REMARKS OF BROOKSLEY BORN CHAIRPERSON COMMODITY FUTURES TRADING COMMISSION THIRD ANNUAL ADVANCED ALI-ABA COURSE OF STUDY INVESTMENT MANAGEMENT REGULATION
October 16, 1997
I am honored to be invited to deliver the keynote address at this ALI-ABA course on investment management regulation. As more and more investment funds use futures and commodity option products to diversify their portfolios and to manage risks, the regulatory program of the Commodity Futures Trading Commission becomes increasingly relevant to this audience.
Since it was established as an independent agency in 1974, the CFTC has witnessed two significant trends. On the one hand, the number and variety of new financial instruments have grown enormously. On the other hand, investment strategies, financial markets and national economies previously defined by clear borders are increasingly linked and interdependent. Consequently, financial regulators must not only be flexible in accommodating innovations within the industries they regulate; they must also continually reevaluate the effectiveness and efficiency of their regulatory frameworks, with careful attention to the activities of other regulators and other markets, both here and abroad.
One of the Commission's top priorities in recent years has been to ensure that the agency is responsive to the competitive challenges facing the U.S. futures industry and its customers, while at the same time preserving important customer protections and market safeguards -- in other words, responsible, prudent and informed regulatory reform. The Commission has accomplished a great deal toward this end, although we can and will do more.
I would first like to highlight for you the Commission's recent approaches toward streamlining regulation and fostering customer-friendly disclosure practices in the area of collective investment vehicles and advisors. Collective investment funds involved in futures or commodity option transactions are, in CFTC parlance, "commodity pools," and persons who manage futures accounts for customers or give trading advice to customers are called "commodity trading advisors."
About two years ago, the CFTC adopted comprehensive revisions of its disclosure document requirements for commodity pool operators and commodity trading advisors. These disclosure documents very much resemble the prospectuses required for investment companies and other publicly offered securities. The CFTC embarked on a wholesale revision of these rules with a view toward making commodity pool and commodity trading advisor disclosure documents simpler, easier to understand and more meaningful to investors. This rulemaking achieved four noteworthy objectives:
First, we created a template for a more readable, logically organized document that gives priority attention to the more important information. To this end, we required a table of contents, specified the order of initial core items and eliminated much of the previously required "boilerplate" language.
Second, we completely redesigned the format, scope and content of past performance presentations. As you may know, unlike the Securities and Exchange Commission, the CFTC has long required disclosure of past performance information -- "track record" data -- as one component of the prospectus. These disclosures, given the complexity of pool structures now in use, had grown in length and difficulty. Streamlining of this disclosure was a key objective of the Commission's efforts. New approaches in this area included a wholly new summary capsule format highlighting the worst monthly loss and greatest cumulative loss suffered by the pool or trading program during the last five years. We also required that monthly and annual returns for the pool or trading program be presented either in a numerical table or in a new bar chart format.
For the first time the Commission required disclosure of a pool's "break-even" point to show an investor the level of trading profits the pool must achieve in a year to cover its fees and expenses and to begin to provide a return to its investors.
Finally, the revised rules called for a comprehensive, integrated and particularized overview of the offered pool or trading program and the principal risk factors relevant to that investment, specifically including risks such as volatility, leverage, liquidity and counterparty creditworthiness that are common in the over-the-counter derivatives context.
We have been pleased with the results of these extensive revisions.
More recently, in January of this year, the Commission formally confirmed its support in principle for the use by commodity pool operators of a two-part disclosure document, analogous to the prospectus and statement of additional information used for mutual funds. In addressing the two-part disclosure concept, we have been working with the National Futures Association, a self-regulatory organization of commodity professionals designated by the Commission under the Commodity Exchange Act to perform certain regulatory functions. We have also been working with the Securities and Exchange Commission in reviewing proposals for "plain English" commodity pool disclosures.
The Commission also has undertaken a number of initiatives designed to enable commodity pool operators and commodity trading advisors to take advantage of the profound technological advances provided by the Internet as an important new medium of doing business. Beginning October 15, 1996, the Commission instituted a six-month pilot program under which commodity pool operators and commodity trading advisors were permitted, on a voluntary basis, to file disclosure documents electronically with the Commission with no filing or processing fees. Staff comments on these documents were provided and responded to electronically, significantly shortening the review process. In April 1997 the success of the pilot program enabled the Commission to make the electronic filing program permanently available, still on a voluntary basis, to commodity pool operators and commodity trading advisors.
In July 1997 the Commission issued interpretive guidance to commodity pool operators and commodity trading advisors concerning electronic delivery of disclosure documents to their customers. The Commission's interpretation enables commodity pool operators and commodity trading advisors to provide required disclosure documents and account statements and to obtain acknowledgments that disclosure documents have been received by customers, all by means of the Internet or other electronic media.
In June 1997 the Commission approved an interpretation permitting streamlined procedures for allocation of customer orders which are bunched for execution by commodity trading advisors. The Managed Funds Association recognized the importance of the customer protections maintained by the Commission in the interpretation, noting that its action provided clarity to all parties and furthered protection of customers by providing for their fair and equitable treatment.
The CFTC has found that, in regulating commodity pools, a high degree of coordination with other regulators and with self-regulatory agencies is beneficial. Commission staff regularly consult and meet with their counterparts at the Securities and Exchange Commission to coordinate and to rationalize the areas where our regulatory regimes intersect. This intersection occurs, for example, where commodity pool interests are sold in a public securities offering.
In the interest of conserving government resources, on September 30, 1997, the Commission issued an order delegating to the National Futures Association the primary responsibility for review of disclosure documents filed by commodity trading advisors and the operators of privately offered commodity pools. The Commission, of course, has retained oversight responsibility and will continue to interpret the rules and to provide exemptions, where appropriate, from the disclosure requirements.
The Commission continues to give careful consideration to the comments received in response to its proposed general interpretation that was designed to guide commodity pool operators and commodity trading advisors in determining when activities conducted on electronic media trigger the requirements to register with the Commission and/or to deliver a disclosure document. The novelty of the Internet phenomenon, coupled with the power of information networks to reach vast numbers of people, raises understandable regulatory concerns, concerns which must be resolved in the context of Constitutional press and speech freedom guaranties. The Commission, as well as the Securities and Exchange Commission, the National Association of Securities Dealers, the National Futures Association and other regulatory and self-regulatory bodies, have been devoting much time and effort to sorting out the issues and challenges posed by this new technology.
In other areas of regulatory reform, the Commission has made fostering the use of technology to reduce costs and to increase efficiency a major priority. In June 1997 the Commission opened the way for futures commission merchants to use electronic media in communicating with their customers. The Commission's release permits futures commission merchants to deliver monthly statements, trade confirmations and other account statements solely by electronic media to customers who consent to electronic transmission in lieu of receiving paper documents. Futures commission merchants, as well as commodity pool operators and commodity trading advisors, are now permitted to comply with recently promulgated SEC guidelines for maintaining required records on electronic media as an acceptable alternative to compliance with the CFTC's recordkeeping requirements. The Commission has also undertaken a program to permit futures commission merchants to file required financial reports electronically.
The Commission has been using its own Internet homepage as an interactive adjunct to its regulatory and enforcement programs. The Division of Enforcement has posted on the Internet the photograph and physical description of Donald Chancey, a fugitive defendant in a civil action brought by the Commission in Georgia. This "electronic wanted poster" enables any visitor to the CFTC's website who has seen Mr. Chancey to provide information concerning his whereabouts. The CFTC homepage also contains information on electronic filing of disclosure documents, as well as information on futures and options trading, the work of the Commission and industry statistics such as the commitments of traders reports.
This past Spring, in response to concerns expressed by futures exchanges, the Commission implemented new "fast-track" procedures for processing futures contract designation applications and exchange rule changes. These procedures significantly streamlined the review process for most new exchange contracts and many exchange rules, permitting approval within 10 days for many types of contracts and 45 days for certain other contracts. The efficiency of the Commission's contract approval process has been greatly increased even for those contracts not eligible for "fast track" procedures, and this summer the Chicago Mercantile Exchange's "E-mini" S&P 500 futures contract and the Chicago Board of Trade's Dow Jones Industrial Average futures contract were approved within days of receiving the statutorily required SEC comment letters.
In one of our most recent regulatory reform actions, in early September 1997, the Commission proposed amendments to its rules governing the risk disclosure obligations of futures commission merchants and introducing brokers. If adopted, the proposed rule amendments should speed the account opening process for the highly accredited customers identified in the rule and provide the flexibility to futures brokers to design their own disclosure of risk by eliminating certain mandatory risk disclosure information and procedures as to such customers. This proposal responds directly to industry calls to permit less burdensome regulatory requirements for sophisticated customers where appropriate.
Many of the Commission's recent actions were undertaken in direct response to concerns raised by members of the industry. Others were undertaken following an internal review and recommendations by Commission staff. The Commission currently is working on several additional regulatory initiatives, most of which are in direct response to issues raised by members of the industry.
For example, in response to concerns expressed by certain futures exchanges and the futures commission merchant community about the need to address the interests of large institutional market participants, the Commission intends to undertake a review of whether to permit certain non-competitive, off-floor transactions executed subject to the rules of a contract market. The futures commission merchant community also has requested that the Commission review whether post-order execution allocation of bunched orders should be allowed with respect to orders of sophisticated customers with their consent.
The Commission also intends to review whether it should use its exemptive authority to expand permitted investments of customer funds by a futures commission merchant or a U.S. clearing organization to include certain additional categories of liquid and readily marketable investments, as advocated by many futures commission merchants. The Commodity Exchange Act currently restricts investment of such funds to obligations of the United States or any state and obligations fully guaranteed by the United States. The Commission also intends to consider a request from industry representatives that it permit futures-style margining of options for certain customers. We will also be reexamining certain aspects of our net capital rules. With respect to each of these proposals, the Commission will seek to accommodate the needs of the industry and its customers with our mission to protect market users and to foster market integrity.
As you can see from this brief description, the Commission has made significant strides in streamlining and modernizing our regulations. We are committed to doing more. I have urged the Commission staff to fill up our regulatory reform suggestion box. I also would like to reiterate my open invitation for industry participants, their counsel and other interested persons to share with us their views on possible regulatory reforms.