1/5/2011

By Tyler Layne

Comment on http://dealbook.nytimes.com/2010/11/01/c-f-t-c-is-set-to-get-tougher-on-fraud/

            The Commodity Futures Trading Commission has long been known as the black sheep of financial regulatory agencies.  Traditionally, the CFTC regulated a very limited set of financial transactions, futures contracts dealing with agricultural commodities.  As such, the CFTC has less than a quarter of the attorneys of its big brother on the other side of the District, the Securities & Exchange Commission.  However, with the recent expansion of futures contracts into areas other than commodities, the CFTC’s enforcement abilities have been strained beyond the means of a small agency with a relatively narrow mission.

            Due to the strain on the CFTC in regulating futures, the SEC has picked up some of the slack, leading some to claim that the SEC was going so far that they were usurping the CFTC’s power.  In 2000, Congress passed the Commodity Futures Modernization Act, mandating that the SEC and CFTC develop a joint regulatory scheme for single-stock futures.  The current chairwoman of the SEC, Mary Schapiro, was formerly a chairwoman at the CFTC.  The two agencies seemed headed towards at least an informal merger.  This was buttressed by the slowing of the economy.  Many investors sought safety in the trading of futures in precious metals, leading gold and silver commodity prices to skyrocket to all-time highs.  As individual investors began participating in the commodity markets on an increased basis, many became worried about what they perceived as unrestrained domination of precious metal, especially silver, and trading by institutional investors, mainly JP Morgan and HSBC, that many believed amounted to market manipulation.  Furthermore, as a result of the volatility in petroleum prices during the 2000’s, many, including President Obama, called for the CFTC to propose rules closing loopholes that had led to speculation and manipulation in crude oil futures trading.  Finally, an outgoing CFTC administrative judge, George Painter, has accused a fellow administrative judge of improprieties that would prevent proper regulation of futures contracts.  As a result of these events, many saw the CFTC as a wholly ineffective regulatory agency that relied on the SEC for much of its power and many of its resources.

            That was all changed by the financial reform movement, which culminated in the Dodd-Frank Act, giving the CFTC unprecedented powers.  The rules proposed under Dodd-Frank would give the CFTC enforcement power paralleling that of the SEC under Rule 10b-5.  In fact, the CFTC powers could be extended past that of the SEC, giving them the power to prosecute lawyers and outside investors who bear responsibility for a violation despite not being a primary violator.  For their part, the chairmen of the CFTC seem to be doing their part to make sure that the CFTC is a regulator in name only no longer.  Chairman Bart Chilton has made regulation of the silver futures market his pet project, calling for an end to years of market manipulation by big banks.  Chairman Gary Gensler has doubled the enforcement staff and hired David Meister, a tough former AUSA and partner at Skadden, to run the enforcement division.  

These actions seem to be a step in the right direction for the CFTC.  The SEC does not have the manpower or inclination to regulate the complicated futures markets, where it is often hard to distinguish between manipulative or fraudulent trading and legal hedging.  Furthermore, Chilton and Gensler seem committed to transforming the CFTC into an entity that will protect investors and the market from the domination of institutional investors.  However, regulation of futures markets is complicated, as is the financial reform that led to the increased enforcement powers of the CFTC.  In his new capacity, Meister must tread a thin line between regulating institutional investors who have run wild through futures markets for years and overregulating small investors, including farmers who use commodities futures to price their crops.  In the final analysis, the increased enforcement powers of the CFTC are certainly needed to put an end to manipulation in complicated markets; however, because many of the CFTC’s regulators’ experience come from the SEC, they must be careful not to overstep their bounds and overregulate the market.  Not all derivatives are bad, and only time will tell if those with these new powers to regulate them realize that.