Written Testimony of
James E. Newsome, Acting Chairman
Commodity Futures Trading Commission
Before the U.S. House of Representatives
Committee on Appropriations
Subcommittee on Agriculture, Rural Development,
FDA, and Related Agencies
March 21, 2001
Thank you, Chairman Bonilla and members of the Subcommittee. I am pleased to be here to testify before you on behalf of the Commodity Futures Trading Commission, and I appreciate the opportunity to discuss issues related to the Commission’s budget appropriation.
First, I would like to discuss the mission and responsibilities of the agency, and provide you with a detailed description of the manner in which we have utilized previous budget allocations to carry out our responsibilities as the Federal regulator for domestic futures and option markets. In addition, I would like to discuss the profound changes in the regulatory landscape resulting from the passage of the Commodity Futures Modernization Act of 2000, and the concomitant regulatory initiatives required by its enactment.
Mission of the Agency
The mission of the Commodity Futures Trading Commission as an oversight regulator is two-fold: to foster open, competitive, and financially safe and sound futures and options markets in the United States, and to protect the public from fraud, manipulation, and abusive practices in these markets. To achieve these goals, the Commission employs a well-trained, dedicated, and responsive staff, consisting of lawyers, economists, accountants, auditors, futures trading specialists, computer specialists, and support and administrative staff. The staff is primarily comprised of three main operating divisions (Economic Analysis, Trading & Markets, and Enforcement), and two offices (Office of International Affairs and Office of the General Counsel). The Commission is headquartered in Washington, D.C., and maintains regional offices in Chicago, New York, Kansas City, Los Angeles and Minneapolis. Commission staff oversee the activities of futures exchanges and registrants—futures commission merchants, salespeople, floor brokers, floor traders, commodity pool operators, commodity trading advisors, and introducing brokers— in addition to working with the exchanges as self-regulatory organizations (SROs) and the National Futures Association (NFA), a statutorily-recognized SRO overseen by the Commission, to maintain safe and secure markets.
Responsibilities of the Agency
The oversight functions of the Commission encompass many diverse areas. The Division of Economic Analysis (EA) has a critical responsibility to ensure that futures and option markets operate competitively, free of manipulation and congestion, and serve the risk-shifting and price-discovery needs of the United States and world economies. EA staff conduct daily market surveillance to ensure that the markets are functioning in an orderly manner and can, in an emergency, order an exchange to take specific action to restore an orderly market. EA staff also analyze reports of large trader positions, in order to identify and address potentially problematic concentrations in the marketplace. The Commission is briefed weekly regarding any surveillance issues or concerns, and additional briefings are scheduled as necessary in response to specific market events. EA staff maintain ongoing liaison with other federal regulators—for example, the United States Department of Agriculture and the Federal Energy Regulatory Commission—to discuss issues of common interest and to share information regarding market conditions.
The Division of Trading and Markets (T&M) develops, implements, and interprets regulations that protect customers, prevent trading and sales practice abuses, and assure the financial integrity of the futures markets and firms holding customer funds. T&M staff oversee the compliance activities of the futures industry self-regulatory organizations, including the futures and options exchanges, their clearinghouses, and the NFA. Regarding solicitation of customers, T&M staff monitor issues relating to the requirements that registrants disclose market risks and past performance information to prospective investors. T&M staff also review registrant compliance with the requirements that customer funds be kept in accounts separate from those maintained by the firm for its own use. In addition, staff ensure that customer accounts are adjusted to reflect the current market value at the close of each trading day. T&M staff oversee NFA’s activities relating to registration of companies and individuals that handle customer funds or give trading advice, and make appropriate referrals to enforcement staff as necessary. Moreover, T&M staff monitor registrants’ supervision systems, internal controls and sales practice compliance and ethics programs. T&M and EA staffs perform trade practice surveillance, and work closely with exchanges in their self-regulatory capacity to ensure that their rules and regulations comport with federal regulation in various areas, including clearance of trades, trade orders and records, position limits, price limits, disciplinary actions, and floor trading practices. The staffs conduct comprehensive semiannual reviews of all domestic futures and options exchanges to ensure that they remain in compliance with the Commodity Exchange Act and its regulations.
The Division of Enforcement (DOE) investigates and prosecutes alleged violations of the Commodity Exchange Act and Commission regulations. DOE takes actions against individuals and firms registered with the Commission, those who are engaged in commodity futures and options trading on designated domestic exchanges, and those who improperly market futures and options contracts.
DOE staff base investigations on information they develop independently, as well as information referred by other Commission divisions; industry self-regulatory organizations; state, Federal, and international authorities; and members of the public. At the conclusion of an investigation, DOE staff may recommend that the Commission initiate administrative proceedings or seek injunctive and ancillary relief on behalf of the Commission in Federal court. Administrative sanctions may include orders suspending, denying, revoking, or restricting registration and exchange trading privileges and imposing civil monetary penalties, cease and desist orders, and orders of restitution. The Commission also may obtain temporary restraining orders and preliminary and permanent injunctions in Federal court to halt ongoing violations, as well as civil monetary penalties. Other relief may include appointment of a receiver, the freezing of assets, restitution, and disgorgement of unlawfully acquired benefits. The CEA also provides that the Commission may obtain certain temporary relief on an ex parte basis including restraining orders preserving books and records, freezing assets, and appointing a receiver. When those enjoined violate court orders, DOE staff may seek to have the offenders held in contempt.
The Division of Enforcement works with the Department of Justice in the prosecution of criminal activity involving commodity-related issues. In addition, DOE staff provide expert help and technical assistance to U.S. Attorneys’ Offices, other Federal and state law enforcement agencies, and international authorities. The Commission and individual states may join as co-plaintiffs in civil injunctive actions brought to enforce the Commodity Exchange Act.
The Office of International Affairs (OIA) assists the Commission in responding to global market and regulatory changes by coordinating the Commission’s international activities. OIA provides information and technical support to the Commission and to its other offices and divisions on international matters; assists the Commission in developing rulemakings having foreign implications; analyzes foreign regulatory developments; develops regulatory information sharing arrangements; shares regulatory and fitness information with foreign authorities; and coordinates technical assistance to foreign jurisdictions. OIA represents the Commission in international organizations, organizes international conferences on behalf of the Commission, and provides technical comments to other U.S. financial regulators with respect to relevant international activities.
The Office of the General Counsel (OGC) is the Commission’s legal advisor. OGC represents the Commission in appellate litigation and in certain trial-level cases, including bankruptcy proceedings that involve futures industry professionals. Through its opinions program, OGC assists the Commission in performing its adjudicatory functions. As legal advisor, OGC reviews all substantive regulatory, legislative, and administrative matters presented to the Commission. OGC also advises the Commission on the application and interpretation of the Commodity Exchange Act and other administrative statutes.
Utilization of Previous Budget Allocations
The Commission’s FY 2000 appropriation was $62.8 M. This was $1.6 M or a 2.6% increase over our FY 1999 level. Actual staffing levels for FY 2000 were down to 556 FTEs in FY 2000 from 567 FTEs in FY 1999.
Approximately three-fourths of the CFTC’s appropriation is to cover the salary and benefits of the Commission staff. Recruiting and retaining a professional staff, consisting primarily of attorneys and economists, continues to be one the Commission’s largest management challenges. Beginning in FY 2000 and continuing in this fiscal year, the Commission has moved aggressively to recruit, and more importantly retain, its highly specialized professional staff by using, when fiscally feasible, all of the flexibilities available to it within Title V.
The remaining quarter of the Commission’s budget covers all other operating expenses. The two largest operating expenses are the lease of office space and the cost of maintaining an information technology infrastructure that enables the Commission to maintain an effective enforcement and market surveillance presence.
Keeping pace with the rapid information technology developments in the futures industry is perhaps the Commission’s second largest management challenge. For the first six months of the year 2000, the Commission undertook an independent assessment of its information technology program. The report included a number of specific recommendations including:
The Commission initiated a number of these changes with FY 2000 and FY 2001 resources. For example, the Commission has already reallocated an additional six FTEs for information technology positions.
In addition to the significant resources devoted to the substantial revisions to the Commodity Exchange Act, the following are some highlights from the on-going work of the Commission’s programs:
Enforcement: In the program areas, the CFTC has used its appropriations to maintain an effective enforcement and market surveillance presence in the growing futures and option markets. The largest share of our resources goes to support the Commission’s enforcement program. The primary goal of the enforcement program is to police futures markets for conduct that violates the Commodity Exchange Act or Commission regulations. The Enforcement program continuously looks for new ways to enhance the Commission’s ability to detect and deter wrongdoing. In FY 2000, for example, the Enforcement staff took action in a variety of areas including:
Fraudulent Internet Solicitations. Internet fraud poses a grave new threat because technology now enables malefactors to solicit business fraudulently from millions of people quickly and cheaply. To combat this threat, the Commission’s enforcement program:
On May 1, 2000 the Commission announced the initial results of a coordinated enforcement initiative with the Securities and Exchange Commission and the Federal Trade Commission aimed at cleaning up Internet Web-sites. As part of the initiative, the Commission filed and simultaneously settled 10 administrative enforcement actions.
Fraudulent Illegal Commodity Contracts. Illegal futures or option contracts continue to pose a financial threat to the public. The Enforcement program actively seeks to protect the public from wrongdoers who fraudulently solicit customers for what are purported to be financed speculative purchases of precious metals and other commodities but which are in fact illegal futures or option contracts. In FY 2000, the Commission brought several civil actions charging defendants with this type of misconduct. The Commission has also issued a Consumer Advisory to address these issues. In the Consumer Advisory, the Commission warns that companies making such pitches often overstate profit potential while minimizing the risk involved, falsely claiming that they are purchasing and storing metal, and charging phony "storage" and "interest" fees.
Other enforcement initiatives focused on fraudulent trade allocations – targeting, for example, wrongdoers who purposefully failed to provide account numbers for trades until after they knew the prices at which the trades had been confirmed in order to allocate profits and losses among their customers.
Market Surveillance, Analysis and Research: As noted above, one of the Commission’s principal responsibilities is to assure that futures markets operate competitively, free of manipulation and congestion, and serve the price-discovery and risk management needs of the US and world economies. The Market Surveillance, Analysis and Research programs in the Division of Economic Analysis focus on these objectives, periodically examine the effectiveness of their programs, and seek to institute revisions that reduce the costs of compliance. The following are examples of FY2000 initiatives in these programs.
Adoption of New Procedures for New Contract Listing and Rule Reviews. The Commission proposed a far-reaching and fundamental change to its procedures for listing new contracts offered by US exchanges. The change responds to US futures exchanges’ concerns that their ability to list new contracts without delay is important to their continued competitiveness, particularly with foreign exchanges. Specifically, the Commission adopted procedures allowing an exchange to list new contracts one day after the exchange files a notice with a certification that the contract meets the Commission’s requirements. The certification, in conjunction with fast-track procedures for approval of new contracts previously adopted by the Commission, ensures that the benefits of a new contract can be brought to the marketplace as soon as possible. Since then, the Commission further streamlined the exchange rules approval process to permit single, weekly summary filings rather than individual submissions.
Listing of a Variety of New Products. The Commission approved 29 new futures and option contracts, two of which were approved under 10-day fast track procedures, and 13 of which were approved under 45-day fast track provisions. In addition, exchanges filed 23 new contracts for listing under the Commission’s certification procedures, which permit exchanges to certify their own contracts and list them prior to receiving Commission approval. Examples of new contracts include:
Trading and Markets. As noted above, T&M staff develop, implement, and interpret regulations that protect customers, prevent trading and sales practice abuses, and assure the financial integrity of the futures markets and firms holding customer funds. During FY 2000, the Commission published the following final rules, proposed rules, orders, and advisories as part of the Commission’s effort to reduce regulatory burdens:
Block Trading Proposals. The Commission approved a proposal by the Cantor Financial Futures Exchange, Inc. (Cantor) to establish block-trading procedures at Cantor. The block-trading program at Cantor allows qualified market participants to negotiate and arrange futures transactions of a minimum size bilaterally, away from the centralized, competitive market. Once the specific terms of the block transaction are agreed to, the counterparties report the relevant details of the transaction to the exchange for clearing and settlement. The Commission also approved a later submission from the Chicago Mercantile Exchange to establish block trading.
Electronic Signatures. The Commission adopted new rules permitting futures commission merchants or FCMs, introducing brokers or IBs, commodity trading advisors and commodity pool operators to accept from their customers, clients or pool participants electronic signatures in those instances where Commission rules require registrants to obtain a signature on a document – such as an acknowledgement of receipt of required disclosure. The new rules include a definition of "electronic signature" patterned on the definition in the Uniform Electronic Transaction Act and a requirement to employ reasonable safeguards in accepting electronic signatures.
Average Price Calculations. The Commission issued an advisory permitting FCMs to calculate average prices for their customers when multiple prices are received on an order or series of orders, when permitted to do so by exchange rules. Previously, the Commission had authorized only US trading clearinghouses to perform the calculations. FCMs now have greater flexibility and increased efficiency in providing average pricing.
Foreign Futures and Options. The Commission adopted a rule permitting foreign firms acting in the capacity of FCMs and IBs to accept and execute foreign futures and option orders received directly from certain sophisticated US customers without the firms being required to register with the Commission.
Commodity Futures Modernization Act of 2000
The Commodity Futures Modernization Act (CFMA) is a sweeping overhaul of the federal futures regulatory framework as set forth in the Commodity Exchange Act. It creates an innovative regulatory regime for domestic futures exchanges, codifies exclusions from futures regulation for swaps and other over-the-counter derivatives, and repeals the 18-year-old prohibition against futures contracts on single securities and narrow-based security indices. The Act is designed to decrease regulatory burdens for domestic exchanges and to provide increased legal certainty for over-the-counter (OTC) derivatives, in accordance with the recommendations of the November 1999 President’s Working Group (PWG) Report on OTC derivatives. In addition, the CFMA clarifies the Commission’s oversight authority regarding the off-exchange sale of foreign currency futures and options to the retail public. The Act also provides a regulatory framework for entities that provide clearing of derivative instruments, a key recommendation of the PWG report.
In furtherance of these objectives, the CFMA requires that the Commission undertake several rulemakings within a statutorily specified time period. For example, the Commission must promulgate rules relating to privacy issues within six months of the date of enactment, as well as rules relating to foreign security futures products within twelve months. In addition, several joint rulemakings with the Securities and Exchange Commission are mandated by the Act in order to permit the trading of security futures products in the United States. Commission staff have formed staff teams to address each of these issues, and have set timetables for completion of each of these projects.
Moreover, enactment of the CFMA resulted in the elimination of certain procedural rules, which previously allowed the Commission to perform its basic oversight functions and approve new markets and contracts. Without new rules in place, the Commission will be hampered in its ability to protect the integrity of the futures markets. Accordingly, the Commission must enact new regulations that will enable it to carry out its oversight responsibilities as well as allow new applicants to be designated or recognized by the Commission. For example, the CFMA created two new categories of Commission-registered or -designated facilities: designated contract market and derivative transaction execution facility. In order to process the applications of entities wishing to operate in either of these categories, the Commission must promulgate procedural rules.
In addition, the CFMA clarified the Commission’s jurisdiction regarding prosecution of fraudulent retail foreign currency bucket shop transactions, and provided a new regulatory framework for the oversight of designated clearing organizations. These provisions could likely increase the regulatory responsibilities and staff workload at the Commission, as could the provisions relating to processing of applications for designated contract markets and derivatives transaction execution facilities. At the same time, as noted above, the Commission is committed to increasing its information technology processes and services, which will involve significant allocation of staff resources.
Finally, technological advancements have had a dramatic effect on the futures and options markets that we regulate. Markets have become increasingly electronic and global, which has caused fundamental changes in the way they develop, function and interact. Accordingly, the Commission is faced with the challenge of adapting our regulatory responsibilities, as well as our internal technological capabilities, to emerging market structures in order to ensure that we foster, rather than impede, technological innovation in financial markets.
All of these changes profoundly alter federal regulation of the commodity futures and option markets; however, they do not diminish the Commission’s oversight responsibilities of self-regulatory organizations, Commission registrants and participants that make up these markets.
Thank you for the opportunity to discuss our mission, our responsibilities, and the challenges that we face in the coming year in rethinking our former methods of regulating the safest, soundest futures and options markets in the world. The Commission looks forward to working with Congress and other federal financial regulators to ensure that we foster innovation and competition in the marketplace to enable the markets to grow and maintain their global leadership role. I would be happy to answer any questions you may have.