February 17, 2005

A Free Market Program: From the CFTC's Chair to the ABA's Ears

KEY WEST, Fla. (HedgeWorld.com)--The acting chair of the Commodity Futures Trading Commission gave the keynote address at a Feb. 4 meeting of the American Bar Association's committee on the regulation of futures. She outlined the principles that guide her discharge of her duties and the tasks that lie ahead, both for the CFTC and for other regulators of, and lawyers for, the derivatives markets.

After the usual caveat that her views don't necessarily represent those of the CFTC or its staff, Sharon Brown-Hruska said that her own understanding of how regulation can and should contribute to the important market functions of price discovery and risk management results in large measure from her exposure to the work and the passion of Gordon Tullock and James Buchanan, two central figures in the law-and-economics school.

In their spirit, she is wary, for example, of the idea that regulators or legislators ought to impose exchange-style transparency on over-the-counter markets, energy markets in particular. That would be "operationally difficult to implement" and it could "do significant harm to the markets if ... done without regard to market structure." In other words, regulation could dry up liquidity, leaving the remaining illiquid markets more, rather than less, susceptible to manipulation.

Mr. Buchanan won the Nobel Prize in economics in 1986. He and Mr. Tullock together founded the Center for the Study of Public Choice, which now is housed at George Mason University, Fairfax, Va. They taught Ms. Brown-Hruska, as she told the ABA, that the scientific rigor of economics could be brought to bear on questions of law and policy. Further, they have taught her that the positive role of regulators is to instill credibility in the markets while minimizing legal uncertainties.

Regulators shouldn't seek to affect prices, she said. "The markets will take care of prices as long as we take care of the markets."

Legal Certainty, Hedge Funds and the Seventh Circuit

With these notions as her foundation, she reviewed some contemporary issues for the assembled lawyers.

She praised Congress for enacting the Commodity Futures Modernization Act of 2000, which accomplished legal certainty for innovative products "through specific exclusions and exemptions that enabled new entrants and new products to be traded without the deliberate imprimatur of the [CFTC]."

She indicated her desire to spread the word of legal certainty on the international scene, working, for example, with the Committee for European Securities Regulators to "focus on what regulators can do to further bring down the frictions to international trade. In the end, it is my hope that instead of the derivatives pie being sliced thinner, the pie will grow larger."

She also might have some evangelical work to do closer to home, with her colleagues in the Securities and Exchange Commission. "As many of you know, the CFTC is in discussion with the SEC to hammer out an exemption from registration with the SEC as Investment Advisers for those Commodity Pool Operators who are already registered with the CFTC," she said. In order to help avoid unnecessary burdens for those markets, "additional guidance from Congress would not be unwelcome."

Near the end of her address, Ms. Brown-Hruska discussed a decision by the Seventh Circuit Court of Appeals in June 2004 that defeated an enforcement action of the CFTC against an allegedly fraudulent retail foreign exchange dealer, Michael Zelener. The court held that the CFTC had no jurisdiction in the matter because the contracts at issue were spot, rather than futures, contracts.

"Here it is 2005, and after decades of interpretations and litigation, we still do not have clarity for something as fundamental and basic as what is a futures contract." She is concerned that without such clarity, innovation will be stifled and market integrity impaired.

Contact Bob Keane with questions or comments at: bkeane@invstmentadvisor.com.

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