Congress, industry debate CFTC authority

The Commodity Futures Modernization Act, passed by Congress in 2000, gave the Commodity Futures Trading Commission the authority to regulate foreign currency futures and options contracts as long as they didn’t fall under another jurisdiction.

However, the recent Zelener case, in which a court ruled that spot forex transactions that called for delivery within two days were cash contracts and therefore not under the jurisdiction of the CFTC, even though the contracts were often “rolled over” like a typical futures contract and bought on margin, raised questions as to how much power the CFTC actually has (see “Court case brings CFTC’s authority into question,” Currency Trader, May 2005).

As a result, the CFTC has asked for greater power in handling similar cases. A Senate committee wants to give it to them, in the form of the Commodity Exchange Reauthorization Act (CERA). The CERA, which is on the calendar for a full vote by the Senate, extends the CFTC’s powers to cover situations like those in the Zelener case.

Nonetheless, a debate rages as to just how muchpower the CFTC should have. While some believe any new rule changes should affect only foreign exchange transactions, others think a variety of commodities should also be covered.

“The Zelener case is not only about foreign exchange products,” says Charles Carey, chairman of the Chicago Board of Trade. “The contract the Zelener Court found to be outside the jurisdiction of the CFTC may just as easily be utilized by scammers to induce the unsuspecting to invest in other commodities.

“Such fraudulent operators could cause a scandal similar to those involving options on sugar and other commodities in the mid-70s. Such a scandal could, as then, reflect adversely on the legitimate financial services and derivatives industry in the U.S.”

However, those who wish to limit the CFTC’s authority are concerned that new rules could give the Commission too much power and distract it from its original mission. “The FIA disagrees with those who seek a broad fix,” says John Damgard, president of the Futures Industry Association (FIA). “Expanding the CFTC’s jurisdiction to apply to any form of non-futures contracts would have profound and, FIA believes, adverse implications for the CFTC’s ability to discharge its oversight of futures and options exchange-trading, especially given the agency’s structure and limited resources.”

“Congress granted the CFTC exclusive jurisdiction over the futures and related options markets in order to make certain the CFTC would concentrate its efforts on those vital areas of our economy.”

Opponents of a broad fix fear that legitimate business transactions (e.g., the purchase of foreign currency at a currency exchange, or transactions done by a bank or insurance company) would suddenly be under CFTC jurisdiction.

“Nearly every prior [change in federal law] involving the scope of CFTC jurisdiction has caused significant disputes or uncertainty with adverse consequences,” says Marc Lackritz, president of the Securities Industry Association. “It is imperative that Congress avoids legislative initiatives that will create these problems in new areas of economic activity — particularly where no compelling publicpolicy case has been presented for enacting legislation that might give rise to such risks.”

Chicago Mercantile Exchange chairman Terry Duffy believes that addressing possible violations in other commodities only after multiple cases of fraud have occurred is a case of closing the barn door after the horse has left.

“Under the Zelener case, it does not matter what the dealer actually does or what the customer actually expects,” Duffy says. “The sharp operators and bucket shops have already figured out that the rationale of the Zelener opinion can apply to commodities other than forex.

How soon will it be before the CFTC’s jurisdiction and its retail consumer protections are reduced to irrelevance?” Duffy says the solution is a rule change that removes any ambiguity from the existing law that allowed the Zelener decision and applies to all commodity products, not just forex. Duffy and the CME have proposed legislation that provides for this without giving the CFTC power over spot forex or interbank transactions.

“The trick is to protect retail customers without upsetting jurisdictional boundaries that were agreed to in the CFMA,” says Daniel Roth, president of the National Futures Association (NFA). “Some have suggested that the best approach is to address Zelener only with respect to forex products. Forex is the current scam of choice among fraudsters, but limiting a Zelener fix to forex ignores the history of sales practice fraud and will not, in our view, really address the problem.

“In NFA’s 20 years of experience, we have seen that boiler rooms really prefer to sell physical commodities that retail customers deal with all the time. Sugar, gold, unleaded gasoline, heating oil these are the products that boiler rooms have historically favored. Foreign exchange rates, by contrast, are fairly arcane.”