
tion and on whose behalf I am testifying today. 



133 

Mr. English. I appreciate that very much. 
Thank you very much, Mr. Raisler. 
Mr. Raisler. Thank you, Mr. Chairman. 
Thank you. 

Mr. English. That concludes our witnesses today. 
[Whereupon, at 11:45 a.m., the subcommittee proceeded to other 
business.] 

[Material submitted for inclusion in the record follows:] 



134 

WRITTEN SUBMISSION OF PATRICK H. ARBOR, 

CHAIRMAN, 

BOARD OF TRADE OF THE CITY OF CHICAGO 

ON H.R. 2374 

Mr. Chairman and members of the Subcommittee, I am Patrick H. Arbor, 
Chairman of the Chicago Board of Trade. Thank you for your invitation to present the 
views of the Board of Trade on H.R. 2374 and the actions taken by the Commodity 
Futures Trading Commission under its new statutory exemptive authority. 
Su pport for H.R. 2374 

The Chicago Board of Trade generally supports H.R. 2374. That 
legislation would confirm that any person or transaction the CFTC exempts under 
Section 4(c) of the Commodity Exchange Act must remain subject to fraud and 
manipulation prohibitions. 

The Board of Trade and other exchanges addressed this issue in their 

December 1992 comment letter on the CFTC's proposed swaps exemption. The 

exchanges urged the CFTC to exempt only those transactions that would be subject 

to "core protections" under the CEA, including antifraud and antimanipulation. The 

exchanges specifically stated: 

"No one can legitimately claim that swaps that 
are futures should be excused from the CEA's 
antifraud and antimanipulation provisions. 
Those protections are central to the customer 
protection and market integrity purposes 
underlying the CEA." 

The Board of Trade also incorporated those comments in its comment letter on the 

CFTC's energy contract exemption. 

Unfortunately, in differing degrees, both the CFTC's swaps and energy 

contract exemptions deviate from that policy. Under the swaps exemption, anyone 

manipulating the price of an exempt swap would not violate the CEA unless that 



135 



manipulation effected a ripple manipulation on a futures exchange or in the cash 
market as a whole. The swaps exemption also may be illusory or at least 
cumbersome when it comes to fraud. Any fraud action would require the complaining 
party to prove first that the swap is a futures contract and second that fraud occurred. 
Other than shielding wrongdoing, no reason exists to make the complaining party 
make a double showing. 

The energy contract exemption has the same flaw in the manipulation 
area as the swaps exemption and contains no antifraud protections. H.R. 2374 would 
remedy the fraud omission somewhat by adopting a policy akin to the swaps 
exemption, but might be interpreted not to prohibit manipulating the price of exempt 
instruments. The attached revised version of H.R. 2374 attempts to address those 
technical issues in H.R. 2374. The revised version also would preserve the rights of 
any parties injured by fraud or manipulation in connection with exempt instruments to 
bring private damage actions. 

As an alternative to H.R. 2374, the CFTC could adopt a regulation that 
prohibits fraud and manipulation in connection with any transaction that is otherwise 
generally exempt from the CEA. The Board of Trade also would support that direct 
approach to maintaining the core protections in the CEA. 
Other Core CEA Protections - Clearing 

Neither the CFTC exemptions adopted to date nor the provisions of H.R. 
2374 address another apparent oversight in the exemptive area -- the role of clearing. 
Clearing is the process for matching trades and removing credit risk for the parties to 
a trade (the risk that a losing party to a trade will not pay the winning party). 



-2- 



136 



Clearing is another core protection of the CEA, as the CFTC recognized 
at its inception. In 1976, the CFTC proclaimed that unless a proposed new futures 
contract was subject to an acceptable clearing system, that new contract would be 
found to be "contrary to the public interest" and therefore unlawful. CEA §5(8). The 
CFTC even has described clearing to be the "essence of the integrity of a futures 
contract." 41 Fed. Reg. 40093 (1976). 

Although the Commission historically had found the absence of clearing 
to be " contrary to the public interest," in the recent swaps and energy contract 
exemptions, the CFTC found the absence of clearing to be " consistent with the public 
interest" for those exempt transactions. Perhaps la>yvyers can perceive a logical thread 
in those policy judgments but I must say, as a businessman, I find that kind of agency 
inconsistency to be difficult to fathom. 

Compounding the puzzling nature of the CFTC's policy toward clearing, 
both the Federal Reserve Board and the Securities and Exchange Commission 
supported expanding the CFTC's exemption in the hope that clearing systems for 
exempt derivative instruments would strengthen financial protections for those 
instruments. Yet the CFTC refused to allow clearing for exempt instruments, a 
process the Commission previously had viewed to be mandated by the public interest. 

In recent weeks, many articles have appeared bemoaning the extent of 
credit risk OTC derivative instruments now face. One guest editorial in the Wall Street 
Journal even suggested that we, the taxpayers, are now underwriting that risk since, in 
the absence of clearing, the U.S. government acts as the guarantor for all off- 
exchange derivative instruments for U.S. financial institutions. Allowing clearing of 



-3- 



137 



exempt instruments would strengthen the existing OTC markets and remove the cloud 
of financial exposure now facing the taxpayers. For these reasons, this Subcommittee 
should direct the CFTC to remove the ban on clearing of exempt instruments. 
Fair Competition 

As you know quite well, Mr. Chairman, Congress recognized in 1992 that 
exchange markets compete with OTC dealer markets. Competition of this kind is 
healthy, as long as it is fair. Congress therefore required the CFTC to promote "fair 
competition" between OTC and exchange markets in exercising its exemptive powers. 
The 1 992 Conference Committee specifically directed the agency to apply its 
exemptive powers in a "fair and even-handed manner to products and systems 
sponsored by exchanges and non-exchanges alike." The CFTC's exemptive actions, 
thus far, have violated that directive. 

Twice the exchanges have asked the CFTC to level the exemptive 
playing field and allow exchange and OTC markets to participate in class exemptions 
on a "fair and even-handed" basis. Twice the CFTC has rejected those requests by 
precluding exchanges from offering exempt instruments. 

The CFTC's policy is both inconsistent with the agency's 1 992 mandate 
and unwise. Exchange trading would offer all market users the benefits of price 
transparency, market liquidity and clearing. By affording market users more exempt 
instruments to choose from, the CFTC would enhance competition for, and reduce the 
cost to market users of, risk management services that are essential to all businesses 
in our economy. 



138 



In 1 992, Congress understood the benefits of, and mandated the CFTC 
to promote, fair competition. The CFTC's exemptive actions have ignored those 
congressional findings. In any legislation you adopt, this Subcommittee and Congress 
should reinforce the CFTC's fair competition mandate in a manner the agency can not 
ignore. 
Professional Trading Market Exemption 

Since Congress granted the CFTC exemptive powers, the Board of 
Trade has studied carefully the exemptions the agency has granted, the rationale for 
those exemptions and the proposed exemptions submitted by others. Based on that 
review, the Board of Trade has decided to file with the CFTC an exemptive request for 
what we call a "Professional Trading Market." Under this proposed exemption, 
exchanges would be able to offer those sophisticated and well-capitalized institutions 
that use the OTC markets the benefits of transparent pricing (through floor or 
electronic trading), legal certainty, and reduced credit risk, all at low regulatory cost. 
Thus, the proposed exemption would promote responsible innovation by exchanges 
and other boards of trade while promoting fair competition between exchanges and 
OTC markets -- the very purposes Congress cited when it enacted Section 4(c) of the 
Act. 

Subject to certain conditions, a Professional Trading Market woulct be 

exempt generally from CFTC regulation. Those conditions would be 

1) only professional traders (no small, retail 
public customers) could trade on this market; 



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139 



2) the board of trade operating the market 
would have to notify the CFTC when the 
market begins operations; 

3) all market participants would be subject to 
special fraud and manipulation prohibitions as 
well as private damage actions; and 

4) all trades must be submitted to a CFTC- 
approved clearing system. 

The proposed "Professional Trading Market" exemption is "consistent 
with the public interest" as required under Section 4(c) of the Act. In applying that 
standard, the CFTC twice has found that any regulatory "concerns regarding financial 
integrity and customer protection" are "addressed . . . through the requirement that 
[exempt transactions] may only be entered into or transacted on behalf of large 
institutions and other professional traders. The proposed exemptions would meet the 
public interest test in exactly the stame way. 

In fact, the proposed "Professional Trading Market" exemption has 
considerably stronger regulatory safeguards than the exemptions the CFTC has 
approved to date. In particular, the notification, private right of action and clearing 
conditions of the proposal make it tighter from every regulatory perspective than other 
exemptions the CFTC has adopted. The Board of Trade therefore will ask the CFTC 
to approve this proposed exemption expeditiously. 
Conclusion 

Mr. Chairman, like you and the members of this Subcommittee, the 
Board of Trade wants both the exchange and OTC markets to prosper. One noted 
industry expert has observed that in today's financial world, exchange and OTC 



140 



markets both compete with and complement each other. The Board of Trade 
therefore has a strong interest in seeing OTC markets thrive in a secure environment 
so long as the competition between exchanges and OTC markets is fair and open. 
The policies I have outlined today would serve to make that objective a reality. The 
Board of Trade looks fonward to working with this Subcommittee under your 
leadership toward implementing those policies. 



141 



[REVISED] 

H.R. 2374 -- To amend the Commodity Exchange Act to ensure the continued 
application of the Act's antifraud and antimanipulation provisions. 

1 The Commodity Exchange Act (7 U.S.C. 1 , et seq) is amended by 

2 adding to Section 4 the following section (e): 

3 (1) It shall be unlawful for any person, directly or indirectly, in or in connection 

4 with any agreement, contract or transaction that is exempt from Section 4(a) of 

5 the Act pursuant to an exemption adopted by the Commission under 

6 Section 4(c) of the Act or is exempt from any Commission-imposed contract 

7 market designation requirement for options, or any similar requirement, 

8 pursuant to an exemption adopted by the Commission under Section 4c of the 

9 Act- 
io (A) To cheat or defraud or attempt to cheat or defraud any 

11 other person; 

12 (B) To make or cause to be made to any other person any 

13 false report or statement thereof or cause to be entered for 

14 any person any false record thereof; or 

15 (C) To deceive or attempt to deceive any other person by 

1 6 any means whatsoever. 

17 (2) In or in connection with any agreement, contract or transaction that is 

18 exempt from Section 4(a) of the Act pursuant to an exemption adopted by the 

19 Commission under Section 4(c) of the Act or is exempt from any Commission- 



-8 



142 



1 imposed contract market designation requirement for options, or any similar 

2 requirement, pursuant to an exemption adopted by the Commission under 

3 Section 4c of the Act, it shall be unlawful for any person to manipulate or 

4 attempt to manipulate the price of 

5 (A) any such agreement, contract or transaction or 

6 (B) any commodity in interstate commerce or any contract of sale of a 

7 commodity for future delivery traded on or subject to the rules of any 

8 contract market. 

9 (3) Any person violating subsections (1) or (2) of this Section shall be 

10 disqualified from relying upon any exemption granted by the Commission under 

1 1 Section 4(c) or Section 4c of the Act. 

12 (4) in accordance with the procedures set forth in Section 22 of the Act, any 

13 person injured by a violation of subsections (1) or (2) of this Section may bring 

14 a right of action for actual damages suffered as a result of that violation against 

15 any person who committed or aided and abetted that violation. This right of 

1 6 action shall be the exclusive remedy available under the Act to any person 

17 injured by a violation of subsections (1) or (2) of this Section. 

18 (5) The proscriptions in subsection (1) of this Section shall not apply to an 

19 exemption for any agreement, contract, transaction, or person (or class thereof) 

20 to the extent that such agreement, contract, transaction, or person (or class 

21 thereof) is or will be subject to federal securities or banking laws that provide 

22 comparable antifraud protection, as determined by the Commission." 



143 



^ ^,^ NORTH AMERICAN SECURITIES ADMINISTRATORS ASSOCIATION. INC. 

^^^^Mfl One Massachusells Avenue. N.V\ .. Suite 310 

WKf Washington. DC. 20001 

^t^ 202/737.0900 

Telecopier: 202/783-3571 

NASAA . 



STATEMENT OF WAYNE KLEIN 

Securities Bureau Chief 
State of Idaho 

on behalf of the 
NORTH AMERICAN SECURITIES ADMINISTRATORS ASSOCIATION 



before the 

SUBCOMMITTEE ON ENVIRONMENT, CREDIT, 

AND RURAL DEVELOPMENT 

Committee on Agriculture 
U.S. House of Representatives 



'H.R. 2374, regarding the application of the Commodity 
Exchange Act's anti-fraud and anti-manipulation protections' 



June 30, 1993 



Preiideni: B«rr> C. Gulhar> <Massachu«eiis) • Presidcnl Eleci: Craig A. Goriisch (Iowa) • Secretary: \Ve&ley L. Ringo (Wisconsin) • Treasurer: Wayntr Klein (Idaho) 
Directors: Le»ls W. Brothers. Jr (\irRinia1 • Philip A Feigln (Colorado) • Marcel del la Gorgendiere (SaskatcheHan) • Mark J. Grirfin (Nevada) 

Richard D. Lalham (Tckas) • Executive Director: FoMler C. Mcsi 



144 



Mr. Chairman and Members of the Subcommittee: 



My name is R. Wayne Klein. I am Chief of the Idaho Securities Bureau and a member 
of the board of directors of the North American Securities Administrators Association 
(NASAA). In the U.S., NASAA is the national voice of the 50 state securities agencies 
responsible for investor protection and the efficient functioning of the capital markets at 
the grassroots level. NASAA and its members work closely with the Commodity Futures 
Trading Commission (CFTC) and National Futures Association (NFA) in combatting 
commodity-related fraud. On behalf of NASAA, I appreciate the opportunity to appear 
before you today. 

INTRODUCTION AND OVERVIEW 

NASAA is pleased to lend its strong support for the immediate adoption of H.R. 2374, 
legislation which would amend the Commodity Exchange Act (CEA) to ensure the 
continued application of the Act's anti-fraud and anti-manipulation protections, even in 
those instances where exemptions from regulatory oversight otherwise are granted. 
NASAA shares the serious concerns, and frankly, the frustrations that have been 
expressed with respect to the CFTC's recent order exempting certain energy contracts 
from most of the provisions of the Commodity Exchange Act, especially the Act's anti- 
fraud and anti-manipulation provisions. 

In addition to expressing support for immediate attention to the issue before the 
Subcommittee today, I also would like to take this opportunity to discuss what we believe 
is a more general (and disturbing) trend at the CFTC - that is, increasingly inadequate 
and lax oversight of the commodities markets.^ In fact, the CFTC's order with respect to 
exempting certain energy contracts is just the latest example of what perhaps may be 
best characterized as the agency's "reluctance to regulate," even in the face of blatant 
threats to investors and the integrity of the markets. Worse yet, the Commission has 
vigorously guarded what it believes to be its "turf," only to turn around and severely limit 
its own regulatory role. This minimalist approach seems to be one of "we won't police 
the area but we don't want anyone else to either." It is our hope that such an approach 
will not persist, and that instead, the Congress and the Clinton Administration will use their 
considerable authority to re-direct the agency's effort with a clear sense of its original 
mission and purpose. 



I 



The Association wishes to make a clear distinction between its concerns about the philosophy and 
actions of Commission leadership in recent years and the Commission's hard-working staff, which deserves 
credit for Its investor protection efforts. 

1 



145 



OVERSIGHT OF THE FUTURES MARKETS 

The futures markets today are recognized at home and abroad as a vital part of the 
financial services industry. They provide the critical functions in our economy of risk 
shifting, liquidity for commodity producers, and price discovery. The regulatory 
environment in which the futures markets operate should recognize and compensate for 
the features unique to them, including: (1) participation by a relatively small number of 
smaller traders; (2) the close relationship between some futures and equity markets; (3) 
the "zero-sum" nature of the market in which every dollar in profit to one person 
represents a dollar in losses to another person; and (4) exclusive regulatory jurisdiction 
by a single agency, the federal Commodity Futures Trading Commission. 

Under the authority of the Commodity Exchange Act, the CFTC is charged with 
overseeing the futures markets. In adopting the Act, Congress described its remedial 
purpose: 

The fundamental purpose of ttie Commodity Exchange Act is to ensure fair 
practice and honest dealing on the commodity exchanges and to provide 
a measure of control over those forms of speculative activity which too often 
demoralize markets to the injury of producers and consumers and the 
exchanges themselves.^ 

Courts which have examined the CEA have repeatedly cited the legislation's protective 
purpose."' While I recognize that Members of this Subcommittee are well aware of the 
history and purpose of this nation's commodity laws, I make this point so that you might 
contrast the recent actions of the CFTC in exercising its new exemptive authority under 
the Futures Trading Practices Act of 1992 (FTPA) with Congress' original purposes in 
enacting the CEA. 



^ See. 7 U.S.C. Section 5; S. Rept. No. 93-1131, 93d Cong., 2d Sess., 1974. 

3 

See , e.g., Commodity Futures Trading Commission v. British American Commodity Options Corp., 

788 F.2d 92, 94 (2d Cir.), cert, denied, 479 U.S. 853, 107 S.Ct. 186, 93 L.Ed.2d 120 (1986); Tamari v. Bache 
& Co. (Lebanon) S.A.L.. 730 F.2d 1103, 1106 (7th Cir. 1984), cert denied, 469 U.S. 871, 105 S.a. 221, 
83L.Ed.2d 151 (1984). 



146 



The CFTC is the exclusive regulator of futures contracts, options on futures and the 
organized commodity exchanges (contract markets).^ As such, if the CFTC fails to 
assert or exercise its jurisdiction in these areas, other regulators, including state securities 
regulators, have very limited authority to act. When Congress acted in 1982 to amend 
the CEA, it included the so-called "open season provision" (Sections 6d and 1 2e of the 
CEA), which gave the states new authority to enforce the CEA in federal courts and to 
move in state court against illegal off-exchange products and operators. These provisions 
were carefully crafted by Congress and intended to foster a meaningful and effective 
CFTC-state partnership in the policing of the legitimate and illegitimate marketplace. We 
are concerned that the CFTC now seems to be taking steps to remove itself from that 
partnership, leaving the states in the unenviable position of having to move in and clean 
up the fraud that can develop due in large measure to deregulatory policies. Given the 
very limited authority of the states under the CEA, the states find such a possibility 
particularly disturbing. We ask you to consider the potentially devastating effects if 
oversight of the futures markets is left to the extremely limited anti-fraud powers of the 
states: 

o If the CFTC removes itself from the partnership with the states, it will take 
with it the extraordinary enforcement powers unique to that agency. At the 
same time, we would lose the years of expertise that have been built up in 
that agency; 

o Only a federal agency such as the CFTC can move swiftly and effectively 
to shut down fraudulent operations acting on a nationwide basis; 

o It is unreasonable to expect the states to shoulder the burden of acting as 
the sole enforcer of violations of the laws in this area when the states have 
no voice in shaping the regulatory policies that may have the effect of 
allowing these very violations or the effect of increasing the volume of fraud 
and abuse; and 

o It is fundamentally unfair to rely exclusively on the states to police the 
marketplace when the states have been denied the authority to deter the 
fraudulent or abusive behavior before it occurs. Is it not better to give law 
enforcers the power to implement standards that will reduce the incidence 
of fraud before it occurs. This is exactly the theory underlying the CFTC's 
current authority to require trading on the exchanges and make it subject 
to all of the statutory safeguards. 



4 



When Congress adopted the CEA in 1974, it preempted the states from applying their investment 
laws to p>ersons and transactions deemed to be within the jurisdiction of the Act. In response to the virulent 
outbreal< of commodity-related fraud in the late 1970s and early 1980s, Congress amended the Act in 1982, 
permitting the states to police off-exchange commodities-related products and those selling them, if such 
sales are illegal under the CEA. The states also may enforce some provisions of the CEA in federal court. 



147 



As a result, I am deeply concerned that during the past several years, the CFTC has 
embarked on a course of abandoning and repudiating its responsibilities to protect the 
integrity of the commodity futures markets and those who invest there. The CFTC's 
action in exempting broad categories of energy products from the anti-fraud and anti- 
manipulation provisions of the CEA is the most recent, and a most egregious, example 
of this new course. Without active and vigorous oversight, the markets under the CFTC's 
exclusive jurisdiction invite fraud and abusive trading. 

Further, it would seem that the wiser course would be to adhere to Congressional intent 
as evidenced by the history of the CEA, and to encourage trading toward the markets, 
rather than the opposite, as the Commission seems to be doing. Congress has explicitly 
required that all futures contracts be traded on designated exchanges. This exchange- 
trading requirement is not the product of some fleeting Congressional whim. Rather, it 
is the result of more than 70 years of Congressional experience with these markets. 

The resulting regulatory framework works rather well in promoting market integrity, 
providing price discovery of commodities, increasing liquidity in the markets, 
and reducing the transaction costs of entering into futures contracts. The efficient 
operation of these markets is vital to the domestic and, indeed, the global economy. 
NASAA's support for encouraging trading on exchanges centers around two central facts: 
(1) affirmatively doing so would help avoid market fragmentation; and (2) this type of 
trading needs appropriate supervision, which is best accomplished by governmental 
oversight of the exchanges. In the end, these markets are far too important to be entirely 
overlooked by a vital regulatory agency. 



WHAT TYPES OF FUTURES TRADING SHOULD BE REGULATED 

Mr. Chairman, as you well know. Congress intentionally has declined to define the term 
"futures contract" under the Commodity Exchange Act for fear that drawing such a 
distinction would encourage the proliferation of products and schemes deliberately 
designed to evade or avoid CFTC jurisdiction. Rather, it has been left to the courts and 
to the CFTC itself to apply established case law and other tests in determining whether 
a contract is a "futures" contract for purposes of the Act. In fact, it was only in the 
Futures Trading Practices Act of 1992 that the CFTC was granted new exemptive 
authority which frees the agency from having to make the "all or nothing" jurisdictional 
decisions faced in the past. It was the hope of NASAA that the Commission would assert 
this new exemptive authority judiciously and prudently in those cases where it was 
determined that, in so doing, restraints on commerce would be reduced and markets 
would be permitted to evolve. It was not expected that the authority would be used to 
alter the Commission's overriding responsibility to protect the public interest. 



148 



However, and in retrospect, perhaps the Commission's most recent action should have 
been anticipated. The agency's track record over the last several years clearly 
demonstrates a disdain for using its regulatory powers to conduct oversight of unusual 
or innovative products. It is instructive to examine the direction in which the CFTC has 
moved in recent years. I, personally, have observed the CFTC's reluctance to exercise 
the very authority it has fought so hard to reserve for itself. 

Paragon Investment Company (P.I.E). In 1985, I learned about a gold and silver 
margin investment scheme being offered in Idaho by California-based Paragon Investment 
Company, also known as P.I.E. In inquiring about the investment, I was falsely told by 
an account executive that if I invested, there would be no exit charges, no interest fees, 
no charges for the unpaid balance, and that I could liquidate the contract whenever I 
chose. The sales pitch included the ail-too familiar assurances: the price of silver would 
shoot up the next day because OPEC ministers were expected to announce that they 
were taking action to shore up the price of oil, thus causing the price of silver to increase; 
the low price of silver made it almost impossible to lose; the price was fantastic and I 
should buy now; most of the salesman's clients have experienced big profits; the big 
brokerage houses had put out the biggest buy signals in a long time and I would be in 
a safe position; the price of silver would shoot up astronomically due to unrest in South 
Africa; and I would be dealing with a good, clean, legitimate company. An investigation 
conducted by the Idaho Securities Bureau uncovered numerous false statements and 
misrepresentations and exposed this as a fraudulent scheme. 

I welcomed this opportunity to accept the CFTC's oft-repeated offer to bring joint 
enforcement actions with the states. At the time, I was a Deputy Attorney General for the 
State of Idaho, and I drafted a joint complaint to be filed in federal court on behalf of 
Idaho and the CFTC against Paragon. Fortunately, the Paragon scheme was structured 
in a way which allowed us to bring an action under the SEC laws, because after six 
months of contradictory answers from the CFTC on whether they would join us in a joint 
action, I gave up on the idea of acting together. Instead, I filed an enforcement 
complaint on behalf of the State in state court under the Idaho Securities Act. During the 
six months that we waited for the CFTC to get back to us, the fraud continued to prosper. 

Ironically, our action attracted substantial print and television media attention in Los 
Angeles. Reporters asked the then-Los Angeles Regional Director of the CFTC for 
comments about our suit. His response was that the CFTC was conducting its own 
investigation of Paragon. Indeed, a few weeks later, the CFTC did file its own suit in 
federal court. 

The State of Idaho received the injunction it sought. So did the CFTC, which additionally 
obtained a receiver and a temporary restraining order. While our action halted 
perpetration of the fraud in Idaho, only the CFTC's action had the effect of stopping the 
practices nationwide. Cooperation here would have made great sense. Instead, we had 
two duplicative actions going their own way, piling up expenses, and using far more 



149 



valuable time than would have been necessary had there been even elennentary 
cooperation. 

In the decision in this CFTC action, the court reaffirmed the characterization of a futures 
contract, basing its rationale on the landmark Ninth Circuit decision in CFTC v. Co-Petro 
Marketing Group . .^ Co-Petro held, in part, that futures contracts were characterized by 
standardization of contract terms and the existence of conditions which facilitate the 
formation of off-setting or liquidating transactions (allowing for non-delivery). 

As I have stated, Congress deliberately left open the question of the definition of a futures 
contract so that the courts and the CFTC would have maximum flexibility to apply the 
CEA to all types of violative behavior. In 1990, however, and ironically, this flexibility 
resulted in the Commission's rebuke of a federal Court. In Transnor (Bermuda) Ltd. v. 
BP North America Petroleum, et al .^ the federal district court for the Southern District of 
New York on April 18, 1990, ruled that certain oil contracts were indeed futures contracts 
and subject to the provisions of the CEA, which requires that futures trading be 
conducted on a designated exchange. This decision left participants in the Brent crude 
oil markets in a state of uncertainty as to the legality of the transactions in which they 
were engaged. 

7776 CFTC Responds to Transnor . The CFTC's reaction to the Transnor decision 
was quick, but beyond its authority and misguided. In its attempt to calm oil traders, 
producers, and purchasers, the CFTC went too far. After the Transnor decision was 
issued, the Commission promptly released an advisory indicating that the agency was 
dedicated to maintaining access to the Brent market. The Judge in New York was sent 
a letter and within a day was provided with a copy of the advisory by the CFTC's general 
counsel. After this rather unusual signal to the Court, the Commission, less than a month 
after the Transnor case was settled, voted to authorize the staff to complete a draft of a 
legal interpretation. Shortly thereafter, another Commission advisory announced that a 
draft legal interpretation was available upon request from the general counsel and that 
comments on it would be received over a two week period. In short, the public, outside 
of the special interest lobbyists, had little time to comment or otherwise offer its views. 
Two months later, on September 25th, the final interpretation was published in the Federal 
Register , having been adopted by a 3 - 1 vote. 



680 F.2d 573 (9th Cir. 1982). 
738 F.Supp.1472 (S.D.N.Y. 1990). 



150 



The Commission's action here had three major flaws: 

o The CFTC presumed to overrule the federal district court in New York in the 
Transnor case by the issuance of its own interpretation; 

o The CFTC went beyond its legal bounds by dealing with a perceived 
problem through a legally obscure procedure. In effect, the CFTC 
attempted to change the law through a legal interpretation, rather than 
following the law determined by Congress assume; and 

o The Commission unilaterally announced a new set of criteria as to what 
distinguishes a futures contract from a forward contract. These new criteria 
were contrary to those set down by the courts and the CFTC in previous 
actions. 

The State of Idaho submitted a comment letter to the CFTC urging restraint: 

The State's foremost concern is that an exclusion as described above, 
unless narrowly drafted, could have far-reaching and objectionable effects. 
As a regulatory agency with responsibility for investor protection, our task 
would be made infinitely more difficult by [a] broad interpretation which did 
not consider the enforcement ramifications of this issue7 

The State urged the CFTC to carefully limit the scope of the exclusion contemplated in 
the interpretation to "apply only in situations where a commercial party is purchasing for 
its own use or inventory" and to limit the exemption to the Brent contracts. We cautioned 
the Commission that a broadly drawn exclusion would legitimize fraudulent practices then 
in use by some commodity firms. 

It appears that the CFTC perceived itself to be between the proverbial "rock and a hard 
place". It wanted to clarify the law with the goal of calming traders in the Brent Oil market. 
On the other hand, it lacked the flexibility under the law to grant any exemption. 

The CFTC's solution was a bad one. It decided to "overrule" the Transnor court and, in 
effect, create an exemption. Since it lacked exemptive authority, however, it chose to alter 
the traditional definitional elements of a futures contract. The Commission arbitrarily 
announced, under the guise of merely "interpreting" the law, that a new standard now 
existed. As a result, the CFTC interpreted away its own jurisdiction and disclaimed 
authority over a broad category of products. The Commission seemed not to care that 
by changing the definition of a futures contract, the new criteria threatened to shield 



' A copy of the June 8, 1990, comment letter is attached. Unfortunately, many of our fears later were 
realized. 



151 



8 



fraud in the trading of other commodities -- a hefty price to pay for helping the oil 
companies. 

In reality, the Statutory Interpretation that was adopted was a broad pronouncement of 
new policy. This was despite a strongly worded 27 page dissent by then-Commissioner 
Fowler West.^ The irony of the Statutory Interpretation was that the CFTC usurped 
judicial and Congressional authority -- then used that putative authority to deny itself 
jurisdiction. 

Unfortunately, since the CFTC has exclusive jurisdiction in this field, the states have 
limited power to use the "open season" provision under the CEA to move against and 
prevent fraudulent activities. We are compelled to live with these federal policies. If the 
CFTC grants an exemption, ruling that the CEA does not apply to certain transactions or 
products, it then also denies the states the ability to use the CEA to stop fraud in sales 
of these products. Our only hope was that Congress would remedy the problem or that 
the courts would recognize that the CFTC action exceeded its authority -- and disregard 
the Statutory Interpretation. We were disappointed in the latter. 

A-Mark Precious Metals. Keith Bybee, a sole proprietor buyer and seller of gold 
and silver in Boise, began buying precious metals from A-Mark Precious Metals for resale 
to customers. A-Mark convinced Bybee to open a margin account that consolidated 
money belonging to him and his customers. A margin account such as Bybee's allowed 
for substantial leverage in his speculative trading of precious metals. All trading was 
required to be done in Bybee's name, not that of his customers. Some 95% of the 
subsequent purchases were offset rather than resulting in delivery of metals. 

By 1986, Bybee had suffered huge losses and A-Mark liquidated his account. As a result, 
over one hundred small investors lost $2 million. Mr. Bybee was convicted in state court 
of fraud and went to prison. In addition, my office obtained a court imposed judgment 
and injunction against him. However, investors were left without restitution. 

Both the bankruptcy trustee and the State of Idaho filed suit against A-Mark alleging that 
its dealings with Bybee, while he was using customer monies, constituted the sale of 
illegal off-exchange futures contracts. Our goal was to go after the commodity firm which 
made Bybee's scheme possible in the first place. Despite our prior experience with 
Paragon Investments, we still wanted to bring a joint enforcement case with the CFTC 
under the 1982 amendments to the CEA. I received informal assurances from staff in the 
CFTC's Division of Enforcement that they concurred with our legal analysis. 
Unfortunately, the Commission would not respond to our request. Finally, we gave up 
on a joint action and filed suit alone under the authority granted to the states in Section 



Commissioner West's dissent from the Statutory Interpretation was refused publication by the CFTC 
at the time of adoption of the Statutory Interpretation. 



152 



6d of the CEA. Our suit represented the first time that a state had acted alone to enforce 
the CEA in federal court. 

The suit by the bankruptcy trustee went to trial first. The district court, applying the 
factors identified in Co-Petro and similar cases, held that the transactions were entered 
into for speculative purposes with no expectation that delivery would occur and found that 
all the elements of futures contracts existed but one -- the public was not involved. 
With that conclusion, he ruled that the investments being sold were not futures contracts. 

The district court's decision was appealed to the Ninth Circuit Court. Since it was this 
same court that had decided both Paragon and Co-Petro . we had high expectations that 
the court would find that a futures contract existed and perhaps even take the opportunity 
to rule that the CFTC's Brent Oil Statutory Interpretation was ultra vires . We were wrong. 

During the appeal, the State of Idaho submitted an amicus curiae brief to the court 
arguing for continued application of the criteria set forth in the long line of cases defining 
futures contracts. We encouraged the CFTC also to file an amicus brief. Its brief, 
however, was limited to informing the court that public participation was not a necessary 
element of a futures contract. In the meanwhile, we were advised that the CFTC's 
general counsel had been actively soliciting amicus briefs opposing the position of the 
State and the bankruptcy trustee that futures contracts were involved. Three parties filed 
such briefs. 

Relying heavily on the recently promulqated CFTC Statutory Interpretation, the Court of 
Appeals issued an astounding opinion. Incredibly, it ruled: 

o The A-Mark contracts were simultaneously futures contracts under the CEA 
and forward contracts excluded from the CEA, pursuant to the Brent 
Statutory Interpretation; 

o That great deference should be given to the Commission's interpretation of 
the CEA, even if it departs from well established case law; and 

o The CFTC's "innovation" in its treatment of delivery obligations was adopted 
for the A-Mark transactions, and so long as offsetting transactions are 
"separate, individually negotiated, new agreements," there is no 
standardization of contracts such that the instruments are covered by the 
statute. 



9 



Krommenhock v. A-Mark Precious Metals Inc.: In Re Bvbee . 945 F.2d 309 (9th Cir. 1991). 



153 



10 

Heretofore, the terms, futures contracts and forward contracts, had been mutually 
exclusive. Contracts were either subject to the provisions of the CEA or excluded from 
the CEA. This new decision, however, created an especially pernicious effect. By first 
defining these contracts as futures contracts, the CFTC gained exclusive jurisdiction. 
State laws generally would not apply. The securities laws cannot be used to proscribe 
conduct. But, by then also finding them to be forward contracts, the CFTC is itself 
deprived of jurisdiction. The A-Mark court was overwhelmingly successful in ensuring that 
there will be absolutely no regulatory oversight of these contracts sold by A-Mark or of 
any contracts structured in a similar manner. 

This decision wrought a second major benefit for fraudulent commodity investment 
schemes. As a result of this case, the concept of offset conducted off of an exchange - 
- which was traditionally the touchstone of an illegal off-exchange futures contract - now 
is legitimized. All that a scam must do is assert that all offsetting transactions are 
separately negotiated and they will be unregulated forward contracts. 

These results are directly contrary to the regulatory and legislative history of the CEA. 
It may have a direct effect on the enforcement efforts of the CFTC. Since the A-Mark 
decision, there seems to me to have been a significant decline in the number of "off- 
exchange" enforcement cases initiated by the CFTC. State regulators also have been 
impaired. The fears expressed in our June 1990 letter to the CFTC were all fulfilled - and 
more. 

FUTURES TRADING PRACTICES ACT of 1992 

We had high hopes for a reversal of this trend with the passage of the Futures Trading 
Practices Act of 1992 (FTPA). New section 4(c) of the CEA specifically authorizes the 
CFTC to grant exemptions that meet a set of very narrow and stringent conditions. 
NASAA generally supported the granting of this authority as it would enable the 
Commission to authorize certain isolated trading without also sanctioning illegal conduct 
that mimicked the outward trading styles of the exempted trades. it was our 
expectation that the exemption would be considered only for those parties that requested 
an exemption and demonstrated sound reasons why the CEA should not apply. This 
would eliminate the need continually to contort the definition of a futures contract in order 
to provide needed relief, as was the case in the Brent Statutory Interpretation. 



See . November 6. 1991 letter from then-NASAA President Lewis Brothers, Jr. to Senator Patrick 
Leahy regarding the Conference Committee's consideration of CFTC Reauthorization Legislation. 



154 



11 



In addition, the Conference Report of the FTPA attempted to repair some of the damage 
caused by the A-Mark decision by making legislative policy clear that:^^ 

o Products cannot be simultaneously futures contracts and forward contracts; 

o The Co-Petro standards still should be used against fraudulent commodity 
schemes; and 

o States and other federal authorities are not precluded from asserting 
jurisdiction over forward contracts, even if the CFTC lacks jurisdiction. 



CFTC ENERGY EXEMPTION 

The CFTC quickly demonstrated that it did not view its exemptive authority granted under 
the FTPA as being limited in scope or to be used sparingly. Neither did it accept the 
admonitions from the FTPA Conference Committee that the expansive definitions adopted 
in A-Mark should be revisited with special consideration for its public policy implications. 

NASAA had hoped and even expected the CFTC to use its new exemptive authority to 
revisit the Brent Statutory Interpretation, making it more narrow -- especially in light of A: 
Mark . Indeed, just the opposite has occurred. 

On April 13th, the CFTC voted 2-1 to exempt certain energy products from its jurisdiction. 
The exemption, as adopted, is extraordinarily broad. It covers transactions, products and 
parties who never even requested application of the exemptive authority. It uses broad 
language that I feel undoubtedly will assist fraudulent operations. In an unprecedented 
move, the divided Commission proclaimed it did not even preserve for itself antifraud 
jurisdiction. 

Commissioner Sheila Bair dissented from adoption of this Rule, saying in part: 

In my view, the final order, by its terms, is not limited to forward contracts 
traditionally excluded from the jurisdiction of this agency. Rather, it goes 
significantly beyond the forward contract exclusion and extends to 
transactions which could very well meet the criteria for illegal off-exchange 
futures contracts traditionally applied by this agency and the courts. I 
believe that exempting such transactions from statutory provisions as basic 
and central to our regulatory scheme as Sections 4b and 4o is a serious 
misapplication of our new exemptive authority, and sets a dangerous 



See Futures Tradino Practices Act of 1992 . Conference Report, U.S. House of Representatives, 
102rxj Congress, 2d Session, Report 102-978, October 2, 1992, page 72. 



155 

12 
precedent. 

As this Subcommittee learned in its hearing on April 28, 1993, the CFTC's Division of 
Enforcement and its Division of Trading and Markets recommended against such a broad 
exemption while abdicating anti-fraud jurisdiction. If the views of these two divisions, 
which have substantial expertise as well as the experience gained from real world 
application of the law, are not heard, I fear that CFTC policies in general, and this 
exemption in particular, have lost any relation to reality. Thus, it seems that deregulatory 
theory alone drives Commission action. 

A more serious effect of this exemptive rule is to discourage the use of reasonably 
regulated and liquid U.S. futures exchanges. When the Commission encourages off- 
exchange or off-shore trading in place of trading on the regulated exchanges, by granting 
wholesale, broad exemptions, it cannot help but speed migration of trading from the 
exchange floor. Indeed, the exchanges even can be beneficiaries of this regulatory 
abdication. They now can trade off-exchange without government regulations - the same 
regulations deliberately imposed by Congress as a result of fraudulent practices and 
which are intended to protect traders, investors, and hedgers. 

Why should we care? Who will complain? The beneficiaries of this largess include the 
CFTC, large traders, the exchanges (to the extent that they take advantage of these off- 
exchange opportunities) and, most sadly, promoters of fraudulent schemes who now can 
structure their investments a certain way and operate with impunity. 

Those who will suffer from this result are those whose voices are not being heard and 
whose interests are not being protected by the CFTC: 

o Individual investors victimized by fraudulent schemes now ignored by the 
CFTC; 

o Hedgers and speculators who trade on the regulated exchanges and now 
will find less liquidity in their markets, more volatility, less efficient price 
discovery (as fewer trades are reported on the organized markets), and an 
increased risk of manipulated prices; 

o The U.S. economy which relies on the organized exchanges for price 
discovery of commodities, ample future supplies as indicated by commodity 
price directions, and a source of actual commodities for delivery; and 

o Regulators and other law enforcement authorities who have reduced abilities 
to assert jurisdiction and apply the law to off-market trading - both 
legitimate and illegitimate. 



156 



13 

Sadly, those groups who will be most disadvantaged by this current action probably do 
not yet know the deleterious effects they will suffer as a consequence. 

RECOMMENDATIONS 

We cannot emphasize enough the seriousness of our concern about the CFTC's actions. 
This broad exemption is particularly intolerable with the disclaimer of anti-fraud jurisdiction. 
The course must be reversed. To do so, NASAA would offer the following 
recommendations: 

o Prompt passage of H.R. 2374. This bill is absolutely necessary to mandate 
preservation of anti-fraud authority both retroactively and prospectively; 

o The CFTC should be directed to withdraw the 1990 Brent Statutory 
Interpretation; 

o Congress should consider requiring the CFTC to provide a reasonable, 
scheduled review of this latest exemption then require each entity seeking 
use of the exemption to make a separate, publicly available application for 
exemption. Each application should be accompanied by an explanation as 
to how the participant and the contemplated transactions satisfy the criteria 
set forth in the Futures Trading Practices Act. 

o The CFTC must take great care in granting exemptions on a broad, generic 
basis without knowing who will be taking advantage of the exemptions. This 
may help reduce the chance that the exemptions would be used by crooks. 
It will also provide information to the CFTC about off-exchange trading with 
which to evaluate the effects of the exemption. Moreover, it makes publicly 
available such economic factors as the volume of, prices of, and parties 
engaging in, such trading; 

o Congress should require the CFTC to embrace the policies set forth in the 
FTPA Conference Report regarding the distinctions between futures and 
forward contracts, the continued validity of prior caselaw establishing the 
futures contract definition, and the jurisdiction of other regulators;and 

o Congress should consider prohibiting the CFTC from granting any 
exemption from its oversight for transactions which are virtually clones of 
products trading on regulated exchanges. This will prevent migration of 
trading from the exchanges and the omission of trading data from the 
financial markets. 



157 



14 

NASAA has sent a letter to President Clinton expressing concern over the direction of the 
CFTC.^^ Our letter urged the President to move quickly to fill the vacancies at the CFTC. 
At the very least, we recommended that President Clinton immediately seek the CFTC's 
agreement to make no further policy changes, such as this, until a full contingent of 
commissioners has been approved -- individuals who will represent the views of this 
Administration. We respectfully urge this Subcommittee to support the same goals. 



CONCLUSION 

NASAA appreciates the opportunity to present its views on this very important issue. We 
commend you for taking steps to halt this regulatory abdication by an agency which was 
entrusted with exclusive jurisdiction. We hope that the oversight process by Congress 
will help prevent any further damage by this agency. 

If the CFTC is allowed to continue on this path, it may be a very short path. If this 
continues and only three more exemptive proposals are adopted -- one for financial 
instruments, one for precious metals, and one for agricultural products -- there will be little 
left to regulate. We can then disband the agency. At least then we could stop what has 
become a cruel hoax on the American public -- that the markets are well protected and 
that the government is acting in the best interests of the general public. 

As the House Committee on Agriculture recognized in 1932: 

So long as these markets are to be regulated as public markets and so long 
as they operate under the apparent supervision of the Federal Government, 
it seems proper that such supen/ision should protect the rights of customers 
as fully as possible. ^^ 

(Attachments follow:) 



" A copy of the letter dated June 2, 1993 is attached. 

" H.R. Rep. No. 1551, 72d Cong., 1st Sess. Section 3, (1932). 



72-584 0-93-6 




158 



NORTH AMERICAN SECl RITIES ADMINISTRA I '. )KS ASSOCIATION, INC. 



AnACHMENT. 



One MjvNjinuselts Avenue. N.W.. Suite .UO 
Washineion. D.C inOOl 

^^^^ :o:/737-nwo 

Telecopier: :n:/78.<-.<.=:T| 

NASAA - 

itjrrv r. (;ulharv. President 

llirector. Securities Divisiun 

' mt- \shhurton Place. I7lh Floor 

Uoston. Massachusetts 02 1 IIK 

(617l727..X54)t 

June 2, 1993 



Honorable William J. Clinton 
The President 
The White House 
Washington, DC 20500 

Dear Mr. President: 

CXi bfhnlf of the North American Sei^urities Administrators Association, ^ 
we urge that prompt attention be focused on filling vacancies at the 
Commodity Futures Trading Commission (CFTC) . There are currently, as a 
practical matter, three vacancies in existence; although the position of 
acting-chairman presently is filled by a ccmmissioner vtiose term hcis expired. 
The acting-chair has indicated that he will depart in August, 1993. 

The CFTC has a critical regulatory role, not only because it oversees 
the large futures industry, but eilso because it has the exclusive regulatory 
authority over futures contracts, unlike the regulatory scheme for the 
securities industry, where the states and the Federal government share 
oversight duties. As a result, the CFTC alone is responsible for the 
approval of innovative financial products, the curbing of destructive 
fraudulent trading schemes, and the promotion of stability and liquidity in 
the trading of financial derivatives. 

Mr. President, the CFTC has the (^:portunity to promote innovation, but 
there must be a balemce struck between promoting financial innovation and 
safeguarding the public. A strong CFTC is especially desirable because of 
its oversight of stock index futures and various forms of program trading, 
which impact the equity markets. 



In the U.S., the North American Securities Administrators 
Association (NASAA) is the national voice of the 50 state agencies 
responsible for investor protection and the efficient functioning 
of capital markets at the grassroots level. 

Prestdcnl: B«rr* C. Gulliirv tMiss«chusct(i> • PrFiideni Elect; Crii| A. Gocllscit llowii • secretary: Weslev L. Rlngo (UKconMn> • I ri-asurer; Wivne Klein ildalioi 
Direclon: Lewis W Brotliers. Jr. iMrtlniai • Khilip A. Felfin (Colorado) • Marcel de la (;or||endlere isaikau he« jn i • vlarh J. tinffln iNevada* 
Richard D. Laltiaoi iTeiafi 



159 



Honorable William J. Clinton 
The White House 
June 2, 1993 
Page 2 of 4 



The CFTC's role in safeguarding the integrity of the commodity 
futures market should not be underestimated. One of the CFTC's 
primary roles is to assure that there is no manipulation of prices 
on the futures exchanges. Any dysfunction of the commodity futures 
markets could have a devastating and global impact on market prices 
for a wide range of commodities. Finally, whilfe recognizing that 
over-regulation can hurt the marketplace, great harm also can come 
from too little regulation. 

Mr. President, recent actions taken by the CFTC have caused 
great concern among state regulators and within Congress. Under 
exemptive authority^ provided in its most recent reauthorization, 
the CFTC, on April 13, 1993, completely dismissed from oversight 
and regulation a large number of energy products. These products 
are believed by many to be futures contracts, which should be 
traded on a futures exchange. While some use of the exemptive 
authority in this area was encouraged by Congress in the CFTC's 
reauthorization, the CFTC surprised most observers, including the 
states and its own Division of Enforcement, by going so far as to 
exempt these products from even its anti-fraud rules. In short, 
the CFTC appears to have served notice, in advance, that it will 
not intervene even if faced with patently fraudulent activity in 
this area. 

The CFTC's recent action greatly expands a controversial legal 
interpretation issued by the CFTC in 1990, involving the Brent Oil 
markets.^ That action directly opened the door to potential abuse" 



^NASAA supported this grant of authority as a means of 
permitting appropriate, narrow exemptions in contrast to the 
prior pattern of wholesale abdication of its responsibilities. 
However, this new power is being badly misused. 

'in September of 1990, the CFTC issued a statutory 
interpretation tailored to protect oil companies involved in the 
so-called Brent Oil market. The U.S. District Court for the 
Southern District of New York had found Brent Oil contracts to be 
illegally traded futures contracts. The CFTC's interpretation, 
which passed by a 3 to 1 vote, essentially purported to overrule 
the court decision. The interpretation declared the Brent 
contracts to be forward contracts, not futures contracts, by 
substantially revising the definitional criteria of what 
constitutes a forward contract and a futures contract under the 
Commodity Exchange Act. 



160 



Honorable William J. Clinton 
The White House 
June 2, 1993 
Page 3 of 4 



of consumers.* Many states are quite concerned that the exclusive 
jurisdiction enjoyed by the CFTC, coupled with the CFTC's 
continuing rush toward deregulation, makes it very hard to provide 
adequate consumer protection in the commodity futures area. 

The vote at the CFTC to grant this broad exemption was 2 to 1. 
That controversial action led to a hearing by a subcommittee of the 
House Agriculture Committee, chaired by the Honorable Glenn 
English, who expressed great concern at the deregulatory 
recklessness displayed by the CFTC. Mr. English stated at the 
hearing that the CFTC's action went beyond the authority granted by 
Congress. He added, "of the 18 years I've been in Congress, this 
is the most irresponsible decision I've come across." 

The states feel that the opportunity to appoint three members 
to the CFTC should be taken as soon as possible. In particular, a 
chairman should be nominated without further delay. Special 
attention should be given to nominating individuals who are 
dedicated to protecting the public and to providing a proper 
regulatory balance. 

Over the past few years, the states have seen their relations 
with the CFTC gradually improve, but the recent trend at the CFTC 
has caused considerable concern. The states have been a willing 
participant with the CFTC's Advisory Committee on CFTC-State 
Cooperation, but changes of commissioners at the CFTC have rendered 
that committee inactive. Our concern is that a lack of action in 



*Relying heavily on the CFTC's Brent interpretation, the 
Ninth Circuit Court of Appeals in California, in 1991, declared 
that certain precious metals transactions were both forward and 
futures contracts. This meant that they were subject to the 
exclusive jurisdiction of the CFTC — and thus no other regulator 
could assert jurisdiction. Incredibly, it also meant that it was 
exempt from CFTC oversight. As a result, no regulatory authority 
could assert jurisdiction. This ruling thwarted the State of 
Idaho's efforts to stop what it felt to be a precious metals scam 
against its citizens which has resulted in the loss of three 
million dollars. 



161 



Honorable William J. 
The White House 
June 2, 1993 
Page 4 of 4 



Clinton 



filling these vacancies will cause a further deterioration at the 
agency, which is the sole regulator of a large, and oftentimes, 
volatile futures industry. It is that volatility, combined with 
the importance of the futures markets, that demands competent and 
dedicated commissioners. 

Respectfully, NASAA requests that you fill these CFTC 
vacancies with individuals whose goal it is to judiciously 
regulate, with an appreciation for the primary purpose of the CFTC, 
protecting the users of the futures markets. 

We pledge our full assistance to you as you deal with the 
financial regulatory area. The executive director of NASAA, Fowler 
West, just completed two terms as a CFTC Commissioner. His leaving 
the CFTC greatly reduced the CFTC's focus on investor protection at 
the commissioner level. This situation needs to be addressed by 
filling these three vacancies with commissioners who believe in 
investor protection. NASAA looks forward to your appointments and 
to working closely with a restored CFTC. 




Sincerely, 




Barry C. Guthary 
President 




Cr^^ Ai Goetttsch 
P^esid^t El96t 



162 



H^2 



CECIL D ANDRUS 

GOVERNOR 




BELTON J PATTY 

DIRECTOR 



ATTACHMENT. 



jy;; i ; 



STATE OF IDAHO 

DEPARTMENT OF FINANCE 

BOISE, IDAHO 83720 

(208)334-3313 



June 8, 1990 



Wendy L. Gramm 

Chairman 

Commodity Futures Trading Commission 

2033 K Street, N.W. 

Washington, D. C. 20581 

Re: CFTC Policy Interpretations on Trans nor 

Dear Chairman Gramm: 

The State of Idaho Department of Finance ("State") wishes to 
express to you the serious reservations it has concerning pro- 
posed CFTC action in the wake of the Transnor (Bermuda) Limited 
V. BP North America Petroleum, et al. , 86 Civ. 1493 (WCC) 
(S.D.N.Y.) ( " Transnor " ) decision. 

Our understanding is that the Commission intends to issue an 
interpretation of the Commodity Exchange Act ( "CEA" ) concluding 
that the 15-day Brent contracts fall within the "forward con- 
tract" exclusion contained in Section 2(a)(1)(A) of the CEA. 
This conclusion is based upon representations to the Commission 
staff that the 15-day Brent contracts are not offered or sold to 
the general public, and are negotiated transactions between 
commercial parties, each of whom is able to make or take delivery 
of Brent crude oil. 

The State's foremost concern is that an exclusion as 
described above, unless narrowly drafted, could have far-reaching 
and objectionable effects. As a regulatory agency with respon- 
sibility for investor protection, our task would be made infi- 
nitely more difficult by an broad interpretation which did not 
consider the enforcement ramifications of this issue. 

As you may know, the State of Idaho currently has a case 
pending in the U. S. District Court for the District of Idaho, 
State of Idaho v. A-Mark Precious Metals, Inc., et al.. Civil No. 
89-1055 , which states a claim under the CEA. A decision on the 
futures contract issue is imminent. Central to this case is a 
determination as to whether the transactions between A-Mark, a 



anks anc 5&L s 

fed't Unions 

oneciton Agencies 



1208133^-3678 
(2061334.2896 
12081 33<-29-l5 




>AHO 



1890-CENTENNIAI-1990 " 

EQUAL OPPORTUNITY EMPLOYER 



Securiites 

Wano CreO<t Cooe 

SuDPOfting Services 



(208) 334-368-1 
(20ei33':-29a5 
(208)234-33ii 



163 



Wendy L. Gramm 

Page 2 

June 8, 1990 

precious metals wholesaler, and its customer, a precious metals 
retailer, were off-exchange futures contracts. Of concern is the 
fact that the retailer acted as a middleman or "broker" for A- 
Mark to facilitate speculation by individual customers in the 
metals markets. A-Mark also acted as an exchange in offsetting 
and clearing the various long and short trades. Because none of 
the regulatory protections of the CEA were in place, over a 
hundred small investors lost approximately $2 million. 

A-Mark knew that individual investors were participating in 
its margin trading program and apparently encouraged the prac- 
tice. Moreover, we disagree that the "Mom and Pop" coin dealers 
in Idaho that used the A-Mark margin program were true commercial 
users which are able to fend for themselves without the protec- 
tions afforded by the CEA. 

The analysis and conclusions of Transnor are not only very 
helpful to us in the A-Mark case, but very useful from an en- 
forcement perspective. Judge Conner's opinion on the definition 
of a futures contract is well-reasoned and soundly grounded in 
both federal and CFTC caselaw. We fear an overly-broad interpre- 
tation of Transnor may not only have serious implications for our 
own case, but could legitimize the practices engaged in by A- 
Mark. VJe urge the Commission to be very cautious in this area. 

We are asking that any interpretation issued by the 
Commission incorporate the following concepts: 

(1) The exclusion should only apply in situations where a 
commercial party is purchasing for its own use or inventory. The 
exclusion should not apply where a commercial buyer is purchasing 
on behalf of its customers, i.e., where the contracts are offered 
or sold directly or indirectly to the public. If commercial 
entities are permitted to act on behalf of their own customers, 
they in essence function as the exchange without meeting the 
registration or regulatory requirements of the CEA, and individ- 
ual investors are not afforded the protections Congress intended 
they have. 

(2) The exception should be limited specifically to the 
Brent contracts. 

We understand that Brent trading involves numerous consider- 
ations aside from the futures contract/forward contract issue. 



164 



Vendy L. Gramm 

Page 3 

June 8, 1990 



We hope, however, that the Commission will be mindful of the 
critical role both it and other agencies play in maintaining the 
integrity of the markets for small and large investors. Perhaps 
a lesson can be learned from the now infamous #85-2 release that 
a narrowly drawn interpretation is less likely to create serious 
gaps in the enforcement structure. We believe a narrow exception 
for Brent contracts can be constructed without opening the door 
to allow every commodity contract entered into between commercial 
parties to fall within the forward contract exclusion. 

We understand that the Commission is under a fairly tight 
time frame on this issue. We, however, are concerned about the 
collateral impact of the decision being contemplated. I will be 
in Washington, D. C. on June 18 and 19 and would be pleased to 
meet with you or your staff to provide further information. If 
CFTC action is expected before that time, I would be willing to 
come to Washington the week of June 11. 

Please contact me if we can be of any assistance during 
this process. We view this as a critical area and are anxious to 
see a proper end result. 

Sincerely, 

WAYNE KLEIN 

Bureau Chief, Securities Bureau 

Department of Finance 

WK/MTS/drc 

cc: Commissioner Fowler C. West 

Commissioner William P. Albrecht 
Commissioner Robert R. Davis 
Commissioner -Kalo A. Hineman 
Lee Poison, NASAA 



J 



165 



H.R. 2374 

Written Statement of Kenneth M. Raisler 

On Behalf of the Energy Group to the 

Subcommittee on Environment, Credit and Rural Development 

Committee on Agriculture 

U.S. House of Representatives 

June 30, 1993 



On behalf of the entities listed in the attached Appendix (collectively, the 
"Energy Group"), I am pleased to submit this testimony on H.R. 2374, a bill to amend the 
Commodity Exchange Act to require the continued application of the Act's anti-fraud and anti- 
manipulation provisions. Each of the members of the Energy Group is a producer, processor 
and/or merchandiser of crude oil, condensates, natural gas, natural gas liquids or their 
derivatives, or is otherwise engaged in a commercial business related to such commodities. 
The Energy Group comprises integrated oil and gas companies as well as refiners and suppliers 
of such commodities, and each of the members of the Energy Group is an active participant 
in the principal domestic and international markets for crude oil and/or natural gas and the 
products and by-products thereof. 

As the applicants for the Commodity Futures Trading Commission's Exemption 
for Certain Contracts Involving Energy Products, 50 Fed. Reg. 21286 (April 20, 1993), the 
Energy Group wants to make it clear that we are adamantly opposed to any form of fraud in 
our markets. Our view, however, is that the bill before the Subcommittee, which removes 
the CFTC's discretion to grant an exemption from the Commodity Exchange Act's (the "Act") 
anti-fraud and anti-manipulation provisions, is not an effective way to address the issue. We 
appreciate the Subcommittee Chairman's invitation to receive our views and hope that this 



166 



testimony may clarify some of the misperceptions about the energy markets, the scope of the 
CFTC's Exemptive Order and its decision not to apply its anti-fraud jurisdiction. In our view, 
the CFTC should retain the discretion granted in the Futures Trading Practices Act of 1992 
(the "FTPA") in order to provide legal certainty and stability in appropriate markets. 

The CFTC's authority to grant exemptive relief is provided in Section 502 of the 
FTPA, which added a new Section 4(c) to the Act and granted the Commission the authority 
to exempt "any agreement, contract, or transaction (or class thereof)" from the off-exchange 
trading prohibition imposed under Section 4(a) of the Act and from any other provisions of the 
Act. The provision "is designed to give the Commission broad flexibility in addressing these 
products either generically or on an individualized, case-by-case basis." H.R. 978, 102d 
Cong., 2dSess. p. 81 (1992) (the "1992 Conference Report"). The 1992 Conference Report 
makes the further point that, "[t]he goal of providing the Commission with broad exemptive 
powers ... is to give the Commission a means of providing certainty and stability to existing 
and emerging markets so that financial innovation and market development can proceed in an 
effective and competitive manner." At no time in the lengthy debate on CFTC Reauthorization 
was it ever suggested that the CFTC's exemptive authority should be limited (other than with 
respect to securities derivatives) or that the CFTC should not have authority to exempt 
transactions from its anti-fraud and anti-manipulation jurisdiction. For the reasons set forth 
in this testimony, we see no basis to upset the careful work of Congress in the FTPA so 
recently enacted. To limit the CFTC's discretion, as suggested in H.R. 2374, could serve to 
undermine the legal certainty and stability that Congress sought to achieve in granting the 
CFTC broad exemptive powers. 

Our testimony addresses the retroactive application of H.R. 2374 to the CFTC's 
Exemptive Order for Energy Contracts. This is the only situation to which the bill would apply 

-2- 



167 



and, to our knowledge, is the only situation where it is currently contemplated to apply. 
Thus, while there may be other special situations where the CFTC may elect to exempt 
contracts from the anti-fraud or anti-manipulation provisions of the Act, our testimony only 
addresses the bill as it applies to Energy Contracts. 

The FTPA 

The Act generally prohibits the trading of futures contracts in the United States 
other than on a designated "contract market", and futures contracts traded off-exchange 
might therefore be found to be in violation of the Act. Act, § 4(a). Pursuant to Section 
2(a)(1) of the Act, however, this prohibition does not apply to "any sale of any cash 
commodity for deferred shipment or delivery", commonly known as a "forward contract". In 
reliance on the forward contract exclusion, commercial entities have, throughout the history 
of the Act and its predecessor statutes, routinely entered into a variety of off-exchange 
transactions in connection with their regular business activities with the understanding that 
such transactions were outside the scope of the Act and Commission regulations. 

As Congress noted in the 1992 Conference Report, however, a District Court 
in 1990 found that certain contracts for the forward purchase and sale of Brent blend crude 
oil, referred to as " 1 5-day Brent contracts" , were futures contracts. 1 992 Conference Report 
at 82, citing , Transnor (Bermuda) Limited v. BP North America Petroleum . 738 F. Supp. 1 472 
(S.D.N.Y. 1 990) (" Transnor "). That decision, the first such decision in the history of the Act 
which found that contracts entered into solely between commercial entities could be 
construed to be futures contracts, created substantial confusion and uncertainty regarding the 
legal status of a wide variety of legitimate and longstanding commercial practices in the 
energy markets. As a result of the Transnor decision, many participants in the Brent market 
and other commercial energy markets either ceased their trading activities completely or 



168 



restricted their activities to areas outside the United States. Those U.S. participants in the 
Brent marlcet which were unable to trade from locations outside of the United States found, 
in many instances, that non-U. S. counterparties simply refused to deal with them. The result 
was a reduction in the level of 15-day Brent transactions, along with a reduction in trading 
in other oil markets, and a significant impairment of hedging and other commercial 
opportunities for energy market participants. This in turn adversely affected energy users and 
consumers. 

In response to the adverse effects of the Transnor decision, and in an effort to 
clarify that 15-day Brent transactions and other similar agreements are outside the Act and 
Commission jurisdiction, the Commission issued a statutory interpretation in September 1 990. 
Statutory Interpretation Concerning Forward Transactions, 55 Fed. Reg. 39188 (Sept. 25, 
1 990) (the "Statutory Interpretation"). The Statutory Interpretation represented an important 
and essential step in resolving the uncertainties generated by the Transnor decision, and the 
Energy Group strongly supports its continued validity. While the Statutory Interpretation gave 
comfort to many market participants, uncertainty remained, particularly among foreign-based 
oil companies who refused to enter into transactions with U.S. -based counterparties because 
of their concern about the application of Commission jurisdiction. 

In the course of its deliberations on the FTPA, the Congressional conferees 
acknowledged the effect of the Transnor decision and the uncertainty that remained after the 
Commission's issuance of the Statutory Interpretation in response to that decision. 1992 
Conference Report, at 82. Congress noted that "[m]any markets of this nature are 
international in scope; foreign parties are already engaging in such transactions free of 
restraints imposed by the Act that may create competitive disadvantages for U.S. 
participants". Id. In granting the Commission exemptive authority by the adding of a new 

-4- 



I 



169 



Section 4(c) of the Act, Congress stated that it "expect[sl and strongly encouragelsl the 
Commission to use its new exemptive powers promptly upon enactment of this legislation in 
four areas where significant concerns of legal uncertainty have arisen: (1 ) hybrids, (2) swaps, 
(3) forwards , and (4) bank deposits and accounts." jd. at 81 (emphasis added). Thus, having 
been given broad exemptive authority. Congress expected and strongly encouraged prompt 
Commission action to address transactions which might not have been sufficiently clarified 
by the Statutory Interpretation. 

CFTC Energy Exemption 

On November 16, 1992, the Energy Group submitted its application for 
exemptive relief for certain contracts for the deferred purchase and sale of energy-related 
commodities. The application took into account the different interests that are addressed by 
CFTC anti-manipulation and anti-fraud jurisdiction. Recognizing the CFTC's historic and 
continuing interest in protecting against manipulation in both the futures and the related cash 
markets, the application proposed that the CFTC's anti-manipulation jurisdiction not be 
restricted with respect to energy transactions. Because the CFTC had never overseen energy 
physical market participants who, as substantial commercial parties, could protect themselves, 
the application did not request that the CFTC apply its anti-fraud jurisdiction. In both 
respects, the application was consistent with the Statutory Interpretation. 

On January 27, 1993, after the publication of the Commission's final rules 
exempting swaps and hybrid instruments (which included bank deposits and accounts), the 
Commission's proposed Order exempting certain contracts involving energy products was 
published. 58 Fed. Reg. 6250. The proposed Order was limited to "commercial participants 
who, in connection with their business activities, incur risks related to the underlying physical 
commodities, have the capacity to make or take delivery under the terms of the contracts, and 

-5- 



170 



are also eligible 'appropriate persons'" as defined in the proposed Order (including entities with 
a net worth exceeding $1,000,000 or total assets exceeding $5,000,000). The proposed 
Order was limited to "bilateral contracts between two parties acting as principals" which 
"[i]mpose[d] binding obligations on the parties to make and receive delivery of the underlying 
commodity or commodities, with no right of either party to effect a cash settlement of their 
obligations without the consent of the other party". Specified contracts which provide for 
settlement of the obligations in a manner other than by physical delivery were permitted in 
the proposed Order. The Order proposed to apply the CFTC's anti-manipulation jurisdiction 
but not its anti-fraud jurisdiction. In addition to issuing the proposed Order, the Commission's 
Federal Register notice identified particular issues for comment. These included the question 
whether "Energy Contracts as described in the release [should] be exempt from section 4b 
of the Act (the anti-fraud provision]". 

Sixteen comments were received by the Commission including eight from active 
participants in the energy cash or forward markets or entities representing such participants, 
three from futures exchanges, three from futures industry associations, one from a bar 
association committee and one from an attorney. All but one of the commenters generally 
supported issuance by the Commission of the proposed Order. No commenter explicitly 
supported the application by the Commission of anti-fraud jurisdiction. To the contrary, 
almost all of the commenters opposed applying this authority. The commenters were of the 
general view that given the commercial characteristics of these transactions and the 
significant requirements to participate, section 4b of the Act (anti-fraud) should not be applied 
to Energy Contracts. Commenters observed that since such transactions generally are 
recognized to be forwards excluded from the Act and the Commission's jurisdiction, 
participants have not had any expectation of protection afforded by the Act or the CFTC. 



171 



Instead, they have relied on existing statutory and common law prohibitions; imposing an 
additional standard of liability would be duplicative and unwarranted. 

At a public meeting on April 1 3, 1 993, the Commission adopted its Final Order 
providing for an Exemption for Certain Contracts Involving Energy Products (the "Exemptive 
Order"). The exemption was adopted by a 2-1 vote, the concern of the dissenting 
Commissioner being that the Commission should apply its anti-fraud jurisdiction. The 
Exemptive Order closely followed the terms of the proposed Order and did retain anti- 
manipulation jurisdiction. The exemption covers contracts for the purchase and sale of crude 
oil, condensates, natural gas, natural gas liquids, and products derived from such commodities 
which are used primarily as an energy source. Contracts must be bought and sold by 
commercial participants, as defined in the Order, be bilateral contracts between two parties 
acting as principals, and impose binding obligations on the parties to make and receive 
delivery without a right of either party to effect a cash settlement without the consent of the 
other party (subject to the parties' rights to enter into specified contracts for settlement of 
their obligations in a manner other than by physical delivery). It is the view of the Energy 
Group that the exemption provides the legal certainty that Congress directed the Commission 
to achieve for commercial contracts in the energy markets. The legal certainty that the 
Commission has provided in its Exemptive Order will avoid potential litigation and allow U.S.- 
based energy companies to enter into transactions in these markets with foreign-based 
companies that, without the Order, have refused to trade because of their concern about the 
application of CFTC jurisdiction. 

Anti-Fraud Jurisdiction 

We reiterate our strongly held position that there is no place for fraud in the 
energy markets. Our view, however, is that H.R. 2374, by directing the CFTC automatically 

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172 



to apply anti-fraud jurisdiction, will not achieve its desired results. Instead, it will create false 
perceptions and confusion that may deter important participation in the markets. 

The CFTC's anti-fraud provisions only apply to transactions that the CFTC 
determines are subject to the Act. The commercial buying and selling of goods, including 
energy, have long been outside of Commission and generally federal government regulation. 
The transactions described in the Exemptive Order are generally recognized by the CFTC and 
others to be forward contracts outside of the CFTC's jurisdiction. The CFTC's Order does not 
seek to expand the types of transactions or range of participants currently in the physical 
energy markets. Instead, the exemption only seeks to provide legal certainty that these 
activities which have been ongoing without CFTC oversight or involvement are clearly outside 
of the CFTC's jurisdiction. While there is no evidence of fraud in the traditional physical 
energy markets covered by the Exemptive Order, if fraud were to occur, CFTC jurisdiction 
would almost certainly be ineffective. The CFTC does not have the staff or the expertise to 
police the physical energy markets and retaining anti-fraud jurisdiction could create the 
misleading impression that it is able to do so. Rather than expecting the CFTC, with its 
limited jurisdiction and resources, to oversee these markets and protect against fraud, 
participants and authorities should seek recourse under other clearly applicable state and 
federal statutes, including those providing for criminal sanctions.* in addition. 



Indeed, the Final Order is fully consistent with the 
recommendation of this Committee, which was adopted into law 
in the Futures Trading Act of 1982, to amend the definition of 
"commodity trading advisor" to eliminate potential Commission 
jurisdiction (including anti-fraud jurisdiction) over persons 
who advise with respect to cash commodities or their- value, 
including advice to individual members of the general public 
regardless of net worth. Futures Trading Act of 19 82, Sec. 
201; H.R. Report No. 97-565, 97th Cong., 2d Sess. 130 (1982). 



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173 



counterparties, of course, can rely on an existing body of commercial contract laws and state 
and common law fraud statutes as the basis to litigate their disputes. 

It is important to recognize that the Exemptive Order does not permit activities 
that could be the cause of public fraud. For example, boilerrooms, generally recognized as 
enterprises that use high-pressure sales tactics to solicit the general public, clearly are not 
eligible for an exemption under the terms of the CFTC's Order. The general public and, 
indeed, individuals are not eligible for the exemption. Both parties to each energy transaction 
must be commercial participants who have substantial net worth or assets ($1 million/$5 
million) to be eligible. Moreover, entities "formed solely for the specific purpose" of taking 
advantage of the exemption are not eligible. Therefore, otherwise ineligible parties cannot 
circumvent the exemption by creating a separate trading vehicle. Public "marketing" and 
"sales", whether high-pressure or not, also are clearly outside the intended scope of the 
Exemptive Order. Because a boilerroom marketing energy products would not qualify for the 
exemption under the specific terms of the Exemptive Order, the CFTC would have available 
its full array of enforcement authority, including its anti-fraud authority. 

Furthermore, the CFTC's anti-fraud statute covers fraud committed by one 
person acting "for or on behalf of" another. It is designed to address activity by a person, 
such as a broker, who is generally in a stronger bargaining position than its customer, and 
incurs specified legal duties to the customer as a result of their relative positions. There are 
no "customers" that can be eligible for the Exemptive Order. The Exemptive Order only 
applies to "bilateral contracts between two parties acting as principals," each commercials 
with a connection to the energy business. In essence, the CFTC's fraud provision has no 
application to transactions eligible for the Exemptive Order. To imply otherwise expands the 



■9- 



174 



scope of the Exemptive Order to exempt transactions that should be governed by all of the 
provisions of the Act. 

Congress directed the CFTC to use its exemptive authority to address legal 
uncertainty in the "forwards" area. It is important to keep in mind that transactions covered 
by the Exemptive Order are or closely resemble "forw/ard" contracts which have never been 
subject to CFTC anti-fraud jurisdiction or any other provisions of the Act. The narrowly-drawn 
Exemptive Order for Energy Contracts, as issued, without the application of the CFTC's anti- 
fraud jurisdiction provides needed legal certainty. In so doing, it avoids competitive 
disadvantage for U.S. participants whose foreign counterparts, no longer confused about the 
applicability of the Act, will not be reluctant to enter into Energy Contracts in the U.S. This 
result provides important benefits to U.S. energy companies (and energy consumers) by 
promoting greater certainty in the sourcing of supply and pricing of purchases and sales of 
crude oil, natural gas and products. 

Conclusion 

For the reasons stated, we cannot endorse H.R. 2374 insofar as it would require 
the application of the anti-fraud provisions of the Act to all exemptions the CFTC may issue. 
We endorse the goal of Congress in the FTPA to give the CFTC "broad exemptive powers" 
to "create legal certainty" and "stability" for markets such as the energy markets. There is 
no evidence that the CFTC has or will abuse its powers. The advantage of the FTPA 
structure, as illustrated by the three exemptions that the Commission has issued to date 
(swaps, hybrids and forwards), is that the CFTC can tailor each exemption to the particular 
market. To the extent that there are unintended effects of the Exemptive Order for energy 
products, which we see no basis to occur, the CFTC can always revisit it to tighten the 
restrictions on who can participate in these markets or to clarify the terms of exempt 

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175 

transactions. To rigidly apply the Act's anti-fraud provisions serves to undermine the goals 
of legal certainty and stability without achieving any other public benefits. I appreciate the 
opportunity to present this testimony. Should the Committee have any questions, I will be 
pleased to respond on behalf of the Energy Group. 

(Attachment follows:) 



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176 



Appendix A 



BP Oil Company 

Coastal Corporation 

Conoco Inc. 

Enron Gas Services Corp. 

J. Aron & Company 

Koch Industries Inc. 

Mobil Sales and Supply Corporation 

Phibro Energy Division of Solomon Inc. 

Phillips Petroleum Company 



177 



ISDA 



1270 Avenue of the Americas 
Suite 2118 
Rockefeller Center 
New York, New York 10020-1702 
(212) 332-1200 
INTERNATIONAL SWAP DEALERS ASSOCIATION, INC. FAX (212) 332 1212 



June 30, 1993 



Honorable Glenn English, 

Chairman, 

Subcommittee on Environment, 

Credit and Rural Development, 

Committee on Agriculture 

U.S. House of Representatives 

Room 1301, Longworth House Office Building 

Washington, D.C. 20515 



Dear Congressman English: 

We appreciate the opportunity to comment on 
H.R.2374, which is being considered by your subcommittee. 
As you know, the International Swaps and Derivatives 
Association (formerly the International Swap Dealers 
Association) is an international association that represents 
over 150 firms that participate in swaps and other 
derivative transactions. 

The purpose of this letter is to express several 
reservations and concerns that we have regarding H.R.2374. 
First, the Futures Trading Practices Act of 1992 (the 
"FTPA") sought to promote legal certainty by vesting the 
Commodity Futures Trading Commission (the "CFTC") with broad 
exemptive authority. By providing the CFTC with this 
authority. Congress permitted the CFTC to fashion the terms 
of an exemption without necessarily having to resolve often 
difficult questions concerning the jurisdictional scope of 
the Commodity Exchange Act (the "CEA"). H.R.2374 would cut 
back on this broad authority less than seven months after it 



178 



was enacted. We believe that this would undermine an 
important goal of the FTPA. As the Conference Report 
states, "[i]n granting exemptive authority to the 
[CFTC] . . ., the Conferees recognize the need to create 
legal certainty for a number of existing categories of 
instruments which trade today outside of the forum of a 
designated contract market (H.R. Rep. No. 978, 102d Cong., 
2d Sess. (1972) at 80) . 

Second, we believe that it is appropriate for the 
CFTC to retain the power, which Congress granted to it in 
the FTPA, to determine, on a case by case basis, whether to 
grant exemptions from the anti-fraud and anti-manipulation 
provisions of the CEA. The Bill by its terms contemplates 
that the CFTC may grant exemptions from these provisions in 
cases where Federal banking and securities laws apply. We 
believe that the CFTC should maintain the authority which it 
now has to grant such exemptions in other circumstances it 
deems appropriate as well. Under the FTPA, the exemptions 
may only be granted where the CFTC concludes that it is 
consistent with the public interest to do so. This Includes 
any exemption from exercising anti-fraud or anti- 
manipulation authority over particular transactions or 
persons. We believe that the public interest test will 
ensure that the CFTC ' s exemptive authority will be used 
judiciously. 

Third, we believe that the enactment of H.R. 2374 
could create confusion as to its applicability to certain 
exemptions already granted by the CFTC. In particular, it 
is not clear whether the Bill would require a change in the 
exemption for swap agreements that is contained in 
Section 35.2 of the CFTC ' s regulations (17 C.F.R. S 35.2). 
That exemption expressly provides that certain specific 
anti-fraud and anti-manipulation provisions will remain 
applicable to swap agreements that, absent the exemption, 
would otherwise be subject to CEA jurisdiction. The 
confusion arises because H.R. 2374 refers only to "anti- 
fraud" and "anti-manipulation" provisions of the CEA; it 
does not specify whether the sections enumerated in the swap 
exemption are the ones contemplated by H.R. 2374. 

Fourth, we believe that any amendment to the CEA 
that would alter the regulatory structure that applies to 
swap agreements, hybrid securities and other off -exchange 
transactions should await completion of the studies now 
being conducted by the General Accounting Office, the CFTC, 
the Securities and Exchange Commission and the Group of 



179 



Thirty concerning these transactions. As the Subcommittee 
is aware, the Conference Report on the FTPA specifically 
contemplated that these studies be undertaken in order to 
determine if there is a need for additional legislation. 

Fifth, we note that H.R.2374 would require the 
CFTC to implement its provisions through the issuance of 
interim final regulations. Such a process would eliminate 
the opportunity for prior notice and public comment. We 
believe it would be more appropriate to require advance 
notice and an opportunity for public comment. Among other 
things, we believe that the CFTC should have the benefit of 
public comment before determining how the anti-fraud or 
anti-manipulation provisions of the CEA will apply in the 
context of a particular rulemaking. 

We will be pleased to respond to any additional 
questions that the Subcommittee may have. 



Sincerely, 

■ / '' I : >///.. ' 

Joseph Bauman, 
Chairman, 

International Swaps and 
Derivatives Association 



180 



coMe< 



;OMMODITY EXCHANGE. INC . FOUR WORLD TRADE CENTER. NEW YORK.N Y. i0048m'212) 938-2919 

FAX (212) 321-9458 



Donna Rebel 
Chairman 



June 28, 1993 



The Honorable Glenn English 

Chairman 

Subcommittee on Environment, Credit, 

and Rural Development 
Committee on Agriculture 
U. S. House of Representatives 
Washington, DC 20515-6001 

Dear Mr. Chairman: 

Commodity Exchange, Inc. (Comex) was pleased to learn of the 
June 30 hearing and markup before your Sucommittee on H.R. 2374, 
a bill to amend the Commodity Exchange Act to ensure continued 
application of the Act's anti- fraud and anti-manipulation 
protections. Due to scheduling conflicts I will be unable to 
testify at the hearing; however, I would like to express Comex's 
views on the pending bill. 

H.R. 2374 would prohibit the CFTC from granting exemptions from 
the Commodity Exchange Act's anti-fraud and anti-manipulation 
provisions unless the exempted transactions or persons would be 
subject to comparable anti-fraud protection under the Federal 
securities and banking laws, as determined by the Commission. 
Comex supports the bill and your continued efforts to ensure the 
integrity of U.S. futures markets. 

Comex firmly believes the American public is best served by 
markets where prices are reached openly and available for all to 
see. As the Commission uses its exemptive authority it should 
seek, to the maximum extent practicable, to ensure comparable 
treatment to exchange- and off-exchange-traded exempted trans- 
actions and individuals. This approach, rather than protecting 
the exchange or off-exchange markets from competing with each 
other, is preferable. The Commission should be mindful that 
granting an exemption to an off-exchange product without a 
similar grant to its exchange-traded counterpart would likely 
favor, in effect, the off-exchange over the exchange-traded 
product. Also, failure to provide comparable treatment could 
potentially hamper the ability of the affected exchange market 
to serve its hedging and price discovery functions. 



181 

ccfviex 



Page 2 



We are unaware of any analyses concluding that retention of 
anti- fraud and anti-manipulation authority by the Commission 
will adversely affect the market for otherwise exempted 
transactions. Retention of these authorities for otherwise 
exempted transactions and persons can serve as a basis for 
relief for participants in transactions found to be fraudulent 
or manipulative. 

Thank you again for this opportunity to express our views on 
H.R. 2374. If I' or anyone on the Comex staff can be of 
assistance as this bill continues through the legislative 
process, please do not hesitate to call on us. 

Sincerely, 



Donna Redel 

o 



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