[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]



            THE COMMODITY FUTURES MODERNIZATION ACT OF 2000

=======================================================================

                                HEARING

                               before the

                            SUBCOMMITTEE ON
                    FINANCE AND HAZARDOUS MATERIALS

                                 of the

                         COMMITTEE ON COMMERCE
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED SIXTH CONGRESS

                             SECOND SESSION

                                   on

                                H.R. 454

                               __________

                             JULY 12, 2000

                               __________

                           Serial No. 106-123

                               __________

            Printed for the use of the Committee on Commerce

                     U.S. GOVERNMENT PRINTING OFFICE
65907CC                      WASHINGTON : 2000



                         COMMITTEE ON COMMERCE

                     TOM BLILEY, Virginia, Chairman

W.J. ``BILLY'' TAUZIN, Louisiana     JOHN D. DINGELL, Michigan
MICHAEL G. OXLEY, Ohio               HENRY A. WAXMAN, California
MICHAEL BILIRAKIS, Florida           EDWARD J. MARKEY, Massachusetts
JOE BARTON, Texas                    RALPH M. HALL, Texas
FRED UPTON, Michigan                 RICK BOUCHER, Virginia
CLIFF STEARNS, Florida               EDOLPHUS TOWNS, New York
PAUL E. GILLMOR, Ohio                FRANK PALLONE, Jr., New Jersey
  Vice Chairman                      SHERROD BROWN, Ohio
JAMES C. GREENWOOD, Pennsylvania     BART GORDON, Tennessee
CHRISTOPHER COX, California          PETER DEUTSCH, Florida
NATHAN DEAL, Georgia                 BOBBY L. RUSH, Illinois
STEVE LARGENT, Oklahoma              ANNA G. ESHOO, California
RICHARD BURR, North Carolina         RON KLINK, Pennsylvania
BRIAN P. BILBRAY, California         BART STUPAK, Michigan
ED WHITFIELD, Kentucky               ELIOT L. ENGEL, New York
GREG GANSKE, Iowa                    TOM SAWYER, Ohio
CHARLIE NORWOOD, Georgia             ALBERT R. WYNN, Maryland
TOM A. COBURN, Oklahoma              GENE GREEN, Texas
RICK LAZIO, New York                 KAREN McCARTHY, Missouri
BARBARA CUBIN, Wyoming               TED STRICKLAND, Ohio
JAMES E. ROGAN, California           DIANA DeGETTE, Colorado
JOHN SHIMKUS, Illinois               THOMAS M. BARRETT, Wisconsin
HEATHER WILSON, New Mexico           BILL LUTHER, Minnesota
JOHN B. SHADEGG, Arizona             LOIS CAPPS, California
CHARLES W. ``CHIP'' PICKERING, 
Mississippi
VITO FOSSELLA, New York
ROY BLUNT, Missouri
ED BRYANT, Tennessee
ROBERT L. EHRLICH, Jr., Maryland

                   James E. Derderian, Chief of Staff

                   James D. Barnette, General Counsel

      Reid P.F. Stuntz, Minority Staff Director and Chief Counsel

                                 ______

            Subcommittee on Finance and Hazardous Materials

                    MICHAEL G. OXLEY, Ohio, Chairman

W.J. ``BILLY'' TAUZIN, Louisiana     EDOLPHUS TOWNS, New York
  Vice Chairman                      PETER DEUTSCH, Florida
PAUL E. GILLMOR, Ohio                BART STUPAK, Michigan
JAMES C. GREENWOOD, Pennsylvania     ELIOT L. ENGEL, New York
CHRISTOPHER COX, California          DIANA DeGETTE, Colorado
STEVE LARGENT, Oklahoma              THOMAS M. BARRETT, Wisconsin
BRIAN P. BILBRAY, California         BILL LUTHER, Minnesota
GREG GANSKE, Iowa                    LOIS CAPPS, California
RICK LAZIO, New York                 EDWARD J. MARKEY, Massachusetts
JOHN SHIMKUS, Illinois               RALPH M. HALL, Texas
HEATHER WILSON, New Mexico           FRANK PALLONE, Jr., New Jersey
JOHN B. SHADEGG, Arizona             BOBBY L. RUSH, Illinois
VITO FOSSELLA, New York              JOHN D. DINGELL, Michigan,
ROY BLUNT, Missouri                    (Ex Officio)
ROBERT L. EHRLICH, Jr., Maryland
TOM BLILEY, Virginia,
  (Ex Officio)

                                  (ii)


                            C O N T E N T S

                               __________
                                                                   Page

Testimony of:
    Levitt, Hon. Arthur, Chairman, Securities and Exchange 
      Commission.................................................    21
    Parkinson, Patrick M., Associate Director, Division of 
      Research and Statistics, Board of Governors, Federal 
      Reserve System.............................................    43
    Paul, C. Robert, General Counsel, Commodity Futures Trading 
      Commission.................................................    39
    Sachs, Lewis A., Assistant Secretary for Financial Markets, 
      Department of the Treasury.................................    47
Material submitted for the record by:
    Bond Market Association, prepared statement of...............    61
    Chicago Board of Trade, prepared statement of................    56
    Gordon, Scott, Chairman, Board of Directors, Chicago 
      Mercantile Exchange, prepared statement of.................    58
    Parkinson, Patrick M., Associate Director, Division of 
      Research and Statistics, Board of Governors, Federal 
      Reserve System, letter dated July 19, 2000, to Hon. Tom 
      Bliley, enclosing response for the record..................    64
    Sachs, Lewis A., Assistant Secretary for Financial Markets, 
      Department of the Treasury, letter dated August 8, 2000, to 
      Hon. Thomas J. Bliley, enclosing response for the record...    66
    Skolnik, Barry W., President, North American Securities 
      Administrators Association, letter dated July 12, 2000, 
      providing comments for the record..........................    60

                                 (iii)

  

 
            THE COMMODITY FUTURES MODERNIZATION ACT OF 2000

                              ----------                              


                        WEDNESDAY, JULY 12, 2000

                  House of Representatives,
                             Committee on Commerce,
           Subcommittee on Finance and Hazardous Materials,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 10 a.m., in 
room 2123, Rayburn House Office Building, Hon. Michael G. Oxley 
(chairman) presiding.
    Members present: Representatives Oxley, Cox, Largent, 
Ganske, Shimkus, Wilson, Fossella, Ehrlich, Bliley (ex 
officio), Towns, Stupak, Barrett, Luther, Markey, Rush, and 
Dingell (ex officio).
    Also present: Representative Ewing.
    Staff present: David Cavicke, majority counsel; Brian 
McCullough, majority professional staff; Shannon Vildostigui, 
majority professional Staff; Robert Simison, legislative clerk; 
and Consuela Washington, minority counsel.
    Mr. Oxley. The subcommittee will come to order.
    Before my opening statement, I would like to recognize the 
gentleman from Illinois, Mr. Ewing, a refugee from the 
Agriculture Committee, who has been kind enough to sit in on 
our hearing since this is the legislation that he authored in 
the Agriculture Committee and he Chairs the subcommittee of 
jurisdiction there. Tom, welcome.
    This subcommittee has dealt with many complex financial 
issues over the years with a great deal of success. Last fall 
financial modernization was enacted into law after years of 
attempts to bring meaning to an evolving financial services 
marketplace. Orders and rules were established for the blurring 
lines between insurance, securities and banking. Our financial 
markets are not the best in the world because they stand still. 
Instead constant developments and new products derived from 
competition emerge to fill the needs of customers.
    Our financial markets have long since passed a time when 
their role was limited to the purchase and sale of securities 
and futures for investment purposes. Increasing need to 
minimize exposure to fluctuating interest rates and uncertain 
financial markets provided the impetus for valuable risk 
management tools such as financial futures and other financial 
derivatives. This evolution has led to futures on broad stock 
indices, and more recently narrow baskets of stocks.
    As with the financial services legislation, new products 
that begin to look alike can cause regulatory and legal 
confusion. H.R. 4541, the Commodity Futures Modernization Act 
of 2000, contains several provisions that seek to eliminate 
confusion and create a defined regulatory structure. Most 
people are unaware of how important the derivative market is 
for our economy. The amounts involved are staggering, with 
trillions of dollars of contracts trading annually. These are 
valuable products that should not be jeopardized with legal 
uncertainty. Because they rely on a regulatory exemption from 
the Commodity Exchange Act, they are subject to changes or 
interpretations by future regulators. If we are agreed that the 
policy of allowing this flourishing market to continue without 
being subject to the CEA, then we need to codify it in 
legislation and eliminate that uncertainty. H.R. 4541 addresses 
this problem in a fashion similar to the recommendations 
outlined in the President's Working Group report.
    I am interested to hear the comments of our witnesses about 
these provisions and further discussion regarding the legal 
uncertainty. Equally important is the repeal of the Shad-
Johnson Accord, which prohibits single-stock futures. Until now 
these products were banned because an agreement on the 
regulatory regime between the SEC and CFTC was never reached 
since the ban was implemented in 1982. The President's Working 
Group on Financial Markets agreed last fall that the 
prohibition could be repealed if certain regulatory issues and 
the concerns about the integrity of the underlying equity 
markets were addressed properly. I know disagreements remain 
between the agencies on this provision as reported, but failure 
to reach agreement now between the SEC and the CFTC is simply 
not an option. We have waited 18 years for the temporary ban to 
be lifted on a potentially useful financial product. If we wait 
any longer, the activity will move offshore, and I am confident 
agreement can be reached.
    Requests were made of the SEC and the CFTC to work together 
to find a compromise solution. I would request that each of 
these agencies provide this subcommittee in writing with the 
status of the negotiations to detail the specifics of what has 
been agreed to and what remains unresolved. I look forward to 
the comments of our witnesses and any suggestions they have for 
their suggestions on improvements to the legislation. We have a 
distinguished group of witnesses today and we look forward to 
hearing from them.
    It is now my pleasure to recognize the gentleman from New 
York, Mr. Towns, the ranking member.
    Mr. Towns. Thank you, Mr. Chairman. I also thank you very 
much for holding this hearing on this very important bill.
    It is unfortunate that the committee has been given such a 
short time to deal with this bill because it raises issues that 
go to the heart of this committee's jurisdiction. However, I 
hope that we could work together to craft a good bill in the 
short time given to us. As it has been described, the bill 
coming over to our committee from the Agriculture Committee has 
three titles. Title I deals with the legal certainty for the 
over-the-counter derivative transactions. Title II provides 
regulatory relief to the U.S. Futures exchanges. Title III 
attempts to address Shad-Johnson and the trading of single-
stock futures.
    I would like to focus my remarks on title I and III of the 
bill. Title I of the bill is critically important to U.S. 
investment in commercial banks and U.S. companies that use OTC 
derivatives to manage risk. This title establishes the 
necessary legal certainty for these OTC derivatives 
transactions. Specifically, the title insures that no court or 
regulator can make a determination that could invalidate 
billions of dollars of legitimate derivative contracts. This 
uncertainty is a cloud hanging over numerous types of 
transactions, such as OTC transactions, government securities 
and other financial instruments. U.S. financial markets should 
not be forced to tolerate the risk of such legal uncertainty.
    Mr. Chairman, this is extremely important. However, let me 
add we have what I see as a unique opportunity before us. As I 
understand it, the language coming out of the Agriculture 
Committee addressing legal certainty is strongly supported by 
the major financial trade associations, the major U.S. 
investment and commercial banks, United States futures 
exchanges, all four members of the President's Working Group. I 
find this unanimity of agreement to be almost unprecedented. We 
should seize this moment. Recognizing that no bill or title is 
perfect, there are obvious issues that need to be resolved in 
title III. However, with title I receiving this kind of broad 
support, it appears evident that we need to act on this 
legislation and at a minimum provide OTC derivative 
transactions with the necessary legal certainty.
    I do want to express my concerns about the portions of the 
Commodity Futures Modernization Act of 2000 dealing with 
single-stock futures. The bill would permit the trading of the 
single-stock futures without the regulatory requirements 
imposed on securities. Stock futures will act as a direct 
surrogate for individual stocks and will be marketed to retail 
investors across this country. The SEC is the expert regulator 
charged with oversight of the securities markets. It is 
critical that the SEC be able to administer the security 
markets provisions it feels are necessary for stock futures.
    The bill also would provide stock futures with regulatory 
advantages over competing securities products such as stock and 
stock options. Customers of single-stock futures would be 
exempt from Federal transaction fees imposed on securities and 
be subject to different margin levels than for stock options. 
This is unfair and should be remedied, and we must find a way 
to do that.
    For these reasons I believe that the stock futures 
provision of the Commodity Futures Modernization Act should be 
modified to address the legitimate concerns of the SEC and 
securities markets regarding the regulatory and competitive 
disparities between futures and securities arising from single-
stock futures. If this cannot be accomplished, if this cannot 
be accomplished, I repeat, within the short time remaining in 
this congressional session, then the stock futures provision 
should be removed from the bill so that Congress can act on the 
important legal certainty provisions in the bill. I strongly 
feel that under no circumstances should we delay a legal 
certainty provision.
    On that note, Mr. Chairman, I yield back the balance of my 
time. I am anxious to hear the comments coming from our 
witnesses.
    Mr. Oxley. I thank the gentleman. The Chair now recognizes 
the chairman of the full Commerce Committee, the gentleman from 
Richmond, Mr. Bliley.
    Chairman Bliley. Thank you, Mr. Chairman. Since 1982, when 
the SEC and the CFTC could not agree on who was to regulate 
single-stock futures, they agreed to ban the product. Although 
the ban was never intended to be permanent, they have yet to 
reach agreement on who should regulate them. Only in Washington 
do we ban something when we can't figure out who regulates it.
    Last November, to assist Congress on issues addressing the 
commodities markets, the President's Working Group on Financial 
Markets issued a report and it detailed changes that should be 
made in order that regulation keep pace with the rapidly 
evolving marketplace. Among the suggested changes was the 
repeal of the ban on single-stock futures. The President's 
Working Group agreed that the ban on single-stock futures could 
be repealed provided issues of regulatory structure and 
integrity of the underlying cash markets could be resolved.
    On the basis of this report I, along with Chairman Larry 
Combest and Chairman Tom Ewing, wrote to the SEC and the CFTC 
asking them to resolve this dispute. The response from the two 
agencies was troubling, as they were once again unable to reach 
any substantial agreement. Although single-stock futures may 
very well turn out to be much fuss about little, their 
prohibition is based on little more than an old-fashioned turf 
war. This is at odds with the principles of capitalism and 
freedom. If the agencies cannot resolve this dispute, Congress 
will have to do it for them.
    The President's Working Group also stressed the importance 
of providing greater legal certainty to over-the-counter 
derivatives. Trillion dollar products are currently traded in 
reliance on a CFTC exemption and a prayer that a court will not 
find the contract to be a future. Systematic risk may exist so 
long as these products trade without adequate legal certainty. 
That is precisely why the President's Working Group strongly 
urges certainty in this area. We need to make sure that those 
investing in our markets have confidence that the products in 
which they are trading are legally binding. Doing so will 
continue the viability of the American market for these 
products.
    Mr. Chairman, under your leadership, this subcommittee has 
worked hard to ensure our financial markets are the envy of the 
world. This bill before us today reflects a good starting point 
for this committee to continue its work of shaping a framework 
which will allow our markets to grow with a certainty that our 
investors have come to expect. We don't have a lot of time to 
consider this important legislation, but we will do our best.
    I yield back the balance of my time.
    Mr. Oxley. The gentleman yields back. The Chair is now 
pleased to recognize the gentleman from Michigan, the ranking 
member of the full committee, Mr. Dingell.
    Mr. Dingell. Mr. Chairman, I thank you for recognizing me 
and I commend you for holding this important hearing, and I 
warmly welcome our distinguished witnesses, especially our 
friend, the Chairman of the SEC.
    Mr. Chairman, I would begin by observing that this 
committee has jurisdiction over the securities industry, and 
the securities markets of this country. I note to you in the 
exercise of that jurisdiction, we have had a remarkable success 
going back to the original 1933 and 1934 acts, and that the 
success of this has been to see to it that our markets are the 
most trusted and respected in the world, which is why everybody 
comes over here to invest in the American securities industry.
    I would note, however, that the same successes have not 
occurred with regard to the futures markets, which at different 
times take on the appearances and some of the characteristics 
of cesspools. The protections which one would observe for the 
American securities markets are very clear. There are paper 
trails, protections against fraud and, in addition to that, 
strong prohibitions against insider trading. A market which has 
been disciplined by this kind of oversight by the SEC and the 
kind of oversight that was crafted by this committee in 1933 
and 1934 has brought remarkable success and extraordinary 
trust.
    As I have observed, the securities market everybody thinks 
runs on money. It does not. It runs on public trust, and if the 
trust is there, people make lots of money and that is people 
inside and outside of the market.
    I would like now to be blunt. This committee has 
jurisdiction of the securities industry. And while the 
Agriculture Committee may have jurisdiction over the futures 
market, I should say that they should exercise that with more 
diligence than they have done so in the past. I intend to see 
that this committee exercises its jurisdiction over the 
securities market to protect the American investors and to see 
to it that the integrity of that market system is carried 
forward and protected.
    I would ask to be forgiven for being blunt. This bill is a 
real turkey, and most of you know that I am a turkey hunter. If 
the bill's many defects are not fixed in this committee, I will 
do everything within my power to put this legislation out of 
its misery at the earliest opportunity.
    First, I support the effort to provide legal certainty for 
the OTC derivatives. The Commerce Committee played an 
instrumental role in crafting and passing the swaps exemption 
in the 1992 Futures Trading Practices Act. I would like to be 
in a position to support the legal certainty provisions of H.R. 
4541. However, the bill before us contains defective provisions 
on the regulation of clearinghouses that must be fixed to 
assure appropriate regulation of the risks that may be 
concentrated there. I am also concerned that the bill's 
definition of eligible contract participants includes retail 
investors who have no business in these unregulated 
institutional markets.
    I have other questions and concerns about this part of the 
bill, but these are the principal ones.
    Second, my general disdain for the quality of futures 
regulation in this country has not improved after reading this 
bill. As I understand it, H.R. 4541 transforms the CFTC from a 
``front line regulatory agency'' into an ``oversight 
regulator'' of what the bill calls ``acceptable business 
practices under core principles'' that will be applicable to 
registered futures markets. I am still waiting to see something 
that would fill that definition. If the CFTC believes that a 
registered entity is violating these yet to be determined core 
principles, it must first notify the entity in writing, then 
recommend an appropriate remedial action to remove the 
deficiency, but only after first conducting a cost-benefit 
analysis of the remedial action; and finally, the burden of 
proof is shifted to the CFTC, which must demonstrate the 
violation by a preponderance of the evidence.
    Now it would go to several things. First of all, when 
events happen in the futures market, they happen very fast 
because it is a very volatile market, and the ability to 
respond to a major scam or serious misbehavior under these 
circumstances is virtually nonexistent. Certainly it is not 
possible under any expectation that it might occur in a timely 
fashion. I am sure that every crook and swindler in the country 
is hoping that these outrageous provisions stay in the bill. I 
support reasonable regulatory relief for the futures exchanges, 
but H.R. 4541 is clearly contrary to the public interest.
    Third, and I have saved the best for last, I see absolutely 
no redeeming value whatsoever in the provisions of this bill 
that would lift the ban against single-stock futures and create 
a defective regulatory structure for these retail products 
under the Commodity Exchange Act and the CFTC, the same CFTC 
that this bill reduces to a defanged oversight regulator of 
core principles.
    This part of the bill, section 8, futures on securities, 
poses a serious threat to the integrity of the country's 
capital markets and undercuts over 6 decades of unparalleled 
investor protection and investor confidence and makes a joke of 
fair competition between the markets. These provisions are 
opposed by anybody who knows anything about securities. The 
Securities and Exchange Commission, the American Stock 
Exchange, the Boston Stock Exchange, the Chicago Board Options 
Exchange, the Chicago Stock Exchange, the Cincinnati Stock 
Exchange, the Nasdaq Stock Market, the New York Stock Exchange, 
the Pacific Stock Exchange, the Philadelphia Stock Exchange, 
the Depository Trust and Clearing Corporation, and the Options 
Clearing Corporation, among others.
    Mr. Chairman, I ask unanimous consent to include in the 
record a May 22, 2000 Business Week article entitled ``The Case 
Against Single-stock Futures'' as well as copies of the June 
27, 2000 letter of the New York Stock Exchange and the July 11, 
2000 memorandum of the United States Securities Markets 
Coalition setting forth these entities' detailed concerns with 
this bill.
    Mr. Oxley. Without objection, so ordered.
    [The article follows:]

                     [Business Week--May 22, 2000]

                 The Case Against Single-Stock Futures
                       Commentary By Joseph Weber
    As if trading stocks wasn't wild enough these days, the folks at 
the Chicago Mercantile Exchange and the Chicago Board of Trade want to 
give investors a chance to take a real roller-coaster ride. Exchange 
officials are teaming up with friendly legislators in Congress to 
revive an idea that some regulators in Washington thought they had 
buried 18 years ago--futures contracts on individual stocks. ``We have 
all the necessary safeguards in 131ace to be able to trade single-stock 
futures, and we see no reason why we shouldn't be able to,'' argues 
Scott Gordon, chairman of the board of the Chicago Merc. ``The public 
interest would be served.''
    And that may be so. But in fact, a strong argument can be made that 
single-stock futures are a financial vehicle whose time has most 
definitely not come. While they surely would be useful to institutional 
investors and a handful of speculators, they pose a risk to small 
investors--and may even encourage stock manipulation.
    To be sure, futures contracts have an honored place in the panoply 
of financial instruments. They can be found for everything from 
Treasury bonds to pork bellies. They are widely used as hedges against 
adverse price moves and are also popular speculations. In theory, both 
speculators and hedgers could make good use of single-stock futures. By 
selling futures contracts, money managers could hedge their portfolios 
against stock drops. By buying them, they could bet on stock-price 
rises when they don't want to--or can't--commit immediately to the 
purchase of certain stocks.
    True, you can do this already with options. But a futures contract 
would be cheaper than an option because it wouldn't include a premium, 
as an option does. ``We want the widest possible array of choices,'' 
says William P. Miller II, a Chicago Mercantile Exchange director who 
chairs the End Users of Derivatives Council for the 12,000-member 
Association for Financial Professionals.
    But that cheapness comes at a cost. For one thing, the futures 
market is a veritable lion's den of risk, particularly for small 
investors, who can put up just modest amounts of money and either win 
or, more often, lose big. If investors bet wrong with options, their 
loss is capped at the premium they paid to buy them; with futures, the 
potential loss is open-ended. To play the futures market, an investor 
need put up as little as 5% of the value of a common futures contract--
vs. the 50% margin required for stocks. What's more, futures players 
don't have the same regulatory protections that investors in the stock 
market take for granted, such as comparable insider-trading rules. 
There is no prohibition of insider trading in the Commodity Exchange 
Act.
    And fears abound that the high leverage connected with futures 
could tempt would-be stock manipulators. An April report on single-
stock futures by the General Accounting Office warns that ``even a 
small price movement in the underlying stock could encourage attempts 
to manipulate stock prices.'' Ordinarily, futures contracts are far 
more volatile than the spot prices of the underlying securities. Thus, 
a scamster could make large sums of money in futures by engineering 
even small moves in the underlying stock. What's more, there's a 
potential feedback loop: If they became popular, the futures ``could 
spawn great volatility in stocks,'' warns Bruce I. Jacobs, a portfolio 
manager at Jacobs Levy Equity Management who has written a book about 
derivatives and stock market crashes.
    Because such issues have never been resolved, futures on single 
stocks have been in limbo for nearly two decades. In 1981, the 
Securities & Exchange Commission and the Commodity Futures Trading 
Commission promised to study all the issues surrounding the idea. 
Meanwhile, they imposed a ``temporary'' ban. Now, the idea has reared 
its head again.
    And it has a real chance at success because of domestic and foreign 
competitive concerns, such as the emergence of single-stock futures 
abroad and similar investment devices in the U.S., as well as the 
growth of electronic-trading technology, and a good old-fashioned wish 
to end regulation. ``We do have the stars aligned,'' says Senator Phil 
Gramm (R-Tex.), chairman of the Senate Banking Committee, who held a 
hearing on the Shad-Johnson Accord and markets regulation on May 8 in 
Chicago. Gramm and Senate Agriculture Committee Chairman Richard G. 
Lugar (R-Ind.) plan to introduce a bill to legalize stork futures. They 
may tie the move to reauthorization of the Commodity Exchange Act, 
which empowers the CFTC, and which expires on Sept. 30.
    Regulators have given the idea a mixed response. SEC Chairman 
Arthur Levitt Jr. and CFTC Chairman William J. Rainer are still 
haggling over just how the new products would be overseen. Rival 
markets are hardly enthusiastic. And no wonder--futures could pose a 
competitive threat. The head of the Mere's archrival in the Loop, 
William J. Brodsky of the Chicago Board Options Exchange, says single-
stock futures must be treated the same as stocks--with the same 
aggressive SEC oversight and stiffer margin requirements--or they 
``would worsen the competitive inequities'' among exchanges. CFTC Chief 
Rainer says the required margin would be somewhere between the 50% 
minimum required for stocks and the 5% to 10% generally required for 
commodity futures contracts.
    Single-stock futures face an even more fundamental question: Is 
Congress rushing to approve a product of limited appeal? The answer to 
that may well be yes. Single-stock futures are already offered on about 
nine European and Asian exchanges--and they've proved to be anything 
but barnburners. They account for less than 1% of the total trading 
volume of the foreign futures markets. ``The anecdotal evidence is that 
the marketplace doesn't want these things,'' adds Robert E. Whaley, a 
professor of finance at Duke University's J.B. Fuqua School of 
Business. Similar products are already available in the U.S., but they, 
too, command fairly small followings. On the over-the-counter market, 
for instance, financial professionals can buy equity swaps. But these 
account for only a fraction of the value of OTC derivatives trading, 
says the GAO.
    Certainly, single-stock futures contracts will be easier to 
understand than these jury-rigged instruments. And that could raise a 
problem: They would also be simpler to market to unsophisticated 
investors, who usually wind up behind the eight ball when they trade 
futures. ``The vast majority of small investors in futures trading--
commodity futures--ultimately come out losing money,'' warns John F. 
Marshall, a professor of finance at St. John's University. It is, in 
his view, ``a zero-sum game.''
    Zero-sum or not, this new game has powerful friends on Capitol 
Hill, and that alone means that single-stock futures may well be on the 
horizon. If they do not turn out to be a flop, as they were overseas, 
their potential for abuse could make them a risky innovation. Small 
investors may pay the price for the Street's latest big idea.
                                 ______
                                 
                                    New York Stock Exchange
                                                      June 27, 2000
The Honorable Tom Bliley
Chairman
Committee on Commerce
2125 Rayburn House Office Building
Washington, DC 20515
    Dear Mr. Chairman: I am writing to share the views of the New York 
Stock Exchange, Inc. (NYSE) on H.R. 4541, the Commodities Futures 
Modernization Act of 2000. The NYSE is interested in two aspects of 
this important legislation--repeal of the Shad-Johnson Accord and legal 
certainty for equity swaps. While we commend Chairman Tom Ewing of the 
Risk Management Subcommittee of the House Agriculture Committee for his 
tireless efforts with regard to Commodity Futures Trading Commission 
(CFTC) reauthorization, we are compelled to oppose H.R. 4541, as 
reported by the Agriculture Committee.
Single Stock Futures
    The NYSE agrees with the President's Working Group on Financial 
Markets that the ``current prohibition on single stock futures can be 
repealed if issues about the integrity of the underlying securities 
markets and regulatory arbitrage are resolved.'' Over-the-Counter 
Derivatives Markets and the Commodity Exchange Act, page 32 
(1999)(emphasis added). Unfortunately, H.R. 4541 does not adequately 
address the issues raised by the Working Group.
    For the last six months, the Securities and Exchange Commission 
(SEC) and the Commodity Futures Trading Commission (CFTC), the two 
agencies with the expertise to address this complex issue, have been 
working diligently to develop a joint regulatory framework applicable 
to single stock futures. Much progress has been made. However, 
difficult issues remain to be resolved.
    It is vital that regulatory issues relating to the SEC's ability to 
adequately enforce the insider trading and other anti-fraud laws, and 
to protect retail investors be resolved properly in the first instance. 
If the right balance is not struck, single stock futures entail a high 
risk of great harm to retail investors and confidence in the U.S. 
securities markets. The United States stock market is unique in the 
world because of its enormous size and its high level of individual 
investor protection. Today, more than 70 million Americans participate 
in the stock market. Individuals and institutions are willing to invest 
in the U.S. stock market because they believe in the integrity of the 
market. Investor confidence is fragile. Once lost, it can be extremely 
difficult to regain.
    H.R. 4541's approach to single stock futures falls short in a 
number of important areas. The SEC's authority to enforce securities 
laws regarding insider trading, manipulation and fraud is too 
circumscribed and would leave the SEC unable to fully protect retail 
investors and market integrity.
    Further, the SEC must have the authority to inspect the 
surveillance programs of futures exchanges that trade single stock 
futures because without direct access to audit trail, coordinated 
market surveillance and inspection authority, the grant of enforcement 
authority to the SEC is illusory. The SEC does not have the resources 
to detect and deter insider trading and other violations of the 
securities laws alone. It depends on the surveillance programs of self-
regulatory organizations (SROs), i.e., the securities markets, to 
augment its efforts. The SEC regularly inspects the surveillance 
programs of the SROs to ensure that they are adequate. The SEC must 
have the same authority with regard to futures exchange surveillance 
programs applicable to single stock futures.
    H.R. 4541 also provides that the SEC can obtain information from 
futures exchanges only with the permission of the CFTC. This 
subordinate role for the SEC is unacceptable. To fully discharge its 
responsibilities under H.R. 4541, the SEC must have the unfettered 
ability to obtain the information that it needs.
    H.R. 4541 requires that margin levels for single stock futures be 
consistent with the margin on comparable options listed on a securities 
exchange. Further work to harmonize margins needs to be done. In 
determining whether margins are consistent, all rules governing margin, 
including the penalties for violating margin rules, must be consistent. 
H.R. 4541 would permit the Federal Reserve Board to delegate its margin 
oversight authority to the CFTC alone. In the NYSE's view, the Fed 
should delegate its margin authority, not to the CFTC, but to the 
Intermarket Margin Board described in H.R. 4541. This Board would 
consist of the Fed, SEC and CFTC. Otherwise, margins on single stock 
futures, even if consistent at the outset, will not remain consistent 
with margins on stock options over time.
    H.R. 4541's recognition that a suitability rule must apply to 
single stock futures is positive. However, the bill should mandate that 
such a suitability rule should be at least as stringent as suitability 
rules applicable to stock options. Also, the fact that suitability is a 
continuing requirement over the life of an account needs to be 
clarified.
    Finally, the provisions of H.R. 4541 are anti-competitive. H.R. 
4541 provides that single stock futures can only be traded on a futures 
exchange. Securities exchanges should have the ability to trade this 
product as well. H.R. 4541 also fails to extend the Section 31 
transaction fee to single stock futures. This fee is applied to all 
stock and stock options sales. Single stock futures will be direct 
substitutes for these products. Competitive fairness requires that 
single stock futures also be subject to this transaction fee.
Legal Certainty for Equity Swaps
    The NYSE's interest in legal certainty for over-the-counter 
derivatives is limited to equity swaps based on single stocks and 
narrow-based indexes. The NYSE is concerned about the legal status of 
these products because they are so closely linked to out own market.
    The NYSE supports legal certainty for equity swaps. However, we 
believe that exclusion from the CEA for equity swaps needs to be 
coupled with Congressional recognition that this type of OTC derivative 
is a security. Only by making it clear that equity swaps are subject, 
at least, to certain investor protection provisions of the securities 
laws can Congress and regulators assure that such products will not be 
used to circumvent the insider trading, fraud and manipulation 
prohibitions of those laws. It is also important that the proper 
margin, capital and sales practice standards apply to these 
instruments, and that they be integrated into the surveillance systems 
currently applicable to equities and all other equity-based 
derivatives. H.R. 4541 falls to clarify that equity swaps are 
securities. Without this clarification, we are concerned that the 
equity swap market may develop only for regulatory arbitrage, not to 
meet the legitimate risk management needs of investors.
    The President's Working Group recommended that an exclusion from 
the CEA for OTC derivatives should only cover swaps between eligible 
swaps participants. The Working Group agreed that consideration should 
be given to restricting the extent to which individuals qualify for the 
exclusion by not making it available to natural persons who own and 
invest, on a discretionary basis, less than $25 million in investments. 
H.R. 4541 defines eligible participant to include individuals with $10 
million in total assets. This threshold would encompass a large number 
of individual investors, and make it all the more pressing for Congress 
to clarify that excluded equity swaps are securities. Without such 
clarification, these individual investors would not have the benefit of 
the customer protections that all other individual investors in 
securities currently enjoy.
    Thank you for considering the NYSE's concerns about H.R. 4541. We 
look forward to working with you and the Committee to address these 
issues.
            Sincerely yours,
                                          Richard A. Grasso
                               Chairman and Chief Executive Officer
cc: Congressman John Dingell
   Congressman Mike Oxley
   Congressman Ed Towns
                                 ______
                                 
                               MEMORANDUM
TO: David Cavicke, Consuela Washington
FROM: The U.S. Securities Markets Coalition
RE: H.R. 4541 and Stock Futures
DATE: July 11, 2000
    This memo serves to provide comment from the U.S. Securities 
Markets Coalition \1\ on H.R. 4541, particularly those aspects of the 
bill that would permit the trading of stock futures.
---------------------------------------------------------------------------
    \1\ The members of the U.S. Securities Markets Coalition are the 
American Stock Exchange, the Boston Stock Exchange, the Chicago Board 
Options Exchange, the Chicago Stock Exchange, the Cincinnati Stock 
Exchange, The Depository Trust Clearing Corporation, the National 
Association of Securities Dealers, the Pacific Exchange, the 
Philadelphia Stock Exchange, and The Options Clearing Corporation.
---------------------------------------------------------------------------
    Stock futures will act as surrogates for stocks and stock options. 
They will trade on public marketplaces, be.marketed to retail 
investors, become part of the price discovery process for stocks and 
derivatives based on stocks, and, unfortunately, be used in schemes 
perpetrated by stock manipulators and scamsters. We therefore find it 
quite unsettling that H.R. 4541, for the most part, rejects the notion 
of applying the securities laws framework to these products. Instead, 
it applies the commodities laws to these products and charges the CFTC 
to oversee them. The commodities laws are not designed to address 
retail trading of a stock-based product. Moreover, the CFTC, whose role 
in supervising the futures markets will be greatly reduced if H.R. 4541 
were passed, has little experience in retail stock-based financial 
product regulation. While the bill provides the SEC certain limited 
authority to apply a handful of securities laws to stock futures, a 
number of important statutory protections have been omitted. Moreover, 
SEC authority would be limited to mere ``enforcement'' authority. It 
would not, for example, have authority to conduct oversight 
examinations of futures exchanges or exercise its rulemaking authority 
to adopt standards that would deter fraud and manipulation.
    As acknowledged by the President's Working Group, the issue of how 
to regulate stock futures presents not only market integrity issues but 
also important regulatory arbitrage issues. Some of these arbitrage 
issues relate primarily to core investor protection concerns, such as 
how to address insider trading issues. Other issues, arising from the 
similarity between stock futures, stock, and stock options, relate 
primarily to fair competition concerns. Most of the issues involve a 
combination of both concerns.
    We remain stalwart in our view that the most effective and fairest 
approach is to treat stock futures as securities. It is the only way to 
ensure that the panoply of securities laws protections apply to a 
product that is security in all but technical name.\2\ It is also the 
only way to ensure that the regulation of stock futures is consistent 
with the regulation of stocks and stock options. As a next best 
alternative, we believe some form of joint SEC/CFTC regulation of stock 
futures could be possible, provided stock futures are treated as 
securities but are exempted from securities regulations where 
commodities regulation better serves the investing public. The approach 
of the Ewing bill, to define stock futures as futures, then engraft 
several securities laws provisions onto the futures regulatory scheme, 
is the least favored approach, and the one that presents the greatest 
erosion of investor and market protections. It is also the approach 
that produces the greatest potential for competitive inequalities 
between futures and securities. We have identified below certain 
essential fixes to the most glaring deficiencies of the Ewing bill. Our 
points follow:
---------------------------------------------------------------------------
    \2\ Most of the attention in this controversy has been focused upon 
the regulation of trading stock futures. Regulation of those that give 
investment advice with respect to stock futures and the regulation of 
managed pools of stock futures outside of the established securities 
framework raise a host of additional investor protection and 
competitive issues that have yet to be fully considered.

 Stock futures, including those that settle in stock, should be 
        allowed to trade on securities exchanges. The Ewing bill 
        restricts the trading of stock futures to futures exchanges. S. 
        2697, by comparison, allows cash-settled stock futures to trade 
        both on futures exchanges and securities exchanges. The CFTC 
        did not object to the provisions of S. 2697 that would allow 
        stock futures to trade on securities exchanges. Allowing stock 
        futures to trade on securities exchanges can be accomplished by 
        defining stock futures as securities under the securities laws 
        and deleting the exclusive jurisdiction provisions of the CEA. 
        The exclusive jurisdiction provisions of the CEA are 
        anticompetitive. In addition to creating legal certainty 
        problems for swaps, these provisions have allowed the CFTC and 
        futures exchanges to block securities exchanges from offering a 
        number of securities derivatives products, including certain 
        securities hybrids and index participations. At the very least, 
        however, any compromise that allows stock futures to trade on 
        other than a securities exchange should allow this ``new'' 
        product to trade both on securities and futures markets.
 If stock futures are permitted to trade under the CEA, then 
        securities exchanges should be allowed to trade futures on all 
        financial instruments. The current bill represents the futures 
        exchanges' view of how stock futures should be allowed to 
        trade--subject to a monopoly on their markets. If Congress is 
        going to consider scrapping traditional jurisdictional 
        boundaries for financial products, fairness dictates that the 
        securities exchanges be provided with an adequate opportunity 
        to make the case for being able to trade financial futures. 
        This is also consistent with Congressman Ewing's stated view 
        that H.R. 4541 should reflect a comprehensive regulatory reform 
        package.
 Margin treatment must be ``truly'' equal between securities 
        (particularly options) and futures markets. The Ewing bill, 
        notwithstanding its basic call for ``consistent'' margin levels 
        between stock futures and stock options, does not create a 
        mechanism that will ensure this result. The Ewing bill would 
        provide a tremendous amount of leeway and ambiguity in 
        determining stock futures margin levels. Its standards for 
        consistent treatment are too loose and would allow separate 
        regulators to arrive at significantly different margin levels. 
        For example, the CFTC would be able to decide stock futures 
        margin levels and the SEC would determine stock option margin 
        levels. How can equal treatment be assured where separate 
        regulators are applying an elastic standard? Even if the margin 
        board (Fed, SEC, and CFTC) were used as permitted, the Fed, in 
        turn, would be able to delegate the ultimate setting of margin 
        levels back to the CFTC and SEC, respectively. The bill also 
        does not contain a legislative mandate for the Fed to ensure 
        that the margin levels across securities and futures markets 
        are equal from a competitive perspective. Nor does the bill 
        address important margin issues apart from margin levels, 
        including who customer margin levels should apply to, permitted 
        margin offsets, and acceptable forms of collateral. For these 
        reasons, we believe either the SEC or the Fed should singly 
        determine margin policy for stock, stock options, and stock 
        futures. If an intermarket margin board is used, once the board 
        arrives at a margin policy it should be the responsibility of 
        the SEC to oversee and administer its implementation across all 
        markets.
 Stock futures must be subject to a sales practice program that 
        is equivalent with that which applies to stock options. The 
        Ewing bill only requires the NFA to adopt a suitability rule 
        that is similar to the suitability rule currently applied to 
        exchange-listed options. Merely adopting such a rule does not 
        ensure that stock futures sales practices will be adequate, 
        much less comparable to the high standards established by the 
        securities markets. For example, as you know, the NASD 
        administers a comprehensive sales practice program that applies 
        to stocks and stock options. Also, related issues such as 
        disclosure (i.e, equivalent of an Options Disclosure) and 
        product advertising must be addressed. The SEC should be 
        provided broad rulemaking authority for sales practices across 
        all public markets for stock, stock options and stock futures 
        products.
 The legislation must mandate a regulatory framework that will 
        ensure futures exchanges trading stock futures adequately 
        surveil their markets for market abuses and share such 
        information with other futures and securities exchanges. Given 
        that stock futures transactions will directly impact stock 
        pricing and likely be used as part of stock fraud and stock 
        manipulation strategies, the SEC should be given authority to 
        oversee the market surveillance programs of stock futures 
        markets. Related to this point, stock futures markets should be 
        required to maintain a real-time consolidated audit trail. 
        While an audit trail requirement is contained in S. 2697, it is 
        not made subject to SEC oversight and rulemaking. Congress 
        should define the basic principles of such an audit trail and 
        provide the SEC with authority to oversee its operation.
 Full anti-fraud anti-manipulation authority of federal 
        securities laws should apply to stock futures. The Ewing bill 
        only extends to stock futures a small fraction of the anti-
        fraud and anti-manipulation provisions contained under the 
        federal securities laws. In addition, it does not provide the 
        SEC with rulemaking and exchange oversight authority, which are 
        necessary to ensure that appropriate market conduct is 
        adequately defined and enforced.
 Stock futures must be traded in an environment that permits 
        and fosters multiple trading and adherence to best execution of 
        customer orders. National Market System principles, including 
        the establishment of market linkages, the availability of 
        realtime quote and trade information, and assuring the 
        practicability of brokers being able to execute investors' 
        orders in the best market must apply to these instruments. The 
        SEC has significant experience in this area. On the other hand, 
        the CFTC has little or no experience in applying these 
        principles. Moreover, application of these principles should be 
        consistent with those applied to securities markets. 
        Accordingly, we believe the SEC should be vested with the 
        authority to apply NMS principles to stock futures, as it does 
        to stocks and stock options.
 Some form of centralized or linked clearing should be mandated 
        for stock futures. This is necessary to promote competition in 
        stock futures across markets for stock futures. For example, 
        centralized clearing would help to ensure that positions opened 
        on one exchange could be closed on another exchange.
 Tax treatment of stock futures must be made consistent with 
        that which applies to stock options. Unless the tax laws are 
        changed, customer transactions in stock futures (traded on 
        either a futures exchange or securities exchange) would be 
        subject to favorable ``60/40'' treatment. Essentially, this 
        means that customers of exchange-traded equity options would be 
        subject to a higher tax rate than customers of stock futures. 
        This violates a longstanding congressional policy of providing 
        equivalent tax treatment for competing products on the options 
        and futures exchanges. The disparity can be addressed either by 
        extending 60/40 tax treatment to equity options or denying 60/
        40 tax treatment to stock futures. The implementation of any 
        stock futures legislation could also be made contingent on 
        achieving tax parity between stock options and stock futures.
 Section 31 fees should apply to stock futures. Imposing this 
        fee on securities markets but not on futures markets would 
        provide an unfair competitive advantage to the futures 
        exchanges. In addition, given that the Ewing bill essentially 
        provides that the SEC shall police the stock futures markets 
        against insider trading and enforce the handful of several 
        other enumerated securities protections, it seems appropriate 
        that the futures markets help fund the SEC budget. Applying 
        Section 31 fees would be appropriate in this regard.
 Unless equivalence of regulation between stock futures and 
        other securities products can be assured, the securities 
        exchanges would need certain regulatory relief in order to 
        remain competitive. For example, the exchanges would need to be 
        freed from procedural requirements, such as SRO rule filings, 
        that can cause significant delays and roadblocks to changing 
        business practices and creating new products. Essentially, 
        securities exchanges would be facing direct competitors 
        operating in a deregulated environment (especially when 
        compared to today's securities exchange markets). They would 
        need to be able act quickly to respond to changing market 
        conditions.
 There are numerous provisions in the Ewing bill that can be 
        construed to expand CFTC jurisdiction over instruments that are 
        securities. For example, new Section 2(c)(2) on pages 18-19 
        gives the CFTC jurisdiction over options on a commodity (other 
        than foreign currency or a security) traded on an organized 
        exchange. The parenthetical does not include all securities 
        options, specifically options on a group or index of 
        securities. Second, the bill creates an entity under CFTC 
        jurisdiction called a derivatives transaction execution 
        facility (``DTEF'') which is a less-regulated version of a 
        board of trade. New Section 5a(e) would allow a DTEF to trade 
        contracts or transactions involving excluded commodities that 
        would otherwise be excluded from the CEA under H.R. 4541. These 
        excluded contracts or transactions would include many 
        securities, such as government securities options, stock 
        options, etc. The bill should be fixed to prohibit a DTEF from 
        trading any instruments excluded from the CEA. There are other 
        places in the bill that might impinge on SEC jurisdiction. The 
        SEC and Commerce Committee should carefully review the bill and 
        identify provisions that affect the regulatory jurisdiction of 
        the SEC.
 We will separately provide a line-by-line set of comments on 
        the Ewing bill shortly.

    Mr. Dingell. I agree with many of their comments. I also 
ask to include in the record a copy of the February 9, 2000 
letter that Mr. Towns, Mr. Markey and I sent to the SEC setting 
forth questions that we believed had to be satisfactorily 
addressed on this matter. I would observe that the bill before 
us does not meet any of the tests that we set forth for a good 
bill.
    [The letter follows:]

                      U.S. House of Representatives
                                      Committee on Commerce
                                                   February 9, 2000
The Honorable Arthur Levitt
Chairman
Securities and Exchange Commission
450 5th Street, NW.
Washington, D.C. 20545
    Dear Mr. Chairman: We are writing concerning the recommendations 
regarding single stock futures that were made in the November 9, 1999, 
Report of the President's Working Group on Financial Markets, entitled 
Over-the-Counter Derivatives Markets and the Commodity Exchange Act.
    As you will recall, the principal focus of the aforementioned 
report was to address legal uncertainty and unnecessary regulatory 
burden questions arising from the treatment of over-the-counter 
(``OTC'') derivatives under the Commodity Exchange Act (``CEA''). The 
Working Group made recommendations with respect to broadening the swaps 
exemption from futures regulation under the CEA, excluding certain 
electronic trading systems for swaps from CEA regulation, promoting 
development of clearing systems for OTC derivatives, and providing 
authority to exempt certain exchange-traded derivatives from CFTC 
regulation. While we have a number of questions and concerns about 
these recommendations, we are writing you today to request information 
and assistance in understanding the far-reaching implications of the 
Working Group's recommendation regarding single stock futures.
    The report states at page 32, in a section on Other Issues, that: 
``The Working Group members agree that the current prohibitions on 
single-stock futures can be repealed if issues about the integrity of 
the underlying securities market and regulatory arbitrage are 
resolved.'' The report then goes on to note that:
          ``From the perspective of the securities laws, the issues 
        raised by trading of single-stock futures include levels of 
        margin, insider trading, sales practices, real-time trade 
        reporting, and activities of floor brokers, as well as the 
        exclusive jurisdiction of the CFTC over futures contract 
        markets. From the perspective of the commodity futures laws, 
        the issues raised by these instruments include clearing, 
        segregation, large trader reporting, and direct surveillance.''
    The Working Group unanimously recommended that the SEC and the CFTC 
``work together and with Congress to determine whether the trading of 
single-stock futures should be permitted and if so, under what 
conditions.'' (emphasis added)
    In light of the highly qualified and conditional natural of the 
Working Group's recommendation in this area, and the enormous 
complexities involved in satisfactorily resolving all of the issues 
raised by trading of single-stock futures, we note with some concern 
the recent request by our colleagues, Representatives Combest, Ewing, 
Bliley, and Stenholm, for the SEC and the CFTC to ``create and present 
to Congress a detailed legislative plan for repealing the current 
prohibition on single stock futures'' no later than February 21, 2000 
so that ``it may aid us as we consider reauthorization of the Commodity 
Exchange Act this session.''
    This request appears to presume that all of the issues that were 
identified by the Working Group regarding the integrity of the 
underlying securities market and regulatory arbitrage either are 
unimportant or can be successfully resolved in a short period of time. 
We are not at all certain that these issues can be resolved consistent 
with the public interest, the protection of investors, and the 
maintenance of fair and orderly markets, especially if done in haste 
and within the confines of a regulatory structure that bifurcates 
regulatory authority over certain financial derivatives between the SEC 
and the CFTC. As the Commission considers this matter, we believe it 
absolutely imperative that the integrity of our nation's securities 
markets and the protections afforded to investors in these markets not 
be undermined in any way. Accordingly, we respectfully request, before 
the Commission submits any detailed legislative proposals to Congress 
relating to this matter, that it satisfactorily address the questions 
enclosed with this letter.
    Thank you for your assistance and cooperation in responding to this 
inquiry. Should you need additional information about this request, 
please have your staff contact Mr. Jeffrey S. Duncan (Rep. Markey) at 
202-225-2836 or Ms. Consuela Washington (Rep. Dingell) at 202-225-3641.
            Sincerely,
                                           John D. Dingell,
                              Ranking Member, Committee on Commerce
                                           Edward J. Markey
 Ranking Member, Telecommunications, Trade and Consumer Protection 
                                                       Subcommittee
                                             Edolphus Towns
       Ranking Member, Finance and Hazardous Materials Subcommittee
cc: The Honorable Tom Bliley
   The Honorable Michael G. Oxley
   The Honorable Larry Combest
   The Honorable Thomas W. Ewing
   The Honorable Charles W. Stenholm
Enclosure
  Questions for the Honorable Arthur Levitt, Chairman, Securities and 
                          Exchange Commission
                            February 9, 2000
    1. Single stock and narrow-based stock index futures (as well as 
options on those products) would function as very close substitutes for 
stocks and stock options. Would the availability of these products 
pursuant to a regulatory scheme that does not contain all of the 
protections afforded under the federal securities. laws undermine the 
policy objectives of such laws?
    2. If single stock and narrow-based stock index futures (as well as 
options on those products) were to be permitted and regulated other 
than as securities, how would the SEC be able to protect and ensure the 
integrity of the underlying securities?
    3. Would the futures markets become the price discovery market for 
stocks? If so, what protections should be in place to ensure prices are 
established in fair manner? How important is it for the SEC to be able 
to establish and police such protections?
    4. If single stock futures (or options on such futures) were 
permitted, would it be beneficial to the public to be able to trade 
them on multiple exchanges and over-the-counter? If so, what market 
linkages would need to be in place to ensure investors get the best 
available price?
    5. Should single stock futures (or options on such futures) be 
subject to centralized clearing? If not, what competitive impediments 
are associated with issuing and clearing such products through other 
clearing mechanisms, particularly if multiple trading is permitted?
    6. If single stock and narrow-based index futures (or options on 
such futures) were not regulated as securities, how would insider 
trading be addressed? The futures exchanges have suggested empowering 
the SEC with the ability to apply insider trading rules to single stock 
futures to the same extent as it applies those rules to options traded 
on a securities exchange. Do you believe this would be an effective 
approach? How much responsibility does exchange surveillance play in 
this process of deterring and detecting insider trading? Would the SEC 
need to have authority to oversee futures exchange surveillance 
programs to ensure that insider trading was being adequately policed? 
Would the SEC need to have the authority to establish books and records 
requirements in order to enforce compliance with insider trading 
restrictions?
    7. In addition to insider trading, how would more general market 
manipulations be addressed? Frontrunning? How much responsibility does 
exchange surveillance play in this process of deterring and detecting 
market manipulation or frontrunning? Would the SEC need to have 
authority to oversee futures exchange surveillance programs to ensure 
that market manipulation and frontrunning prohibitions were being 
adequately policed? Would the SEC need to have the authority to 
establish books and records requirements in order to enforce compliance 
with applicable market manipulation and frontrunning restrictions?
    8. What is the appropriate margin scheme that should be applicable 
to single stock and narrowbased stock index futures (or options on such 
futures)? Should stock and stock index futures margin levels be 
harmonized with those applicable to securities products? Should a 
single regulator set and administer the process? The futures exchanges 
have suggested that they would be willing to apply stock options margin 
treatment to single stock futures. Would this mean a margin of 20%? Who 
would approve changes to this level?
    9. We understand some trading of single-stock futures has taken 
place on markets outside the U.S. Have you studied the impact that 
trading of such products has had on the underlying stock markets? As a 
general matter, how are such products regulated? Is the regulation of 
futures, options, and stocks subject to a single regulator in such 
markets? If so, do you believe this plays a significant role in any 
apparent successful oversight of such products?
    10. If single stock and narrow-based stock index futures (or 
options on such futures) were permitted and not regulated as 
securities, presumably the products would be subject to either CFTC 
supervision or some type of dual Jurisdiction shared between the SEC 
and CFTC. Either scheme, if designed to address the numerous existing 
regulatory disparities between securities and futures products, would 
create an additional layer of regulation on the financial services 
community. Would this result in excessive compliance costs for the 
financial community? Is it preferable to link consideration of reform 
of the Shad-Johnson Accord with broader regulatory reform, such as 
merging the SEC and CFTC, and harmonizing the laws for all stock-based 
exchange traded products?
    11. What expertise does the CFTC have that would justify it as 
being considered as the sole or primary regulator for single stock and 
narrow-based stock index futures contracts? There is movement to 
convert the CFTC into a ``supervisory'' agency. How would any such 
reorganization affect the CFTC's ability to adequately oversee stock-
based futures trading?
    12. Exchange-listed stocks and stock options are subject to listing 
standards that help to ensure that adequate information about the 
underlying instrument is available (i.e., in compliance with securities 
registration provisions) and a base level of market liquidity is 
present (i.e., minimum public float and holders). What standards should 
apply to single stock and narrowbased stock index futures (or options 
on such futures)?
    13. What audit trail requirements should be applicable to single 
stock and narrow-based stock index futures (or options on such 
futures)? Should the futures exchanges be required to implement audit 
trails as precise and extensive as in the securities markets?
    14. What securities market transparency provisions, such as quote 
dissemination and transaction reporting requirements, should apply to 
single-stock and narrow-based index futures (or options on such 
futures)?
    15. Narrow-based stock index futures are currently banned along 
with single stock futures because they can act as surrogates for 
futures on individual securities. Do you believe that any relaxation of 
the current ban on narrow-based stock index futures would undermine the 
policy objectives of the Shad-Johnson Accord?
    16. Should consideration of modifying the Shad-Johnson Accord be 
linked with consideration of whether the exclusive jurisdiction clause 
of the CEA should be removed? Would removal of the exclusive 
jurisdiction clause pave the way for securities exchanges to offer 
futures or futures-like products, such as index participations and 
zero-strike options?
    17. What is the appropriate disclosure regime for single stock and 
narrow-based stock index futures (or options on such futures)? For 
example, should an equivalent of the Options Disclosure Document apply? 
Should there exist enhanced risk disclosure requirements for stock 
futures as is required for penny stocks and day traders? For uncovered 
options writing?
    18. What regulatory requirements should apply to single stock 
futures (or options on such futures) to address their possible use in 
connection with obtaining control of publicly traded companies? For 
example, should Regulation 13D of the Exchange Act or an equivalent 
provision apply to these products?
    19. What regulatory requirements should apply to single stock 
futures to address their use by entities engaged in distributing 
securities related to the futures products? For example, should 
Regulation M of the Exchange Act or an equivalent provision apply to 
these products?
    20. The best execution standards applicable to securities brokers 
serve an important investor protection function in the equities and 
options markets. We are not aware of any similar standards applicable 
in the futures markets. If single stock futures (or options on such 
futures) were traded on multiple markets, do you agree that best 
execution standards would be critical to the fair operation of those 
markets? If such standards were applicable, how would they work, 
particularly if certain key market transparency measures, such as real 
time quote availability (with size) and market linkages, were not 
available?
    21. Heightened sales practice and suitability requirements apply to 
securities options transactions. We are not aware of the existence of 
similar standards in the futures markets. Do you believe such 
heightened standards should apply to single stock and narrow-based 
stock index futures (or options on such futures)? What would be the 
results if they did not apply?
    22. Should the short swing profit restrictions contained in Section 
16 of the Exchange Act apply to single stock futures (or options on 
such futures)? What would be the results if they did not apply?
    23. Assuming insider trading and other anti-manipulation provisions 
were applied to single stock futures, how would issuer repurchase 
transactions through the use of futures be addressed? Would an 
equivalent of Exchange Act Rule 10b-18 be warranted or necessary?
    24. If single stock and narrow-based stock index futures (or 
options on such futures) were traded on futures exchanges, would 
additional intermarket coordination mechanisms be necessary? For 
example, would trading halt policies need to be synchronized? Who would 
mandate and oversee this process? Would surveillance monitoring 
programs need to be coordinated? What regulator would oversee this 
process?
    25. In addition to the disparities that exist between securities 
and futures products with regard to policies designed to protect the 
market and investors, a number of competitive disparities also exist 
that might place securities markets in an unfavorable position vis-a-
vis the futures markets unless addressed. For example, favorable ``60/
40'' capital gains treatment is available to all futures products; 
however tax code changes would need to be made to broadly extend such 
treatment to securities markets. Also, securities markets are subject 
to Section 31 transaction fees. There exists no equivalent under the 
futures regime. Should these and other competitive disparities be fully 
addressed in connection with any revisit of the Shad Johnson Accord?
    26. Section 11A of the Exchange Act requires the securities markets 
to consolidate last sale prices and quotations and make the data 
available on a real-time basis. The CEA does not contain a similar 
requirement. If this situation persists and multiple futures markets 
trade single stock futures (or options on such futures), it would be 
difficult for equity investors to accurately ascertain the price of any 
particular stock futures contract during the trading day. As part of 
any plan to permit single stock futures, would it be desirable to 
require the futures markets to consolidate market data and make it 
available to all investors?
    27. If single stock and narrow-based stock index futures are 
permitted, should the regulation of all securities and securities-based 
derivatives be consolidated under one regulator? How can the Shad-
Johnson prohibition be lifted unless the SEC and CFTC are merged?
    28. The ability of investors to recover damages under the federal 
securities laws exists for cases involving manipulation and fraud (as 
well as insider trading) associated with the purchase or sale of 
securities. Are identical protections afforded to investors under the 
commodities laws with regard to manipulation and fraud? If not, should 
investors in single stock and narrow-based stock index futures (or 
options on such futures) be afforded such protections?
    29. The securities options exchanges maintain rules imposing limits 
on the aggregate number of options contracts that a member or customer 
may hold or exercise. These rules are intended at least in part to 
prevent the establishment of options positions that can be used to 
manipulate or disrupt the underlying market so as to benefit the 
options position. Should similar limits be applied to single-stock and 
narrow-based stock index futures? Who would approve and oversee the 
enforcement of such limits? Should any changes be coordinated between 
securities and futures markets?
    30. The futures exchanges have informally suggested ways of 
addressing margin and insider trading concerns associated with 
permitting stock index futures (or options on such futures). What are 
the complexities and limitations with their approach? Of course, margin 
and insider trading are but two of many protections afforded under the 
federal securities laws. How would these other protections be 
replicated for single stock and narrow-based stock index futures? If 
not replicated, would the absence of such protections invite regulatory 
arbitrage, thereby undermining the federal securities laws?
    31. Large trader reporting is a key requirement of the CEA. Large 
trader reports are the linchpin of the CFTC's and futures markets' 
surveillance systems. The Government Securities Market Reform Act of 
1993 gave the Treasury large position reporting authority for the 
Treasury securities markets, which it uses to monitor trading in 
Treasury bills, notes, and bonds. The Market Reform Act of 1990 gave 
the SEC the authority to implement a large trader reporting system, but 
the SEC has failed to do so. The trading of single stock futures would 
make the connections between the equities and futures markets even 
closer than they are today. Given this close connection and the 
importance of large trader reporting system in preventing futures 
markets manipulations, shouldn't a large trader reporting system on the 
equities markets be a necessary precondition to permitting single stock 
futures?
    32. If single stock and narrow-based index futures (or options on 
such futures) were permitted, would-the SEC have adequate resources to 
police this additional market for insider trading, market manipulation, 
frontrunning, or other abuses? If not, please provide an estimate of 
what additional resources and personnel would be needed?

    Mr. Dingell. Mr. Chairman, I am highly skeptical about the 
wisdom of authorizing single-stock futures or futures on narrow 
stock indices or narrow groups of stocks.
    As the GAO warned in its April report, even a small price 
movement in the underlying stock could encourage attempts to 
manipulate stock prices. I would note to you at this time, Mr. 
Chairman, that there is growing concern about the efforts of 
organized crime to penetrate and to manipulate the markets. 
This certainly will assist that group in their nefarious 
attempts.
    I would note that futures are a highly leveraged zero sum 
game. A lot of people are going to get burned in this, and 
trust in the market as well as volatility are going to be moved 
into dangerous levels and dangerous areas. The stock markets 
have been the envy of the world in this country, and they will 
be reduced to a commodity with futures markets being the price 
discovery point. This concerns me. Nevertheless, if it is the 
judgment of my colleagues that we should authorize these ill-
advised instruments, it is absolutely imperative that the 
integrity of the Nation's securities markets and the 
protections afforded investors not be undermined in any way. At 
a minimum, we need to provide protections substantially similar 
to those that we have applied with respect to options on stocks 
and narrow indices.
    In closing, I want to assure my colleagues that I approach 
this issue with an open mind given the general sorry character 
of the legislation. I have a measure of skepticism about the 
merit of the bill. I am happy to work with you to try to write 
a good bill. Barring that, I am committed to using this turkey 
for target practice.
    I would observe that there is much that can be done to 
improve this bill. Perhaps the best thing to do is kill it, but 
I am willing to try to make a silk purse out of a sow's ear if 
that is the wish of the committee. I yield back the balance of 
my time.
    Mr. Oxley. The gentleman yields back. The gentlewoman from 
New Mexico, Ms. Wilson.
    Mrs. Wilson. I will enter any statement for the record.
    Mr. Oxley. Bless you.
    Dr. Ganske.
    Mr. Ganske. Thank you, Mr. Chairman. I am looking forward 
to the testimony today. This is how I see this issue now. If an 
investor who owns stock in a company worth $50 a share and is 
worried about a price drop so he can sell a futures contract, 
if the stock dropped below $50 at a specified date, the 
contract's purchaser must either take delivery on the stock at 
$50 a share or pay the investor the difference per share. If 
the stock climbs above $50 by the specified date, the investor 
pays $50 per share to the contract's purchaser who profits from 
the rise in value.
    I must say, Mr. Chairman, I haven't had a single 
constituent write me or phone me on this issue so I wonder why 
this is coming up. What concerns me about this is the margin 
requirement for a stock is 50 percent, while the requirement 
for a futures contract is 5 percent. I am worried that the 
introduction of single-stock futures will increase speculation 
on individual issues.
    This was something that was a problem back in 1929, and it 
looks to me like the basic idea is back. The futures markets 
want to trade single-stock futures which in economic terms are 
virtually identical to stocks, and I think this enters a lot of 
volatility and speculation into a market which already may have 
a lot of speculation and when investors like Warren Buffett, 
who lives on the edge of my district, are having a hard time 
figuring out what the proper valuation of a stock price is, I 
wonder whether the little guy is going to have problems on 
that, too. So I will be looking forward to your testimony 
today. I thank you.
    Mr. Oxley. The gentleman yields back. The gentleman from 
Michigan, Mr. Stupak.
    Mr. Stupak. Thank you, Mr. Chairman. The piece of 
legislation that we are examining today has potential to have a 
large impact on our securities market. While there are portions 
of this bill which will bring certainty to our financial 
markets, I have concern about ending the prohibition on single-
stock futures. This committee has long ensured that the 
Nation's securities market were fair to and protected 
investors. While we have long understood that investors and the 
securities market undertook risk and unlike bank deposits were 
subject to the uncertainty of the market, we have always made 
sure that the market was fair. We wisely banned insider 
trading, created the Securities and Exchange Commission to 
police unfair dealing, and we required that brokers sell 
products to investors only if suitable for that investor's 
profile.
    H.R. 4541 would allow for the trading of a new financial 
product, a future based on a single stock. Like options, the 
value of the future would be directly related to the underlying 
exchange-traded security. Like options, these products would 
affect the exchange and the over-the-counter stocks owned by 
average retail investors. However, unlike options in stocks, 
they would not be subject to the insider trading prohibition. 
Brokers would not be held to the same suitability standards for 
single-stock futures as for exchange-traded securities. Single-
stock futures would receive preferential tax treatment. They 
would be exempt from the SEC transaction fees. They would have 
a separate margin requirement which could allow consumers to 
undertake dangerous levels of margin in their pursuit of high-
flying returns, only to find earth-crashing bankruptcy.
    With so many retail investors in the market and with so 
many already having problems with the current requirements, and 
with the SEC continuing combatting stock fraud and market 
manipulation, with all of these events occurring, now is not 
the time to remove the rules on a new riskier product. Now is 
not the time to return the retail investor to the Wild West, 
where ruthless gunslingers live without rules while individual 
investors try to stay alive.
    Mr. Chairman, I am not opposed to the creation of a new 
financial product which may provide benefits to both 
institutional and retail investors, I certainly support 
insuring that our financial markets continue to be the world 
leaders. However, allowing an exchange to sell a high-risk 
product to retail investors without the protection of our 
Nation's security laws will not improve our markets, it will 
harm our markets.
    I look forward to this hearing and working with you to 
improve this legislation to protect retail investors. I yield 
back the balance of my time.
    Mr. Oxley. The gentleman yields back. The Chair recognizes 
Mr. Markey.
    Mr. Markey. Thank you, Mr. Chairman. In George Orwell's 
1984, one of the worst things you could do was to commit the 
offense of crime think. That was the act of even thinking bad 
thoughts about Big Brother or the Party. It was a very serious 
offense. We are here today because Brooksley Born, the former 
chair of the CFTC, committed an act of regulatory crime think. 
She issued a notice to the world that the CFTC was thinking 
about whether it should step up oversight for the OTC swaps 
market. How shocking. How terrible. The swaps dealers went 
berserk. The Fed and Treasury had conniptions. Congress passed 
a moratorium on any CFTC's consideration of Brooksley Born's 
ideas and now we are considering legislation aimed at making 
certain that no future CFTC ever, ever, ever commits regulatory 
crime think again.
    Now, those of us who served on the conference committee on 
the Futures Trading Practices Act of 1992 thought we had 
already addressed the issue of the status of the OTC swaps 
under the Commodities Exchange Act. We included a provision 
aimed at providing the swaps dealers legal certainty that swaps 
would not be regulated as futures. At the time the dealers 
hailed this as solving the legal certainty problem. But now 8 
years later, we are told we need to fix the fix we made.
    Now I have no objection to doing this, but it seems like a 
bit of an overreaction. But more disturbingly, this bill 
contains a provision which would repeal the restrictions on 
single-stock futures. Last year the President's Working Group 
on Financial Markets stated the Working Group members agree 
that the current prohibitions on single-stock futures can be 
repealed if issues about the integrity of the underlying 
securities market and regulatory arbitrage are resolved. The 
report goes on to note that from the perspective of the 
securities laws, the issues raised by trading of single-stock 
futures include levels of margin, inside trading, sale 
practices, real time trade reporting and activities of floor 
brokers as well as the exclusive jurisdiction of the CFTC over 
futures contract markets. From the perspective of the 
commodities futures laws, the issues raised by these 
instruments include clearing, segregation, large trader 
reporting and direct surveillance.
    The Working Group unanimously recommended that the SEC and 
CFTC work with Congress to determine whether the trading of 
single-stock futures should be permitted and, if so, under what 
conditions. In light of that highly qualified and conditional 
Working Group recommendation in this area and the enormous 
complexities involved in satisfactorily resolving all of the 
issues raised by the trading of single-stock futures, I believe 
that this Congress is moving too quickly to approve legislation 
in this area. I believe it is absolutely imperative that the 
integrity of our Nation's securities markets and the 
protections afforded to investors in these markets not be 
undermined in any way. Accordingly, I believe we must either 
transfer jurisdiction over stock index and single-stock futures 
to the SEC, or delete the bill's provisions allowing for 
single-stock futures.
    I yield back the balance of my time.
    [Additional statement submitted for the record follows:]
 Prepared Statement of Hon. W.J. ``Billy'' Tauzin, a Representative in 
                  Congress from the State of Louisiana
    Thank you Mr. Chairman.
    Mr. Chairman, I will keep my remarks this morning very brief as I 
am eager to hear from Chairman Arthur Levitt of the SEC, as well as 
from our other distinguished witnesses here today. But let me take just 
a moment to frame the main issue before us as I see it.
    We are here today to discuss a bill, H.R. 4541, that attempts to do 
a good thing: Modernize the Commodity Exchange Act (CEA). Modernization 
of the CEA, I think, is needed considering that the ``Shad-Johnson 
Accord,'' which is codified in the CEA, has left us with a great deal 
of legal uncertainty when it comes to regulating specific, complex 
financial products out there today.
    Specifically, H.R. 4541, would, for the first time, permit the 
trading of ``stock futures'' despite that the CFTC and the SEC have 
never been able to reach an agreement on their respective jurisdiction 
over such futures as the Shad-Johnson Accord contemplated they would.
    While I am not opposed to the debut of stock futures trading on our 
exchanges, I don't believe that this bill, as reported out of the 
Agriculture Committee, adequately addresses the complex investor 
protection and competitive fairness issues that need to be considered.
    The bill as drafted does not treat stock futures as securities and 
does not provide the SEC with the authority to supervise their trading. 
Consequently, H.R. 4541 does not provide an appropriate regulatory 
framework for the trading of stock futures, and herein lies the main 
problem with this bill.
    Though it is an obvious point, ``stocks,'' or literally, units of 
equity ownership in a corporate entity, are the most widely traded 
securities that we know of today. It only stands to reason then that 
``stock futures''--or agreements to buy or sell actual SECURITIES for a 
fixed price, at a specified point in time--should be subject to at 
least some oversight from the SECURITIES and EXCHANGE COMMISSION.
    If we treat stock futures as commodities, and exempt them from the 
application of the federal securities laws--as H.R. 4541 proposes to 
do--my fear is that these futures will serve as surrogates for 
individual stocks and will be marketed to retail investors across the 
country--free of basic disclosures . . . registration requirements . . 
. and other important investor protections that are the bedrock of 
securities regulation in this country.
    Now I have been a member of this Committee of sometime, and I need 
look no further than our experience with H.R. 10 to realize that 
jurisdictional battles in the context of financial services legislation 
are hard fought.
    But in this case, I believe that Chairman Levitt, many members of 
this Subcommittee, and the vast majority of the securities industry 
participants probably share my concerns about the stock futures 
provisions of this bill. In addition to the SEC, the New York Stock 
Exchange (NYSE), the Securities Industry Assc. (SIA), the Chicago Board 
of Options (CBOE), and the National Assc. of Securities Dealers (NASD) 
all oppose H.R. 4541.
    So, let me close by saying that I don't think it would be wise for 
this Subcommittee, or this Full Committee, to adopt CEA modernization 
legislation without addressing the concerns raised by these parties.
    With that Mr. Chairman, I yield back the balance of my time.

    Mr. Oxley. The gentleman yields back. In deference to the 
distinguished Chairman of the SEC, we are going to go forward 
with the hearing. The Chair will stay here and we will proceed.
    Mr. Levitt. Where has everybody gone?
    Mr. Oxley. This is a vote on the Journal. It is usually a 
device of the leadership to find out how you are going to vote 
on a particular legislation. I prefer to keep the leadership in 
the dark as far as my vote is concerned, and would rather hear 
from the distinguished Chairman of the SEC. It is an honor to 
have you back again to our committee and you may begin.

   STATEMENT OF HON. ARTHUR LEVITT, CHAIRMAN, SECURITIES AND 
                      EXCHANGE COMMISSION

    Mr. Levitt. Thank you very much, Chairman Oxley and thank 
you for the opportunity to address this subcommittee concerning 
H.R. 4541. This bill would provide legal certainty for over-
the-counter derivatives and lift the ban on single-stock 
futures. As you know, the Commission fully supports both of 
these objectives. In some important respects, however, I firmly 
believe that the bill presents serious and unwarranted risks to 
the investing public as well as to our securities markets.
    As we consider the implications of the bill, it serves us 
well to remember both the wisdom embodied in our securities 
regulatory framework and the prosperity that it has fostered. 
Its wisdom I think is quite simple: A recognition that 
protecting investors is not just the right thing to do, but the 
smart thing to do; that it is investor confidence that 
ultimately fuels competition; that vibrant markets rest on a 
foundation of integrity. I strongly believe that the 
unequivocal commitment to protecting investors made by your 
predecessors and mine has been critical to the success of the 
Nation's securities markets.
    The bill before you, consistent with the Working Group's 
recommendations, goes a long way toward providing greater legal 
certainty for OTC derivatives by excluding certain products 
from the CEA. In some important respects, however, the bill 
differs from the Working Group's recommendations. My staff and 
I would be glad to go into detail and discuss with you the 
particulars of those differences. The bill would also lift the 
ban on single-stock futures contained in the Shad-Johnson 
Accord. Now, I don't have any particular interest in justifying 
the historical origins of the ban today. I have made clear my 
view that market demand and not regulatory fiat should 
determine the availability of investment vehicles. But I do 
think we should squarely face the fact that single-stock 
futures are an economic substitute for the underlying security. 
We must not ignore the fabric of protections that retail 
securities investors rely on and the confidence that these 
protections engender. Some may dismiss this concern as kind of 
a guise for the protection of turf. I assure you that the 
questions surrounding how best to ensure that regulatory 
disparities do not erode investor confidence are profoundly 
serious and substantive.
    Building upon the CFTC's acknowledgment that we should 
jointly regulate these products, the SEC staff has crafted a 
plan under which these products can trade. In my judgment, an 
enduring regulatory framework must have a number of salient 
elements. First, single-stock futures are undeniably a proxy 
for stocks and stock options. Thus, the framework must 
recognize the legitimate interests of both the SEC and the CFTC 
in determining how best to regulate these products.
    Second, the framework must encourage fair competition among 
markets by, for example, including mechanisms to harmonize the 
regulatory requirements across the securities and commodity 
markets, particularly with respect to margin. Competitive 
market forces, rather than government regulation, should pick 
the winners and pick the losers. Legislation also should 
facilitate the listing of the same single-stock futures on 
multiple exchanges. This would avoid any one market having an 
exclusive franchise by forcing all markets to compete for 
investors' business.
    Third, the framework must acknowledge that single-stock 
futures will be retail products. While complex derivative 
products might not attract retail customers, a simple future on 
a share of a blue chip stock is sure to do so. Investor 
protection therefore becomes absolutely essential, as does 
clear and direct SEC authority over market participants that 
trade single-stock futures.
    Finally, the framework must avoid any harm to existing 
capital markets. In lifting the ban on single-stock futures and 
reopening jurisdictional issues, legislative changes should not 
take away existing SEC authority over financial products. The 
Shad-Johnson Accord clarified the SEC's jurisdiction over 
securities options. That jurisdiction should not be diminished 
in any way, nor should legislation eliminate the SEC's existing 
role in evaluating products such as stock indices.
    I firmly believe that the commitment to protecting 
investors embodied in these four principles is essential to 
maintaining the quality of our markets as well as our global 
competitive edge. Unfortunately, the bill in its current form 
simply fails to honor that commitment.
    I would be happy to provide whatever assistance you may 
need as you consider these important issues. Thank you very 
much.
    [The prepared statement of Hon. Arthur Levitt follows:]
Prepared Statement of Hon. Arthur Levitt, Chairman, U.S. Securities and 
                          Exchange Commission
    Chairman Oxley and Members of the Subcommittee: I am pleased to 
testify today on behalf of the Securities and Exchange Commission 
(``SEC'' or ``Commission'') as you consider H.R. 4541, the Commodity 
Futures Modernization Act of 2000. My testimony today focuses on two 
key topics. First, I address OTC derivatives markets. Second, I address 
the competition, investor protection, and market integrity issues 
raised by single stock and stock index futures.
             i. legal certainty for otc derivatives markets
    As you know, the President's Working Group on Financial Markets 
(``Working Group'') issued a report last year on OTC Derivatives 
Markets and the Commodity Exchange Act (``OTC Derivatives 
Report'').1 The OTC Derivatives Report contained several 
recommendations related to legal certainty for OTC derivatives 
products.
---------------------------------------------------------------------------
    \1\ Report of the President's Working Group on Financial Markets, 
Over-the-Counter Derivatives Markets and the Commodity Exchange Act 
(Nov. 1999).
---------------------------------------------------------------------------
    The enormous size of the OTC derivatives markets 2 
demonstrates their critical role in our capital markets. Derivatives 
contracts play a crucial role in risk management for a vast array of 
businesses. Accordingly, I can think of few more important issues for 
Congressional consideration than legislation to implement the 
recommendations by the Working Group to give legal certainty to the OTC 
derivatives market. The Commission reiterates its strong support for 
implementation of the recommendations by the Working Group related to 
legal certainty for the markets that trade these products.
---------------------------------------------------------------------------
    \2\ According to data from the Bank for International Settlements, 
at the end of June 1999, the total estimated notional amount of 
outstanding OTC derivative contracts was $81.5 trillion. The Global OTC 
Derivatives Market at end--June 1999, 45/1999E (Nov. 25, 1999) .
---------------------------------------------------------------------------
    The Working Group was given a fairly narrow task--to determine 
whether the Commodity Exchange Act (``CEA'') provided an appropriate 
regulatory framework for the OTC derivatives markets. The Working Group 
unanimously concluded that for certain OTC derivatives the CEA was not 
the appropriate framework. In addition, the Working Group determined 
that steps needed to be taken to ensure that the CEA did not stifle the 
natural development of these markets. For a more detailed discussion of 
the Working Group's recommendations, I refer you to earlier Commission 
testimony.3
---------------------------------------------------------------------------
    \3\ See Testimony of Annette L. Nazareth, Director, Division of 
Market Regulation, U.S. Securities and Exchange Commission, Concerning 
the Report to Congress on Over-the-Counter Derivatives Markets and the 
Commodity Exchange Act by the President's Working Group on Financial 
Markets, Before the Senate Comm. on Agriculture, Nutrition, and 
Forestry (Feb. 10, 2000). See also Testimony of Annette L. Nazareth, 
Director, Division of Market Regulation, U.S. Securities and Exchange 
Commission, Concerning Recent Recommendations by the President's 
Working Group on Financial Markets, Before the House Comm. on Banking 
and Financial Services (Apr. 11, 2000); Testimony of Annette L. 
Nazareth, Director, Division of Market Regulation, U.S. Securities and 
Exchange Commission, Concerning the Report to Congress on Over-the-
Counter Derivatives Markets and the Commodity Exchange Act by the 
President's Working Group on Financial Markets, Before the Subcomm. on 
Risk Management, Research and Specialty Crops, House Comm. on 
Agriculture (Feb. 15, 2000).
---------------------------------------------------------------------------
    The consensus achieved by the Working Group was of historic 
significance. Four of the leading U.S. financial regulators unanimously 
agreed that the Report's recommendations, which reflected their 
combined regulatory expertise, urgently required implementation. The 
Commission strongly supports the efforts made in H.R. 4541 to further 
the goals of the Working Group. However, as we have stated in the past, 
it is not necessary to link resolution of all of the issues raised in 
the bill to the passage of the much needed provisions on legal 
certainty for OTC derivatives.
    H.R. 4541 differs from the Working Group's recommendations 
regarding legal certainty in several key respects. For example, the 
Bill does not fully adopt the Working Group's recommendations on the 
regulation of clearing systems. By expressly providing that clearing 
agencies registered with the SEC may voluntarily register with the CFTC 
even though they are not required to do so, the Bill creates potential 
issues as to which set of regulations would prevail in the event of a 
conflict. The Working Group specifically recommended that a clearing 
system regulated by one agency should not become subject to regulation 
by another agency as a result of clearing OTC derivatives. The 
Commission staff would be happy to discuss those differences in detail 
with you or your staff and provide technical assistance to the 
Subcommittee.
    The Commission continues to strongly support the implementation of 
the Working Group's recommendations that are designed to provide legal 
certainty for the OTC derivatives markets. Those recommendations should 
be implemented immediately. We appreciate the Subcommittee's efforts in 
furtherance of this goal, and we are committed to working with you as 
modifications are made to this bill.
              ii. lifting the ban on single stock futures
    The Commission supports lifting the ban on single stock futures as 
soon as the regulatory issues underlying that ban are resolved. This 
year, the Commission devoted tremendous staff resources to designing a 
legislative framework to permit the trading of single stock and narrow-
based stock index futures. Disparities between futures and securities 
regulation made this a difficult task. As a result of our efforts, 
however, the Commission strongly believes that these products can trade 
under the regulatory system that we have outlined below.the regulatory 
system that I will outline for you today.
    Among other things, the Commission staff focused on issues raised 
by the Working Group. In its OTC Derivatives Report, the Working Group 
identified several issues that would have to be addressed before 
trading of single stock futures can begin. Furthermore, the Working 
Group noted that these issues were best resolved by the Commission and 
the CFTC.
    The CFTC and the SEC engaged in extensive discussions on this 
topic. Chairman Rainer and I have not agreed on all aspects of a 
regulatory framework for single stock futures. However, we did reach 
agreement on fundamental principles for creating such a 
framework..4 Most important among these principles was that 
single stock futures should be subject to joint regulation by the CFTC 
and the SEC. This is a positive step forward from outdated notions of 
exclusive jurisdiction and the view that because a product can be 
considered a ``future'' it should be solely regulated by the CFTC. It 
reflects movement towards truly modern financial regulation--regulation 
that recognizes the need for agencies with legitimate regulatory 
interests and expertise in a product to participate in that product's 
oversight.
---------------------------------------------------------------------------
    \4\ Letter from the Honorable Arthur Levitt, Chairman, SEC, and the 
Honorable William Rainer, Chairman, CFTC, to the Honorable Larry 
Combest, Chairman, House of Representatives Committee on Agriculture, 
the Honorable Tom Bliley, Chairman, House of Representatives Committee 
on Commerce, the Honorable Tom Ewing, Chairman, Subcommittee on Risk 
Management, Research, and Specialty Crops, House of Representatives 
Committee on Agriculture, and the Honorable Charles Stenholm, Ranking 
Member, House of Representatives Committee on Agriculture (March 2, 
2000).
---------------------------------------------------------------------------
A. Requirements for a Legislative Framework
    1. General Principles for Markets that are Competitive, Fair, and 
Free From Fraud and Manipulation--The process of working through 
important issues with the CFTC led the Commission staff to identify 
requirements for legislation to permit the trading of single stock 
futures. Contrary to what some have suggested, this is not a turf 
battle between the futures and options markets and the agencies that 
regulate them. Single stock futures would be nearly perfect surrogates 
for the underlying securities. As a result, there are fundamental 
issues of market integrity and investor protection at stake. For this 
reason, we should move forward in a reasoned and principled manner, as 
we consider how to permit an entirely new product to trade. If 
legislation is crafted correctly, markets will compete and regulators 
will cooperate. I think it would be useful to review the components 
that we believe are critical for an appropriate legislative framework.
Shared Jurisdiction
    First, single stock futures are undeniably a substitute for stocks 
and stock options, and are fully expected to be a retail product. 
Therefore, the framework must recognize the legitimate interests of 
both the SEC and the CFTC in regulating these products. Single stock 
futures possess attributes of both securities and futures contracts. As 
a result, joint regulation of single stock futures is appropriate and 
exclusive jurisdiction is ill advised. Shared jurisdiction and joint 
regulation entail both recognizing each agency as best qualified to 
apply the key components of the laws that it administers and 
coordinating the agencies' efforts to ensure efficient market 
regulation that is not duplicative or overly burdensome.
    At the practical level, this means ensuring that both agencies have 
the authority to carry out core functions, and that both encounter no 
jurisdictional barriers in the suppression of fraud and manipulation. 
Yet, at the same time, mechanisms should be devised to coordinate on 
certain costly issues so that the traditional regulator takes the lead.
Encourage Fair Competition
    Second, the framework must encourage fair competition among 
markets. We do not want a framework that lets differences in regulation 
determine winners and losers. Any legislation should allow both 
securities and futures markets to enter the competitive fray, but 
should not give any type of market an artificial competitive advantage.
    For example, the SEC and the CFTC should have joint authority to 
harmonize the margin requirements for single stock futures on an 
ongoing basis. Otherwise, the market with the more lenient margin 
requirements will have an artificial competitive edge. Competition 
should be based on better products, services, and prices--not on 
regulatory differences.
    The legislation also should require coordinated clearing of single 
stock futures so that a future purchased on one exchange could be 
offset on another exchange that trades the same type of future. This 
would allow the same single stock future product to be listed on 
multiple exchanges. In the options markets, multiple listing has 
narrowed spreads and reduced prices to investors. Coordinated clearing 
also makes it more viable for new markets to enter the competitive 
arena over time. Without coordinated clearing, new markets will not be 
able easily to offer the same products as competitors.
Protect Investors
    Third, the framework must acknowledge that single stock futures 
will be retail products. Complex derivative products generally do not 
attract retail customers but a simple future on a share of a blue chip 
stock will. Accordingly, legislation must maintain the SEC's ability to 
protect investors and to maintain integrity of the markets on which 
they trade. For this reason, the SEC should have clear and direct 
authority over the markets and market participants that trade single 
stock futures. I think it is important to explore a few examples of 
what might happen if the SEC does not have such authority.
    In the securities markets, recommendations that brokers make to 
investors are governed by the suitability rules of self-regulatory 
organizations subject to SEC oversight. The customer protection regime 
is quite different under the futures laws. Investors receive a one-time 
disclosure document informing them that they can lose money on futures. 
The implications of these differences are quite significant. If the 
securities law principle of suitability is not applied to single stock 
futures, a broker could recommend such a product to any customer with 
no liability under the securities laws, even if the recommendation was 
unsuitable for the customer. Moreover, in many cases a broker who sells 
securities will also be licensed to sell single stock futures. As a 
result, the SEC is very concerned that investors will not understand 
that the protections they enjoy when they purchase one product from 
their broker will not also apply to the other. Worse yet, brokers could 
have an incentive to offer the riskier single stock futures to 
investors if they could do so without the suitability responsibilities 
that attach to the sale of securities. There is no public policy reason 
to create a framework with such a disparity in investor protections.
    Next, consider a corporate insider who learns that his company is 
about to receive an unsolicited bid to be taken over. The insider buys 
a substantial amount of single stock futures on a futures exchange and 
earns huge profits on the transaction. This case involves insider 
trading that takes money out of the pockets of investors who did not 
have this information. This is exactly the type of situation that the 
Commission needs its full authority to address. Without direct 
authority over the futures exchange or a requirement for insider 
reporting, the SEC may have difficulty ever learning of the futures 
purchase by the insider. Such activities could destroy years of 
Commission efforts to protect investors from insider trading abuses.
    Investors also currently rely on the Commission to protect them 
from unscrupulous, or even just sloppy, practices by investment 
advisers and mutual fund managers. A bill should not introduce single 
stock futures into the mix of investment opportunities that investment 
advisers may recommend to their clients or that portfolio managers may 
purchase for the mutual funds they manage without regulation by the 
SEC. This would leave investors in funds consisting of single stock 
futures without the same protections that investors in mutual funds 
have enjoyed since 1940.
    These are only a few examples, but I hope they illustrate why the 
investor protections contained in the securities laws should be 
extended to single stock and narrow-based stock index futures. Please 
recognize that the SEC's instruments for investor protection are 
interlinked. Enforcement actions coupled with inspections and the 
ability to promulgate new regulations are essential ingredients of 
ensuring the integrity of America's markets. Direct access to audit 
trails, coordinated market surveillance, inspection authority, as well 
as suitability and customer protection regulation are all necessary to 
the SEC's ability to effectively regulate and protect investors. 
Although the SEC actively pursues people who violate the securities 
laws, much of our success results from preventing problems before a 
single investor is harmed.
    The SEC has many decades of experience and legal precedent in 
protecting the public--expertise that should be carried over to equity 
substitutes such as single stock futures. Our securities markets are 
second to none because of the investor confidence that has flourished 
under this regulatory framework. It would be extremely unwise to move 
ahead with legislation that lacks the elements necessary to ensure the 
market integrity, suitability, and customer protections that investors 
have come to expect under the securities laws.
Do Not Harm Existing Markets
    Fourth, the framework must avoid any harm to existing capital 
markets. In lifting the ban on single stock futures and reopening 
jurisdictional issues, legislative changes should not take away 
existing SEC authority over financial products. For instance, the Shad-
Johnson Accord clarified the SEC's jurisdiction over security options, 
and that jurisdiction should not be diminished in any way. Nor should 
legislation eliminate the SEC's existing role in evaluating stock 
indexes for susceptibility to manipulation and compliance with 
appropriate standards that assure they will not become a surrogate for 
single stocks. Given the CFTC's exclusive jurisdiction over such 
futures, the standard put forward in any bill and the SEC's role in 
applying it must be sufficient to deter insider trading through index 
futures. Investors have strong expectations about the integrity of 
markets that the SEC regulates, and the resulting investor confidence 
fuels the success of those markets. Accordingly, legislation should not 
eliminate any existing SEC oversight of securities and related markets.
    Moreover, we cannot allow market integrity issues in new markets to 
migrate to existing capital markets. Because there are times when 
problems in one market may be identified and understood only by 
reference to another market, legislation must provide for coordinated 
surveillance of all markets.
    Adherence to these principles will leave U.S. markets for these 
products better positioned to compete against their foreign 
counterparts. When U.S. markets are forced to compete against each 
other for investors' business and to maintain the integrity that 
promotes investor confidence and attracts additional business, those 
markets should be leaders in the international arena. As markets around 
the world compete for customers and capital, one overriding principle 
will serve as our competitive advantage: the quality of our markets.
    2. Discussion Draft--The Commission staff has prepared a discussion 
draft that incorporates these legislative goals into amendments to the 
federal securities laws and the Commodity Exchange Act. The SEC's 
proposal extends the protections of the federal securities laws to 
single stock futures. However, much of the proposal is devoted to 
ensuring that those laws do not unnecessarily burden the markets and 
intermediaries that trade single stock futures. We look forward to 
comments from the CFTC and to having a dialogue with your Subcommittee 
on our suggested approach. We are setting out below a brief summary of 
the principal elements of that plan--a plan that presumes shared SEC 
and CFTC jurisdiction over these products.
    First, this draft framework defines single and narrow-based stock 
index futures as securities. This triggers SEC oversight and the 
application of the securities laws. We then focus on detailed 
regulatory relief for some of these intermediaries and markets as a 
means to avoid unnecessary or duplicative regulation.
    For example, floor brokers on designated contract markets that are 
already registered with the CFTC would be completely exempt from SEC 
registration. We also create a simple process of notice registration 
with the SEC for certain markets and intermediaries that are already 
registered with the CFTC. Those markets and intermediaries would have 
to comply only with securities law provisions that are considered 
``core.'' We clearly exempt these markets and intermediaries from the 
numerous non-core provisions of the securities laws where the CEA and 
CFTC regulation sufficiently addresses the same public policy concerns.
    For the core provisions of the securities laws that would still 
apply to these entities, we provide innovative ways to relieve their 
regulatory burdens and to coordinate our regulatory efforts with the 
CFTC. For example, for many of the proposed rule changes that CFTC-
regulated markets would submit to the SEC we have provided for 
immediate effectiveness of such changes and a limited scope of review. 
In appropriate areas, such as examinations, we recognize that the CFTC 
should be the lead regulator for such CFTC-regulated entities and limit 
our activities accordingly.
    In addition to the detailed regulatory relief and coordination 
provisions, we provide minimum requirements to be incorporated into 
listing standards for these products. Such requirements, along with 
provisions related to coordinated clearing, are aimed at promoting 
market integrity and intermarket competition.
    Finally, we incorporate these products into other relevant 
securities laws, such as the Securities Act of 1933, the Investment 
Company Act, and the Investment Advisers Act. In doing so, we avoid 
unnecessarily burdensome regulation under these acts as well.
    This discussion draft shows that the protections of the securities 
laws can be extended to single stock and narrow-based stock index 
futures while still permitting the efficient operation of our markets. 
Our discussion draft would achieve the goals of creating a new market 
for single stock and stock index futures that is competitive, fair, and 
free from fraud and manipulation. U.S. investors deserve nothing less. 
U.S. capital markets provide the lifeblood of American business and are 
the place where American families invest their hard-earned dollars with 
hopes of earning returns that will provide for everything from their 
children's educations to their retirements. We cannot afford to put 
these markets at risk.
B. Comparison to H.R. 4541
    Crafting our plan was not easy. Therefore, I appreciate your 
efforts in drafting the bill. Moreover, I am heartened by the bill's 
attempt to recognize some of the principles that the Commission feels 
are so important in this area. Unfortunately, the bill as written 
ultimately does not vindicate those principles and achieve the goals of 
the legislative framework previously outlined. The bill does not 
sufficiently extend the protections of the securities laws to single 
stock and narrow-based stock index futures. The Commission therefore 
could not support the legislation in its current form.
    As you continue to revise your legislation, I would hope your bill 
ultimately can answer questions, such as the following, in the 
affirmative:

 Does the bill clarify in both the CEA and the securities laws 
        that the SEC has full authority over single stock and narrow-
        based stock index futures and that the securities laws 
        protections apply to these products?
 Does the bill provide for expedited registration of the 
        intermediaries and exchanges that trade these products with 
        both the SEC and the CFTC?
 Does the bill provide real mechanisms for both the SEC and the 
        CFTC to ensure that the relevant securities and futures 
        regulations, such as those related to margin, remain harmonized 
        on an ongoing basis?
 Are there provisions for coordinated clearing of these 
        products?
 Are there provisions that enable the CFTC and SEC to work 
        together to foster competition in the markets for these 
        products?
 Will both the CFTC and SEC be able to effectively prosecute 
        frauds involving these products?
                            iii. conclusion
    Once again, the Commission appreciates the efforts that the 
Subcommittee has made in bringing derivatives issues to the forefront. 
We believe that the regulatory provisions that we have set forth can 
support the work of the Subcommittee in its efforts to repeal the ban 
on single stock futures and eliminate uncertainty for the OTC 
derivatives markets in a way that fosters competition, bolsters market 
integrity, and ensures that no harm befalls America's capital markets 
or investors.
    The Commission appreciates the Subcommittee's efforts with respect 
to derivatives issues. Just as derivatives products themselves can be 
complex, so too are the issues that surround these products. Having 
regulated securities derivative products for decades, the Commission 
welcomes the opportunity to actively participate in the dialogue about 
derivative products that your bill will engender. We look forward to 
sharing our views with your Subcommittee, the Working Group, market 
participants, and other legislators as changes continue to be 
considered.
    Thank you.

    Mr. Oxley. Thank you, Chairman Levitt. We accept your 
offer. This is enormously difficult legislation for the 
committee, as you know. It is very detailed and somewhat 
arcane, and so your staff and your help would be most 
appreciated. As you know, we are under a time constraint with 
the referral of the bill and essentially have until the end of 
this month. Even though technically we have until September, 
with the August recess, we are really faced with 3 weeks in 
which we have to act. The game plan is we have our hearing 
today, we mark up the bill in our subcommittee next week, and 
then the full committee the last week in July. So time is of 
the essence. We are prepared to roll up our sleeves with you 
and with our friends on the other side of the aisle to try to 
craft legislation that is in the best interests of the 
investing public. I think if we all share that same goal, I am 
sure we do, we can make enormous progress.
    Let me begin with some questions. Do you anticipate 
reaching general agreement on regulation of single-stock 
futures in time for the committee to reflect that agreement in 
this legislation?
    Mr. Levitt. I am not certain. The chairman of the CFTC and 
I have been talking about this issue for a number of months, 
and I think both of us are motivated by what we believe is in 
the best interests of our markets and investors.
    The issues are very difficult and complex. Our staffs are 
meeting almost as we talk, and I am told some progress has been 
made. I have advised our staff that I would be prepared to 
commit any amount of time to accomplishing a meeting of the 
minds that would avoid a legislative solution. I think that we 
are far better able to craft this than anyone else, and, 
working with our colleagues in the Treasury Department, I can 
promise you that progress has already been made and more will 
be made. Whether we can meet the very tight legislative 
timetable, I simply don't know.
    Mr. Oxley. Is it your goal then, that if in fact everything 
were to happen the way we would want it, for you to reach an 
agreement and then we would essentially codify that agreement 
in the legislation?
    Mr. Levitt. I guess in the best of all worlds that is how 
it would work. The Commission is motivated exclusively by what 
we regard as being in the best interest of America's investors. 
Putting a highly leveraged new product into the hands of 
America's retail investors at a point in time when the market 
already has an abundance of speculation is playing a very 
dangerous game. Because of that, we are greatly concerned that 
the basic protections that have been afforded retail investors 
in terms of equity investment be present in allowing a product 
which is merely a proxy for a retail stock investment.
    Mr. Oxley. Some distinguished people, including Chairman 
Greenspan, have said publicly they think that unless we lift 
the Shad-Johnson Accord the business essentially will flow 
overseas; that is, the traffic in single-stock futures. Does 
that cause you some concern?
    Mr. Levitt. Let me give you kind of an unorthodox response 
to that. As Chairman Greenspan knows, we both are passionate 
believers in free markets, but the notion that we would lose 
single-stock futures to any market, and that loss could be in 
any way a danger to the United States economy or the United 
States markets, I think, is an absurdity. If the world is 
crying for single-stock options--single-stock futures, let them 
have them in my judgment. It is not our job to determine what 
products should or shouldn't be traded, but in my judgment in 
no way would the U.S. markets or economy be impaired by the 
loss of that product to other markets. The use of that product 
in Australia and other parts of the world thus far has been a 
dismal failure.
    My concern is that we are taking legitimate market 
products, the futures market, which has been largely an 
institutional market, transferring it to a retail incarnation 
and leaving it, according to this bill, without the protections 
that we give investors in our equity markets.
    Mr. Oxley. Having said that, though, if all of us were able 
to craft the necessary protections in the marketplace in a 
regulatory scheme that we would envision, would you then feel 
comfortable with lifting the accord?
    Mr. Levitt. Yes. You know, the Accord is kind of a jerry-
built structure to accommodate what I regard to be an 
irrational distribution of regulatory authority, but it is what 
it is, and if there is a way of lifting it and protecting 
investors, I would enthusiastically support it, as I support 
other aspects of the bill in terms of relieving the legal 
uncertainty from the trading of derivatives. I think that is a 
very important and useful objective, although I fail to see its 
relationship to this part of the bill. But my answer to your 
question is very definitely yes.
    Mr. Oxley. If we were to start the world all over again, 
wouldn't it make sense to have single-stock futures regulated 
by the Securities and Exchange Commission as securities?
    Mr. Levitt. Absolutely.
    Mr. Oxley. Let me yield to my good friend from New York.
    Mr. Towns. Thank you, Mr. Chairman.
    Could you please give your views on the argument or 
statement that has been made that markets are hindered by the 
application of securities regulations? Haven't the options 
markets thrived under the securities law?
    Mr. Levitt. I remember full well how the options markets 
were introduced to America's investors. I was the head of the 
American Stock Exchange at that time, and we were early 
participants in that market. In those early years, there were 
all kinds of complaints and scams and scandals involving the 
use of that new product. We had the unfortunate experience of 
having to fine and censure 22 specialists on the floor of the 
American Stock Exchange in connection with the trading of 
options.
    Any new product involves a measure of uncertainty and a 
measure of risk. Options, because they are more leveraged than 
common stock certainly represented that.
    Now when you take the futures on single securities, they 
are merely proxies for those securities; and one of the 
dangers, in my judgment, in this bill is the amount of leverage 
that is entailed. The amount of borrowing that a retail 
investor could now embark upon is substantially greater. You 
are taking a new universe of retail investors, most of whom 
have never seen a down market, many of whom in my judgment are 
more leveraged than they already should be, and you are 
allowing them to use a new product, totally new to them, a 
future on an individual stock, which will enable them to buy 
that stock for a fraction of what they would have paid had they 
bought either an option or the stock itself; and the risk is 
unlimited in terms of what happens to that future.
    And I suggest to you that, if we take that step, if the 
Congress of the United States is prepared to take that step, we 
all have a responsibility to America's investors to see to it 
that they have the same protections that they have when they 
purchase common stock and common stock options.
    Mr. Towns. Thank you very much.
    According to my staff, you seem to have a plan for trading 
single-stock futures that could work. Could you please tell us 
about it? I would like to know more about that.
    Mr. Levitt. We do have a series of recommendations with 
respect to how single-stock futures could work under the joint 
oversight of both the CFTC and the SEC. The plan is fairly 
detailed. We have submitted it to the CFTC. They are 
considering the plan. They have not yet responded to the plan 
in detail. It is my hope and expectation that their response to 
this plan will enable us to move forward together on a response 
to this legislation.
    Mr. Towns. Mr. Chairman, I would like to ask that he submit 
it for the record, submit the plan for the record.
    Mr. Oxley. Without objection.
    Mr. Levitt. We will submit the plan.
    Mr. Towns. Thank you.
    [No response was received by the subcommittee.]
    Mr. Towns. I yield back the balance of my time.
    Mr. Oxley. The gentleman yields back.
    Let me recognize the gentleman from Illinois, Mr. Shimkus.
    Mr. Shimkus. Thank you, Mr. Chairman.
    This is an interesting time. It is good to have Chairman 
Levitt back. A couple of quick questions. I always like to boil 
it down.
    Of course, in your opening statement you mention that this 
isn't a turf battle, but I would submit that turf battles are 
pretty important. Especially in our role in the Commerce 
Committee, we like to protect our turf; and we think that we do 
so in the best interests of the public as much as the Founding 
Fathers liked to protect the turf of the executive and the 
judicial branch. That is not a bad thing, especially if you 
feel that the turf you are protecting, you are doing it based 
upon sound principles of protecting the interests of the 
investors. That is my little opening statement.
    Mr. Chairman, some of these questions may have been asked 
when I went to the vote, but in H.R. 4541, it contemplates a 
role for your agency in crafting a suitable rule for single-
stock futures along with the National Futures Association. You 
have addressed some of the concerns you have with that. Do you 
have any additional ones that you may have left out?
    Mr. Levitt. Well, the problem with the aspect of the bill 
that I think represents a serious risk for America's investors 
and markets deals with an assumption that the CFTC will oversee 
this product. The bill really calls for exclusive CFTC 
jurisdiction. There really is no assurance that there will be 
the same kind of oversight or regulation as far as the SEC is 
concerned. Whatever input we have would have to be at the 
pleasure of the CFTC.
    I have suggested before that in light of, again, what I 
think is an artificial kind of overall regulatory structure, 
the best way to proceed on this would be joint SEC/CFTC 
oversight. This bill does not provide for that in any way, 
shape or form and leaves, in my judgment, America's investors 
very, very vulnerable.
    Mr. Shimkus. Let me go on. The bill again states that 
margins on single-stock futures could not be less than options 
on the same underlying stock. Further, it gives the Federal 
Reserve margin authority and even allows it to designate that 
authority to intermarket margin boards made up of the Federal 
Reserve, CFTC and the SEC. Do you think that this solution will 
work?
    Mr. Levitt. No, I think the solution is a contrived 
solution. I think there is no assurance that the Federal 
Reserve board will indeed produce such a board; and I--going 
back to my experience in running very complicated businesses, I 
reject the notion of boards as a solution to very complicated 
underlying problems.
    Mr. Shimkus. And I would just encourage you, we do value 
your input and especially on this issue. The last thing that we 
want to do is throw out a product that will put at risk the 
individual investors. I look forward to working with you and 
the chairman and, if we move legislation, to move it with your 
support.
    Mr. Levitt. I appreciate that. Thank you.
    Mr. Oxley. Mr. Rush from Illinois.
    Mr. Rush. Chairman Levitt, I appreciate you being here this 
morning. You had some insightful and cogent remarks as relates 
to H.R. 4541. I do have a couple of questions. Are there any 
benefits to the small investor in the quest to regulate single-
stock futures? Are there any benefits and, if so, what are 
those benefits?
    Mr. Levitt. Congressman Rush, are you asking me if I 
believe there are significant benefits to the retail investor 
in the purchase of futures and single-stock futures?
    Mr. Rush. Right. That is the question.
    Mr. Levitt. Again, this is a personal answer. It is based 
on my experience with handling many, many investors through the 
years. I think those benefits at best are marginal. I think I 
have expressed before my belief that this is not a product that 
America's investors are desperately crying for at this point in 
time. There are other products I might say the same thing 
about, but it is everyone's right to do with their money what 
they will. But I also think it is our responsibility to see to 
it that we protect innocent investors from products that can be 
used unscrupulously and from products that represent levels of 
risk that call for a very specific kind of regulatory 
oversight.
    Mr. Rush. Although some financial markets feel they would 
lose business because of participation by the small investors, 
does the single-stock futures market have enough opportunities 
to include the small investors' participation?
    Mr. Levitt. I think the experience of other markets with 
single-stock futures has not proven this to be a very 
successful undertaking. However, if it does have a potential 
for success with retail investors in our markets, with the 
level of speculation that exists today with investors being 
moved more by emotion than intellect, I think we have to offer 
those investors the kinds of protections that we have tried to 
outline in our testimony.
    Mr. Rush. Thank you, Mr. Chairman. I yield back the balance 
of my time.
    Mr. Oxley. The gentleman yields back.
    If I can just intervene. That was an interesting comment 
you made in terms of the investors being driven more by emotion 
than intellect. How would investor protection necessarily aid 
that individual who is overtaken by emotion?
    Mr. Levitt. Well, my concern about that kind of attitude in 
our markets is that it does fuel speculation; and much of the 
Commission's work has been dedicated, through a program of 
investor education in town meetings, in cautioning investors 
about scams in the markets at a point in time. Today the 
emphasis in our town meetings, the emphasis in our brochures 
and on our website has been to caution investors about 
borrowing, about margin. Therefore, when we are thinking of 
introducing a product which will exacerbate the level of 
borrowing, I think it becomes even more important for us to 
assure investors that we maintain the basic protections that 
presently exist in our markets.
    Mr. Oxley. Thank you.
    The gentleman from Oklahoma, Mr. Largent.
    Mr. Largent. Thank you, Mr. Chairman.
    I would like to ask you, Chairman Levitt, there really 
hasn't been a case made for additional CFTC regulation of the 
over-the-counter energy derivatives market. Why do you believe 
that additional regulatory jurisdiction is necessary?
    Mr. Levitt. You know, I don't think that I have any feeling 
about that. That is a CFTC matter, and I really am not familiar 
with the issue.
    Mr. Largent. Okay. Are you looking to expand your oversight 
jurisdiction of the gasoline markets?
    Mr. Levitt. No.
    Mr. Largent. I have no further questions.
    Mr. Oxley. The gentleman from Michigan, Mr. Dingell.
    Mr. Dingell. Welcome, Mr. Chairman.
    Mr. Levitt. Thank you.
    Mr. Dingell. I am glad to see you back here again. I have a 
series of questions I hope you will answer as briefly as you 
can because of the large amount of ground we have to cover.
    What will be the impact of single-stock or narrow group 
index futures contracts on the underlying stock market, do we 
know?
    Mr. Levitt. I don't think so.
    Mr. Dingell. If we lend additional volatility by reducing 
the margin, by moving these into futures from the normal 
securities market which has 50 percent margin, what would be 
the effect on volatility of the market?
    Mr. Levitt. If there was substantial interest in such 
business, I think it would increase the volatility.
    Mr. Dingell. By what order?
    Mr. Levitt. I don't know.
    Mr. Dingell. Substantially?
    Mr. Levitt. Yes.
    Mr. Dingell. You have had some attempts lately by the Mafia 
to enter into and manipulate the market in securities. You have 
been devoting major efforts to addressing that question. What 
would a 5 percent margin and reduced regulation of futures do 
to the attempts of organizations like this to manipulate the 
market?
    Mr. Levitt. I think it would just give them additional 
opportunities to do their work.
    Mr. Dingell. What would be your ability to deal with those 
kinds of attempts by Mafiosi and other groups to enter the 
market for that purpose?
    Mr. Levitt. Under the provisions of this bill, practically 
nonexistent.
    Mr. Dingell. Have there been any studies of manipulation of 
the markets?
    Mr. Levitt. With all due respect, I don't think that we 
need studies to understand the impact of the kind of leverage 
that we are talking about in terms of manipulation.
    Mr. Dingell. You are talking about leverage because of 
reduced regulation and----
    Mr. Levitt. And increased volatility.
    Mr. Dingell. Have there been any studies on increased 
volatilities?
    Mr. Levitt. I am not certain.
    Mr. Dingell. Are there adequate protections and 
surveillance mechanisms in the bill before us today of the 
level of magnitude that you at the SEC would be able to apply 
to securities?
    Mr. Levitt. I don't believe so, sir.
    Mr. Dingell. Is it fair to observe that a future on a 
single-stock would be, for all intents and purposes, 
interchangeable with the sale of the stock?
    Mr. Levitt. Absolutely.
    Mr. Dingell. So the investor should have the same 
protections whether there is a sale of a future or a sale of 
the underlying security?
    Mr. Levitt. Yes.
    Mr. Dingell. Now, I want you to submit for the record the 
differences between your ability at the SEC to address insider 
trading and those at CFTC. It is fair to say, however, that 
CFTC has much reduced abilities to address the insider trading 
questions, does it not? Much less than you have?
    Mr. Levitt. I am not precisely certain about the CFTC's 
abilities in this regard. I do know that we have seen more 
insider trading today than ever in the history of our markets, 
and it is one of the major areas of Commission concern.
    Mr. Dingell. If there is reduced authority to address 
insider trading questions or reduced ability at the SEC to 
require paper trails and things of that kind because of 
transference of your responsibilities to the SEC, what would be 
the impact on investors?
    Mr. Levitt. I think it leaves America's investors extremely 
vulnerable.
    Mr. Dingell. Would you give us a short statement at your 
convenience on the differences between insider trading 
authorities and paper trail requirements at the SEC and the 
CFTC?
    Mr. Levitt. Yes, sir.
    Mr. Dingell. Are you given adequate authority under this 
bill to police the single-stock futures markets for insider 
trading?
    Mr. Levitt. No.
    Mr. Dingell. Why do you say that?
    Mr. Levitt. Because it gives exclusive jurisdiction to the 
CFTC.
    Mr. Dingell. It also reduces CFTC's authority over insider 
trading, does it not?
    Mr. Levitt. You know, I don't know the answer.
    Mr. Dingell. Would you, at your convenience, respond?
    Mr. Levitt. Yes.
    Mr. Dingell. So if there was to be some kind of major 
problem in the market with regard to volatility, with regard to 
market drop, let's say something like happened in 1987 where 
the market fell 500 points, and let's say there was some kind 
of insider trading or manipulation going on, could the CFTC 
under the authorities it has under this legislation or your 
agency under the authorities it has under this legislation 
respond quickly enough to address the problems that might exist 
there?
    Mr. Levitt. I don't believe so.
    Mr. Dingell. Now, if we are to go forward in lifting the 
ban on single-stock futures, what regulatory structures should 
we impose and who should enforce it?
    Mr. Levitt. In my judgment, if we do that, we should 
recognize and the bill should acknowledge that a single-stock 
future is a security; and all of the protections offered by the 
present securities legislation should be available to investors 
in a single-stock future. We should try to create a kind of 
regulatory scheme where there is a joint regulation, shared 
regulation, by the CFTC and the SEC.
    Mr. Dingell. Does this legislation do that?
    Mr. Levitt. It does not do that.
    Mr. Dingell. It has been said that there is no difference 
between an option and a single-stock future; is that true?
    Mr. Levitt. That is not true. An option has a limited 
amount of risk. A single-stock future has an unlimited amount 
of risk. I would suggest to you that a naked option is more 
closely aligned to a single-stock future.
    Mr. Dingell. So an option you can lose your money but your 
loss--your potential loss on a single-stock future is 
unlimited, isn't that right?
    Mr. Levitt. Yes, sir.
    Mr. Oxley. The gentleman's time has expired.
    Mr. Dingell. I thank the Chair. I look forward to 
continuing this at a later time.
    Mr. Oxley. The Chair now recognizes the gentleman from 
Iowa, Dr. Ganske.
    Mr. Ganske. Thank you, Mr. Chairman.
    The idea that stocks are inherently risky and the 
government should keep people from speculating with excessive 
leverage was obvious in the 1930's. Then people thought the 
1929 crash had been worsened because overleveraged investors 
were forced to sell. Well, it is hard to remember that 70 years 
later; and free market advocates claim, if we don't allow such 
blatant gambling on stocks, the action will go to some overseas 
market. That seems to be a recurrent theme. We shouldn't let 
this go to some overseas market. Mr. Chairman, would you 
comment on that, please?
    Mr. Levitt. Again, I preface that by saying that my 
response to that may seem personal and impetuous, but my answer 
to your question is, so be it. If insisting that single-stock 
futures for retail investors have the same protections that 
investment in stocks do means we lose that market, so be it. It 
is a price well worth paying in terms of saving America's 
investors from the kinds of dangers that an unregulated market 
would represent.
    Mr. Dingell. Would the gentleman from Iowa yield?
    Mr. Ganske. I would be happy to yield.
    Mr. Dingell. I thank the gentleman.
    Mr. Chairman, what has been the rush overseas into single-
stock futures where they are offered? It has not been moving 
fast. It is something on the order of 1 percent?
    Mr. Levitt. That is correct. It has not been successful in 
Europe or Australia.
    Mr. Dingell. So what they found is that no one really wants 
these things overseas?
    Mr. Levitt. Thus far.
    Mr. Dingell. I thank the gentleman for yielding.
    Mr. Ganske. The futures market talk of single-stock futures 
as providing ``additional risk management tools,'' as Scott 
Gordon, chairman of the Chicago Mercantile Exchange, put it in 
an interview. They say you can already duplicate in a single-
stock future with a complicated trade in the options market, so 
why worry? Mr. Chairman, would you comment on that?
    Mr. Levitt. You know, in general, some of the products that 
are in our markets today are ones that I think individual 
investors have to be very careful about. I think the 
proliferation of new products in our markets has been a 
benefit. Our markets are more liquid today than ever before, 
and I think our futures markets have been a vital part of 
managing risk. Our futures markets have been largely 
institutional, and, while I applaud the growth and discipline 
of those markets and the inventiveness and creativity of new 
products, when you translate what has been largely an 
institutional product to a retail product, that is a different 
ball of wax and one, regardless of the benefits to our 
institutional markets, whose benefits I think are largely 
nonexistent to the typical retail investor. And I want to be 
absolutely certain, and all of us should be certain, that 
investors know what they are doing and are protected from the 
kind of leverage that is involved and the opportunity for scam 
that is created by subjecting investors to this product.
    Mr. Ganske. Mr. Chairman, can you tell us about any scams?
    Mr. Levitt. Well, I could tell you about so many scams, but 
since America's investors have not had the opportunity to 
invest in single-stock futures, I can't go into any of those.
    Mr. Ganske. Are there scams overseas?
    Mr. Levitt. I don't know the answer to that.
    Mr. Ganske. I thank you.
    Thank you, Mr. Chairman.
    Mr. Oxley. The gentleman's time has expired.
    The gentleman from Michigan, Mr. Stupak.
    Mr. Stupak. Mr. Levitt, is there any reason to preclude 
securities exchanges from trading single-stock futures if they 
are allowed to trade on futures exchanges?
    Mr. Levitt. No. We have had such extraordinary success at 
the Commission by forcing our options markets to trade the same 
options to really let competition work. The impact of that has 
been to reduce spreads by almost a third. The template is 
clear. It is there. If we are going to go ahead with a program 
to introduce single-stock futures, they should be available to 
every market to compete to reduce the cost of that investment 
to the benefit of America's investors.
    Mr. Stupak. With the rise in day trading, isn't the 
potential for increased leverage in the stock market a real 
concern?
    Mr. Levitt. It is a real concern, yes sir.
    Mr. Stupak. Do you believe that unless the tax treatment 
and transaction fee treatment for these products traded on a 
futures exchange or securities exchanged are not rationalized, 
Congress would be determining winners and losers in the 
marketplace?
    Mr. Levitt. I think to the extent there are disparities, 
regulatory disparities and margin disparities, they absolutely 
would be.
    Mr. Stupak. Could an investor who decided that futures were 
too risky and chose to invest in equities be harmed by single-
stock futures? Specifically, would trading in futures affect 
the underlying stock price?
    Mr. Levitt. I suppose trading in a single-stock future 
could affect the underlying stock price. I don't really know 
what impact that would have because, frankly, I don't know the 
extent of interest that retail investors would have in this 
product in the United States.
    Mr. Stupak. Would institutional interest really drive the 
harm to the market? If you really get into the futures, if the 
institution gets into the futures, could that not undermine the 
value of the market as we know it now?
    Mr. Levitt. I don't necessarily think so. I think that 
institutions are very sophisticated; and if they choose to use 
futures as they have used other derivative products to manage 
risk, I think that is constructive for our markets. I have very 
few problems with the use of futures as an institutional 
mechanism.
    Mr. Stupak. I yield back the balance of my time.
    Mr. Oxley. The gentleman yields back.
    The gentleman from Maryland.
    Mr. Ehrlich. I yield.
    Mr. Oxley. The gentleman yields.
    The gentleman from Wisconsin, Mr. Barrett.
    Mr. Barrett. Thank you, Mr. Chairman.
    Mr. Chairman, I want to thank you for coming to Milwaukee 
for the town hall meeting. I am still getting many compliments 
for your appearance.
    Mr. Levitt. Thank you.
    Mr. Barrett. I am learning as quickly as I can on this 
topic, and my understanding is that the reason we are here is 
back in 1982 this was one of the areas where there was not 
agreement reached between the SEC and the CFTC and that there 
still remains some disagreement now.
    What I would like you to do is perhaps help me understand 
where the SEC is coming from on four issues if we have time: 
the margin levels, the suitability requirements, the 
enforcement authority and the security transaction fees.
    Maybe we can start with the margin levels. I know that was 
something that Mr. Dingell alluded to in his questioning.
    Mr. Levitt. Well, in brief, the bill that is before us 
today provides for margin to be determined if--as I understand 
it, if the Federal Reserve Board goes along with it, the 
creation of a board that would adjudicate margin differences.
    I think that that is a problematic, questionable solution 
that could very well result in margin levels that are different 
based upon the product rather than any kind of consistency, and 
I think that could very well lead to arbitraging margin. And, 
as Congressman Stupak mentioned before, it represents 
government choosing winners and losers by determining where the 
best deal may be; and I don't think that is our job.
    Mr. Barrett. What would be the response from the CFTC on 
that, do you think?
    Mr. Levitt. You know, I am not certain. But I think the way 
to respond to that----
    Mr. Oxley. If I can interject, the CFTC will have an 
opportunity to testify and answer that question soon.
    Mr. Barrett. It is safe to say that is a disagreement 
between the SEC and the CFTC?
    Mr. Levitt. I am not certain how the CFTC approaches that 
issue. Our position has been that we have got to work together 
to see to it that margins are harmonized. I think this bill 
misses the point by creating what I regard to be a very 
complicated, problematic kind of solution involving a board. I 
think we should go directly to the mark and say margin will be 
harmonized and an investor will not be able to take advantage 
of a product because it is traded over there and they have to 
put up less money than if it is traded over here.
    Mr. Barrett. The enforcement authority issue, obviously an 
area where you have to have agreement. What is the issue that 
remains unresolved there?
    Mr. Levitt. The real issue is the basis of CFTC 
enforcement, which I think is really superb, is largely 
predicated on the institutional investor and lacks the kind of 
history that the SEC has in terms of protecting individual 
American investors. It is almost a cultural difference in that 
it lacks the self-regulatory organizations that form the basis 
of a partnership between SEC regulation and New York Stock 
Exchange and Nasdaq regulation. It lacks a history of 
inspection, examination, a history of cases predicated on 
protecting individual investors, a surveillance mechanism, 
maybe most importantly the whole question of suitability, where 
the CFTC might say we place a warning up there for investors, 
warning them that there is great speculation involved in terms 
of a future.
    The SEC requires much more with respect to suitability. 
Brokers must determine whether a given investor really should 
be buying a product. It is not enough that a broker tells your 
Aunt Sally that this future is dangerous. If a broker tells 
her, yes, it is dangerous Aunt Sally and she chooses to invest 
in it anyway and she loses her money, under SEC regulation we 
can prosecute the broker because it is highly unsuitable for 
Aunt Sally to be buying a dangerous product. Futures regulation 
is a very different kind of oversight geared toward very 
different kinds of constituents.
    Mr. Barrett. Thank you.
    Mr. Oxley. The gentleman's time has expired.
    The gentleman from California, Mr. Cox.
    Mr. Cox. Thank you, Mr. Chairman.
    I want to once again welcome Chairman Levitt; and because I 
am tardy to this hearing, I am going to try to catch up on the 
testimony. Thank you.
    Mr. Oxley. Let me now turn to our guest panelist, Mr. 
Ewing, who has a brief statement. The Chair would ask unanimous 
consent that Mr. Ewing be recognized for 5 minutes for a brief 
statement. The gentleman from Illinois.
    Mr. Ewing. Thank you, Mr. Chairman. I don't think that I 
will take the entire time. I want to thank you for holding the 
hearing.
    And to Chairman Levitt, I have the greatest respect for 
your knowledge and ability on these issues; and I think that 
there is--I hope that there is opportunity for this committee 
working with you to improve the legislation that was sent here 
dealing with this important subject.
    I just have maybe one question. The futures exchanges today 
are trading stock indices, and I think that the courts have 
actually said that they could trade narrow stock indices. How 
do you see the difference between that and the single-stock 
futures?
    Mr. Levitt. First let me say, Congressman Ewing, that I 
greatly respect the work that you have done, the background 
that you have brought to introducing this bill, the sincerity 
of your motives in terms of doing something which you believe 
will be beneficial to America's markets.
    I believe that our predecessors who came up with the 
agreement between the CFTC and SEC and authorized the trading 
of futures on broad indices felt that that would not have the 
retail impact that trading a future on a narrow index might 
have. Now while the courts ruled in that direction, I certainly 
stand behind the motivation that was displayed before. We need 
securities laws to apply to indexes that can be manipulated. I 
think what is important is a question of degree.
    In my judgment, trading a broad index represents little or 
no danger to a retail investor. Trading a narrow based index 
which does create opportunities for manipulation represents a 
greater danger to a retail investor. Trading a single-stock 
future, a future on a single underlying stock, represents, in 
my judgment, the greatest amount of risk to a retail investor 
unprotected by the oversight of securities laws.
    Mr. Ewing. Mr. Chairman, I appreciate your attitude of 
cooperation and the ability to work on this bill. I believe 
that we can find a common ground that will protect our 
investors, protect our markets and make this legislation work; 
and I certainly look forward to in the next few weeks working 
with you and with the other parties involved to try and arrange 
and come to those conclusions and certainly with this committee 
and other committees of the Congress. Thank you very much.
    Mr. Oxley. Mr. Chairman, we again appreciate your 
participation in this and look forward to working with you and 
your staff on these next couple of weeks to try to craft a 
compromise legislation. Again, thank you for your appearance.
    Mr. Levitt. Thank you.
    Mr. Oxley. The Chair would announce that we have three 
votes on the floor of the House. I would propose that we 
introduce our next panel. If they will come forward we will 
begin your testimony, and then when we have to break we will 
take a break. Since we have three votes, it will be probably 
somewhere in the nature of a half hour by the time we get over 
and get back. The witnesses and others may want to, during that 
break, have an opportunity to have lunch or whatever; and we 
will just play it by ear.
    Mr. Oxley. Let me introduce our second panel of the day. C. 
Robert Paul is General Counsel for the Commodity Futures 
Trading Commission; Mr. Lewis A. Sachs, Assistant Secretary for 
Financial Markets, Treasury Department; and Mr. Patrick M. 
Parkinson, Associate Director, Division of Research and 
Statistics, at the Federal Reserve.
    I am sure that you heard my discussion with Chairman Levitt 
in regard to the timetable that this committee faces on this 
important legislation, and we particularly appreciate your 
coming here with short notice to help us understand this very 
difficult issue.
    We will begin with Mr. Paul.

    STATEMENTS OF C. ROBERT PAUL, GENERAL COUNSEL, COMMODITY 
  FUTURES TRADING COMMISSION; PATRICK M. PARKINSON, ASSOCIATE 
    DIRECTOR, DIVISION OF RESEARCH AND STATISTICS, BOARD OF 
 GOVERNORS OF THE FEDERAL RESERVE SYSTEM; AND LEWIS A. SACHS, 
 ASSISTANT SECRETARY FOR FINANCIAL MARKETS, DEPARTMENT OF THE 
                            TREASURY

    Mr. Paul. Thank you, Chairman Oxley, Chairman Towns and 
members of the subcommittee. I am pleased to appear on behalf 
of the Commodity Futures Trading Commission to discuss the 
important issues addressed in H.R. 4541.
    The Commission commends the efforts of Chairman Combest, 
Chairman Ewing and Congressman Stenholm to modernize the 
Commodity Exchange Act by introducing H.R. 4541 to provide 
legal certainty for over-the-counter derivatives, remove 
impediments to innovation and reduce systemic risk. There are, 
however, two areas of concern, the scope of the energy 
exemption and new burdens on our enforcement authority, that 
preclude the Commission from supporting the legislation in its 
current form.
    The Commission supports the provisions of H.R. 4541 which 
enhance legal certainty for over-the-counter derivatives by 
excluding from the CEA certain bilateral transactions and 
electronic trading facilities. This bill also permits clearing 
of OTC derivatives and authorizes a mechanism for the CFTC to 
regulate facilities that clear OTC derivative contracts.
    We support this recommendation with the following 
reservation: The bill would allow securities clearing systems 
to clear a broader range of contracts than futures clearing 
systems.
    This bill would codify an exemption from most provisions of 
the Commodity Exchange Act for transactions in energy 
commodities. This is an area in which H.R. 4541 diverges from 
the recommendations of the President's Working Group, and the 
Commission believes that these provisions raise concerns that 
have yet to be resolved.
    The exemption for energy commodities is not governed by the 
same considerations that form the basis of the Working Group's 
recommendations with respect to financial products. The 
President's Working Group stated that the activities of most 
financial derivatives dealers are already subject to direct or 
indirect Federal oversight. The same cannot be said of trading 
in energy derivatives. The President's Working Group also found 
that most financial OTC derivatives are not susceptible to 
manipulation. The case has not been made for energy products.
    Last month, the Commission published in the Federal 
Register its comprehensive regulatory reform package, which 
alters fundamentally the Commission's approach to regulation of 
markets and participants under its jurisdiction. H.R. 4541 
attempts to codify much of the Commission's regulatory reform 
proposal, and we welcome this support of the Commission's 
initiative.
    The Commission will be moving to oversight regulation in 
which the agency will no longer act as a gatekeeper and will 
intervene only when a problem arises. To succeed, however, the 
Commission must be able to act quickly and effectively to 
address fraud and manipulation, as well as to protect the 
financial integrity of the markets.
    Section 15 of the legislation erects several barriers to 
enforcement action by the Commission. When there is a violation 
of the core principles, the Commission must delay any action 
until it provides an appropriate remedy to the violator. 
Moreover, the bill requires that the remedy be based upon a 
cost-benefit analysis. Thus, the provision may allow registered 
entities to postpone and possibly avoid responsibility for 
violation of core principles.
    H.R. 4541 addresses the issue of equity futures contracts 
and reflects efforts to develop a plan to amend the Shad-
Johnson Accord.
    The Working Group recommended that the CFTC and the SEC 
work together to determine whether and how the Accord should be 
amended. The agencies agree in principle that equity futures 
should be available to the marketplace. The agency staffs have 
agreed on many specific conditions to lifting the ban, such as 
authorizing the SEC to prosecute insider trading, harmonizing 
margin requirements, notice registration of each other's 
registrants, applying customer suitability rules to all 
intermediaries, testing personnel, establishing uniform listing 
standards for single-stock futures and providing SIPC coverage 
to customer accounts carried by securities intermediaries and 
segregation to customer accounts carried by futures 
intermediaries. We acknowledge, however, a fundamental 
disagreement concerning the appropriate legislative approach.
    The Commission has sought to avoid creating a framework 
that potentially could result in overregulation of markets and 
intermediaries; and, therefore, the CFTC staff has advocated 
identifying those core provisions from each regulatory regime 
necessary to ensure an appropriate level of oversight for 
trading these products. While the agencies have agreed in 
principle that duplicative regulation must be avoided, the CFTC 
staff expressed concern that an ``umbrella'' approach imposing 
the panoply of securities regulation to these products could 
result in overly burdensome regulation.
    The CFTC believes that it is important to bring single-
stock futures to the market in a way that does not result in 
the government favoring one market over another. Subjecting the 
futures exchanges to securities laws that address public policy 
concerns already addressed by the CEA creates a burden that may 
preclude fair competition between futures and securities 
exchanges.
    The Commission notes, however, that SEC's belief that 
defining equity futures products as securities is essential to 
fulfilling its regulatory functions. This fundamental 
difference in approach has led to an apparent impasse, but the 
agencies have nonetheless continued to try to reach a 
resolution.
    With respect to H.R. 4541, we have no objection to the 
Shad-Johnson provisions as they bear on regulatory issues 
related to the CFTC agency oversight of single-stock futures, 
but the CFTC continues to recommend a regulatory structure that 
would allow single-stock futures to trade on both securities 
and futures exchanges.
    Again, the Commission appreciates the opportunity to 
present its views. I would be happy to answer any questions you 
may have.
    [The prepared statement of C. Robert Paul follows:]
   Prepared Statement of C. Robert Paul, General Counsel, Commodity 
                       Futures Trading Commission
    Thank you, Chairman Oxley and members of the Subcommittee. I am 
pleased to appear on behalf of the Commodity Futures Trading Commission 
to discuss the important issues addressed in H.R. 4541.
    The Commission commends the efforts of Chairman Combest, Chairman 
Ewing, and Congressman Stenholm to modernize the Commodity Exchange Act 
by introducing H.R. 4541 to provide legal certainty for over-the-
counter derivatives, remove impediments to innovation, and reduce 
systemic risk. This bill responds to the President's Working Group's 
request for urgent legislative action on its recommendations so that 
the U.S. may retain its leadership in rapidly developing financial 
markets. Implementation of the Working Group's proposals is essential 
to enable U.S. markets to keep pace with the technological and 
structural changes occurring in markets around the world, and reform of 
the Commodity Exchange Act is a critical element of this process. The 
Commission recognizes the challenges involved in an undertaking of this 
complexity and appreciates the comprehensive approach to this task. The 
CFTC welcomes many of the provisions of H.R. 4541. There are, however, 
two areas of concern--the scope of the energy exemption and new burdens 
on our enforcement authority--that preclude the Commission from 
supporting the legislation in its current form.
    The provisions of H.R. 4541 enhance legal certainty for over-the-
counter derivatives by excluding from the CEA certain bilateral 
transactions entered into on a principal-to-principal basis by eligible 
parties. Legal certainty is a crucial consideration when parties to OTC 
derivative contracts decide with whom and where to transact business, 
and the President's Working Group recognized that legal certainty for 
OTC derivatives is vital to the continued competitiveness of U.S. 
markets.
    The Commission supports H.R. 4541's exclusion for electronic 
trading facilities for OTC financial derivatives to promote an 
environment in which innovative systems can flourish without undue 
regulatory constraints. H.R. 4541 also permits clearing of OTC 
derivatives and authorizes a mechanism for the CFTC to regulate 
facilities that clear OTC derivative contracts. Again, the President's 
Working Group specifically recommended removing legal obstacles to the 
development of appropriately-regulated clearing systems to reduce 
systemic risk, and we support this recommendation with the following 
reservation. The bill would allow securities clearing systems to clear 
a broader range of contracts than futures clearing systems. Futures 
clearing facilities would have to register in a dual capacity--as 
futures and as securities clearing facilities--to clear the same mix of 
contracts available to securities clearing facilities holding a single 
registration. By denying futures clearing systems an equal opportunity 
to compete, the bill may inadvertently determine winners and losers. We 
urge the Committee to avoid placing futures clearing facilities at a 
competitive disadvantage.
    The Commission also supports the bill's revision of the Treasury 
Amendment to make clear our jurisdiction over transactions entered into 
between retail customers and unregulated entities, including so-called 
``bucket shops.'' We have long sought legal clarity in this area to 
protect the public from foreign currency fraud, and the President's 
Working Group acknowledged the need for such a clarification.
    H.R. 4541 would codify an exemption from most provisions of the 
Commodity Exchange Act for transactions in energy commodities. This is 
an area in which H.R. 4541 diverges from the recommendations of the 
President's Working Group, and the Commission believes that these 
provisions raise concerns that have yet to be resolved.
    The Commission notes that this exemption for energy commodities, 
particularly as it relates to electronic trading systems that 
approximate exchange environments, is not governed by the same 
considerations that formed the basis of the Working Group's 
recommendations with respect to financial products. While there are 
some similarities between the trading of financial products and non-
financial products, there are also significant differences. Most 
dealers in the swaps markets are financial institutions subject to 
supervision by bank regulatory agencies, affiliates of broker-dealers 
regulated by the SEC, or affiliates of FCMs subject to CFTC oversight. 
``Accordingly, the activities of most derivatives dealers are already 
subject to direct or indirect federal oversight.'' (PWG at 16). The 
same cannot be said of trading in energy derivatives. The decision to 
extend the exclusion in H.R. 4541 to energy derivatives would leave 
these OTC products in a regulatory gap--neither directly regulated as 
financial products nor indirectly regulated by an agency with 
jurisdiction over commercial participants in the energy market. Thus, a 
principal argument warranting the exclusion of financial derivatives 
from the CEA--the fact that derivatives trading in these products is 
subject to direct or indirect federal oversight--does not fit OTC 
energy transactions.
    The President's Working Group also stated that most financial OTC 
derivatives are not susceptible to manipulation. That case has not been 
made for energy products.
    The CFTC has already exempted many types of energy trading from the 
provisions of the Commodity Exchange Act. But the exemption for energy 
commodities included in H.R. 4541 expands the scope of the Commission's 
existing exemptions for such contracts. The Commission's 1993 energy 
exemption is limited to those parties with the capacity to make or take 
delivery or the ability to contract to do so, but H.R. 4541 would 
extend the exemption to encompass eligible contract participants as 
defined in the bill, not just those acting in a commercial capacity. 
The 1993 energy exemption is also limited to transactions in which the 
material economic terms are subject to negotiation and that may not be 
cleared. H.R. 4541 specifically permits clearing and places no limits 
on standardization of contract terms. In essence, unlike the 
Commission's current energy exemption, H.R. 4541 would exempt 
transactions that may be indistinguishable from those conducted in a 
traditional exchange environment. It is this multilateral trading 
aspect of the proposed statutory exemption that gives rise to the 
Commission's concerns.
    The Commission recognizes that under the proposed exemption, energy 
transactions remain subject to the CEA's antifraud and antimanipulation 
provisions and to such transparency rules or regulations as the 
Commission may impose. We support the retention of these provisions. 
The Commission's responsibility to police for fraud and manipulation, 
however, can best be carried out if the Commission is also granted the 
commensurate authority to promulgate regulations, where necessary, in 
those areas.
    Last month, the Commission published in the Federal Register its 
comprehensive regulatory reform package, which alters fundamentally the 
Commission's approach to regulation of markets and participants under 
its jurisdiction. This proposal is based on a comprehensive evaluation 
of the CFTC's current regulatory structure and represents an effort to 
streamline that structure and to relieve domestic exchanges from 
unnecessary regulatory requirements. The proposal also follows the 
Congressional directive to transform the Commission from a frontline to 
an oversight regulator. The CFTC recently held two days of public 
meetings, with 23 witnesses representing a broad spectrum of interested 
parties, to maximize the input the agency receives in crafting this new 
framework.
    H.R. 4541 attempts to codify much of the Commission's regulatory 
reform proposal, and we welcome the bill's support of the Commission's 
initiative to give registered entities the flexibility to determine the 
best way to structure their business and to meet their self-regulatory 
obligations consistent with enumerated core principles.
    In administering the new flexible structure envisioned by H.R. 4541 
and the Commission's regulatory reform proposal, the Commission will be 
moving to oversight regulation in which the agency will no longer act 
as a gatekeeper and will intervene only when a problem arises. To be 
successful in an oversight capacity, however, the Commission must be 
able to act quickly and effectively to address fraud and manipulation, 
as well as to protect the financial integrity of the markets.
    Section 15 of the legislation erects several barriers to 
enforcement action by the Commission. When there is a violation of the 
core principles, the Commission must delay any action until it provides 
an appropriate remedy to the violator. Moreover, the bill requires that 
the remedy be based upon a cost/benefit analysis. Thus, the provision 
may allow registered entities to postpone and possibly avoid 
responsibility for violations of core principles by tying up the 
Commission in legal wrangling over whether the agency successfully met 
the cost/benefit test. Another consequence is that this section would 
essentially turn back the regulatory clock and force the agency to 
revert to frontline regulation and issuance of prescriptive rules.
    Section 15 also shifts the burden of proof to the Commission in 
making a determination that a registered entity is violating a core 
principle. This new obligation would severely limit the Commission's 
ability to take appropriate remedial action outside the context of a 
formal enforcement proceeding. It is important for the Commission and 
regulated entities to be able to avail themselves of procedures 
designed specifically to craft regulatory changes without the burden of 
proof and evidentiary requirements characteristic of formal enforcement 
proceedings. These less formal procedures have worked well in those 
situations in which the Commission has found it necessary and 
appropriate to take remedial action involving a registered entity.
    H.R. 4541 addresses the issue of equity futures contracts and 
reflects efforts to develop a plan to amend the Shad-Johnson Accord. 
The Working Group recommended that the CFTC and the SEC work together 
to determine whether and how the Accord should be amended. The agencies 
agree in principle that equity futures should be available to the 
marketplace. On March 2, the two agencies presented to Congress our 
areas of agreement and issues that remained unresolved through that 
point, and on May 23, Chairman Levitt and Chairman Rainer met with 
Senators Lugar and Gramm to discuss the issue further. The agency 
staffs have agreed on many specific conditions to lifting the ban, such 
as harmonizing margin requirements, restricting dual trading, testing 
for sales and supervisory personnel, and the establishment of uniform 
listing standards for single stock futures. We acknowledge, however, a 
fundamental disagreement concerning the appropriate legislative 
approach.
    The Commission has sought to avoid creating a framework that 
potentially could result in over-regulation of markets and 
intermediaries, and therefore the CFTC staff has advocated identifying 
those core provisions from each regulatory regime necessary to ensure 
an appropriate level of oversight for trading these products. While the 
agencies have agreed in principle that duplicative regulation must be 
avoided, the CFTC staff expressed concern that an ``umbrella'' approach 
imposing the panoply of securities regulation to these products could 
result in overly burdensome regulation. The CFTC believes that it is 
important to bring single stock futures to the market in a way that 
does not result in the government favoring one market over another, 
either by applying too light a touch or by being too heavy-handed. 
Subjecting the futures exchanges to securities laws that address public 
policy concerns already addressed by the CEA creates a burden that may 
preclude fair competition between futures and securities exchanges. The 
Commission notes, however, the SEC's belief that defining equity 
futures products as securities is essential to its fulfillment of its 
regulatory functions.
    This fundamental difference in approach has led to an apparent 
impasse, but the agencies have nonetheless continued to try to reach a 
resolution. Last week, CFTC and SEC staff met twice with Treasury 
Department staff to focus negotiations on specific unresolved issues. 
We plan to continue these discussions.
    With respect to H.R. 4541, we have no objection to the Shad-Johnson 
provisions as they bear on regulatory issues related to the CFTC's 
oversight of single stock futures. We wish to note, however, that we 
have stated from the outset of the discussion on repeal of the Accord 
that the CFTC believes a regulatory structure that would allow single 
stock futures to trade on both securities and futures exchanges is 
preferable to a structure that allows them to trade only on futures 
exchanges.
    Again, the Commission appreciates the opportunity to present its 
views. I would be happy to answer any questions you may have.

    Mr. Oxley. Thank you, Mr. Paul.
    We have had the second bell; and I guess, in deference to 
the members, we will suspend play here and recess the 
committee. The committee will stand in recess until 12:30.
    [Brief recess.]
    Mr. Oxley. The subcommittee will reconvene with our 
apologies. Mr. Parkinson, please proceed.

                STATEMENT OF PATRICK M. PARKINSON

    Mr. Parkinson. Thank you, Chairman Oxley. I am pleased to 
be here today to present the Federal Reserve Board's views on 
H.R. 4541, the Commodity Futures Modernization Act. My 
testimony will be quite similar to testimony that Chairman 
Greenspan and I presented last month to committees in the 
Senate and House, respectively. The Board continues to believe 
that such legislation modernizing the CEA is essential. To be 
sure, the Commodity Futures Trading Commission has recently 
proposed issuing regulatory exemptions that would reduce legal 
uncertainty about the enforceability of the over-the-counter 
derivatives, and would conform the regulation of the futures 
exchanges to the realities of today's marketplace. These 
administrative actions by no means obviate the need for 
legislation, however.
    I will focus on three areas that the legislation covers: 
First, over-the-counter derivatives; second, regulatory relief; 
and third, single-stock futures. In its November 1999 report on 
over-the-counter derivatives, the President's Working Group 
concluded that OTC transactions should be subject to the CEA 
only if necessary to achieve the public policy objectives of 
the act; that is, deterring market manipulation and protecting 
investors against fraud and other unfair practices.
    In the case of financial derivative transactions involving 
professional counterparties, the Working Group concluded that 
regulation was unnecessary for these purposes because financial 
derivatives generally are not readily susceptible to 
manipulation and professional counterparties can protect 
themselves against fraud and unfair practices. Consequently, 
the Working Group recommended that financial over-the-counter 
derivative transactions between professional counterparties be 
excluded from the coverage of the CEA.
    The provisions of H.R. 4541 that address OTC derivatives 
are generally consistent with the Working Group's conclusions; 
therefore, the Federal Reserve Board believes it would be 
appropriate to enact those provisions.
    The Working Group did not make specific recommendations 
about the regulation of traditional exchange-traded futures 
markets. Nonetheless, it called for the CFTC to review the 
existing regulatory structures, particularly those applicable 
to financial futures, to ensure they remain appropriate in 
light of the objectives of the CEA. The Board supports the new 
approach to regulation that was outlined in proposals issued by 
the CFTC last month. For some time the Board has been arguing 
that the regulatory framework for futures trading, which was 
designed for the trading of grains futures by the general 
public, is not appropriate for the trading of financial futures 
by large institutions. The CFTC's proposals recognize that the 
current one-size-fits-all approach to regulation of futures 
exchanges is inappropriate, and they generally incorporate 
sound judgments regarding the degree of regulation needed to 
achieve the CEA's purposes.
    Similarly, the Federal Reserve Board generally supports the 
regulatory relief provisions of H.R. 4541. However, the CFTC 
has expressed concerns that the bill unduly restricts its 
authority to correct violations of the core principles of 
regulation. To facilitate expeditious passage of legislation, 
it thus may be prudent to address the CFTC's concerns about its 
enforcement authority. The Working Group concluded that the 
current prohibition on single-stock futures can be repealed if 
issues about the integrity of the underlying securities markets 
and regulatory arbitrage are resolved.
    The Board believes that such instruments should be allowed 
to trade on futures exchanges or on securities exchanges with 
primary regulatory authority assigned to the CFTC or the SEC, 
respectively. However, the SEC should have authority over some 
aspects of trading on these products on futures exchanges. The 
scope of the SEC's authority should be resolved through 
negotiations between the CFTC and the SEC. Whatever agreement 
they reach should be codified through amendments to H.R. 4541. 
In any event, the bill should allow securities exchanges to 
compete with futures exchanges in listing single-stock futures.
    H.R. 4541 reflects a remarkable consensus on the need for 
legal certainty for OTC derivatives and regulatory relief for 
U.S. futures exchanges, issues that have long eluded 
resolution. These provisions are vitally important to the 
soundness of our derivatives markets in what is an increasingly 
integrated and intensively competitive global economy. The 
Federal Reserve Board trusts the remaining differences 
regarding single-stock futures can be resolved quickly so that 
this important piece of legislation can be expedited through 
this Congress.
    Thank you. I am pleased to answer any questions you may 
have.
    [The prepared statement of Patrick M. Parkinson follows:]
    Prepared Statement of Patrick M. Parkinson, Associate Director, 
Division of Research and Statistics, Board of Governors of the Federal 
                             Reserve System
    I am pleased to be here to present the Federal Reserve Board's 
views on the Commodity Futures Modernization Act of 2000 (H.R. 4541). 
My testimony today will be quite similar to testimony that Chairman 
Greenspan and I presented last month to committees in the Senate and 
House, respectively. The Board continues to believe that such 
legislation modernizing the Commodity Exchange Act (CEA) is essential. 
To be sure, the Commodity Futures Trading Commission (CFTC) has 
recently proposed issuing regulatory exemptions that would reduce legal 
uncertainty about the enforceability of over-the-counter (OTC) 
derivatives transactions and would conform the regulation of futures 
exchanges to the realities of today's marketplace. These administrative 
actions by no means obviate the need for legislation, however. The 
greatest legal uncertainty affecting OTC derivatives is in the area of 
securities-based transactions, to which the CFTC's exemptive authority 
does not extend. Furthermore, as events during the past few years have 
clearly demonstrated, regulatory exemptions carry the risk of amendment 
by future commissions. If our derivatives markets are to remain 
innovative and competitive internationally, they need the legal and 
regulatory certainty that only legislation can provide.
    In my remarks today I shall focus on three of the areas that the 
legislation covers: (1) OTC derivatives; (2) regulatory relief for U.S. 
futures exchanges; and (3) repeal of the Shad-Johnson prohibition of 
single-stock futures.
                            otc derivatives
    In its November 1999 report, Over-the-Counter Derivatives and the 
Commodity Exchange Act, the President's Working Group on Financial 
Markets (PWG) concluded that OTC derivatives transactions should be 
subject to the CEA only if necessary to achieve the public policy 
objectives of the act--deterring market manipulation and protecting 
investors against fraud and other unfair practices. In the case of 
financial derivatives transactions involving professional 
counterparties, the PWG concluded that regulation was unnecessary for 
these purposes because financial derivatives generally are not readily 
susceptible to manipulation and because professional counterparties can 
protect themselves against fraud and unfair practices. Consequently, 
the PWG recommended that financial OTC derivatives transactions between 
professional counterparties be excluded from coverage of the CEA. 
Furthermore, it recommended that these transactions between 
professional counterparties be excluded even if they are executed 
through electronic trading systems. Finally, the PWG recommended that 
transactions that were otherwise excluded from the CEA should not fall 
within the ambit of the act simply because they are cleared. The PWG 
concluded that clearing should be subject to government oversight but 
that such oversight need not be provided by the CFTC. Instead, for many 
types of derivatives, oversight could be provided by the Securities and 
Exchange Commission (SEC), the Office of the Comptroller of the 
Currency, the Federal Reserve, or a foreign financial regulator that 
the appropriate U.S. regulator determines to have satisfied its 
standards.
    The provisions of H.R. 4541 that address OTC derivatives are 
generally consistent with the PWG's conclusions. At the margin, the 
provisions differ from those recommended by the PWG in terms of the 
range of counterparties covered by the exclusions. However, these 
differences reflect reasonable judgments regarding the types of 
counterparties that can protect themselves against fraud and unfair 
practices. Therefore, the Federal Reserve Board believes it would be 
appropriate to enact these provisions.
              regulatory relief for u.s. futures exchanges
    The PWG did not make specific recommendations about the regulation 
of traditional exchange-traded futures markets that use open outcry 
trading or that allow trading by retail investors. Nevertheless, it 
called for the CFTC to review the existing regulatory structures, 
particularly those applicable to financial futures, to ensure that they 
remain appropriate in light of the objectives of the CEA. In February, 
the CFTC published a report by a staff task force that provided a 
comprehensive review of its regulatory framework and proposed sweeping 
changes to the existing regulatory structure. Last month the CFTC 
issued a revised set of proposals for public comment. With some 
exceptions, the regulatory relief provisions of H.R. 4541 are 
consistent with the CFTC's proposals.
    Using the same approach as the PWG, the CFTC has evaluated the 
regulation of futures exchanges in light of the public policy 
objectives of deterring market manipulation and protecting investors. 
When contracts are not readily susceptible to manipulation and access 
to the exchange is limited to sophisticated counterparties, the CFTC 
has proposed alternative regulatory structures that would eliminate 
unnecessary regulatory burden and allow domestic exchanges to compete 
more effectively with exchanges abroad and with the OTC markets. More 
generally, the CFTC proposes to transform itself from a frontline 
regulator, promulgating relatively rigid rules for exchanges, to an 
oversight agency, assessing exchanges' compliance with more flexible 
core principles of regulation.
    The Federal Reserve Board supports the general approach to 
regulation that was outlined in the CFTC's proposals. For some time the 
Board has been arguing that the regulatory framework for futures 
trading, which was designed for the trading of grain futures by the 
general public, is not appropriate for the trading of financial futures 
by large institutions. The CFTC's proposals recognize that the current 
``one-size-fits-all'' approach to regulation of futures exchanges is 
inappropriate, and they generally incorporate sound judgments regarding 
the degree of regulation needed to achieve the CEA's purposes.
    Similarly, the Federal Reserve Board generally supports the 
regulatory relief provisions of H.R. 4541. However, the CFTC has 
expressed concerns that the bill unduly restricts its authority to 
correct violations of the core principles of regulation. To facilitate 
expeditious passage of legislation, it thus may be prudent to address 
the CFTC's concerns about its enforcement authority.
                          single-stock futures
    The PWG concluded that the current prohibition on single-stock 
futures (part of the Shad-Johnson Accord) can be repealed if issues 
about the integrity of the underlying securities markets and regulatory 
arbitrage are resolved. The Board believes that such instruments should 
be allowed to trade on futures exchanges or on securities exchanges, 
with primary regulatory authority assigned to the CFTC or the SEC, 
respectively. However, the SEC should have authority over some aspects 
of trading of these products on futures exchanges. The scope of the 
SEC's authority can and should be resolved through negotiations between 
the CFTC and the SEC. The Congress should continue to urge the two 
agencies to settle their remaining differences. Whatever agreement they 
reach should then be incorporated through amendments to H.R. 4541. In 
any event, the bill should allow securities exchanges to compete with 
futures exchanges in listing single-stock futures.
    If it would facilitate repeal of the prohibition, the Federal 
Reserve Board is willing to accept regulatory authority over levels of 
margin on single-stock futures, as provided in H.R. 4541, so long as 
the Board can delegate that authority to the CFTC, the SEC, or an 
Intermarket Margin Board consisting of representatives of the three 
agencies. The Board understands that the purpose of such authority 
would be to preserve the financial integrity of the contract market and 
thereby prevent systemic risk and to ensure that levels of margins on 
single-stock futures and options are consistent. The Board would note 
that, for purposes of preserving financial integrity and preventing 
systemic risk, margin levels on futures and options should be 
considered consistent, even if they are not identical, if they provide 
similar levels of protection against defaults by counterparties, taking 
into account any differences in (1) the price volatility of the 
contracts, (2) the frequency with which margin calls are made, or (3) 
the period of time within which margin calls must be met.
                               conclusion
    H.R. 4541 reflects a remarkable consensus on the need for legal 
certainty for OTC derivatives and regulatory relief for U.S. futures 
exchanges, issues that have long eluded resolution. These provisions 
are vitally important to the soundness and competitiveness of our 
derivatives markets in what is an increasingly integrated and intensely 
competitive global economy. The Federal Reserve Board trusts that the 
remaining differences regarding single-stock futures can be resolved 
quickly, so that this important piece of legislation can be expedited 
through this Congress.

    Mr. Oxley. Thank you, Mr. Parkinson.
    Mr. Sachs.

                   STATEMENT OF LEWIS A. SACHS

    Mr. Sachs. Thank you, Mr. Chairman, and members of the 
subcommittee. I appreciate the opportunity to appear before you 
today to discuss H.R. 4541, the Commodity Futures Modernization 
Act of 2000.
    Mr. Chairman, the OTC derivatives markets provide a number 
of benefits to our economy, enhancing the ability of businesses 
to manage their risk profiles, to compete more effectively in 
the global marketplace and to deliver more efficiently and at 
lower cost a wide range of products and services to the 
American consumer. It was with this in mind that last year the 
President's Working Group on Financial Markets, chaired by the 
Secretary of the Treasury, was requested to conduct a study of 
the OTC derivatives markets and the Commodity Exchange Act.
    In response, the Working Group developed a set of unanimous 
recommendations designed to reduce systemic risk, promote 
innovation, protect retail customers, maintain U.S. 
competitiveness in these markets and protect the integrity of 
the underlying markets. We believe that it is important to move 
forward with appropriate legislation designed to accomplish 
these important objectives as soon as possible. The legislation 
before you today largely incorporates the recommendations of 
the Working Group with respect to OTC derivatives, and we 
support enactment of these provisions.
    Let me touch upon a few of the specific objectives that the 
bill addresses. First, H.R. 4541 would provide legal certainty. 
With regard to swap agreements, the Working Group sought to 
address an area in which the need for change had been clearly 
demonstrated. The Commodity Exchange Act was designed to 
address issues of fraud, manipulation and price discovery. 
Therefore, the Working Group unanimously recommended clarifying 
the legal status of these instruments by creating a statutory 
exclusion from the CEA only for transactions among large 
sophisticated parties involving instruments not readily 
susceptible to manipulation and that do not currently serve a 
price discovery function. This bill would establish such an 
exclusion and would permit the electronic trading of these 
instruments, and we are supportive of these provisions.
    Second, this bill would provide for the development of 
appropriately regulated clearinghouses. Well-designed 
clearinghouses can help to reduce systemic risk. Consistent 
with the Working Group's recommendation, the bill provides for 
the development of clearinghouses through clarification of 
their legal status and also requires that they be regulated. We 
believe these provisions can make an important contribution 
toward mitigating systemic risk.
    Finally, this legislation takes an important step toward 
protecting retail customers by providing the CFTC with explicit 
authority to regulate foreign currency bucket shops. We are 
pleased that the provisions have been included in this bill.
    Let me discuss the bill's provisions relating to the reform 
of the Shad-Johnson Accord. We believe, as the Working Group 
report states and has been quoted several times here today, 
that the current prohibition on single-stock and narrow based-
stock index futures can be repealed if issues about the 
integrity of the underlying securities markets and regulatory 
arbitrage are resolved. There are a number of concerns, 
however, that the regulatory agencies consider important that 
have not yet been resolved.
    As we have stated, it is important for the SEC and CFTC to 
jointly address these issues. We are committed to making every 
effort to facilitate progress in resolving these issues. 
However, if these issues cannot be resolved on a timely basis, 
we believe that it is important to move forward with 
legislation designed to clarify the legal certainty for OTC 
derivatives and to implement the other recommendations of the 
Working Group.
    Turning finally to the bill's provisions regarding 
regulatory relief for futures exchanges, we continue to support 
the view that it is appropriate to review from time to time 
existing regulatory structures to determine whether they 
continue to serve valid public policy functions. Broadly, we 
are supportive of the CFTC efforts to provide appropriate 
regulatory relief to the futures exchanges. We recognize the 
need for competitive parity between the exchanges and off-
exchange markets, particularly as the status of off-exchange 
markets is clarified.
    Before concluding, Mr. Chairman, let me touch upon one 
issue that is not part of the bill before you today but which 
is related and vitally important to the smooth functioning of 
our markets during periods of volatility. I would like to take 
this opportunity to strongly urge Congress to adopt the Working 
Group recommendations regarding the treatment of OTC 
derivatives and certain other financial contracts in cases of 
bankruptcy or insolvency. Rarely are there tangible steps the 
government can take that can have a meaningful impact on the 
mitigation of systemic risk, and this is one such opportunity.
    In conclusion, Mr. Chairman, we have an opportunity to 
advance legislation that will create a modern legal and 
regulatory framework for OTC derivatives. We look forward to 
working with you and the other members of this committee and 
our colleagues of the Working Group to advance these important 
objectives.
    That concludes my opening remarks. I would be happy to 
answer any questions and ask that my prepared remarks be 
submitted for the record.
    [The prepared statement of Lewis A. Sachs follows:]
 Prepared Statement of Lewis A. Sachs, Assistant Secretary, Department 
                              of Treasury
    Chairman Oxley, Ranking Member Towns, members of this Subcommittee, 
I appreciate the opportunity to appear before you today to discuss H.R. 
4541, the Commodity Futures Modernization Act of 2000.
    In November 1999, the President's Working Group on Financial 
Markets presented its report Over-the-Counter Derivatives Markets and 
the Commodity Exchange Act to the Congress. In this report, the Working 
Group, which is chaired by Secretary Summers and includes the Chairmen 
of the Federal Reserve, the Commodity Futures Trading Commission and 
the Securities and Exchange Commission, set forth a series of unanimous 
recommendations designed to reform the legal and regulatory framework 
affecting the OTC derivatives market. The legislation before you today 
would enact many of those important recommendations.
    I would like to begin by providing some background on OTC 
derivatives and the recommendations of the President's Working Group on 
Financial Markets. I will then turn to H.R. 4541 more specifically, 
including the bill's treatment of OTC derivatives, regulatory relief 
for the futures exchanges, and the reform of the Shad-Johnson 
restrictions on the trading of single stock and narrow-based stock 
index futures.
 i. otc derivatives and the president's working group's recommendations
    Mr. Chairman, our financial sector is the central nervous system of 
the American economy. As our economy and our financial markets have 
evolved over the past two decades, so too have the needs of the 
financial sector. Most notably, in an era of globalization, volatility 
of interest rates, increased securitization and the growth of the bond 
markets relative to the traditional loan markets, businesses and 
financial institutions have required a more diverse and effective set 
of tools for managing risk.
    In that sense, the over-the-counter derivatives market has grown 
directly in response to the needs of the private sector. An OTC 
derivative is an instrument that allows a party seeking to reduce its 
risk exposure to transfer that exposure to a counterparty that wants 
and may be in a better position to assume the risk. This is an 
important development that has significantly enhanced the ability of 
businesses to manage their risk profiles, to compete more effectively 
in the global marketplace, and to deliver more efficiently and at lower 
cost a wide range of services and products to the American consumer.
    Because of these rising demands, the notional value of global OTC 
derivatives has risen more than five-fold over the past decade, to more 
than $80 trillion according to estimates produced by the Bank for 
International Settlements.
    The benefits to the American economy of OTC derivatives would 
continue to grow within a proper and appropriate framework of legal 
certainty. For example:

 By helping businesses and financial institutions to hedge 
        their risks more efficiently, OTC derivatives enable them to 
        pass on the benefits of lower product costs to American 
        consumers and businesses.
 By allowing for the transfer of unwanted risk, OTC derivatives 
        promote the more efficient allocation of capital across the 
        economy, further increasing American productivity.
 By providing better pricing information, OTC derivatives can 
        help promote greater efficiency and liquidity of the underlying 
        cash markets that feed into a stronger economy for all 
        Americans.
 And, by enabling more sophisticated management of assets, 
        including mortgages, consumer loans and corporate debt, OTC 
        derivatives can help lower mortgage payments, insurance 
        premiums, and other financing costs for American consumers and 
        businesses.
    Thus, OTC derivatives have the potential to bring important 
benefits to our economy. It was with the importance of OTC derivatives 
in mind that, last year, the Congress requested that the Working Group 
conduct a study of the OTC derivatives market and recommend changes 
required to ensure that we continue to reap such benefits.
    In response, the Working Group developed its set of unanimous 
recommendations designed to achieve four objectives:

 First, to reduce systemic risk in the OTC derivatives market 
        by removing legal impediments to the development of clearing 
        systems and ensuring that those systems are appropriately 
        regulated.
 Second, to promote innovation in the OTC derivatives market by 
        providing legal certainty for OTC derivatives and electronic 
        trading systems. This would strengthen the overall legal 
        framework governing the OTC derivatives market and, in turn, 
        would stimulate greater competition, transparency, liquidity, 
        and efficiency and deliver stronger benefits to US consumers 
        and businesses.
 Third, to protect retail customers by ensuring that 
        appropriate regulations are in place to deter unfair practices 
        in all markets in which they participate and by closing 
        existing legal loopholes that allow unregulated entities to 
        pursue such unfair practices through foreign currency 
        transactions.
 And fourth, to maintain US competitiveness by providing a 
        modernized framework that will lead those engaged in the 
        financial services industry to continue the operations of their 
        businesses in the United States, and thereby promote the 
        continued leadership of American capital markets.
    Given the scope of the bill before you today--providing legal 
certainty to OTC derivatives, reforming the Shad-Johnson Accord, and 
providing regulatory relief for futures exchanges--today I would add a 
fifth important objective:

 To protect the integrity of the markets underlying the 
        derivatives in question--in particular, the securities markets.
    While seeking to accomplish these objectives, we need to recall 
that the emergence of the OTC derivatives market has come during an era 
of unprecedented economic strength and prosperity.
    It is to be expected that in times of distress some participants in 
these markets, as in other financial markets, will be adversely 
affected. The recommendations we have made, and the provisions in this 
bill, will not prevent these situations from occurring, nor are they 
intended to do so. What needs to be protected, however, is the 
financial system as a whole, and not individual institutions.
    We believe that our recommendations with respect to clearing and 
those designed to enhance transparency and legal certainty and to 
clarify the treatment of derivatives in the case of bankruptcy or 
insolvency can contribute to enhancing the stability of the system more 
broadly.
          ii. the commodity futures modernization act of 2000
    Let me now turn to the legislation before you today, H.R. 4541. Mr. 
Chairman, we believe that this bill incorporates many of the 
recommendations of the Working Group with respect to OTC derivatives 
which, if enacted, would promote greater legal certainty for these 
instruments and help to advance the Working Group's other objectives. 
In particular, with respect to legal certainty, we believe that this 
bill, with minor changes, would strike the appropriate balance between 
allowing the economy to realize more fully the benefits of derivatives 
and, at the same time, ensuring the integrity of the underlying 
markets, providing appropriate protection for retail customers, and 
where possible, taking steps to mitigate systemic risk.
    Moreover, we believe that it is important to move forward with 
appropriate legislation as soon as possible. A failure to act in this 
area would risk a situation in which the existing legal framework for 
our financial markets would lag significantly behind the development of 
the markets themselves.
    In the absence of an updated legal and regulatory environment, 
needless systemic risk might jeopardize the broader vitality of the 
American capital markets; innovation might be stifled by the absence of 
legal certainty; and American consumers might be deprived of the 
benefits that a more appropriate legal framework would promote. We also 
risk an erosion of the competitiveness of American financial markets, 
with an increasing amount of business moving offshore to jurisdictions 
in which the regulatory framework has kept up with the pace of change.
    With this in mind, I would like to address the three major areas of 
the bill:

 First, the bill's approach to OTC derivatives;
 Second, the provisions of the bill designed to provide 
        regulatory relief for futures exchanges; and
 Finally, the provisions of the bill providing for the repeal 
        of the Shad-Johnson restrictions on the trading of single stock 
        and narrow-based stock index futures.
OTC Derivatives
    Let me first discuss the bill's provisions regarding OTC 
derivatives. H.R. 4541 would take significant steps toward achieving 
the Working Group's goals by enacting most of our recommendations 
regarding OTC derivatives. While there are a few changes which we would 
like to see enacted, such as amendments to the definition of eligible 
contract participants and of excluded commodity, we believe that the 
legislation takes an appropriate approach to OTC derivatives and 
encourage the Congress to adopt these provisions. Let me touch upon a 
few of the specific objectives that this bill helps to accomplish.
    First, H.R. 4541 would provide legal certainty. The Working Group 
members spent several months studying and developing recommendations 
regarding the appropriate status of OTC derivatives under the Commodity 
Exchange Act. We focused upon areas in which the need for change had 
been demonstrated in our markets.
    With regard to swap agreements, the Working Group sought to remove 
the cloud of legal uncertainty resulting from questions about the 
enforceability of certain swap contracts in U.S. courts. This 
uncertainty resulted from a lack of clarity regarding whether the CEA 
applies to certain OTC derivative transactions. The CEA was designed 
primarily to address issues of fraud, manipulation, and price 
discovery. Thus, the Working Group unanimously recommended that the 
legal status of such contracts be clarified by creating a statutory 
exclusion from the CEA for certain OTC derivative transactions which do 
not require regulation for these public policy reasons. The exclusion 
is limited to transactions involving qualified participants who do not 
require the additional protections of the CEA, and the instruments 
subject to the exclusion generally are not susceptible to manipulation, 
nor do they serve a primary price discovery function at this time.
    H.R. 4541 would establish such an exclusion for certain swap 
agreements and thereby ensure that the U.S. OTC derivatives market can 
develop within the kind of innovative and legally stable environment on 
which the continued competitiveness of our financial markets depend.
    Second, H.R. 4541 would provide for the development of 
appropriately-regulated clearinghouses. The Working Group's report 
recommended that Congress enact legislation to provide a clear basis 
for the development of appropriately-regulated clearing systems for OTC 
derivatives. Well-designed clearinghouses can help to reduce systemic 
risk: first, by diminishing the likelihood that the failure of a single 
market participant can have a disproportionate effect on the market as 
a whole; and second, by facilitating the offsetting and netting of 
contract obligations. In addition to these benefits, however, clearing 
tends to concentrate risks and certain responsibilities for risk 
management in a central counterparty or clearinghouse. Therefore, 
appropriate regulation of clearing systems is essential to ensure that 
they indeed serve to mitigate systemic risk.
    Under the Working Group framework, regulatory oversight could be 
provided by the CFTC, SEC, a federal banking regulator, or by a 
recognized foreign regulatory authority, depending on the structure of 
the clearinghouse and its activities.
    H.R. 4541 provides for the development of clearinghouses, and 
requires that they be regulated. It thereby can provide the beneficial 
effects of reducing systemic risk by encouraging the development of 
such systems through the clarification of their legal status and by 
subjecting them to appropriate supervision.
    However, we believe that H.R. 4541 could be improved by clarifying 
the scope of the SEC's authority to regulate clearinghouses that clear 
securities and that also wish to clear OTC derivatives.
    Finally, H.R. 4541 takes important steps toward protecting retail 
customers. The Working Group recommended that the CFTC be granted 
explicit authority to regulate foreign currency ``bucket shops'' and to 
prosecute such entities when they attempt to defraud retail customers. 
H.R. 4541 provides such authority to the CFTC, thus strengthening 
protection for small investors. Again, this is an area in which 
problems have arisen, and the need for appropriate oversight clearly 
has been demonstrated. We are pleased to see these provisions 
incorporated in the bill.
The Shad-Johnson Accord
    Let me now turn to the section of the bill addressing reform of the 
Shad-Johnson Accord. The members of the Working Group agreed that the 
current prohibition on single-stock and narrow-based stock index 
futures could be repealed if issues about the integrity of the 
underlying securities markets and regulatory arbitrage are resolved. 
Our view remains unchanged.
    The provisions contained in this bill regarding futures on non-
exempt securities are a good starting point, although a number of 
issues remain unresolved. The bill addresses some of the customer 
protection and enforcement concerns identified by the CFTC, the SEC, 
and others as necessary conditions for repealing the prohibition on 
single-stock futures. However, there are a number of concerns that the 
regulatory agencies consider important, but that have not been resolved 
in the legislation. We hope that the SEC and CFTC can provide specific 
comments on these issues in the near future so that they can be 
incorporated into this bill.
    In particular, certain issues related to the harmonization of 
margin requirements will need to be clarified. While we do not see the 
need to establish margin requirements in statute, it will be important 
for regulatory authorities to establish margin levels that do not 
encourage regulatory arbitrage or lead to a substantial increase in 
leverage in our financial system.
    While we have no objection to the introduction of single-stock or 
narrow-based stock index futures, it is vitally important that the 
integrity of the underlying markets be preserved, and that these 
instruments not be used as a means to avoid the regulations of the cash 
markets. Therefore, we continue to encourage efforts by the SEC and 
CFTC to reach an agreement on a regulatory framework for these products 
that preserves the integrity of the underlying securities markets. 
However, if these issues cannot be resolved on a timely basis, we 
believe that it is important to move forward with legislation designed 
to clarify the legal certainty for OTC derivatives and to implement the 
other recommendations of the Working Group.
Regulatory Relief
    The third component of this bill addresses regulatory relief for 
the futures exchanges. The Treasury Department continues to support the 
view that it is appropriate to review, from time to time, existing 
regulatory structures to determine whether they continue to serve valid 
public policy functions. Like the OTC markets, exchange trading of 
derivatives should not be subject to regulations that do not have a 
public policy justification. Broadly, we are supportive of the CFTC's 
efforts to provide appropriate regulatory relief to the futures 
exchanges, consistent with the public interest. To this end, the CFTC 
has recently released its regulatory relief proposal for public 
comment. We will be submitting a formal comment letter on this proposal 
in the near future.
    There may, however, be unforeseen consequences to legislating such 
regulatory relief. Once such provisions are written into law, the 
regulators will have no ability to review and amend them should 
subsequent market developments warrant change or should other problems 
arise. Again, we are supportive of appropriate regulatory relief for 
futures exchanges, but suggest that certain aspects of that relief may 
be more appropriately provided through administrative action.
iii. the importance of clarifying the treatment of financial contracts 
                             in bankruptcy
    Mr. Chairman, although not part of this bill, I would like to take 
this opportunity to strongly urge Congress to adopt the President's 
Working Group recommendations regarding the treatment of OTC 
derivatives and certain other financial contracts in cases of 
bankruptcy or insolvency. Rarely are there tangible steps the 
government can take that could have a meaningful impact on the 
mitigation of systemic risk. Enacting the recommendations of the 
Working Group designed to clarify the treatment of these instruments in 
bankruptcy is one of those steps. By establishing a framework through 
which creditors and counterparties can work out a swift resolution in 
cases of bankruptcy or insolvency, enactment of these recommendations 
can serve to reduce the impact of the failure of any one institution on 
the stability of the system more broadly.
                             iv. conclusion
    In conclusion, Mr. Chairman, we have an opportunity to advance 
legislation that will create a modern legal and regulatory framework 
for OTC derivatives designed to promote innovation, protect retail 
customers, reduce systemic risk, maintain U.S. competitiveness, and 
ensure the integrity of our markets. We look forward to working with 
the members of this Committee, other members of Congress, and our 
colleagues on the President's Working Group in an effort to further 
advance these important objectives.
    Thank you.

    Mr. Oxley. Thank you, Mr. Sachs. Let me begin my 5 minutes 
with Mr. Parkinson. The provisions on legal certainty in the 
legislation, does that really solve all of the legal certainty 
problems that OTC markets now face?
    Mr. Parkinson. I think it solves the most significant legal 
certainty problems; that is, those relating to eligible 
participants, that is, institutions and wealthy individuals use 
of securities-based derivatives, electronic trading systems--
other than perhaps those for agricultural products--and 
clearing facilities. What it leaves unresolved is whether the 
CEA applies to retail swap transactions, but I would note that 
we don't believe that there is a significant amount of retail 
activity at this time that is being imperiled by that 
uncertainty.
    Mr. Oxley. Do the margin provisions in the bill adequately 
address concerns about consistent margins on single-stock 
futures and options?
    Mr. Parkinson. Yes, in the sense that the bill empowers the 
Federal Reserve to ensure that margins are consistent, and it 
makes clear what is meant by consistency in this context. I 
think we do have some technical comments regarding the 
provisions that define what consistency means, which I think 
would be the major source of potential confusion and conflict. 
But yes, I think in that sense it does provide a solution.
    Mr. Oxley. Let me ask Mr. Paul, what is the overlap between 
your regulatory relief proposal and this bill?
    Mr. Paul. Congressman, the bill attempts to codify very 
much of our regulatory relief proposal as published in the 
Federal Reserve last June. However, our proposal is out for 
public comment, and the comment period extends until August 7. 
We anticipate getting comments in response to those, perhaps 
making further refinements in our proposal, but we believe that 
the codification put forth in the legislation is fundamentally 
close with our proposal and we would expect where our proposal 
ends up that we would support the legislation and would look 
forward to working with congressional staffs to fine-tune any 
adjustments that would be required so that our regulatory 
proposal would match up with the codification.
    Mr. Oxley. You heard some criticism from the dais earlier 
about shifting from a front-line regulator to an oversight 
role. First of all, your comments; and second, how would it 
impact this legislation?
    Mr. Paul. I will answer the second question first.
    One way that it would impact, as I suggested in my remarks, 
my opening remarks, is that because we are moving from 
prescriptive rules to general core principles, we believe it is 
more important than ever that we have enforcement authority 
that we can exercise quickly and effectively. And we are 
concerned with the form of the legislation currently, that may 
delay and hamstring us in administering or taking quick and 
decisive enforcement action. So we believe that if we modify 
that provision in the legislation, we would be in a position to 
continue with our current enforcement efforts, and I guess in 
connection with some of the comments made earlier I just want 
to make the point that we believe that in our 25-year history 
we have a very effective record of meaningful and diligent 
enforcement in protecting the futures markets, both for 
institutional as well as retail investors.
    Mr. Oxley. Mr. Sachs, what has been the Treasury's role in 
facilitating agreement between the SEC and CFTC on the 
regulation of single-stock futures?
    Mr. Sachs. Mr. Chairman, we have only in recent weeks been 
asked to see if we can help facilitate those discussions. The 
CFTC and SEC have had an extensive period of discussion on 
Shad-Johnson to see if they could resolve the remaining issues. 
We have held several meetings. We have another one I believe 
this afternoon, to see if we can't move the process along 
further, to make clear to everyone where there is agreement and 
where there is disagreement and to see if we might not be able 
to help bridge that gap.
    Mr. Oxley. Is it possible for CFTC and the SEC, with your 
help, to reach an agreement before we start to mark up this 
vehicle?
    Mr. Sachs. I don't know the answer to that yet, Mr. 
Chairman. It is still early in our involvement. The issues are, 
as everyone has stated, quite complicated. The two different 
approaches that the different agencies take to the way that 
they regulate their own markets are quite different. We are 
going to make every effort to try to get this done on a timely 
basis to be helpful to your committee. But I can't provide any 
guarantees.
    Mr. Oxley. This is somewhat similar to operating 
subsidiaries during the last session. I hate to reopen old 
wounds, but it struck me as there are some similarities here. 
Other than the CFTC, who I am sure watched from afar with 
fascination, but as far as the role of the Fed and the Treasury 
and ultimately getting an agreement from Mount Olympus on op 
subs which allowed us to go forward and pass historic 
legislation, and perhaps Mr. Sachs we can make history one more 
time in that regard.
    Mr. Sachs. I hope to be able to come back in a few weeks 
and say that everyone was able to learn from the experience of 
last year and push this along. I can only--we will be happy to 
report to you every several days.
    Mr. Oxley. We appreciate your working with our staff. As I 
say, we are under a severe time constraint and we want to make 
every effort to try to craft legislation. We appreciate your 
participation, all of your participation.
    The gentleman from Staten Island.
    Mr. Fossella. Thank you, Mr. Chairman. Just a brief 
question for all members of the panel. Do you have any concern 
whatsoever--some opponents of the bill have raised concern 
about its impact on the margins and potential for insider 
trading and a concern that there will be manipulation of stock. 
Do you have any opinion on that? And if so, I would like to 
hear it.
    Mr. Paul. Let me take the first crack in answering that, 
Congressman.
    From the very beginning in our negotiations with the SEC, 
the CFTC has recognized the importance of harmonizing margins 
between the two markets. We have discussed a number of 
approaches to that with the SEC. We are in general agreement 
that the margins should be harmonized. Whether we do that with 
the intervention of the Federal Reserve Board or whether we do 
it just between our two agencies, we think either way would 
work and we would be willing to take either approach.
    With respect to insider trading, we have acknowledged and 
are in full agreement with the SEC that it is absolutely 
essential that any trading of single-stock futures or narrow-
based indices on the futures side would not provide a vehicle 
to circumvent the securities laws and the protections that 
currently exist. That is why we have advocated and continue to 
support that the SEC be given authority to prosecute insider 
trading wherever it takes place, whether it be on the 
securities or futures side. We think that the bill does that, 
but we are interested in continuing to work with the SEC on any 
ways that we can make that stronger and make that clearer.
    So I actually think that both agencies are in nearly full 
agreement on both those issues.
    I will just add one other thing which has come up 
throughout the conversation today, and that is customer 
suitability. We also agree with the SEC for the need for 
customer suitability on the futures side. We agree that to the 
extent that any futures registrants should be trading these 
products, they should be subject to customer suitability rules 
on the futures side equivalent to the rules on the securities 
side.
    Mr. Fossella. When was the last time you met with the SEC?
    Mr. Paul. On this matter was last Friday, and we are 
scheduled to meet again this afternoon, which we may be 
postponing until tomorrow based on running over today. We 
continue to move closer to full agreement.
    Mr. Parkinson. On the margin issue, I think this is being 
painted as much more difficult than it actually is. We hear 
again and again that the margin for single stocks in the 
security markets is 50 percent and that margins in the futures 
markets are 5 percent. In a sense, but only in a very 
misleading sense, that is true. The 50 percent margin is the 
initial margin on an individual stock. The 5 percent margin or 
5.5 percent margin is the maintenance margin on a stock index. 
Maintenance margins in the securities markets are 25 percent, 
not 50 percent. Furthermore, if one used the same methodology 
that the Chicago exchanges use in coming up with their 5.5 
percent on a stock index product, that would translate into a 
significantly higher margin for a single stock. I think, 
depending on the volatility of the individual stock, that could 
be anywhere from 10 percent to 30 percent, with the 10 percent 
applying to the lower volatility high-cap stocks, and the 30 
percent applying to the truly speculative issues of thinly 
capitalized firms.
    Thus, I think framing the issue on terms of 50 percent 
versus 5 percent makes it look like the differences between the 
margining systems used in the futures markets and the margining 
systems that are in place in securities markets are much 
greater than they in fact are.
    Mr. Sachs. I have nothing further to add to either of these 
comments.
    Mr. Fossella. Mr. Sachs, are you concerned at all, or Mr. 
Parkinson, that there may be a competitive disadvantage between 
the exchanges?
    Mr. Sachs. With respect to single-stock futures?
    Mr. Fossella. Yes.
    Mr. Sachs. Well, we hope that--we think that it is possible 
to craft the legislation such that those advantages would not 
be--so that there wouldn't be those advantages and 
disadvantages. I think if we can all come to agreement on how 
these instruments should be regulated, that there would not be 
meaningful differences such that one set of exchanges would 
have an advantage over the other. And that is actually 
something that we need to keep in mind as we work on this 
agreement and as you consider the legislation.
    Mr. Parkinson. One obvious point, the H.R. 4541 allows 
single-stock futures to be traded on futures exchanges, but 
does not permit securities exchanges to trade them, so that 
obviously is a severe competitive imbalance. I think we have 
urged, and I believe Bob has urged, that as this legislation 
moves forward, it should be modified so if we have trading of 
single-stock futures, as everyone is urging, that stock 
exchanges and futures exchanges be able to compete in listing 
the products.
    Mr. Fossella. Thank you, Mr. Chairman.
    Mr. Oxley. The gentleman's time has expired. The gentleman 
from New York, Mr. Towns.
    Mr. Towns. Mr. Chairman, I am certain that every question 
has been asked and every answer has been given. I think that 
what I would basically say is that I look forward to working 
with you to try and resolve some of the problems that exist, 
and I think that working together we can come up with a 
solution and be able to move something forward.
    I think that the time to do it is now. We don't have a big 
turnaround time, but the point is if we work hard in some of 
the areas, I think we can come up with a compromise. I look 
forward to working with you and of course, Mr. Chairman, 
working with you and trying to resolve those issues to be able 
to move this legislation forward.
    On that note I yield back the balance of my time.
    Mr. Oxley. I thank the gentleman for his comments. Indeed, 
I share them as well. We want to thank all of you. This 
committee does not want to stand in the way of the SEC and the 
CFTC meeting during this critical period of time. In that 
regard I would ask unanimous consent that all opening 
statements be made part of the record and the subcommittee 
stands adjourned.
    [Whereupon, at 12:57 p.m., the subcommittee was adjourned.]
    [Additional material submitted for the record follows:]
      Prepared Statement of Board of Trade of the City of Chicago
    The Chicago Board of Trade is pleased to submit for the record this 
testimony on H.R. 4541. We strongly endorse this vital legislation. We 
appreciate this Subcommittee's interest in the issues addressed in H.R. 
4541 and welcome the opportunity to summarize for you our views on the 
legislation.
    All commerce involves price risk. Futures markets help to address 
that price risk by offering a vehicle for shifting those risks to 
others or identifying a going market rate. For many decades, 
agricultural futures contracts traded on U.S. futures exchanges were 
the only organized, centralized markets for managing price risk. Since 
1975, that list of commodities has expanded to include precious metals, 
petroleum products, foreign currency and interest rates. In 1982, the 
list was expanded again to include stock indexes like the Dow Jones 
Industrial Average. All of those markets are regulated under the 
Commodity Exchange Act, a statute administered since 1975 by the 
Commodity Futures Trading Commission.
    In the last fifteen years this landscape has changed. Financial 
engineers on Wall Street have invented swaps and other derivatives to 
replicate the risk-shifting benefits of futures trading. Swaps have 
become enormously popular and profitable, offering tailored, customized 
risk-shifting service to most facets of our economy. Swaps are traded 
on interest rates, currency rates, commodity prices and equity 
securities. Today, swaps are even offered in more standardized versions 
on electronic trading platforms. And, swap transactions are not subject 
to any form of regulation that even approaches the regulation of 
futures or securities markets.
    This development triggered or exacerbated three problems.
    First, the Commodity Exchange Act covers all futures contracts. All 
futures must be traded on CFTC-regulated exchanges, absent an 
exemption. If a swap is a futures contract, it is illegal and voidable 
by either party to the transaction. As a result, swaps today are said 
to operate under a cloud of legal uncertainty caused by the perceived 
lack of specificity in the Commodity Exchange Act's coverage.
    Second, as the President's Working Group observed last year, the 
development and maturation of the swaps market has blurred many of the 
traditional ways that swaps were distinguished from futures contracts. 
Since swaps are largely unregulated and futures are heavily regulated, 
the Working Group unanimously agreed that something should be done to 
rectify that competitive disparity without imposing additional burdens 
on swaps.
    Third, despite the current legal uncertainty, equity swaps are 
being offered on single equity securities. In 1982, however, Congress 
adopted what is known as the Shad-Johnson Accord and imposed what it 
thought was a ``temporary'' moratorium on trading in futures on single 
equity securities. (The moratorium was to be temporary while the SEC 
and CFTC figured out the best way to regulate single stock futures. 
Congress is still awaiting that joint recommendation some 18 years 
later.) If equity swaps are futures, they too are subject to that 
``temporary'' ban. If swaps are not futures, then the futures exchanges 
simply need to start offering equity swaps to avoid the ban. Since 
figuring out what transactions are futures and what transactions are 
not has stymied Congress, the courts and commentators for many years, 
the President's Working Group recommended last year finding a way to 
simply lift the ban while addressing any major market integrity issues.
    H.R. 4541 attempts to resolve each of these three challenges. It 
does so by promoting fair competition to strengthen U.S. markets while 
minimizing, but not eliminating, regulatory arbitrage. It treats the 
competitive interests of the swaps dealers, futures exchanges and 
options exchanges in a fair and even-handed manner. It recognizes and 
tries to anticipate the role of technology in the markets of the 
future. And it preserves important public and market integrity 
protections. H.R. 4541 is comprehensive, balanced and responsible.
    First, H.R. 4541 attempts to address the legal uncertainty issue by 
creating bright-line tests defining what transactions are subject to 
the CEA and what are not. The lines drawn are basically adapted from 
last year's President's Working Group Report. Any transactions in 
financial commodities, called excluded commodities, not on a physical 
trading facility are excluded from the CEA unless they involve a retail 
customer. Special rules apply to these transactions when traded on 
electronic trading facilities. In that context, the CEA does not apply 
to trades that meet two tests: trades must be principal to principal 
(not on behalf of customers) and limited only to sophisticated 
counterparties or institutions. Excluded transactions may be subject to 
clearing arrangements and still be excluded from regulation.
    As a result of these provisions, many futures contracts traded 
today on CFTC-regulated exchanges, including futures on currencies, 
Eurodollars and stock indexes, could be offered without any form of 
regulation, even if traded on the same centralized electronic systems 
the futures exchanges use. This regulatory arbitrage is even more 
pronounced when one considers that over 95% of the market participants 
in exchange-traded futures today are the same professional, 
sophisticated counter-parties that are eligible to trade in the 
excluded futures. The net result of these provisions: same contracts, 
same customers, same trading system, but very different regulatory 
treatment.
    H.R. 4541's second prong attempts to minimize this regulatory 
arbitrage by modernizing the regulatory burdens imposed on exchanges. 
Instead of current law's innumerable rigid mandates that promote 
government micromanagement, H.R. 4541 requires exchanges to meet 
flexible performance standards, subject to the CFTC's oversight, in 
order to discharge their self-regulatory obligations. Exchanges could 
tailor their systems for compliance with specific self-regulatory 
requirements to the needs of different markets, rather than the current 
``one size fits all'' brand of regulation. On balance, the message of 
H.R. 4541 to the futures exchanges is this--Congress will not shackle 
your over-the-counter competition; it wants you to compete with them 
and is willing to give you many of the tools you believe you need to 
compete effectively on a fair, if not completely level, playing field.
    The third prong of H.R. 4541 involves a similar message in the area 
of equity-based derivatives. The 1982 ban on single stock futures would 
be lifted subject to special regulatory requirements that are designed 
to accommodate the areas of concern expressed by the Securities and 
Exchange Commission, and others. Specifically, single stock futures 
must be: 1) cash-settled; 2) not susceptible to manipulation; 3) traded 
at margin levels that are consistent with stock options margins; 4) 
traded only on stocks that meet SEC eligibility requirements for stock 
options; 5) traded without dual trading brokers; and 6) offered only on 
exchanges that agree to provide the SEC such information as the SEC and 
CFTC jointly consider to be necessary for the SEC to carry out its 
enforcement powers. Under those enforcement powers, the SEC is free to 
bring actions to enforce core securities law protections in connection 
with single stock futures trading: insider trading, short swing 
profits, manipulation, front-running, tender offer pricing and 
integrity and trading in restricted securities. The SEC would be able 
to bring these actions unilaterally without seeking cooperation or 
concurrence from the CFTC.
    In addition, margins for single stock futures would ultimately be 
set and supervised by the Federal Reserve Board or an Intermarket 
Margin Board where the SEC and CFTC would have an equal voice. And the 
futures industry-wide self-regulatory body, the National Futures 
Association, would adopt and enforce a special suitability rule for any 
futures professional that recommended a single stock futures trade to a 
customer. NFA must consult with the SEC and CFTC, and obtain CFTC 
approval of this rule, within 9 months of the date of enactment.
    H.R. 4541 responds to the three critical issues that the General 
Accounting Office, in its April 2000 report, identified for single 
stock futures--insider trading, margin and suitability--by, in effect, 
incorporating securities law concepts into the futures regulatory 
apparatus. Through these special provisions, H.R. 4541 addresses the 
major areas of possible regulatory arbitrage between futures exchanges 
and options exchanges. As in the area of off-exchange and on-exchange 
futures trading described earlier, the bill minimizes, but does not 
eliminate entirely, regulatory arbitrage. Instead, H.R. 4541 promotes 
competition by finally allowing the futures exchanges to offer equity-
based derivatives that swaps dealers and options exchanges now may 
offer in other guises.
    Mr. Chairman, many observers believe that U.S futures exchanges are 
falling behind their competition both overseas and over-the-counter. 
Today, the Swiss-German electronic exchange, called EUREX, has replaced 
the Chicago Board of Trade as the futures exchange with the highest 
trading volume. To address these threats, the Board of Trade is 
restructuring and reorganizing its business operations to maximize our 
chances of capturing the benefits of new technology and innovations. We 
know we are in for a fight and we are willing to compete. Rationalizing 
regulation and removing competitive barriers imposed by statute, as 
contemplated by H.R. 4541, are critical elements in our competitive 
battle.
    For these reasons, the Chicago Board of Trade strongly endorses 
H.R. 4541. It tackles the difficult challenges of modern markets in a 
pro-competitive manner without sacrificing important regulatory 
interests. We urge you to join the House Agriculture Committee by 
giving H.R. 4541 favorable treatment in this Subcommittee and the Full 
Committee. We look forward to working with you as your deliberations 
progress.
                                 ______
                                 
   Prepared Statement of Scott Gordon, Chairman, Board of Directors, 
                      Chicago Mercantile Exchange
    Chairman Oxley, members of the Subcommittee, I am Scott Gordon, 
Chairman of the Board of Directors of the Chicago Mercantile Exchange 
(CME). The CME welcomes the opportunity to provide this testimony for 
the record. More than a year ago, on May 19, 1999, the Exchange 
appeared before the Risk Management Subcommittee of the Agriculture 
Committee to offer its view of the reauthorization process and the 
important issues facing the industry and the Commission. Even at that 
early stage of the process, the CME and the Chicago Board of Trade had 
taken the lead and proposed a legislative framework for rationalizing 
the regulation of derivatives markets.
    The CME and CBOT were joined by the New York Mercantile Exchange in 
our effort to craft amendments to the Commodity Exchange Act to enhance 
competition and customer opportunity. We proposed five principles and a 
long list of detailed proposals. We proposed a means to rationalize the 
CEA and to restore internal consistency in concert with sound public 
policy. Within our framework, each segment of the industry, other than 
securities exchanges, which seek protection from legitimate 
competition, got exactly what it had been publicly seeking. Our 
proposal went farther than the OTC request for codification of the 
swaps exemption. We proposed that swaps could be cleared without losing 
their exemption. We were diligently following advice of congressional 
leaders that we needed to gain sufficient support from the derivatives 
industry to ensure passage of much needed reform legislation. We 
proposed a five-part plan:

 Convert the CFTC to an oversight agency
 Reform the artificial competitive constraints imposed by the 
        Shad/Johnson Accord
 Expand access to futures markets
 Provide legal certainty to OTC markets
 Level the regulatory playing field
    Since that testimony, most of the participants and regulators in 
the financial services industry have worked in good faith to find a 
compromise proposal. The President's Working Group on Financial Markets 
issued an extensive report. On February 28, 2000, the Department of the 
Treasury submitted a draft amendment to the Commodity Exchange Act that 
embodies the recommendations of the PWG.
    Chairman Ewing held extensive hearings, listened to all views and 
concluded that the time is ripe to alleviate the excessive regulatory 
burdens that have greatly disadvantaged U.S. futures exchanges in 
comparison to their global competition. Chairman Ewing sought a 
consensus-driven solution that balanced the interests of all 
participants in the financial services industry.
    This intensive effort by Chairman Ewing and the staff of his 
Subcommittee produced the bill that is the subject of today's hearing. 
We are on record praising H.R.4541 as providing a significant reform of 
financial services regulation and creating a more equitable regulatory 
environment for futures exchanges. By providing a comprehensive 
approach to the inter-related goals of modernizing exchange regulation, 
reforming Shad-Johnson and establishing legal certainty for the OTC 
market, this bill appropriately balances the interests of all 
participants in the financial services industry while promoting the 
public interest.
    We strongly support Chairman Ewing's proposal to reform the Shad/
Johnson Accord. Eighteen years ago, the Shad-Johnson Accord resolved a 
jurisdictional conflict between the SEC and the CFTC. It included a 
temporary ban on most equity futures contracts. It was not intended as 
a permanent barrier to innovation and growth. Futures exchanges were 
able to develop broad based stock index futures under Shad/Johnson. 
Those products have matured into vital financial management tools that 
enable pension funds, investment companies and others to manage their 
risk of adverse stock price movements.
    The CME's long standing goal is freedom to list and trade futures 
contracts now forbidden by the Shad/Johnson Accord without being 
subjected to multiple regulators and without changing the principles 
upon which futures trading has been conducted for more than 100 years. 
Remember, we created a tremendously useful product, equity indexes, in 
the face of overwhelming opposition. The SEC and its exchanges opposed 
futures on indexes with all of the same arguments that they now raise 
against futures on individual securities. Nonetheless, equity indexes 
are among the most popular contracts on securities exchanges as well as 
futures exchanges. Futures trading of equity indexes has enhanced 
customer opportunity with none of the ill consequences predicted by the 
SEC or securities exchanges. In fact, their business has directly 
benefited.
    The options markets and swaps dealers offer customers risk 
management tools and investment alternatives involving both sector 
indexes and single stock derivatives. Futures exchanges have been 
frozen out. Shad/Johnson's ``temporary'' ban lasted 18 years during 
which time single stock futures have thrived in the OTC market in the 
form of equity swaps and on option exchanges in the form of synthetic 
futures. Recently the President's Working Group, the General Accounting 
Office and congressional leaders have all called for an end to the ban.
    On December 17, 1999, Chairman Lugar (Senate Agriculture Committee) 
and Chairman Gramm (Senate Banking Committee) asked CFTC Chairmen 
Rainer and SEC Chairman Levitt for a ``detailed report addressing the 
desirability of lifting the current prohibition on single stock futures 
together with any legislative proposals . . . no later than February 
21, 2000.'' On January 20, 2000, Commerce Committee Chairman Bliley 
along with Chairmen Combest and Ewing asked the SEC and CFTC to create 
a ``joint legislative plan for repealing the current prohibition on 
single stock futures . . . no later than February 21, 2000.'' On March 
2d, Chairmen Levitt and Rainer responded by presenting ``the current 
views'' of the agencies, but failed to offer a specific legislative 
plan.
    Of course, we are pleased that the CFTC and SEC have agreed that it 
is appropriate that U.S. exchanges be permitted to compete in world 
markets and offer U.S. customers the opportunity to manage risks by 
means of equity futures contracts. We are also pleased that they have 
found a way to accommodate their jurisdictional and regulatory concerns 
on several important issues. But it is far too late in the game to be 
satisfied with signs of progress. We share Senator Lugar's 
``disappointment'' that the agencies were unable to resolve all of 
their jurisdictional concerns within the time frame requested.
    Today, Shad-Johnson is a bar to useful competition. The SEC invoked 
Shad-Johnson to bar futures on the Dow Jones Utilities and 
Transportation Averages--because that index did not ``reflect'' the 
utilities and transportation sectors. The United States Court of 
Appeals overturned and vacated that SEC decision, Board of Trade v. 
Securities and Exchange Commission, No. 98-2923 (7th Cir., August 10, 
1999). The court of appeals found: ``The stock exchanges prefer less 
competition; but if competition breaks out they prefer to trade the 
instruments themselves . . . The Securities and Exchange Commission, 
which regulates stock markets, has sided with its clients.'' Slip Op. 
at 4.
    Congress intended the Shad-Johnson ban on single stock futures to 
be temporary. The court of appeals found that the ban ``was a political 
compromise; no one has suggested an economic rationale for the 
distinction.'' Slip Op. at 4. In the absence of such a rationale, 
Congress should lift the single stock futures ban and allow the 
marketplace to decide whether these instruments would be useful new 
risk management tools. Many exchanges around the world trade single 
stock futures; no reason exists to deny U.S. customers and markets the 
same opportunity.
    H.R. 4541 will enact an appropriate division of responsibility 
between the SEC and CFTC for futures trading of contracts currently 
prohibited by the Shad/Johnson Accord. It protects the SEC's 
enforcement authority and forecloses avoidance of securities act 
proscriptions by means of futures contracts. It protects options 
exchanges from regulatory arbitrage arising out of disparate margin 
treatment. It serves the public interest in fair competition and access 
to new products. It imposes more restrictions on futures exchanges than 
we had hoped for but not so many that we will be unable to fairly test 
the market's appetite for new products
    Last year, the 106th Congress took dramatic action and modernized 
regulation of most financial services firms by adopting the Gramm-
Leach-Bliley Act. The consequences of excluding the derivatives 
industry from this progressive groundswell would be disastrous. We hope 
that Congress will act expeditiously on H.R. 4541 to ensure that 
complete financial regulatory reform becomes part of the legacy of this 
Congressional Session. We pledge to work diligently with members of the 
House to ensure that the all of the fundamental principles of this bill 
are enacted into law this year.
    Thank you again, Mr. Chairman, for the opportunity to include our 
written testimony in the record of this hearing.
                                 ______
                                 
          North American Securities Administrators 
                                  Association, Inc.
                                             Washington, DC
                                                      July 12, 2000
David Cavicke, Majority Counsel
2125 RHOB
Washington, DC 20515
    Dear Mr. Cavicke: The North American Securities Administrators 
Association (NASAA) \1\ appreciates the opportunity to provide comments 
on H.R. 4541, the Commodity Futures Modernization Act of 2000. We 
support your effort to modernize our futures laws and provide legal 
certainty for over-the-counter derivatives.
---------------------------------------------------------------------------
    \1\ The oldest international organization devoted to investor 
protection, NASAA was organized in 1919. Its membership consists of the 
securities administrators in the 50 states, the District of Columbia, 
Canada, Mexico and Puerto Rico. NASAA is the voice of securities 
agencies responsible for investor protection and efficient capital 
formation.
---------------------------------------------------------------------------
    NASAA also supports lifting the Shad-Johnson ban on single stock 
futures once the regulatory oversight concerns underlying the ban are 
addressed. Any regulatory framework must recognize the expertise of 
both the SEC and the CFTC in regulating these products and the unique 
enforcement role played by the 20-plus states that have adopted the 
Model Commodity Code. Both federal agencies and state securities 
agencies must have the authority to carry out their core functions; 
there should be no barriers in their efforts to curtail fraud and 
manipulation.
    In 1974, Congress preempted state securities agencies from applying 
their laws, including enforcement, to persons and transactions within 
the Jurisdiction of the Commodity Exchange Act (CEA). Not long after, 
there was a proliferation of off-exchange commodities fraud. In 1978, 
Congress passed Section 6(d) of the CEA to provide the states with the 
authority to enforce state laws of general criminal application and 
allowed the states to enforce the CEA in federal court.
    It would be unwise at this time to move ahead with legislation that 
lacks the elements necessary to ensure the market integrity and 
customer protections that investors have come to expect under the 
securities laws.
    It is important to recognize that single stock futures will be a 
substitute for stocks and stock options and be sold as a retail 
product. While complex derivatives are sold mostly to institutional 
customers, futures on a single stock are the type of product that will 
be attractive to the retail investing public. Single stock futures must 
be offered to retail investors with the same protections afforded to 
those who now buy stocks and stock options. Americans are investing in 
our capital markets in record numbers due largely to confidence in the 
markets instilled by our complementary Federal/state/industry system of 
regulation.
    Any legislation to lift the current ban on single stock futures 
must maintain the SEC's ability to protect investors and to maintain 
integrity of the markets on which they trade. The SEC should have clear 
and direct authority over the markets and market participants trading 
single stock futures.
    SEC and CFTC Chairmen Arthur Levitt and Bill Rainer have made 
considerable progress toward reaching agreement on a regulatory regime 
for single stock futures. They should be given sufficient time to 
finalize the details of a plan to share regulation of single stock 
futures so each agency can utilize its expertise and create a framework 
that allows for effective and efficient joint regulation of these 
products.
    NASAA appreciates the efforts of your Subcommittee to consider H.R. 
4541 under a limited time frame. We urge you to amend the current 
version of the legislation and extend the protections of the securities 
laws to single stock and narrow-based stock index futures. American 
investors deserve no less.
    Please do not hesitate to contact me at 317-232-6695 or Deborah 
Fischione, NASAA's Director of Policy, at 202-737-0900.
            Sincerely,
                                       Bradley W. Skolnik  
                                  Indiana Securities Commissioner  
                                                    NASAA President
                                 ______
                                 
           Prepared Statement of The Bond Market Association
    The Bond Market Association is pleased to comment on H.R. 4541, the 
Commodity Futures Modernization Act of 2000. H.R. 4541 represents an 
important step in the regulatory reform of the markets for derivative 
financial products. The bill includes a number of proposals designed to 
streamline the regulatory environment for derivatives, and clarify 
several important areas of legal uncertainty which result in undue 
systemic risk. For these reasons, we commend Chairman Oxley for 
focusing the subcommittee's attention on H.R. 4541 and we support these 
aspects of the bill.
    Reauthorization of the Commodity Exchange Act (CEA) presents an 
opportunity to clarify the regulation of certain financial products and 
to eliminate any misconception regarding the scope of authority 
provided under the CEA. We concur with the widely held belief that 
swaps are inappropriately regulated as futures, and we believe that the 
CEA should codify the principle that swaps should not be regulated as 
futures by the Commodity Futures Trading Commission (CFTC). Such 
clarification would mitigate legal risk for market participants and 
would help maintain over-the-counter markets as viable alternatives to 
traditional, organized exchanges. It would also help avoid duplicative 
and unnecessary regulation. Congress has the opportunity through the 
CEA reauthorization to help assure that the capital markets can 
continue to operate as efficiently as possible.
    The Bond Market Association represents securities firms and banks 
that underwrite, trade and sell fixed-income securities in the U.S. and 
international markets. Our interests in H.R. 4541 relate to how the 
bill would affect the efficient operation and regulation of the markets 
for bonds and other fixed-income securities and related instruments, 
and our comments will focus on just those aspects of the bill.
The Financial Markets and the CEA
    As the Subcommittee is aware, the financial markets have grown 
increasingly complex in recent years. Issuers of securities and other 
market participants have become accustomed to having a wide array of 
products available to meet very specific financing and hedging needs. 
Unfortunately, the United States regulatory system has not kept pace 
with the evolution of the marketplace. Issuers, underwriters and 
dealers now find themselves laboring to decipher a web of overlapping 
and often contradictory statutes and regulations that reduce efficiency 
and increase costs. Of particular concern is the potential for private 
parties to exploit ambiguities in the CEA to abandon responsibility for 
otherwise enforceable contracts--even if there is no fraud or bad 
faith--by alleging that a transaction is an illegal off-exchange 
futures transaction. We know that this subcommittee, regulators and 
participants in these markets have an interest in ensuring the finality 
of financial contracts and thereby reducing potential risks to the 
financial system as a whole, and we commend Chairman Oxley for 
exploring ways to improve and update the Commodity Exchange Act.
    The Association takes an active interest in promoting and ensuring 
safe and efficient bond markets that allow governmental entities and 
corporations to raise debt capital at the lowest possible cost. Toward 
that end, the basic policy positions we seek to advance as Congress and 
the regulatory agencies deal with issues surrounding the CEA are:

 preserving the finality and enforceability of contracts freely 
        negotiated between market participants;
 maintaining the OTC markets as a viable alternative to 
        traditional organized exchanges; and
 avoiding duplicative or unnecessary government regulation in 
        the trading and clearance of debt instruments.
    Consistent with the above principles, we offer the following 
summary of our views on certain issues that are integral to the current 
discussion of CEA reauthorization. The Association:

 supports provisions of the bill which would reaffirm and 
        clarify the Treasury Amendment and recommends an additional 
        change;
 supports the goals of other provisions of H.R. 4541 designed 
        to provide ``legal certainty'' for over-the-counter 
        derivatives; and
 supports provisions of the bill related to derivatives 
        clearing organizations;
 urges the adoption of legislation to reduce systemic risk in 
        the financial markets by reforming bankruptcy and insolvency 
        law to clarify and enhance the ability to close-out and net 
        financial contracts.
Treasury Amendment
    The market for government securities is well regulated under a 
structure tailored to the unique qualities of the market. Under 
authority provided by the Government Securities Act of 1986 and 
subsequent 1993 amendments, the Treasury Department is a principal 
rulemaker for the government securities market. The Treasury 
Department, in consultation with other regulators, has published 
detailed rules regarding large position reporting and record-keeping. 
The National Association of Securities Dealers and bank regulators have 
published rules regarding sales practices. The SEC has broad authority 
to enforce antifraud statutes on government securities market 
participants. The CFTC and the organized exchanges, of course, regulate 
activity related to transactions in listed futures contracts on 
government securities. This balanced arrangement ensures that the 
government securities market remains safe and well-regulated in 
addition to serving as a model of market efficiency.
    Efficient and sound regulation of the government securities market 
is important because it helps ensure that taxpayers pay the lowest 
possible interest cost on the government's borrowing and that other 
U.S. borrowers whose debt is priced relative to Treasury securities--
corporations, financial institutions, homebuyers, consumers and 
others--also enjoy efficiently determined borrowing costs. There are 
approximately $3.1 trillion of marketable Treasury securities 
outstanding, and over $200 billion of Treasury securities change hands 
every day. Any undue risk or uncertainty regarding the market's 
regulatory structure can have significant effects on the government's 
interest cost and the interest rates faced by other borrowers.
    When the CEA was first enacted in 1974, Congress included a 
provision precluding the CFTC from regulating ``transactions in foreign 
currency, security warrants, security rights, resales of installment 
loan contracts, repurchase options, government securities, or mortgages 
and mortgage purchase commitments, unless such transactions involve the 
sale thereof for future delivery conducted on a board of trade.'' This 
provision has become known as ``the Treasury Amendment.'' The Treasury 
Amendment is important because it helps prevent duplicative or 
conflicting regulation.
    Despite the plain meaning of existing statutory language, the 
Treasury Amendment does not explicitly address questions regarding the 
regulation of financial products which involve government securities. 
These include, for example, instruments such as repurchase agreements, 
swap contracts and forward delivery contracts. This issue was 
addressed, albeit indirectly, by the U.S. Supreme Court in its 1997 
decision in Dunn v. CFTC, where the Court generally held that 
``transactions in'' foreign currency encompass all transactions 
relating to foreign currency. Market participants nevertheless widely 
believe that the same standard applies to other financial products 
covered under the Treasury Amendment, including government securities.
    H.R. 4541 would generally maintain the current structure of the 
Treasury Amendment. The bill would specify that the CEA does not apply 
to transactions in government securities, foreign currency, security 
warrants, security rights, resales of installment loan contracts, 
repurchase transactions in a financial commodity--a particularly 
important and welcome clarification--or mortgages or mortgage purchase 
commitments. Futures contracts related to these products traded on an 
``organized exchange'' would still be subject to CFTC regulation under 
the bill. The bill retains existing statutory language, implying 
Congress' intent to embrace the Supreme Court's interpretation of such 
language. However, H.R. 4541 would not expressly codify the Supreme 
Court's interpretation of existing law regarding financial products 
involving the enumerated instruments. We, therefore, suggest amending 
H.R. 4541 to fully clarify the scope of the Treasury Amendment 
provisions and address any remaining legal uncertainty regarding the 
scope of the Treasury Amendment's applicability. In particular, we 
suggest adding language to Section 4 of the bill specifying that the 
Treasury amendment exclusions apply to transactions ``in or in any way 
involving'' the specified instruments.
Organized Exchanges
    H.R. 4541 would also clarify the applicability of the Treasury 
Amendment by specifying an exception to the general exclusion for 
contracts traded on an ``organized exchange.'' Current law provides an 
exception to the Treasury Amendment for contracts traded on a ``board 
of trade.'' The definition of ``board of trade'' is somewhat vague with 
respect to both evolving electronic trading systems and the roles of 
certain traditional market participants such as inter-dealer brokers. 
If ``board of trade'' was defined under current law to include 
electronic trading facilities or situations where market participants 
conduct transactions in a screen-based format and settle them through 
an independent clearing mechanism, significant market disruption would 
result. In particular, such a definition would subject already 
regulated markets to a duplicative layer of government regulation.
    We support the clarification of the Treasury Amendment exclusion 
from the CEA through the ``organized exchange'' exception. The bill as 
introduced, however, included a vague definition of organized exchange 
that would have required that transactions take place on a ``bona fide 
principal-to-principal basis,'' calling into question the applicability 
of the exception to traditional ``back-to-back'' principal 
transactions. The Agriculture Committee during its deliberations on 
H.R. 4541 clarified the definition of organized exchange by eliminating 
the confusing term ``bona fide.'' We strongly support this change and 
we urge that it be retained in the legislation.
Legal Certainty for OTC Derivatives
    Under current law, the CEA effectively gives a party the right to 
rescind a contract if the party is successful in its allegations that 
the transaction was actually an illegal, off-exchange futures contract. 
Under the CEA, over-the-counter commodity futures transactions are per 
se illegal unless they are excluded by the Treasury Amendment or some 
other exclusion or exemption. Private parties have taken the position 
that such transactions are subject to rescission. This harsh 
consequence of voiding a contract is particularly troublesome in light 
of the difficult questions associated with defining a future versus a 
forward transaction. We believe the financial markets should not be 
subject to the risks posed by the ability to abandon contract 
obligations when the CEA status of a financial transaction is 
challenged. H.R. 4541 includes two key provisions designed to address 
this problem.
    First, the bill would specify that financial contracts may not be 
rescinded ``solely on the failure of the agreement, contract, or 
transaction to comply with the terms or conditions of an exemption or 
exclusion from any provision of this Act or regulations of the 
Commission.'' Second, the bill would specify that the CEA does not 
apply to over-the-counter derivative contracts entered into between 
``eligible contract participants'' which are not conducted on a 
``trading facility'' other than an ``electronic trading facility.'' 
Together, these two provisions represent a major step towards 
addressing the question of the ``legal certainty'' of over-the-counter 
derivative contracts, a goal which we fully support.
Clearing Organizations
    The process of clearing securities and derivatives transactions is 
vital to the efficient operation of the capital markets. Efficient 
clearing reduces risks and costs and makes possible the smooth 
operation of the markets. Following a transaction, both parties submit 
the details of the transaction to a clearing organization. The clearing 
organization compares the transaction--ensures that details submitted 
by both parties are identical--and, once compared, usually guarantees 
the transaction in the unlikely event that one party becomes insolvent 
before the transaction settles. Clearing organizations also net 
outstanding transactions of individual participants in order to 
minimize separate payments for offsetting trades or positions, and 
monitor margins or collateral required to be held against net 
positions.
    H.R. 4541 includes a provision designed to streamline the 
regulation of derivatives clearing organizations. Specifically, Section 
14 of the bill would generally make it unlawful for derivatives 
clearing organizations to operate unless registered with the CFTC. In 
order to prevent duplicative levels of regulation, the bill provides an 
exemption from this requirement for clearing organizations which are 
regulated by the SEC, a federal bank regulator or a foreign regulatory 
body. This exemption is critical in helping to ensure that clearing 
organizations are not subject to superfluous, conflicting, multiple 
levels of regulation. For this reason, we support the exemption.
    The bill as introduced contained a provision which would have 
mandated CFTC regulation for clearing organizations which clear 
futures, options on futures or options on commodities which are not 
securities regardless of the above exception. However, during its 
deliberations, the House Agriculture Committee included an exemption 
from this requirement for clearing organizations that clear instruments 
or transactions which are generally exempted from regulation under the 
CEA. The change adopted by the Agriculture Committee to Section 14 of 
the bill is extremely important in ensuring that clearing organizations 
that clear both securities and over-the-counter derivatives are not 
subject to multiple levels of regulation. We fully support the 
Agriculture Committee's changes, and we are hopeful that the 
committee's changes will remain in the bill.
Other Provisions of H.R. 4541
    In addition to the provisions cited above, The Bond Market 
Association offers these comments on other provisions of H.R. 4541:

 Shad-Johnson accord--Although presumably intended to permit 
        single-stock futures, the bill expressly would allow futures on 
        ``non-exempt securities,'' thereby permitting futures on single 
        debt instruments or on narrow debt indices. Key aspects of the 
        Shad-Johnson provisions in H.R. 4541 have apparently been 
        drafted to apply specifically to stock futures and in some 
        cases are inconsistent with the way the debt markets operate. 
        They could result in confusion and uncertainty if applied to 
        futures on single debt instruments. The subcommittee may wish 
        to review the Shad-Johnson provisions of the bill to ensure 
        their consistency with debt market operations and with other 
        provisions of the law. We would be happy to consult with 
        subcommittee members on this issue if requested.
 Bankruptcy--Although not part of H.R. 4541, the report of the 
        President's Working Group on the Financial Markets on financial 
        derivatives recommended the adoption of changes to the 
        Bankruptcy Code and banking law designed to reduce systemic 
        risk. The Working Group's recommendations would streamline the 
        process by which financial contracts can be netted and resolved 
        in cases of bankruptcy or insolvency. We support these 
        provisions and urge that they be enacted.
Summary
    In recent years, we have seen a rapid acceleration in the 
development of new and sophisticated financial products designed to 
mitigate risk, reduce costs and enhance efficiency. Unfortunately, the 
evolution of our regulatory structure for financial derivatives has 
lagged behind the evolution of the markets themselves. It is 
appropriate, therefore, for Congress to address the uncertainty and 
risk which has arisen as a result of a system of regulation which never 
anticipated the market we have today.
    The Bond Market Association supports provisions in H.R. 4541 
designed to enhance and clarify the Treasury Amendment. We also 
recommend an additional change to the Treasury Amendment to clarify the 
treatment of products involving excluded transactions. We also support 
the goal of key provisions of the bill to provide legal certainty with 
respect to the regulation of over-the-counter derivatives. In addition, 
we support provisions in the bill adopted during Agriculture Committee 
deliberations designed to prevent the duplicative regulation of 
clearing organizations. We raise questions regarding the application of 
the Shad-Johnson provisions to single-debt futures, and we urge the 
adoption of bankruptcy and insolvency legislation designed to reduce 
systemic risk in the financial markets.
    We appreciate the opportunity to present our views on H.R. 4541. We 
commend Chairman Oxley and other members of the subcommittee for their 
quick action on these important issues, and we look forward to working 
with subcommittee members and staff as the legislative process moves 
forward.
                                 ______
                                 
                             Federal Reserve System
                                         Board of Governors
                                                      July 19, 2000
The Honorable Tom Bliley
Chairman
Committee on Commerce
House of Representatives
Washington, D.C. 20515
    Dear Mr. Chairman: Enclosed are my responses to your additional 
questions concerning H.R. 4541, the Commodity Futures Modernization Act 
of 2000.
    Please let me know if I can be of further assistance.
            Sincerely,
                                       Patrick M. Parkinson
            Associate Director, Division of Research and Statistics
Enclosure
              Follow-up Questions for Patrick M. Parkinson
    Question 1. I Would an alternative approach to providing legal 
certainty under which futures were defined as contracts on enumerated 
agricultural products and any other derivatives product traded on a 
futures contract market provide greater legal certainty than the 
approach in H.R. 4541? Would the Fed support such an approach?
    Answer 1. Yes. Such an approach would provide greater legal 
certainty. But the approach would need to be supplemented with 
provisions to address public policy concerns about fraud and 
manipulation for those transactions that would be excluded from the CEA 
under this alternative approach but not under the working group's 
approach. Whether the Fed would support such an alternative approach 
would depend on how those concerns are addressed.
    Question 2. Do the margin provisions in the bill adequately address 
concerns about consistent margins on single stock futures and options?
    Answer 2. Yes. They empower the Federal Reserve to ensure that 
margins are consistent and make clear what is meant by consistency. 
However, the language clarifying what is meant by consistency should be 
moved from Section 8(g)(7)(D)(ii) to Section 8(g)(4)(B)(v).
    Question 3. Futures trading on a futures exchange could be 
regulated in one of two ways: (1) as securities with SEC exemptions 
from non-core provisions or (2) as futures with only core securities 
provisions applying. Which structure does the Fed support?
    Answer 3. The Federal Reserve does not have a position on this 
issue.
    Question 4. Do you support the creation of the intermarket margin 
board as provided in the bill?
    Answer 4. Yes. As I said in my testimony, the Board is willing to 
accept regulatory authority over levels of margin on single-stock 
futures, so long as the Board can delegate that authority to the CFTC, 
the SEC, or an Intermarket Margin Board.
    Question 5. Do you support enacting the legal certainty portions of 
the bill without removing the ban on single stock futures? Under this 
scenario will legal uncertainty still exist for OTC derivatives in 
securities based transactions.
    Answer 5. Yes. We support enacting the legal certainty provisions 
of the bill, even if the ban on single-stock futures is not removed. We 
would, however, prefer a comprehensive bill that allows U.S. investors 
to trade single-stock futures.
    Under this scenario, legal certainty would still exist with respect 
to the enforceability of securities-based swaps between eligible 
participants. However, legal uncertainty would still exist on the 
question of whether securities-based swaps are subject to the 
securities laws.
    Question 6. Do the clearing provisions in the bill place futures 
clearing systems at a competitive disadvantage to securities clearing 
systems?
    Answer 6. Yes. An SEC registered clearing organization could clear 
both securities and securities-based derivatives, whereas a CFTC-
registered clearing organization could not. As a practical matter, this 
would allow an SEC clearing organization to offer lower margins on 
securities-based derivatives when those positions were hedged with 
securities, as they often are. Other things equal, this would place 
CFTC-registered clearing systems at a competitive disadvantage.
    Question 7. Are futures exchange's ``know your customer rules'' and 
``risk acknowledgment'' sufficient substitutions for suitability rules?
    Answer 7. I have not studied these rules closely enough to permit 
me to answer this question with any confidence.
    Question 8. To what extent, if any, does the CFTC's regulatory 
relief proposal reduce the need for legislation?
    Answer 8. The CFTC's regulatory relief proposal is no substitute 
for legislation. It does not address the most serious legal certainty 
issue--the enforceability of securities-based swaps.
    Question 9. The Working Group report concludes that electronic 
trading systems should be permitted to develop unburdened by an 
anticipatory regulatory framework? How does H.R. 4541 achieve, or fail 
to achieve, this result?
    Answer 9. H.R. 4541 achieves this for electronic trading systems 
for financial derivatives. For non-financial derivatives (other than 
derivatives based on agricultural commodities and metals), it leaves 
some burdens (statutory prohibitions of fraud and manipulation, 
possibly CFTC rules and regulations relating to data dissemination) but 
frees such systems from the kinds of burdens that would most concern 
the PWG and market participants. For electronic trading systems for 
agricultural and metals derivatives, achievement of a result consistent 
with the Working Group's conclusion would depend on CFTC regulatory 
exemptions for such systems.
                                 ______
                                 
                                 Department of the Treasury
                                                     August 8, 2000
The Honorable Thomas J. Bliley
Chairman, Committee on Commerce
U.S. House of Representatives
Washington, D.C. 20515-6115
    Dear Chairman Bliley: I am pleased to enclose responses to your 
questions submitted following the July 11, 2000 hearing held by the 
Subcommittee on Finance and Hazardous Waste on H.R. 4541, ``The 
Commodity Futures Modernization Act of 2000.''
    Question 1: In your testimony you state that certain aspects of the 
regulatory relief may be more appropriately addressed through rule 
making than legislation. With which provisions of the bill are you 
particularly concerned?
    Answer 1: The Treasury Department continues to support the view 
that it is appropriate to periodically review existing regulatory 
structures to determine whether they continue to serve valid public 
policy and regulatory functions. We are concerned, however, that there 
may be unforeseen consequences to legislating such regulatory relief as 
is contained in sections 12, 13, 14, 15, 16, 17, and 21 of H.R. 4541. 
Once codified, regulators will no longer have the flexibility to review 
and amend provisions when market developments necessitate change or 
problems arise. Such aspects of regulatory relief may be more 
appropriately provided through administrative action. However, if 
Congress legislates regulatory relief, it is important that the 
language is drafted carefully to ensure that futures on government 
securities are not excluded from most of the provisions of the CEA that 
currently apply, as well as from regulation under the securities laws, 
in a manner that would undermine the regulatory framework for the 
government securities market established by the Government Securities 
Act in 1986.
    Question 2: Do you support the creation of the intermarket margin 
board as provided in the bill?
    Answer 2: The Treasury Department generally supports the provisions 
in section 8 of H.R. 4541 to create an intermarket margin board, 
comprised of the Board of Governors of the Federal Reserve System 
(``Fed''), Securities and Exchange Commission (``SEC''), and Commodity 
Futures Trading Commission (``CFTC''), to set and maintain margin 
levels for single stock and narrow-based stock index futures. We concur 
that such a board should endeavor to harmonize margin levels on single 
stock futures and options, taking into consideration material 
differences in contract size, price volatility, mark-to-market 
frequency, and the period of time within which margin calls must be 
met. This provision should not supersede or limit the emergency powers 
of the CFTC contained in Sec. 8a(9) of the Commodity Exchange Act 
(``CEA'') regarding establishment of temporary emergency margin levels.
    Question 3: Do you support enacting the legal certainty portions of 
the bill without removing the ban on single stock futures? Under this 
scenario will legal uncertainty still exist for OTC derivatives in 
security-based transactions?
    Answer 3: The Working Group report recommended that legal certainty 
for swap transactions be provided and that the prohibition against 
single stock futures could be repealed if integrity and regulatory 
arbitrage issues could be resolved. However, the recommendations were 
not contingent upon each other. The Treasury Department has been 
working diligently with the CFTC and SEC to resolve Issues related to 
the Shad-Johnson Accord prohibition against single stock futures. We 
support enacting the legal certainty portions of the legislation as 
soon as possible. Failure to clarify and resolve the legal certainty 
issue could result in a situation which the existing legal framework 
for U.S. financial markets significantly lags developments and 
innovations in those markets.
    If issues related to the Shad-Johnson Accord cannot be resolved on 
a timely basis, we believe it is imperative to advance the other 
provisions of H.R. 4541 designed to clarify legal certainty for OTC 
derivatives, provide for the development of appropriately-regulated 
clearinghouses, and protect retail customers from fraud and abuse in 
foreign exchange futures and futures-options transactions with 
unregulated/unaffiliated entities.
    With respect to legal certainty for securities-based OTC 
derivatives, because the legal certainty provisions of H.R. 4541, as 
reported by the House Agriculture Committee, would exclude such 
derivatives from the CEA, these provisions would eliminate the concern 
about their enforceability that exists under current law. The legal 
certainty provided to these instruments by sections 4, 5, 6, and 7 of 
H.R. 4541 is not dependent upon the removal of the ban on exchange-
traded futures on single securities or narrow indexes.
    Question 4: Do the clearing provisions in the bill place futures 
clearing systems at a competitive disadvantage to securities clearing 
systems?
    Answer 4: The Treasury Department believes that the clearing 
provisions in section 14 of the bill will create a level playing field 
for clearing systems. Futures clearing organizations will be able to 
clear exchange-traded futures, futures-options, and commodity options 
as well as non-security OTC derivative instruments. Securities clearing 
organizations will be able to clear exchange-traded and OTC securities 
transactions as well as OTC derivatives.
    Question 5: Are futures exchanges' ``know-your-customer rules'' and 
``risk acknowledgements'' sufficient substitutions for suitability 
rules?
    Answer 5: The CFTC and SEC currently are discussing customer 
suitability requirements for securities futures in the context of 
modifications to the Shad-Johnson Accord. The Treasury Department feels 
that it is appropriate that the CFTC and SEC should discuss and agree 
to the approach and specific requirements ultimately mandated with 
respect to these instruments. The Working Group stated that the current 
prohibition against single stock and narrow-based stock index futures 
could be repealed if such issues regarding the integrity of the 
underlying securities markets and regulatory arbitrage could be 
resolved, but preferred that the CFTC and SEC reach a mutually 
acceptable resolution. We recently have assumed a role in these 
discussions as a facilitator between the two agencies, and we support 
actions taken by Congress to urge progress in these discussions.
    Question 6: To what extent, if any, does the CFTC's regulatory 
relief proposal reduce the need for legislation?
    Answer 6: The Treasury Department believes that it is imperative to 
provide for legal certainty for OTC derivatives through legislation. 
The CFTC proposal to grant regulatory relief to the futures exchanges 
does not reduce the need for the other provisions of the bill to 
clarify legal certainty for OTC derivatives, provide for the 
development of appropriately-regulated clearinghouses, and protect 
retail customers from fraud and abuse in foreign exchange futures and 
futures-options transactions with unregulated unaffiliated entities.
    Question 7: The Working Group report concluded that electronic 
trading systems should be permitted to develop unburdened by an 
anticipatory, regulatory framework. How does H.R. 4541 achieve, or fail 
to achieve, this result?
    Answer 7: The Working Group recommended a broad exclusion from the 
CEA for electronic trading systems (``ETSs'') that limit trading to 
eligible participants trading on a principal-to-principal basis 
involving OTC financial commodities with non-finite supplies. The group 
felt that development of such systems should be encouraged by providing 
greater legal certainty, rather than burdening markets with a new 
anticipatory scheme of regulation that could inhibit innovation and 
prove to be inappropriate. Section 6 of H.R. 4541 amends the CEA to 
permit such ETSs consistent with the Working Group's recommendations.
    I hope this information is helpful to you and your staff. Please 
feel free to contact me if I can be of further assistance. We look 
forward to continuing to work with you.
            Sincerely,
                                                  Lee Sachs
                             Assistant Secretary, Financial Markets
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