[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]





                     HEARING TO REVIEW PROPOSALS TO
                  ESTABLISH EXCHANGES TRADING ``MOVIE
                               FUTURES''

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

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                        GENERAL FARM COMMODITIES
                          AND RISK MANAGEMENT

                                 OF THE

                        COMMITTEE ON AGRICULTURE
                        HOUSE OF REPRESENTATIVES

                     ONE HUNDRED ELEVENTH CONGRESS

                             SECOND SESSION

                               __________

                             APRIL 22, 2010

                               __________

                           Serial No. 111-49


          Printed for the use of the Committee on Agriculture
                         agriculture.house.gov



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                        COMMITTEE ON AGRICULTURE

                COLLIN C. PETERSON, Minnesota, Chairman

TIM HOLDEN, Pennsylvania,            FRANK D. LUCAS, Oklahoma, Ranking 
    Vice Chairman                    Minority Member
MIKE McINTYRE, North Carolina        BOB GOODLATTE, Virginia
LEONARD L. BOSWELL, Iowa             JERRY MORAN, Kansas
JOE BACA, California                 TIMOTHY V. JOHNSON, Illinois
DENNIS A. CARDOZA, California        SAM GRAVES, Missouri
DAVID SCOTT, Georgia                 MIKE ROGERS, Alabama
JIM MARSHALL, Georgia                STEVE KING, Iowa
STEPHANIE HERSETH SANDLIN, South     RANDY NEUGEBAUER, Texas
Dakota                               K. MICHAEL CONAWAY, Texas
HENRY CUELLAR, Texas                 JEFF FORTENBERRY, Nebraska
JIM COSTA, California                JEAN SCHMIDT, Ohio
BRAD ELLSWORTH, Indiana              ADRIAN SMITH, Nebraska
TIMOTHY J. WALZ, Minnesota           DAVID P. ROE, Tennessee
STEVE KAGEN, Wisconsin               BLAINE LUETKEMEYER, Missouri
KURT SCHRADER, Oregon                GLENN THOMPSON, Pennsylvania
DEBORAH L. HALVORSON, Illinois       BILL CASSIDY, Louisiana
KATHLEEN A. DAHLKEMPER,              CYNTHIA M. LUMMIS, Wyoming
Pennsylvania                         ------
BOBBY BRIGHT, Alabama
BETSY MARKEY, Colorado
FRANK KRATOVIL, Jr., Maryland
MARK H. SCHAUER, Michigan
LARRY KISSELL, North Carolina
JOHN A. BOCCIERI, Ohio
SCOTT MURPHY, New York
EARL POMEROY, North Dakota
TRAVIS W. CHILDERS, Mississippi
WALT MINNICK, Idaho
------

                                 ______

                           Professional Staff
                    Robert L. Larew, Chief of Staff
                     Andrew W. Baker, Chief Counsel
                 April Slayton, Communications Director
                 Nicole Scott, Minority Staff Director

                                 ______

      Subcommittee on General Farm Commodities and Risk Management

                   LEONARD L. BOSWELL, Iowa, Chairman

JIM MARSHALL, Georgia                JERRY MORAN, Kansas, Ranking 
BRAD ELLSWORTH, Indiana              Minority Member
TIMOTHY J. WALZ, Minnesota           TIMOTHY V. JOHNSON, Illinois
KURT SCHRADER, Oregon                SAM GRAVES, Missouri
STEPHANIE HERSETH SANDLIN, South     STEVE KING, Iowa
Dakota                               K. MICHAEL CONAWAY, Texas
BETSY MARKEY, Colorado               BLAINE LUETKEMEYER, Missouri
LARRY KISSELL, North Carolina        ------
DEBORAH L. HALVORSON, Illinois
EARL POMEROY, North Dakota
TRAVIS W. CHILDERS, Mississippi

                Aleta Botts, Subcommittee Staff Director

                                  (ii)













                             C O N T E N T S

                              ----------                              
                                                                   Page
Boswell, Hon. Leonard L., a Representative in Congress from Iowa, 
  opening statement..............................................     1
    Prepared statement...........................................     2
Moran, Hon. Jerry, a Representative in Congress from Kansas, 
  opening statement..............................................     2
    Prepared statement...........................................     3
Peterson, Hon. Collin C., a Representative in Congress from 
  Minnesota, opening statement...................................     4
    Prepared statement...........................................     4

                               Witnesses

Berkovitz, Dan M., General Counsel, Commodity Futures Trading 
  Commission, Washington, D.C....................................     4
    Prepared statement...........................................     6
Jaycobs, Richard, President, Cantor Futures Exchange, L.P., New 
  York, NY.......................................................    24
    Prepared statement...........................................    26
Swagger, Robert S., Chairman and CEO, Media Derivatives, Inc., 
  Scottsdale, AZ.................................................    31
    Prepared statement...........................................    33
Pisano, A. Robert, President and interim CEO, Motion Picture 
  Association of America, Inc., Washington, D.C..................    39
    Prepared statement...........................................    40
Harbinson, Scott, International Representative, International 
  Alliance of Theatrical and Stage Employees, Ellicott City, MD; 
  on behalf of Directors Guild of America........................    50
    Prepared statement...........................................    52
Moore, Schuyler M., Adjunct Professor, UCLA School of Law; 
  Adjunct Professor, UCLA Anderson School of Management; Partner, 
  Stroock & Stroock & Lavan LLP, Los Angeles, CA.................    54
    Prepared statement...........................................    56

                           Submitted Material

Chance, Ph.D., C.F.A., Don M.; on behalf of Cantor Fitzgerald, 
  submitted statement............................................    75
Independent Film & Television Alliance, submitted statement......    73
Plott, Charles R., Professor of Economics and The Edward S. 
  Harkness Professor of Economics and Political Science, Division 
  of the Humanities and Social Sciences, California Institute of 
  Technology, submitted letter...................................    88
Rutledge, M.B.A., Ann, Adjunct Associate Professor, Department of 
  Finance, Hong Kong University of Science and Technology, 
  submitted letter...............................................    91
Submitted questions..............................................    92

 
                     HEARING TO REVIEW PROPOSALS TO
                  ESTABLISH EXCHANGES TRADING ``MOVIE
                               FUTURES''

                              ----------                              


                        THURSDAY, APRIL 22, 2010

                  House of Representatives,
 Subcommittee on General Farm Commodities and Risk 
                                        Management,
                                  Committee on Agriculture,
                                                   Washington, D.C.
    The Subcommittee met, pursuant to call, at 10:30 a.m., in 
Room 1300, Longworth House Office Building, Hon. Leonard L. 
Boswell [Chairman of the Subcommittee] presiding.
    Members present: Representatives Boswell, Marshall, Walz, 
Schrader, Markey, Kissell, Pomeroy, Childers, Peterson (ex 
officio), Moran, Luetkemeyer, and Goodlatte.
    Staff present: Aleta Botts, Clark Ogilvie, Rebekah Solem, 
John Konya, James Ryder, Debbie Smith, Kevin Kramp, Tamara 
Hinton, and Sangina Wright.

OPENING STATEMENT OF HON. LEONARD L. BOSWELL, A REPRESENTATIVE 
                     IN CONGRESS FROM IOWA

    The Chairman. Our hearing will come to order. I would like 
to thank everyone for joining us here today as we take a 
thorough review of proposals to establish exchanges to trade 
movie futures. I would like to give a special thanks to our 
witnesses for testifying before the Committee and offering 
their insight.
    The hearing today explores a novel, new product being 
considered for trading on a futures exchange regulated by the 
Commodity Futures Trading Commission. This product is movie 
futures or box office derivatives. When the Commodity Exchange 
Act was first passed in the 1930s, it was very unlikely that 
the Congress envisioned such a product would be regulated by 
the Act. Even with subsequent amendments to the CEA, I doubt 
those here today foresaw the development of this type of 
exchange. Nevertheless, two applicants have developed proposals 
to establish these box office exchanges and are seeking 
approval of contracts that would be offered there.
    I am pleased that both applicants are here today to discuss 
the products in more detail and, hopefully, answer some of the 
concerns that have been raised about the nature of the 
marketing of these products. Mitigating financial risk is a 
primary reason for futures exchanges; however, the natural 
hedgers of the products have for the most part insisted they 
will not be using the products to hedge their risk for various 
reasons. We look forward to hearing from our witness today on 
why this may or may not be the case.
    The CFTC has approved the application to establish these 
exchanges, but the contract applications are still pending. 
This hearing is especially timely, given the current state of 
financial regulatory affairs and the actions going on in the 
Senate that we understand would establish in statute a 
prohibition of such exchanges. I hope the witnesses will 
provide this Committee with the context necessary to better 
understand these exchanges and the issues presented by them so 
that the Members here will be able to ascertain the correct 
course of action, going forward, and for future consideration 
of these applications by the CFTC and the law by the Congress.
    Again, I would like to thank everyone for joining us today.
    [The prepared statement of Mr. Boswell follows:]

  Prepared Statement of Hon. Leonard L. Boswell, a Representative in 
                           Congress from Iowa
    I would like to thank everyone for joining me here today as we take 
a thorough review of proposals to establish exchanges to trade ``movie 
futures.'' I would like to give a special thanks to our witnesses for 
testifying before the Committee and offering their insight.
    The hearing today explores a novel new product being considered for 
trading on a futures exchange regulated by the Commodity Futures 
Trading Commission. This product is movie futures, or box office 
derivatives. When the Commodity Exchange Act was first passed in the 
1930s, it is very unlikely that the Congress envisioned such a product 
would be regulated by the Act. Even in subsequent amendments to the 
CEA, I doubt those of us here today foresaw the development of this 
type of exchange.
    Nevertheless, two applicants have developed proposals to establish 
these box office exchanges and are seeking approval of contracts that 
would be offered there. I am pleased that both applicants are here 
today to discuss their products in more detail and hopefully answer 
some of the concerns that have been raised about the nature of the 
market for these products.
    Mitigating financial risk is a primary reason for futures 
exchanges. However, the natural hedgers of these products have, for the 
most part, insisted that they will not be using the products to hedge 
their risks for various reasons. I look forward to hearing from our 
witnesses today on why this may, or may not, be the case.
    The CFTC has approved the applications to establish these 
exchanges, but the contract applications are still pending. This 
hearing is especially timely given the current state of financial 
regulatory affairs and the action taken in the Senate yesterday that we 
understand would establish in statute a prohibition of such exchanges. 
I hope the witnesses will provide this Committee with the context 
necessary to better understand these exchanges and the issues presented 
by them, so that the Members here will be able to ascertain the correct 
course of action, going forward, and for future consideration of these 
applications by the CFTC and of the law by the Congress.
    Again I would like to thank everyone for joining me today, and at 
this time I would like to turn it over to my good friend and colleague, 
Jerry Moran from Kansas, for any opening remarks he would like to make.

    The Chairman. And at this time I will turn it over to my 
good friend and colleague, Jerry Moran of Kansas, for any 
remarks he would like to make.

  OPENING STATEMENT OF HON. JERRY MORAN, A REPRESENTATIVE IN 
                      CONGRESS FROM KANSAS

    Mr. Moran. Mr. Chairman, thank you. If somebody told me 
several months ago or a month ago we would have the Motion 
Picture Association of America and the Directors Guild in front 
of the Agriculture Committee, I would have thought they were 
kidding. But here we are, and we are here to review a proposal 
to establish two box office future exchanges and the contracts 
to be traded on those exchanges. In fact, the exchanges are no 
longer proposals, because the CFTC has approved both the Cantor 
Exchange and the Media Derivatives Exchange within the last 
week.
    It is my understanding that while the exchanges have been 
approved, the actual contracts are still pending Commission 
review and approval. Hopefully, Mr. Berkovitz will elaborate on 
the process. Up until 2 weeks ago I had never heard, and I am 
simply here to learn about a new exchange, the contracts those 
exchanges plan to trade, and the benefits and challenges that 
each may present.
    The Commodity Exchange Act sets forth a set of standards an 
exchange must meet before it is approved by the Commission. I 
hope to learn how each exchange has met those standards and the 
analysis used by the Commission in reaching its decision. For 
instance, I hope the Commission and the witnesses explain the 
economic relevance of these exchanges and the potential 
contracts these exchanges will trade. I also want to know how 
these exchanges will prevent potential fraud and manipulation 
that might occur. In addition, there are some witnesses that 
have concerns about the contracts, and I want to gain a greater 
appreciation of those concerns.
    I look forward to hearing the witnesses' testimony and hope 
to learn much more about this new concept of box office futures 
exchanges. Thank you, Mr. Chairman.
    [The prepared statement of Mr. Moran follows:]

 Prepared Statement of Hon. Jerry Moran, a Representative in Congress 
                              from Kansas
    Thank you Mr. Chairman. If someone would have told me a month ago 
this Subcommittee would be holding a hearing where representatives of 
the Motion Picture Association of America and the Directors Guild of 
America were witnesses, I would have thought you were kidding. However, 
here we are reviewing a proposal to establish two box office futures 
exchanges and the contracts to be traded on those exchanges. In fact, 
the exchanges are no longer proposals because the Commodity Futures 
Trading Commission (CFTC) approved both the Cantor Exchange and the 
Media Derivatives Exchange within the last week. It is my understanding 
that while the exchanges were approved, the actual contracts are still 
pending Commission review and approval. Hopefully, Mr. Berkovitz will 
elaborate on that process.
    Up until a few weeks ago, I had never heard of the concept of a box 
office futures exchange. I am simply here to learn about a new 
exchange, the contracts those exchanges plan to trade, and the benefits 
and challenges each may present.
    The Commodity Exchange Act sets forth a set of standards an 
exchange must meet before it is approved by the Commission. I hope to 
learn how each exchange has met those standards and the analysis used 
by the Commission in reaching its decision. For instance, I hope the 
Commission and the witnesses explain the economic relevance of these 
exchanges and the potential contracts the exchanges will trade. I also 
want to know how these exchanges will prevent potential fraud and 
manipulation that might occur. In addition, there are some witnesses 
that have concerns about these contracts and I want to gain a better 
appreciation of those concerns.
    I look forward to hearing from all the witnesses in today's hearing 
and hope to learn more about this new concept of a box office futures 
exchange.

    The Chairman. Thank you, Mr. Moran. And I would like to 
recognize the full Committee chair, Mr. Peterson, who has 
joined us, for any remarks he might want to make at this time.

OPENING STATEMENT OF HON. COLLIN C. PETERSON, A REPRESENTATIVE 
                   IN CONGRESS FROM MINNESOTA

    Mr. Peterson. I want to thank the gentleman. I just want to 
commend you and the Ranking Member for being on top of this 
issue. It sounds like there are going to be votes, so I won't 
take up any time and let you get on with the business. I look 
forward to hearing what the witnesses have to say.
    [The prepared statement of Mr. Peterson follows:]

  Prepared Statement of Hon. Collin C. Peterson, a Representative in 
                        Congress from Minnesota
    Thank you, Chairman Boswell for holding this hearing today. While I 
am interested to hear what the witnesses today have to say both for and 
against this idea of establishing movie futures trading exchanges, I 
have to say that I have some significant questions about this idea, and 
I'm glad that we are having this hearing to learn more about the 
details involved.
    Futures markets were created to trade contracts to buy specific 
quantities of a commodity or a financial instrument at a specific price 
at a specific time in the future. At a fundamental level, this is a 
risk management tool that offers benefits to both a buyer and seller of 
a given product. Now we're in a situation where people want to sell 
futures on movies the way they would sell a contract to purchase wheat. 
I understand that markets evolve, but this seems to be a stretch.
    The question is whether this is a stretch too far. Returns on a box 
office are certainly different from bushels of wheat or barrels of oil. 
The CFTC has approved the applications to establish these exchanges 
based on their authorities in the Commodity Exchange Act. Given that it 
is hard to imagine these products being contemplated in the writing of 
that statute, I have to question what door to novel financial products 
this current example opens and exposes in the law.
    I am interested in hearing more about the CFTC's decision making 
process and what they are considering as they make the determinations 
on these markets and products. I want to hear from the applicants for 
these futures contracts about what their rationale is for creating 
these exchanges, and I want to hear from the groups opposing this about 
why they are opposed to the idea and what they think will happen if 
these markets are approved.
    There are a lot of questions about this out there, and I hope that 
we'll get some answers today. Thank you again, Chairman Boswell, and I 
look forward to the testimony.

    The Chairman. Thank you. And I want to state to the other 
Members present, that their statements can be included in the 
record to get us right on to the task before us. We would 
recognize the first witness, and thank Mr. Berkovitz for being 
here. So, Mr. Berkovitz, please begin.

   STATEMENT OF DAN M. BERKOVITZ, GENERAL COUNSEL, COMMODITY 
                  FUTURES TRADING COMMISSION,
                        WASHINGTON, D.C.

    Mr. Berkovitz. Thank you, Mr. Chairman. Good morning, 
Chairman Boswell, Ranking Member Moran, Chairman Peterson, 
Members of the Subcommittee. Thank you for inviting the 
Commodity Futures Trading Commission to testify at this hearing 
on the possible trading of movie futures contracts. I would 
like to request that the Commission's full written testimony be 
included in the record.
    The Commission's testimony addresses the standards and 
procedures with which an exchange must comply to be approved as 
a designated contract market, or DCM. This testimony will also 
describe the process for the Commission's review of the box 
office receipt futures contracts proposed to be listed for 
trading by the two recently approved DCMs, Media Derivatives, 
and Cantor Futures Exchange.
    An applicant for a DCM license must demonstrate to the 
Commission that it complies with the requirements of the 
Commodity Exchange Act and the Commission's regulations.
    Specifically, the applicant must make a showing that it 
complies with the eight designation criteria and 18 core 
principles in the CEA. The Act generally requires that the 
Commission approve or deny a designation application within 180 
days after it is filed. If the Commission denies the 
application, it must specify the grounds for the denial.
    With regard to the approval of a product to be traded on 
the DCM, the CEA provides that a DCM may either self-certify 
new futures and options contracts, or voluntarily request 
approval of new products. To self-certify a new contract, the 
exchange must provide to the Commission, at a minimum, the 
rules that establish or relate to the contract's terms and 
conditions, along with a statement certifying that the contract 
complies with the Act and the Commission's regulations.
    If an exchange requests Commission approval for a new 
contract, the CEA requires the Commission to approve or 
disapprove such product within 90 days. The CEA requires the 
Commission to approve such contract unless the Commission finds 
that the new contract would violate the CEA. It is the 
Commission's practice that all new contract filings are posted 
on the Commission's website, and public comment is requested. 
The primary focus on the Commission's review is to ensure that 
the contract is not readily susceptible to manipulation, and 
that the contract has speculative position limits or position 
accountability levels as appropriate.
    The contract market designation process and the contract 
approval process are separate and distinct. The two processes 
involve different review procedures, time frames, and approval 
standards. Contract market applicants have the option to submit 
an application that does not include any proposed contract; 
however, in conjunction with the review of a new DCM 
application where the contract is not part of the application, 
the Commission staff typically inquires about the type of 
contract the applicant intends to offer for trading. 
Information about potential products to be traded helps inform 
the staff about the nature of surveillance and oversight 
measures that the exchange should have in place to be 
designated.
    The Commission has recently approved contract market 
designation for two applicants that contemplate listing box 
office receipt contracts. The Commission designated Media 
Derivatives, Inc. on April 16 of this year, and Cantor Futures 
Exchange on April 20. Neither of these futures exchanges 
submitted their proposed futures contracts as a part of that 
DCM application. In both cases, the Commission carefully 
considered the applicants' submitted materials, representations 
made, and demonstrations related to the designation criteria 
and core principles. The Commission determined that the Media 
Derivatives and Cantor applications satisfied the requirements 
of the CEA and CFTC regulations, including the designation 
criteria and core principles. The order of designation for both 
Media Derivatives and Cantor requires them to submit to the 
Commission for review and approval any new class or category of 
media-related products prior to listing them for trading. In 
doing so, the Commission preserved its ability to affirmatively 
review and approve these categories of futures contracts prior 
to their listing by the DCM.
    Media Derivatives' and Cantor's proposed contracts are 
under active review. The Commission will carefully review these 
proposed contracts according to the time frame and standards 
under the CEA and the Commission's regulations. The focus of 
these reviews will be to determine whether the contracts are 
not readily susceptible to manipulation, whether there are 
appropriate position limits or accountability levels, and the 
integrity of the cash settlement process.
    In summary, the Commission is committed to fulfilling its 
statutory responsibilities to oversee the futures markets. It 
has carefully reviewed the two recent DCM applications and 
determined that they met the statutory standards.
    With respect to the contracts submitted for approval, the 
Commission, similarly, will conduct a thorough and careful 
review, seek and consider public comments, and make a decision 
based on whether the contracts under review meet the statutory 
criteria.
    Thank you for this opportunity to testify. I look forward 
to any questions you may have.
    [The prepared statement of Mr. Berkovitz follows:]

  Prepared Statement of Dan M. Berkowitz, General Counsel, Commodity 
              Futures Trading Commission, Washington, D.C.
    Chairman Boswell, Ranking Member Moran, and Members of the 
Subcommittee, thank you for inviting the Commodity Futures Trading 
Commission (``CFTC'' or ``Commission'') to testify at this hearing to 
review proposals to establish exchanges trading ``movie futures.'' The 
Commission appreciates this opportunity to present to the Subcommittee 
information about the standards and procedures used by the Commission, 
pursuant to the Commodity Exchange Act (``CEA''), to review 
applications for new exchanges seeking to trade futures contracts.
    This testimony will address the standards and procedures that 
approved exchanges--called ``designated contract markets'' (``DCMs'')--
must follow in order to trade new futures contracts. In addition, this 
testimony will describe the Commission's activities with respect to the 
two applications recently approved for DCMs that intend to trade 
futures contracts whose settlement prices are based on the level of box 
office receipts from movie theaters (``movie futures'' or ``box office 
receipt futures''), as well as the status of the Commission's reviews 
of those proposed contracts.
The CFTC and its Mission
    First, I would like to provide some background on the CFTC and its 
mission. The CFTC was established in 1974 as an independent agency with 
the mandate to regulate commodity futures and option markets in the 
United States. The CFTC assures the economic utility of the futures 
markets by encouraging their competitiveness and efficiency, protecting 
market participants against fraud, manipulation, and abusive trading 
practices, and ensuring the financial integrity of the clearing 
process. Through effective oversight, the CFTC enables the futures 
markets to serve the important economic function of providing a means 
for price discovery and offsetting price risk.
    The CFTC currently oversees 16 DCMs and one exempt commercial 
market that lists a significant price discovery contract. The CFTC also 
oversees 14 clearinghouses, which reduce systemic risks by providing a 
guarantee of performance for all cleared trades. The CFTC oversees 
66,187 registrants, which includes 51,921 salespersons, 1,277 commodity 
pool operators, 2,568 commodity trading advisors, 7,114 floor brokers, 
1,447 floor traders, 166 futures commission merchants, and 1,694 
introducing brokers. In 2009, 2,051 contracts were listed for trading 
on CFTC-regulated facilities, with a total trading volume of nearly 3 
billion contracts.
    There are several critical elements of the CFTC's oversight of 
futures and option trading. These include, among other things, regular 
surveillance of traders' positions and trading activity to detect and 
deter manipulation, market congestion, and abusive and unfair trading 
practices. Another fundamental component of market oversight involves 
the evaluation of the futures exchanges' capabilities and operations to 
ensure that they can fulfill the statutory requirements and their self-
regulatory obligations. Such reviews are conducted initially for 
prospective DCM applicants and regularly thereafter through 
comprehensive staff evaluations of the exchanges' operations (called 
rule enforcement reviews).
Application Process for Contract Market Designation
    An entity that seeks to establish an exchange for the trading of 
commodity futures, options and futures options must apply to the 
Commission to be designated as a contract market. In order to obtain 
Commission designation, an exchange must demonstrate to the Commission 
that it complies with the requirements of the CEA. Specifically, the 
applicant must make a showing that it meets eight designation criteria 
and complies with 18 core principles as specified in the CEA.
    In general, to meet the requirements of the designation criteria 
and the core principles, the exchange applicant must demonstrate, among 
other things, that it has rules defining the manner in which it intends 
to operate and that it has rules, systems and structures to ensure the 
market and financial integrity of contracts to be traded on the 
exchange. For example, the designation criteria require an exchange to 
have systems in place to prevent market manipulation, to ensure fair 
and equitable trading, and to arrange for the clearing of transactions 
through a registered clearing organization. The core principles require 
an exchange to provide a competitive, open, and efficient market, only 
list for trading on the exchange contracts that are not readily 
susceptible to manipulation, establish and enforce position limits or 
accountability levels, and monitor trades for price distortion and 
disruptions of delivery or cash settled process. The core principles 
also address such issues as composition of boards, fitness standards 
for directors and members of the disciplinary committee, conflicts of 
interest in the decision-making process, and the emergency authority of 
the exchange and its management.
    The CEA requires that the Commission approve or deny a designation 
application within 180 days of the filing of the application (Section 
6(a) of the CEA, 7 U.S.C.  8(a)). If the Commission denies the 
application, it must specify the grounds for the denial. Following a 
refusal to designate an applicant as a contract market, the Commission 
must provide the applicant with an opportunity for a hearing on the 
record before the Commission (Section 6(a), 7 U.S.C.  8(a)). The 
applicant thereafter has a right to appeal an adverse decision directly 
to a Federal appeals court (5 U.S.C.  706(2)).
    The statute also contains a provision for staying the running of 
the 180 day time limit when an exchange is notified that the 
application for contract market designation is materially incomplete, 
and provides the Commission with at least sixty days for review once 
the application has been resubmitted in completed form.
CFTC Review of DCM Applications
    The review of new exchange applications is a key element of the 
CFTC's oversight program. Such reviews are designed to ensure that the 
applicant has the ability to comply with all statutory and regulatory 
requirements. The review encompasses all aspects of the applicant's 
proposed operations, and it is comprehensive in its scope. 
Additionally, although not required by law, the CFTC's policy is to 
post all pending applications on its website, so that interested 
parties can comment on the merits of the filing.
    The CFTC staff evaluates an applicant's ability to comply with the 
designation criteria and the core principles by conducting a thorough 
examination of the following elements of the proposed exchange:

   the rule book to ensure that the exchange has rules that 
        promote transparent, fair and competitive markets, such as 
        rules describing operation of the market, providing trading 
        parameters and detailing the rights and obligations of 
        participants in the market;

   clearing arrangements and settlement procedures;

   surveillance systems, staffing and capabilities, including 
        the exchange's ability to obtain large trader and transaction 
        data to identify unusual price changes and concentrated 
        positions and to monitor position limit violations;

   the adoption of trade execution systems and procedures to 
        ensure the integrity of trades, business continuity and data 
        retention and to allow the exchange to carry out trade practice 
        surveillance;

   disciplinary procedures that address rule violations and 
        dispute resolution programs;

   procedures for having an open, competitive and transparent 
        trading system to provide for the price discovery function of 
        the centralized marketplace and to make available information 
        to all traders on prices, volume and terms, through public 
        dissemination of price and trade activity information as well 
        contract terms;

   procedures and rules to minimize conflicts of interest, 
        including composition requirements for the Board of Directors 
        and the establishment of a regulatory oversight committee;

   procedures to take appropriate emergency action to protect 
        traders and the market in cases where intervention is required; 
        and

   the exchange's rules, trading protocols or policies to 
        ensure that they do not result in any unreasonable restraints 
        of trade or any anti-competitive burden on trading in the 
        market.

    Upon the conclusion of its review, the CFTC staff evaluates whether 
the applicant meets the requirements of the CEA, and recommends to the 
Commission whether to issue an order designating the exchange as a 
contract market. If the Commission finds that the applicant meets the 
requirements of the CEA and votes to designate, it issues an Order of 
Designation which may impose certain conditions involving financial, 
jurisdictional and regulatory compliance issues.
    In conjunction with the review of a new DCM application, the CFTC 
staff typically inquires about the types of contracts to be traded on 
the exchange. Information about potential products to be traded helps 
inform the staff about the nature of the surveillance and oversight 
measures the exchange should have in place. The purpose of such 
information is to address, in a generic way, the exchange's ability to 
comply with designation criteria and core principles that address such 
issues as contract manipulation, general availability of information 
involving contract terms, mechanisms for executing trades, and 
recording and storage of trade information.
    Notwithstanding the fact that the Commission may generally be 
cognizant during the course of the application review process of the 
possible contracts that an applicant plans to offer, under the CEA and 
the Commission's regulations, the contract market designation process 
and the contract approval process are separate and distinct processes 
subject to different review procedures, timeframes, and approval 
standards.\1\ In contrast to the contract market approval process under 
the CEA prior to the passage of the Commodity Futures Modernization Act 
(``CFMA''), in which a prospective exchange had to include a contract 
as part of its application package, since the passage of the CFMA 
contract market applicants have the option to submit an application 
that does not include any proposed product.\2\
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    \1\ See section 5c of the Act, 7 U.S.C.  7a-2(c), section 6(a) of 
the Act, 7 U.S.C.  8(a), regulation 38.3, 17 CFR  38.3, regulation 
38.4, 17 CFR  38.4, and regulation 40.3, 17 CFR  40.3.
    \2\ Because the CEA, as amended by the CFMA, no longer requires 
that applicants include a proposed contract in their application to be 
designated as a DCM, staff's review of the application is limited 
regarding compliance with two contract-specific core principles; 
specifically, Core Principles 3 (Contracts Not Readily Subject to 
Manipulation) and 5 (Position Limits or Accountability). While the 
other core principles require DCMs to have structures, rules and 
procedures to address generic concerns, Core Principles 3 and 5 are 
contract-specific. Staff is, therefore, limited in its ability to 
assess compliance with those two core principles when a DCM application 
does not include a contract. Instead, the analysis of a DCM's 
compliance with Core Principles 3 and 5 is primarily carried out in the 
context of the contract review process.
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Contract Certification and Approval
    The CEA provides that a DCM may either self-certify new futures and 
option contracts or voluntarily request approval of new products. To 
self-certify a new contract, the exchange must provide to the 
Commission, at a minimum, the rules that establish or relate to the 
contract's terms and conditions, along with a statement certifying that 
the contract complies with the Act and the Commission's regulations 
thereunder. A self-certification filing must be received by the 
Commission prior to the open of business on the business day prior to 
the intended initial listing day. Commission staff conducts a due-
diligence review of the contract to verify the validity of the 
exchange's self-certification and, when necessary, may request 
amendments to the contract or additional information related to the 
contract or the underlying cash market.
    With respect to products submitted for approval, the CEA specifies 
that the Commission must act to approve or disapprove within 90 days of 
the request for approval (Section 5c(c)(2)(C) of the CEA, 7 U.S.C.  
7a-2(c)(2)(C)). The Commission's regulations state that products 
submitted for approval may be deemed approved 45 days after the filing 
if the filing is complete and is not amended by the exchange, except 
for amendments made at the request of the Commission (17 CFR  
40.3(b)). The review period may be extended to 90 days if the product 
raises novel or complex issues that require additional time for review 
or is of major economic significance (17 CFR  40.3(c)). All new 
contract filings are posted on the Commission's website, and the public 
is welcome to comment on those filings. The CEA provides, ``The 
Commission shall approve any such new contract or instrument . . . 
unless the Commission finds that the new contract or instrument . . . 
would violate the Act.'' (Section 5c(c)(3) of the CEA, 7 U.S.C.  7a-
2(c)(3)).
    The primary focus of the Commission staff's review of a contract 
approval request is to ensure that the contract is not readily 
susceptible to manipulation (Core Principle 3) and that the contract 
has speculative position limits or position accountability, as 
appropriate (Core Principle 5). If an exchange seeks approval of a 
contract, it must demonstrate that the terms and conditions as a whole 
will result in a deliverable supply such that the contract will not be 
conducive to price manipulation or distortion, in accordance with the 
Commission's Guideline No. 1 (17 CFR Part 40, Appendix A (2009)). For 
cash-settled contracts, such as the box office receipts contracts filed 
for approval by MDEX and Cantor, Guideline No. 1 specifies that the 
final cash settlement price must be not readily susceptible to 
manipulation, must be reflective of the underlying market, and must be 
reliable, acceptable for hedging, publicly available and timely.
MDEX and Cantor Applications for DCMs
    The Commission has recently approved contract market designation 
for two applicants that contemplate listing box office receipt 
contracts. These exchanges are Media Derivatives Inc. and the Cantor 
Futures Exchange.
    Media Derivatives Inc. (``MDEX'') was formed in April 2007 to 
operate as an electronic futures exchange to trade contracts based on 
movie box office revenues and other unspecified entertainment industry 
contracts. It is a Delaware corporation and wholly-owned subsidiary of 
Veriana Networks, Inc., a privately-held media and technology company. 
MDEX submitted its application for contract market designation on 
September 25, 2009; the voluntary public comment period was open until 
November 5, 2009. That application was preceded by numerous draft 
materials submitted by MDEX to the Commission, as well as numerous 
supplemental materials submitted after the formal filing date.
    Some notable features of the MDEX application: MDEX has contracted 
with the National Futures Association (``NFA'') to provide it with 
regulatory services and has an agreement with the Minneapolis Grain 
Exchange to provide clearing services. In addition to its reliance on 
NFA, MDEX will conduct its own real-time surveillance and some general 
market compliance. MDEX will be an intermediated market and will 
utilize an electronic trading system with web-based access or direct 
connections. MDEX initially intends to trade Opening Weekend Motion 
Picture Revenue contracts in the form of binary options and collared 
futures. That contract review process is separate from its DCM 
application approval.
    The Cantor Futures Exchange (``Cantor'') was created to operate a 
non-intermediated electronic trading system to likewise trade, among 
other things, futures contracts on movie box office receipts. Cantor 
operates as a Delaware Limited Partnership and is a wholly-owned 
subsidiary of Cantor Fitzgerald, L.P., a global financial service firm. 
Cantor submitted its application to become a DCM on November 28, 2008; 
the voluntary public comment period was open until January 28, 2009.
    The NFA will provide regulatory services to Cantor, including 
general market compliance and surveillance responsibilities. Like MDEX, 
Cantor will be responsible for certain aspects of its market 
surveillance and its market compliance. As proposed, clearing services 
will be provided by the Cantor Clearinghouse, which is also a wholly-
owned subsidiary of Cantor Fitzgerald, L.P., and which submitted an 
application to become registered as a derivatives clearing organization 
contemporaneously with the Cantor DCM application. As a non-
intermediated exchange, Cantor has undertaken certain functions that 
normally fall to intermediaries, such as filing certain reports with 
the Commission and providing trade confirmations and account statements 
to market participants.
    As with the MDEX application, Commission staff was aware of 
Cantor's intention to initially list box office receipt contracts. 
Again, that contract review process is separate from its exchange 
application approval.
    Staff's review of both the MDEX and Cantor applications addressed 
each of the regulatory requirements mentioned above.\3\ The CFTC staff 
carefully considered the applicants' submitted materials, 
representations made, and demonstrations related to the eight 
designation criteria and 18 core principles, and in light of the 
expected novel products that they intend to list, put special emphasis 
on those designation criteria and core principles relating to the 
prevention of market manipulation and fair and equitable trading.
---------------------------------------------------------------------------
    \3\ Except, as noted in note 2, supra, if the application does not 
include a contract, the Commission is limited in its review of the 
applicant's ability to comply with Core Principles 3 and 5 in the 
absence of a contract.
---------------------------------------------------------------------------
    More specifically, staff considered whether MDEX and Cantor had the 
ability generally to detect and prevent market manipulation and trade 
practice violations, and also considered the extra steps MDEX and 
Cantor would need to take if they offered futures contracts based on 
box office revenue, such as the implementation of firewalls within a 
movie studio. In this regard, staff considered the sources of data for 
box office revenue figures, whether the information provided by these 
sources is reliable and verifiable, what extra tools MDEX and Cantor 
possess to track this information and analyze its reliability, and what 
extra market surveillance resources each exchange would be able to use 
to detect attempted manipulation or abusive trading practices.
    Staff also considered the fact that NFA will be providing 
regulatory services for both applicants. NFA currently provides 
regulatory services to four other DCMs, and the Commission has 
previously found that NFA maintains acceptable surveillance and 
compliance practices in the context of other designated contract 
markets to which it provides regulatory services.
    Staff concluded that the MDEX application satisfied the 
requirements of the designation criteria and core principles, and 
recommended Commission approval of the exchange. The Commission 
approved the designation of MDEX as a contract market on April 16, 
2010.
    Staff concluded that the Cantor application satisfied the 
requirements of the designation criteria and core principles, and 
recommended Commission approval of the exchange. Cantor was designated 
as a contract market on April 20, 2010.
    The Orders of Designation for both MDEX and Cantor require them to 
submit to the Commission for review and approval any new class or 
category of media-related products prior to listing them for trading.
MDEX and Cantor Requests for Contract Approval
    MDEX's and Cantor's proposed contracts are under active 
consideration for Commission approval as they were not part of the 
Commission's designation of MDEX and Cantor as DCMs. In conditioning 
these designations on the submission of the exchanges' initial 
contracts and all other new classes of media-related contracts for 
prior Commission approval, the Commission recognized that media 
contracts may require special review of other issues to ensure, among 
other things, that the contracts are consistent with the Act and the 
Commission's regulations and that the exchanges have appropriate 
surveillance and compliance measures in keeping with the unique nature 
of these contracts.
    On March 9, MDEX requested approval of its collared futures and 
binary option contracts based on the Opening Weekend Motion Picture 
Revenues for the film Takers. The 45 day fast track review period would 
have ended on April 23, but the staff extended that review period by an 
additional 45 days so that it now expires at the end of the statutory 
review period (90 days after Commission receipt). That statutory review 
period ends June 7, 2010. MDEX has indicated that it also intends to 
list other media-related futures contracts.
    On March 30, Cantor Exchange requested approval of its Domestic Box 
Office Receipts futures contract based on the film The Expendables. The 
Commission's 45 day review period for that contract ends May 14, but 
the Commission may extend that review period to June 28, 2010. Cantor 
has stated that it also intends to list other, non-media-related, more 
traditional futures contracts.
    The Commission will specifically evaluate whether the MDEX and 
Cantor contracts are not readily susceptible to manipulation and 
whether the cash settlement provisions of each contract meet the 
Commission's Guideline No. 1 requirements, among other criteria. In 
addition, the Commission will consider other issues that have been 
raised as well as comments filed by interested parties related to those 
contracts.
Conclusion
    In summary, the Commission is committed to fulfilling its statutory 
responsibilities to oversee the futures markets in a timely, efficient, 
and thorough manner. The Commission has carefully reviewed the two 
recent DCM applications and determined that they met the statutory 
standards. With respect to the contracts submitted for approval, the 
Commission similarly will conduct a thorough and careful review, seek 
and consider public comments, and make a decision based on whether the 
contracts under review meet the statutory criteria.
    Thank you, and I look forward to answering any questions.

    The Chairman. Thank you. Before we continue, I would like 
to recognize Mr. Goodlatte from Virginia who has joined us. And 
although he is not a Member of the Subcommittee, he is here 
with us today, he is the former Chairman of the full Committee. 
And I have consulted with the Ranking Member, and we are 
pleased to welcome him to join us in questioning today. 
Welcome.
    Mr. Goodlatte. Thank you, Mr. Chairman. It is a pleasure to 
be here. I look forward to hearing the testimony of the 
witnesses regarding this very interesting subject.
    The Chairman. Welcome.
    The first question, I guess, would be: In reviewing the 
applications, did the CFTC examine the question of whether 
legitimate hedgers, both short and long, exist for these 
products? And, if so, what did the CFTC discover?
    Mr. Berkovitz. As I have described, Mr. Chairman, the 
contract application and review process and the designation 
process for the exchange are two distinct processes. In the 
designation process for the exchange itself, in approving the 
exchange, we reviewed whether it met the designation criteria 
in the statute, including whether they have the trading 
facility, how the trades are executed, the financial integrity 
of the contracts, and the various systems in place to ensure 
fair and equitable trading.
    Regarding the contracts, the questions that you have raised 
are more appropriately part of the contract approval process 
which we are in right now. So those questions are some of the 
questions that we are looking at in the contract approval 
process.
    The Chairman. I appreciate that. Another question: Would 
you explain why the Commission approved the ability for people 
with material inside information to participate in these 
markets? All things being equal, would people with material 
inside information be allowed to participate in an SEC-
regulated market?
    Mr. Berkovitz. We have addressed that in a condition for 
the application. As I mentioned in the oral testimony, 
generally the exchange approval process and the contract 
approval process are different. In these particular instances 
we have looked at the request for approval of the exchange with 
a view towards what contracts will be included in the exchange. 
We have been in discussion with both applicants, so we have an 
idea. We did, in fact, know their intentions to list these 
movie futures contracts.
    As part of that, to address the concern you have raised 
about people with inside information, potentially about the 
eventual box office numbers, trading in those futures 
contracts, we have included in the contract approval process 
the condition that these exchanges have what we call firewalls 
between the people inside the studios who would have actual 
knowledge of the box office receipts from the people in those 
movie studios who might be trading for hedging purposes or 
whatever purposes for the studio.
    We have included firewall conditions as part of the 
exchange approval process for both exchanges. Not only does it 
prohibit them from--people with that inside information about 
the actual box office receipts from trading, but it would 
prevent them from communicating information to others in the 
organization who might trade on that information. So those 
conditions have been included as part of the approval process 
for the exchange.
    In addition, as part of the contract approval process, we 
are looking at that question further in terms of whether the 
contracts themselves are susceptible to manipulation. So the 
question is, in view of these particular contracts now and 
examining the concerns that have been raised by these 
contracts, we are looking at that issue with respect to these 
particular contracts: Are those firewalls sufficient? Have 
other concerns been raised that need to be addressed as part of 
the contract approval?
    The Chairman. I will have further questions, but I will 
recognize Mr. Moran at this time.
    Mr. Moran. Thank you. Mr. Berkovitz, how does the CEA 
define a commodity? And how does the box office futures 
contract fit within that definition?
    Mr. Berkovitz. The Commodity Exchange Act defines a 
commodity very broadly. It is basically anything, a good, an 
article, a service, or an interest in anything in which a 
contract for future delivery is dealt in. So if something is 
subject to a contract for future delivery, then under the 
Commodity Exchange Act, it would be a commodity.
    Mr. Moran. And the future delivery in this case is, what?
    Mr. Berkovitz. The future delivery is the box office 
receipt. It is a number that is related to the actual box 
office receipts.
    Mr. Moran. My questions may be more related to the actual 
contracts. But what type of data do the exchanges use to settle 
those contracts?
    Mr. Berkovitz. According to the information that has been 
supplied to us to date, and we are looking at this question in 
great detail, but they basically--they are going to be relying 
on the tally of box office receipts that are provided. There is 
a service that provides from the movie theaters to the studios 
what the actual box office receipt numbers are. That gets fed 
to the studios, and the studios--I believe, and they will be 
able to answer the questions--also collect some of this data 
and the studios put the data together, and then there is the 
final number from the receipts that they get plus their own 
information.
    Mr. Moran. When you say a final number, is that an actual 
hard number, or is that an estimate?
    Mr. Berkovitz. I believe there is an actual firm number.
    Mr. Moran. Okay. How is the opening price of a contract 
determined? And are there currently any other exchanges that 
use that method?
    Mr. Berkovitz. We can provide further information for the 
record on this. But, generally, my understanding of it is that 
it is similar to the process that other exchanges use for 
determining what the opening price of a contract is, that 
before the contract is actually open for trading, that there is 
a type of bidding process that goes on that the exchanges use 
to establish where the contractors should start to be traded. 
But we can get you further information on exactly how that 
would be determined and any similarities or differences.
    Mr. Moran. Do you have an estimate of the time frame in 
which the CFTC would make a decision in regard to the actual 
contracts?
    Mr. Berkovitz. There is a statutory deadline, I believe, it 
is June 7 for one of the contracts and June 28 for the other 
one.
    Mr. Moran. Mr. Chairman, thank you. And I yield back.
    The Chairman. Thank you. The chair now recognizes Mr. 
Kissell from North Carolina.
    Mr. Kissell. Thank you, Mr. Chairman.
    Mr. Berkovitz, I am trying to get an understanding, as the 
Ranking Member said, of knowledge of this subject matter, when 
the Commission is looking at a new product coming on to a 
market--and you mentioned about the factors that are considered 
as to whether this is a legitimate product or not. How 
judgmental does the Commission become in terms of one extreme, 
just strictly, ``Okay, it meets the points, fine, let's do 
it.'' And the other extreme, ``This just has no business being 
there, this just is not something we should be doing.'' How 
does that weigh in terms of, once again, is it just black and 
white there, or judgmental it shouldn't be there?
    Mr. Berkovitz. Generally, our first look at it would be, is 
this something that is indeed a contract for future delivery? 
That's our jurisdictional base. So we will say, is this a 
contract for future delivery that is appropriate for further 
review?
    If it is indeed a contract for future delivery, then we 
apply the standards set forth in the Act. Primarily, is it not 
susceptible to manipulation? Are there appropriate position 
limits? Is the settlement price of the contract appropriately 
determined? Is there the process for determining that price, is 
there integrity in that process?
    Mr. Kissell. What considerations might be given to unique 
circumstances that could affect a movie's popularity in terms 
of the investments that were made versus the insurance that 
might be used to offset unexpected things? What if we found out 
3 days before the release that a star had been having illicit 
affairs? Or the snows came deep in February and affected the 
opening days; or there was some other crisis that kept people 
at home? Are we opening ourselves up to issues there that are 
beyond what we should normally expect? How does that play in?
    Mr. Berkovitz. Well, our primary focus is on ensuring that 
there was no manipulation of the price of that commodity that 
is traded. So we would have our surveillance and the 
exchanges--we require of the exchange to have surveillance, 
too, to ensure that there is no artificial price created 
through any intentional manipulation of the price. And we watch 
the price move to ensure that indeed the price of these--or any 
contracts that are traded on any exchanges, are determined 
according to the laws of supply and demand, basically.
    Mr. Kissell. Thank you, Mr. Berkovitz. Mr. Chairman, I am 
looking forward to hearing more of the arguments from the 
individuals. I yield back.
    The Chairman. Thank you. Mr. Goodlatte.
    Mr. Goodlatte. Thank you, Mr. Chairman.
    Mr. Berkovitz, welcome. Can you think of any other 
commodity that is traded on the major exchanges that is 
anything like a motion picture?
    Mr. Berkovitz. In a broad sense, the motion picture 
contract, one could describe it as an event type contract that 
is related to an economic event or an event. We have weather 
derivatives, we have----
    Mr. Goodlatte. But weather derivatives are beyond the 
control of any individual. Are they not?
    Mr. Berkovitz. Certainly.
    Mr. Goodlatte. And the gentleman from North Carolina, he 
raised several different types of events. Some of those events 
were like a big snowstorm. That is beyond the control of 
anybody who is trying to predict. And that certainly would not 
be unlike buying corn futures, not knowing what the weather was 
going to be like or things like that.
    On the other hand, the motion picture itself, each one of 
those that is produced is a very unique product, very much 
unlike the next one. Whereas, one barrel of oil is not very 
much different than the next one, one bushel of corn is not 
very much different than the next one, one Euro dollar is not 
very much different than the next one.
    So it seems to me that in looking at the very broad 
definition of commodities that the CFTC has, nonetheless in 
looking at motion pictures you are going into an area that we 
have never done before, in my opinion.
    Can you give me anything that is like that, that is of such 
subjective value as a motion picture that is offered on these 
exchanges?
    Mr. Berkovitz. I think the issue that you raised in terms 
of control or ability to affect the price in terms of a weather 
derivative, nobody can affect the temperature in Chicago or 
Seattle. The question that has been raised about these 
contracts: Can somebody affect the box office receipts? In that 
sense, that distinction is indeed something we are looking at 
and seeing whether----
    Mr. Goodlatte. I have heard there is some discussion at the 
CFTC about actually excluding people who are involved in the 
making of a motion picture from being able to trade these 
futures contracts. Is that correct?
    Mr. Berkovitz. The conditions that were imposed upon the 
exchanges themselves, the firewall that is between the people 
that actually have knowledge about the actual box office 
receipts, we are examining again whether those firewalls are 
sufficient for these particular contracts, because these 
concerns have been raised about who really has this type of 
knowledge.
    Mr. Goodlatte. But if you were to do that and to say that 
all of the producers and directors, actors and the crews, and 
the people involved in the promotion of the movie and so on 
were not allowed to participate because they have a better idea 
than the average public about whether this movie is going to be 
an Avatar or whether it is going to be a bust. Correct? That 
would be a concern. But aren't those the same people that you 
ordinarily are wanting to have participating in commodity 
trading? Because they are the ones who benefit from one of the 
principle purposes of commodity trading, which is to take the 
risk out of what you are investing in.
    Like a farmer being able to buy or sell corn futures 
because he wants to average out the future price, because 
weather or other market conditions might affect his price. Or 
somebody in manufacturing who is concerned about the price of 
natural gas or oil that they use as a resource for their 
business, they want to buy futures. Southwest Airlines very 
notoriously, during the spike-up in prices, they had bought jet 
fuel futures or oil futures or something that allowed them to 
have a competitive advantage because they had built in a hedge 
against the risk of higher prices at a time when prices did go 
higher. But here, you are talking about eliminating from the 
very marketplace the people who might most benefit from being 
able to hedge, because they don't know for sure whether the 
movie is going to be a hit or not. Therefore, if they could 
sell futures on it, they would take away the reward of the 
smash hit, but they would also eliminate the crash of the total 
dud.
    So it seems to me that the bottom line here is that we are 
not really talking about a commodity. We are talking about each 
individual unique product, and the very people who would 
benefit from commodity futures trading would of necessity have 
to be excluded because they could manipulate it.
    Mr. Berkovitz. I think your point is well taken. An oil 
company is another example. The people inside an oil company 
are allowed to trade on what they believe will be the price of 
oil. They may have specific knowledge about whether a field is 
coming on or not. They might have superior knowledge of what is 
going on in the oil market, but presumably those traders do not 
have knowledge of exactly what the price on the New York 
Mercantile Exchange would be. So, per se, it is not illegal or 
unlawful for somebody with knowledge about the commodity to 
trade on the commodity.
    Mr. Goodlatte. Sure. But like we said earlier, one barrel 
of oil is not much different than the next barrel of oil. But 
one motion picture is completely different than the next one.
    And then it is also subject, wouldn't you say, to 
manipulation by people who are not actually engaged in the 
production of the movie? For example, movie reviewers or 
entertainment companies that can play up the movie on their 
television networks, or on the Internet, or in other 
marketplaces? They also could say, ``Well, let's buy some 
futures in this movie, and then let's really push the heck out 
of this movie to try to drive up the box office.'' Or, ``Let's 
buy futures, and then let's pan the movie and see if we can 
drive it right down through the floor and make a profit on 
selling the failure of the movie.''
    I don't trade in commodities, so I don't know the puts and 
options and so on that are involved here. But nonetheless, it 
seems to me that a lot of people could try to profit from this 
and manipulate it, whereas there is only so much you can say 
about an ear of corn or a barrel of oil, or a quantity of some 
other source of energy or food, or even a currency like the 
Euro dollar or other things.
    Mr. Berkovitz. Indeed, the concerns that you have mentioned 
about the potential for manipulation, the different 
characteristics of these contracts that you have mentioned, we 
will be looking at all that very closely in the product review. 
We have initially, as a condition of the approval of the 
exchange itself, have the firewall. But whether that is 
sufficient or not in light of these particular contracts is 
something that we are going to be looking very closely at to 
address those very concerns that you have raised.
    Mr. Goodlatte. Thank you, Mr. Chairman.
    The Chairman. Thank you. Chairman Peterson.
    Mr. Peterson. Thank you, Mr. Chairman. So in your view or 
the Commission's view, the movies are a commodity?
    Mr. Berkovitz. We are looking at indeed whether to approve 
these as contracts for future delivery.
    Mr. Peterson. So if you decide, if you approve this, then 
you are deciding they are a commodity?
    Mr. Berkovitz. If we were to approve it.
    Mr. Peterson. And apparently you are thinking about having 
anybody who knows anything about this prevented from trading in 
it, from what I understand?
    Mr. Berkovitz. I want to draw the distinction. The current 
firewall is between the people who actually know what is the 
number of the box office receipts.
    Mr. Peterson. I understand. But there has also been 
discussion of trying, excluding anybody that has anything to do 
with the movie business.
    Mr. Berkovitz. We are considering whether the current 
exclusion is broad enough.
    Mr. Peterson. So what you are basically talking about, 
then, is authorizing gambling. I mean, maybe it should be 
regulated by states or something. I mean, if you include 
anybody that is involved in this, then the only people you will 
have left are people that are gambling on this, basically. 
Right? I mean, I am just trying to understand what is going on 
here.
    Mr. Berkovitz. If we determine that the contract, with 
whatever conditions that may be placed on it, satisfies the 
conditions of the Commodity Exchange Act and our regulations, 
then it will be permitted to be traded on these exchanges, if 
we make that determination for these products.
    Mr. Peterson. So can there be other derivatives created off 
of these, then? If these are approved, would you be able to 
have credit default swaps be set up to further make bets 
against what is going to happen or to protect?
    Mr. Berkovitz. Well, if somebody created an instrument that 
would fit the definition of a swap under current law, we would 
have to look at the instrument. But that might be something 
that would not be within our jurisdiction, because it would be 
excluded from our jurisdiction if it fit the definition of 
swaps and it was traded by people who could trade the swap, the 
eligible contract participants. So it would certainly be 
possible to create a swap derivative.
    Mr. Peterson. Is that being done now at all?
    Mr. Berkovitz. I wouldn't have knowledge of that.
    Mr. Peterson. I mean, they raise money to finance these 
movies. I don't know, I guess that would be one thing. I don't 
know who can tell us that.
    Mr. Berkovitz. Presumably, under current law, if somebody 
were to create a swap rather than a futures contract based upon 
movie box office receipts, and sell it to only the people who 
met the statutory criteria, sophisticated parties, called in 
the Act, eligible contract participants, then that would not be 
something if they traded it under the--according to the way the 
Act specifies, that would not be something within our 
jurisdiction. They could do that. That would be outside the 
CFTC's jurisdiction.
    Mr. Peterson. Unless we pass a bill here.
    Mr. Berkovitz. Exactly.
    Mr. Peterson. And the Senate apparently, in the bill that 
they have moved out of the Agriculture, Nutrition, and Forestry 
Committee, has put a prohibition on these contracts. Is that 
correct?
    Mr. Berkovitz. That is my understanding.
    Mr. Peterson. Have you looked at the language of that?
    Mr. Berkovitz. We haven't seen the final language. We 
understand that that provision is in there, but we haven't seen 
the final language. It was just reported out yesterday.
    Mr. Peterson. And we can do that, the Senate, in 
legislation? We can ban a particular type of contract?
    Mr. Berkovitz. You can exclude. Right now in the Act onions 
are excluded from the definition of commodity. So, certainly, 
Congress can put it in the definition of commodity and Congress 
can take it out.
    Mr. Peterson. That is how they have done it. They have said 
that movies are not a commodity.
    Mr. Berkovitz. I believe that is what they have done for 
the box office receipts, I believe they have taken it out of 
the definition of commodity.
    Mr. Peterson. Thank you, Mr. Chairman.
    The Chairman. Thank you. The chair now would recognize the 
gentleman from Missouri, Mr. Luetkemeyer.
    Mr. Luetkemeyer. Thank you, Mr. Chairman.
    Mr. Berkovitz, can you give me a definition of what you 
believe a movie or a motion picture that would be something 
that you could put on the exchange?
    Mr. Berkovitz. The definition of a motion picture? We have 
not--CFTC has not undertaken to define what a motion picture 
is.
    Mr. Luetkemeyer. To me, that is a pretty important point. 
We have a motion picture now. It can be anything from what we 
believe is the big blockbuster, Avatar, all the way down to--it 
listed here a while ago a documentary, X rated movies, 
cartoons. And by your box office receipt thing, it has to be on 
600 movie screens. We have made-for-TV movies which generate 
income from the standpoint that they are put on TV and 
advertisers pay to have their advertisements shown during a 
showing of that movie. Is that going to fall under the 
definition here of somebody that could actually trade a 
contract on a movie that is being made for TV; and, if we don't 
generate enough advertising revenue to pay for the production 
of the movie, that the producers are covered? Is that something 
that could also be construed here to fall under your definition 
of movie?
    Mr. Berkovitz. The contract terms--when I talk about our 
product approval, the approval of the contract terms, each of 
these contracts, they are contracts for future delivery. They 
have specifications in the contract, what can be traded, which 
types of movies can be traded. And--I don't have the 
application right in front of me, but it is specified in the 
application. So that is part of what we are reviewing, is what 
are the movies or what may be that will be the subject of these 
contracts, whose box office receipts will be something that 
will be put on the exchanges of contract for future delivery.
    So that is something we are looking at, what is going to be 
subject to these box office receipts.
    Mr. Luetkemeyer. Well, to me it seems like that is--you are 
going to have to nail down the definition of what a motion 
picture is, because I think you can construe it to be any of 
those things that we just mentioned. I mean, we are talking 
about documentaries which take a lot of monies to produce 
sometimes; X rated films, somebody is going to go out there and 
produce one of those and want to protect themselves; you have 
cartoons. All those things are types of motion pictures that if 
they fall under your definition here of 600 movie screens, I 
mean, can you look at a TV screen as a movie screen?
    I think that at this point your terminology is going to 
have to really be nailed down a little bit more confining. I 
mean, right now we have this language so broad that that whole 
list of things we are financing everything that can be put on a 
movie screen, including what goes on a TV, in my judgment, from 
what you see here. It is very concerning to me.
    Right now, is there a defined market? Is there some folks 
out there that really want to trade in these things right now? 
Or is the Cantor Group just hoping that there is going to be 
something happening? Is there really a defined group out there 
that is looking to try and take the risk off of these folks?
    Mr. Berkovitz. I think the witnesses on the second panel 
might be in a better position to answer that. Our role is to 
determine whether, in fact, these products, and some of the 
issues you have described, meet the specifications in the Act.
    Mr. Luetkemeyer. Let me ask this question then. What do you 
see as an inherent problem from your standpoint at the CFTC?
    Mr. Berkovitz. Our role is to ensure that any contracts 
that are traded on our regulated facilities are not susceptible 
to manipulation; that there are appropriate position limits on 
these contracts to ensure that no single entity has too great a 
share of the market and then can influence the prices by having 
too great a share; or--and that the settlement process, the 
process for determining that the final price of these 
contracts, the box office receipt number, that that process has 
integrity and that is a reliable number and the market can have 
confidence that it is accurate. And that is really our 
statutory role, that we have been directed to do under the Act.
    Mr. Luetkemeyer. Mr. Peterson asked a while ago, and a 
couple other folks referred to, the numbers of people who have 
access to the movie production, whether it be the actors or 
anybody who works on the sets, the writers, whomever. All those 
folks at this point are not prohibited from being able to 
participate in this? Are you looking to try and do that?
    Mr. Berkovitz. We are looking to draw the appropriate 
firewall, if you may, between the people who have actual 
knowledge of the box office receipt numbers who will know what 
that price is, and to ensure that they will not be able to 
trade or give information to others who are trading. Whether 
that is the full extent of the separation, that is something 
that we are looking at in this product approval process.
    Mr. Luetkemeyer. Thank you, Mr. Chairman.
    The Chairman. Thank you. The chair recognizes the gentleman 
from Georgia, Mr. Marshall.
    Mr. Marshall. Thank you, Mr. Chairman. I was out for a 
little while meeting with some folks, so I may be asking 
questions that have been already asked and answered. If I do, I 
apologize for that.
    It is hard for me to see who takes the other side of this 
product if you don't exclude insiders. So the movie is in 
production, something occurs, it looks like it is just not 
going to produce. Basically, the house is on fire but we are 
the only people who know it, so we are going to rush out and 
buy insurance. Well, I would be a fool to be the other side of 
that deal, and I think the market would pretty quickly conclude 
that this is too dangerous and could really get stuck as a 
result of the fact that people will have unique knowledge about 
whether to buy or to sell concerning this particular product.
    And so from a packaging perspective, I could see those who 
are interested in offering the product trying to sanitize it so 
that it behaves more like regular futures and commodities that 
you wouldn't have inside information along those lines. I am a 
little surprised, though, that the CFTC is, as part of the 
approval process, coming up with this firewall concept. Can you 
give us examples of other products where you have firewalls? Is 
this sort of a new concept for these products? Or are there 
other products where you have firewalls? I know CFTC personnel 
specifically can't invest and other people who have unique 
knowledge, the owners of the exchange, things like that. But 
beyond that, can you pick a commodity where the CFTC has 
imposed some sort of firewall concept like this?
    Mr. Berkovitz. I believe it is a new type of condition.
    Mr. Marshall. Well, I don't like the fact that--we are very 
clumsy with our efforts to legislate in this arena. Witness the 
fact that we have an exception for onions, for God's sake. I 
don't think we really want to set up some regime where 
everybody is running to us because they are worried that some 
product might be approved inappropriately by the CFTC. And so 
we start adding to the list. It is now onions and now it is 
movies and now it is whatever. I don't know what it is going to 
be.
    So it seems to me the CFTC needs to help us out here in 
coming up with some principle, or the parties here need to come 
up with some principle that can guide the CFTC and guide 
Congress in concluding: Yes, this is an appropriate product, or 
no this is not an appropriate product. And I just don't see how 
firewalls cut it. It is a license to lie is basically what it 
is. It is hard for me to believe that the other side to the 
deal, being sophisticated parties, would believe that the 
firewalls would actually work. That you think you need a 
firewall suggests that you are worried about all kinds of 
manipulation issues. It is one thing for the party that is 
putting together the product to feel like it needs to have a 
firewall because nobody is going to buy the product otherwise. 
It is another thing for the CFTC to say there has to be a 
firewall. That suggests to me that the CFTC has a very limited 
confidence in the product; or, the CFTC is worried about 
manipulation, that this is an extraordinary--too focused, maybe 
too much of a rifle shot kind of product here, where it would 
be just too easy for people to manipulate the price and, 
consequently, the market, that very small market.
    So I would like you guys to come up with some principle 
other than firewalls. I mean, if firewalls don't exist for any 
other commodity, it seems to me a big stretch for the CFTC to 
say, well, we are going to come up with this concept with 
regard to this particular commodity, without maybe a broader 
discussion with Congress about the CFTC's appropriate role, and 
whether or not the CFTC should be about the business of 
approving products with firewalls.
    You know, it gets close to sort of wandering into, there is 
a big difference, or at least historically, as I understand it, 
a big difference between the SEC's and CFTC's work. Where these 
exchanges have been concerned, we want insider information. It 
is all price discovery stuff. So whatever information you can 
get, you bring it to the table. Where the SEC is concerned, we 
are worried about insider trading. They have actually got 
authority to pursue insiders. And you are kind of setting up an 
insider trading regime within the CFTC without having gone 
through some legislative process to determine whether or not 
the CFTC's role should be changed.
    I am just expressing my concern in light of the fact that 
there doesn't appear to be any other product ever approved by 
the CFTC or any exchange that has this firewall concept in it. 
Thank you, sir.
    The Chairman. Thank you, Mr. Marshall. You have made some 
points that we have been hearing about. So I appreciate that.
    At this time we would like to recognize the gentlelady from 
Colorado, Ms. Markey.
    Ms. Markey. Thank you very much, Mr. Chairman.
    So obviously this is brand-new territory, and there is a 
lot of concern, a legitimate concern, raised here this morning. 
And let me just take a little different vein.
    You have expertise at the CFTC with traditional commodities 
that are traded, and this is a new product. What kind of 
expertise do you have on hand right now with your current 
staff? And how do you plan on developing the expertise that you 
are going to need in-house to make sure that these products are 
not susceptible to manipulation?
    Mr. Berkovitz. Our first defense, of course, will be the 
exchanges themselves. They are required to police their own 
markets, that is a condition of our approval of the exchanges; 
that they have surveillance and they have anti-manipulation 
processes in place. And both of the exchanges I believe have 
contracted with the National Futures Association to undertake 
that, who has the expertise to do this. They do the 
surveillance, market surveillance programs for a number of 
exchanges.
    So the exchanges are the front lines in this, and they have 
submitted their programs to us and that has been part of the 
approval process. And then on top of that, the CFTC 
surveillance program is in addition to that. And, indeed, to 
address that very concern, the market surveillance systems that 
they are required to have pursuant to the designation criteria, 
and the core principles are something that we have looked at 
and found that they are adequate.
    So it is not just the CFTC by itself and our staff who will 
be overlooking these contracts. It will be the exchanges and 
the National Futures Association also.
    Ms. Markey. And of course, as you know, Congress is looking 
at legislation to regulate derivatives. So you will already 
have a lot more on your plate within the next year. And then 
this is taking on additional work and an additional commodity. 
What are your staffing levels like right now, and with the 
exchange, in order to handle all this additional work 
regulations that are going to have to be written, staff that 
has to get up to speed on new products?
    Mr. Berkovitz. The Congress and the Administration have 
been very supportive of increasing the CFTC resources in the 
past few years to meet these additional responsibilities, both 
in terms of the current volume of futures trading and number of 
contracts continue to increase; with new products coming on, 
and then, as you mentioned, with the legislation, which will 
require substantial new resources. And I believe that is in our 
budget request.
    So it is a very real concern that the agency have adequate 
resources to undertake both these new markets within existing 
authority, as well as the new authorities that we may get under 
the legislation.
    Ms. Markey. Thank you, Mr. Chairman, for holding this 
hearing. And I yield back.
    The Chairman. Thank you. The chair recognizes the gentleman 
from Minnesota, Mr. Walz.
    Mr. Walz. Thank you for being here, Mr. Berkovitz. I 
appreciate it. I think all of us are trying to get a handle on 
what is happening here. It is an interesting discussion, and an 
important one, because the need is always there for financial 
instruments and innovation, and trying to balance those things 
out. I am interested to hear from Mr. Jaycobs and the folks 
from Cantor, kind of an impeccable timing of bringing up a new 
financial instrument in this environment. But I think that is 
the nature of it, and we have to be open to be able to hear 
that.
    A couple questions I have in watching this and trying to 
understand your position, not just on this issue, but a little 
broader. Do you see yourselves as just a passive pass-through 
to make sure the rules are enforced exactly as you interpret 
them? Or do you see yourself to anticipate and be more 
proactive against those? I am kind of getting the feeling, it 
seems to me that--and this may be the proper role. I am trying 
to understand it. That it is just passive, that these are the 
rules, and they fall within the rules so we have to do it.
    Mr. Berkovitz. I would describe it as a very active 
enforcer of the rules that we have. We have the rules and we 
have to follow the rules. We try to be very proactive, 
anticipating and looking ahead, to avoid problems, rather than 
simply looking behind.
    Mr. Walz. I want to make sure that I fall on the right side 
of this. Do you see it, is it the appropriate role of the CFTC 
to determine if there is a need for this product? Or is that 
for the market to determine, those folks who are coming to you?
    Mr. Berkovitz. It is not within our purview to determine 
whether indeed there is a need or not.
    Mr. Walz. So that might be kind of at the heart of this. I 
think some of us are trying to grapple, is there a real need 
for this, what is it for, and all of that. But asking you to do 
that is an inappropriate position to put you in. Am I correct? 
Am I summing that up right?
    Mr. Berkovitz. That is not something that is one of the 
criteria for approving these products or not.
    Mr. Walz. I think we are all struggling with this. And it 
may seem like a very simplistic question, because I am trying 
to understand this and trying to understand the definition of a 
question. I don't want to go down the road that the President 
did at one point on a pejorative towards Las Vegas. But there 
is a very specific reason for that. And I am trying to 
understand how this is different than a wager. And I say, for 
example, is this a bad example of--something like the Minnesota 
Vikings. They field the team, they put it together. And is 
there a future trading on how well they do this year? Is that 
different? Or is that a wager to determine whether they win the 
Super Bowl or not?
    Mr. Berkovitz. That is nothing that is traded on any of our 
futures.
    Mr. Walz. Is it different than this, though, by definition? 
Is it different than the movies futures? You know, you have a 
product. You have investors that get in it. You can buy into 
the studio right now. You can get dividends off that on a 
regular exchange on the big board. You can do all that. But the 
performance of it tends to be based on more of a wager because 
of all of these factors people brought up. That is what I am 
trying to understand, if this is the appropriate place for it. 
I think it would be--I am trying to see this. I think it would 
be appropriate for me, on what I know as a casual observer of 
movies, about which ones are going to hit big and which ones 
aren't. But that is wagering, it seems to me. I don't know. I 
am trying to get that from your expertise on this. It is 
somewhat subjective.
    Mr. Berkovitz. We don't really approach the question from 
that perspective. Somebody comes in with an application and 
say, ``We would like to trade the contract for future delivery 
or an option on a future for a certain commodity.'' And we look 
at that application. We are proactive in whether, indeed, the 
contract meets the statutory standards, whether it is 
susceptible or not to manipulation, what are the appropriate 
limits again and the integrity of the process. So we do a very 
thorough active review of that as it is presented to us.
    Mr. Walz. So you are operating inside the framework you 
were given, and I think that is probably appropriate. I think 
some of these questions are for the next panel.
    I thank you for your patience and your willingness to help 
us understand this. I yield back.
    The Chairman. Thank you. The chair recognizes the gentleman 
from Oregon, Mr. Schrader.
    Mr. Schrader. Thank you, Mr. Chairman. I guess I am biased, 
because I am one of the few Members that do not worship at the 
grail of liquidity and derivatives in this august body of ours. 
And while I appreciate what you do and CFTC has a stellar 
record, it is going to take some convincing to me that this is 
a good idea. What I have heard so far is it is going to be up 
to us to decide yes or no, passing legislation, create another 
onion exemption. I think that is unfortunate. But I see this as 
ripe for manipulation. I see no overriding public interest in 
this at all. Frankly, the people that are most affected don't 
like it, from what I have gathered so far. I guess we will hear 
more about that, going forward.
    To be honest, I think it would be sheer folly. We are in 
the middle of the worst derivative crisis this country has ever 
seen since the Great Depression. We are going to create another 
instrument, one that the public is going to see as, frankly, 
legalized gambling. I think the person who votes for this sort 
of thing would be absolutely insane. But maybe I could be 
convinced otherwise. I look forward to the rest of the 
testimony. Thank you. I yield back.
    The Chairman. Thank you. Mr. Berkovitz, at the University 
of Iowa, the College of Business operates the Iowa Electronic 
Markets. While originally created as a teaching tool for 
students, this market is now open to non-students and includes 
trading in elections futures from presidential races to control 
of Congress to individual races. Small market, with investors 
limited to $500. But it is a market nonetheless. The Iowa 
Electronic Markets operations under a No Action letter provided 
by the CFTC, where the CFTC says it will not take action 
against the university for offering political futures contracts 
on their exchange. It seems to me that elections contracts 
raise many of the same concerns we will hear from the next 
panel. What is the price discovery or hedging service the 
contract provides? What is the ability of the industry 
insiders, in the case of elections that would be pollsters, 
consultants, media, using their knowledge to trade or 
manipulate these markets? And what is their utility? For 
example, is an elected official ever going to short his own 
election? And granting No Action relief to the Iowa Electronic 
Markets, did the CFTC look at these issues? And why are these 
markets permitted?
    Mr. Berkovitz. My understanding on the Iowa Electronic 
Markets is this is being done and overseen by the University of 
Iowa as an academic and a research undertaking. There is a 
dollar limitation on it. It is being supervised by the 
university. My understanding, it is not for profit as well. 
Under those circumstances, the CFTC granted the No Action 
letter to enable it to operate.
    The questions that you have raised, though, in terms of the 
broader, beyond Iowa, are questions that do concern the 
Commission. In 2008, the Commission issued what is called a 
concept release, sort of like a discussion paper. It was in the 
Federal Register notice, inviting public comment on some of 
those very questions: What should the Commission's position be 
with respect to these, what they call prediction markets, where 
you can theoretically predict the outcome of an election or 
over events?
    And what should the regulatory position towards these 
markets be? Should we have an active role and regulate them 
like futures contracts? Are they inherently different from 
futures contracts? We have numerous public comments on that, 
and we are still reviewing that issue at the Commission.
    The Chairman. Any other questions from anybody on the dais? 
Seeing none, thank you very much for sharing. And we would like 
to excuse you at this time and invite the other panel to take 
their place.
    Thank you, gentlemen. We will just go through each and ask 
you to make your statement, if we could. And we will ask that 
you consider the 5 minute rule. We would like to hear from you, 
and then we will have an exchange of questions.
    So we would like to start off with Mr. Jaycobs, President 
of Cantor Futures Exchange, New York.

    STATEMENT OF RICHARD JAYCOBS, PRESIDENT, CANTOR FUTURES 
                  EXCHANGE, L.P., NEW YORK, NY

    Mr. Jaycobs. Thank you, Chairman Boswell, Ranking Member 
Moran, and Members of the Subcommittee. Good morning. I am 
Richard Jaycobs, President of the Cantor Futures Exchange.
    We have been working on the development of a futures 
exchange for box office receipts for over 2 years, but it 
wasn't until the last 4 weeks that we received any attention at 
all on the subject. And I welcome the opportunity to help 
alleviate the concerns and put into the proper context what we 
are building, how it works, and what benefits can be achieved 
through this.
    I would like to emphasize three points about the economic 
purpose and the integrity of futures contracts on box office 
receipts. First, for the private and institutional investors 
who have invested up to $8 to $10 billion of private money in 
films, futures contracts can be an important risk management 
tool just as they are in agriculture, energy, and many other 
industries. Movie futures will make more capital available at 
lower cost and, as a result, create American jobs.
    Second, Cantor Futures contracts are an effective pricing 
tool. The anticipated box office revenue of a motion picture is 
the basis upon which many decisions and commitments are made. 
By establishing this exchange, a market mechanism is created to 
provide independent judgment of that anticipated revenue, and 
it gives participants in that market and others better 
information. For example, screen allocations by movie theaters, 
distribution terms by independent distributors can be 
negotiated in the full transparency of a public price.
    Third, as a regulated futures exchange, we observe all 
market activity. Together with the National Futures Association 
and the CFTC, we have proper and prudent safeguards against 
manipulation. Cantor Exchange takes the issue of market 
integrity and transparency very seriously. Our parent company, 
Cantor Fitzgerald, was founded in 1945, and has extensive 
capital market experience. Cantor supports this Committee's 
efforts and goals for financial regulatory reform through 
greater market transparency, competition, and centralized 
clearing for financial markets.
    We are proud of our long record as a responsible market 
participant and a reputation as a caring corporate citizen in 
the aftermath of the 9/11 tragedy. In the wake of our nation's 
financial crisis and the debate on financial reform, any new 
financial product clearly should come under scrutiny.
    Since 2000, CFTC has designated more than 10 new exchanges 
with the creation of over 1,000 new futures contracts. As an 
experienced and expert regulator, the CFTC is well equipped to 
consider the public utility of new futures contracts and to 
ensure that any proposed futures contract meets the public 
policy, anti-manipulation, and fair competition requirements of 
the law. The box office contract will not proceed without CFTC 
approval and the legislation on this issue is not needed.
    The MPAA has said that movies futures are not legitimate, 
that they create an online platform for gambling, and that they 
are susceptible to manipulation. These are inaccurate and 
overreaching statements. The revenue generated by millions of 
moviegoers can be determined directly from the published 
reports of distributors or estimated from the electronic sales 
records.
    Initially, Cantor intends to use the box office numbers 
released by the studios; however, if the accuracy of the studio 
data appears to be manipulated, we will be able to detect this 
by comparing it to electronically captured sales records. 
Publicly available information enables the market to develop 
reliable estimates of a film's future box office potential, and 
in fact, several commercial entities already exist to make box 
office forecasts based solely on public information.
    The MPAA has also said that futures contracts based on box 
office receipts have no economic purpose. However, Lionsgate 
Entertainment, one of the most successful film distributors in 
North America that is not a member of the MPAA, has said in its 
letter to the committee, ``A market in domestic box office 
receipts would substantially widen the number and breadth of 
financing sources available to the motion picture industry by 
lowering the risk inherent in such financing.'' This is a key 
point. While the six MPAA members may not appreciate the value 
of film futures, other studios, producers, distributors, 
exhibitors and investors certainly do. Many sound, commercially 
important regulated markets would not exist today if large 
entrenched interests could simply have blocked their creation.
    The community of private and institutional investors who 
currently finance a significant percentage of domestic film 
production have no access to a risk mitigation tool. They have 
no voice here in front of this panel today. They have no trade 
association that represents their interest. We believe this 
group alone satisfies the requirement for a group of hedgers.
    In closing, better transparency is a critical component of 
a well-functioning market. Futures exchanges have proven their 
worth by bringing transparency and greater price discovery to 
market participants. The box office contract is designed to 
accomplish that same goal. When fully implemented, the market 
for these contracts will benefit all participants in the motion 
picture industry by providing additional capital at lower cost.
    In closing, what I would like to reference now is that 
injected into the regulatory reform debate in the Senate of 
course is the language prohibiting this contract. We obviously 
would like to express our view that we oppose that. Thank you 
for the opportunity.
    [The prepared statement of Mr. Jaycobs follows:]

   Prepared Statement of Richard Jaycobs, President, Cantor Futures 
                      Exchange, L.P., New York, NY
    Thank you Chairman Boswell, Ranking Minority Member Moran, and 
other Members of the Subcommittee. I appreciate the opportunity to 
appear today and to submit written testimony on the application of the 
Cantor Futures Exchange, L.P. (``Cantor Exchange'') to the Commodity 
Futures Trading Commission (``CFTC'') for designation as a contract 
market, and to discuss the public utility, transparency, and risk 
management benefits of Cantor Exchange's proposed movie box office 
futures contracts. Cantor Exchange's futures contracts are designed to 
bring risk management, transparency and financial flexibility to a wide 
range of participants in the film industry, similar to the role of 
regulated futures markets in agriculture, energy products, financial 
instruments, and other sectors of the marketplace.
Introduction to Cantor Fitzgerald and the Cantor Exchange
    I am here today in my capacity as the President of the Cantor 
Futures Exchange. Our parent company is Cantor Fitzgerald, which began 
as an investment banking and brokerage business in 1945. Following the 
loss of 658 of its 960 New York-based employees in the 9/11 World Trade 
Center attacks, Cantor rebuilt to become one of the leading and most 
widely-respected global financial services firms, recognized for its 
leadership in serving institutional clients in the fixed income and 
equity markets and for capital markets investment banking. Driven to 
succeed in order to help the families of its employees who perished on 
September 11, Cantor provided over $180 million to the families over 
five years, including healthcare benefits for 10 years for the families 
that needed it. In addition, to commemorate those who were lost, Cantor 
and its affiliates forego all their revenues each September 11, 
donating the full amount to charities that help wounded veterans, 
children with medical and special needs, and other worthy causes. 
Turning a tragic day into something positive and uplifting, these 
annual Charity Days to date have generated over $50 million for 
charitable organizations. Over the past eighteen months, as the 
financial markets experienced substantial turmoil, Cantor has added 
hundreds of new jobs, continuing its expansion and growth during a most 
difficult time in the global capital markets.
    Cantor Fitzgerald is one of 18 primary dealers authorized to trade 
U.S. Government securities with the Federal Reserve Bank of New York. 
Cantor Fitzgerald has been a major participant in the futures markets 
and has itself sponsored futures exchanges in the past. Indeed, Cantor 
Fitzgerald has been involved in operating futures exchanges since 1998. 
Cantor Exchange's affiliation with Cantor Fitzgerald underscores Cantor 
Exchange's capability and expertise to professionally operate, finance 
and monitor a well-run, efficient, federally regulated futures 
exchange.
Cantor Exchange's Movie Box Office Futures Contract
    Cantor Exchange has submitted an application to the CFTC to 
establish a futures market for contracts linked to the domestic box 
office receipts (``DBOR'') of upcoming film releases. These contracts 
will be cash-settled at a value that is directly indexed to the dollar 
value of movie tickets sold in the U.S. and Canada that consumers 
purchase over a period of approximately 4 weeks.
    The goal of Cantor Exchange has always been to assist the motion 
picture industry by expanding the breadth and depth of financing 
sources available to the industry. Enlarging the potential sources of 
film financing will lower the cost of making a film, help create 
American jobs, and contribute to stabilizing large and small members of 
the industry alike as they face the challenge of raising financing in 
the high-risk endeavor of filmmaking.
    We believe that a critical element in this effort is a public, 
transparent, and appropriately regulated futures market. It's important 
to point out that the film industry consists of many participants. In 
addition to the major studios, they include mini-majors and other 
smaller studios, independent producers and distributors, theater owners 
and investors. I've talked with a great number of them in the past 
weeks and months, and it's absolutely clear that there is wide and deep 
support for the ability to hedge theatrical risk and that hedging 
capability will drive a fundamental improvement in film finance.
    Our box office receipt contract is a straightforward hedging 
vehicle. It is an important design feature of our contract that box 
office receipts are a real and knowable value, based upon credible 
marketplace data. DBOR contracts are structurally identical to cash-
settled futures contracts on many economic indices that similarly 
provide for cash payments based on real underlying economic value. In 
the case of DBOR contracts, settlement is based on the aggregate box 
office receipts of the underlying film as reported by the distributor 
of each film and captured by Rentrak Theatrical.
    DBOR contracts are not a direct investment in film, but rather a 
cost effective means to hedge the extraordinarily high risk of the 
movie-going public's willingness to pay between $5 and $15 to watch any 
single film. Some films, like ``Avatar'', generate audiences and 
revenue that not only have strong openings but sustain their financial 
strength over a protracted period, whereas the audience for films like 
``Gigli'' and others evaporated quickly as consumers shift their 
preferences to better movies. The transparency offered by a regulated 
public market and the ability to hedge risk has indisputably been shown 
to result in reduced capital costs and greater competition, and that is 
the function and value that we propose to bring to the marketplace.
    We believe one of the immediate beneficiaries of our DBOR futures 
contract will be investors who provided the capital investment to make 
these films and are locked into multi-year, illiquid investments. Then, 
we expect the transparent public pricing and commercial potential of 
DBOR contracts will be recognized by theater owners to help reduce 
revenue volatility across their business by hedging their exposure to 
film-release volatility. We believe that every segment of the motion 
picture industry will ultimately find value in using box office receipt 
futures to hedge risk and broaden access to less expensive financial 
resources.
    While the Motion Picture Association of America, the MPAA, has 
raised concerns about our contract's usefulness as a hedging vehicle, 
it's often been the case in the history of the markets in our country--
the oil and aluminum industries are notable examples--that industry 
participants that initially resisted change came to see the futures 
market as an instrumental element of their industry's business and 
financial practices.
Comprehensive Regulatory Review Process
    Cantor Exchange has been working with the CFTC on its application 
to become a designated contract market. For over two years, Cantor has 
worked diligently with two staff teams of the CFTC to comprehensively 
demonstrate why box office futures satisfied the CFTC's Core Principles 
as required by the Commodity Exchange Act, including the ability to 
adequately prevent market manipulation and enforce equitable access and 
trading rules. I want to emphasize this point: our proposed exchange 
has proper and prudent safeguards against trading on inside information 
consistent with CFTC requirements. Indeed, these issues had been the 
subject of intense scrutiny by the professional staff of the CFTC and, 
by all accounts, had been successfully addressed in the application 
process.
    Our application was formally submitted to the CFTC on November 28, 
2008. A public comment period on our exchange was held by the CFTC 
during January 2009 and no comments were received. A second public 
comment period on the subject of box office receipt contracts was 
available to the industry in October 2009 when Media Derivatives 
applied for designation and again no comments were received. The CFTC's 
review of Cantor Exchange's application is substantially complete and a 
decision on our application is expected this month.
    Despite receiving no comments during either public comment process, 
we are here today at the first ever Congressional hearing on an 
exchange application in the history of the CFTC because a segment of 
the motion picture industry has raised public policy objections at the 
eleventh hour to any form of futures contract based on domestic box 
office receipts. We think it is clear that the assertions of the MPAA 
are groundless.
    The law and regulations of the United States are clear and 
unequivocal about fair trading rules, market surveillance, compliance 
and enforcement to ensure financial integrity and transparency of 
futures markets. As an expert agency and regulator of futures markets, 
the CFTC is well-equipped to consider the public utility and 
transparency that box office receipt contracts will bring to the motion 
picture industry. The CFTC has adequate authority to ensure that any 
proposed futures contract meets the public policy, anti-manipulation, 
and fair competition requirements of current law. The CFTC does not 
need further legislation or regulation to make an appropriate 
determination of this issue.
    Since enactment of the Commodity Futures Modernization Act in 2000, 
the CFTC has designated over ten additional futures exchanges as 
contract markets, including Trend Exchange (Media Derivatives) on April 
16, 2010. The CFTC has also registered at least nine clearinghouses as 
``derivatives clearing organizations'' during that time. Countless new 
products have been filed with the CFTC since enactment of the CFMA, 
with the majority ``self-certified'' by exchanges for immediate 
trading. None of these innovative exchanges or the products that they 
self-certified under the watchful eye of the CFTC has been associated 
with any form of systemic risk or financial stress.
    We expect that the creation of futures contracts based on box 
office receipts could dramatically lower financing costs for motion 
pictures; we expect that futures contracts could act as an engine for 
overall growth in the motion picture industry; and we expect that small 
and independent firms and financial investor partners would benefit 
considerably by having a hedging vehicle.
    We did not expect, however, the inaccurate, over-reaching and 
extraordinary claims of gambling, manipulation, and commercial damage 
made by the six largest studios' trade association, the MPAA, on March 
23. Through its unfounded and insupportable assertions, the MPAA 
essentially has impugned all futures trading, attacking the practices 
of the energy, aluminum, agricultural products and other industries as 
equivalent to gambling and marketplace manipulation.
    Cantor Exchange appreciates the opportunity to address these 
assertions with the Subcommittee. The primary purpose of my testimony 
today is to reinforce to the Members of this Subcommittee the sound and 
sensible answers that were presented to CFTC staff over the last two 
years. In so doing, our hope is that the Subcommittee recognizes the 
careful, thorough and considerable effort that both Cantor Exchange and 
the CFTC have put forward to ensure that Cantor Exchange and the DBOR 
contracts meet the letter and the spirit of the Commodity Exchange Act 
and, just as importantly, represent a positive innovation for the 
motion picture industry.
Economic Purpose of Box Office Contracts
    The motion picture industry is undergoing radical transition 
brought about by changes in film distribution technology, the Internet, 
and the ongoing financial crisis. All of these factors have combined to 
partially destabilize this very important American industry. The number 
of motion pictures produced in 2009 dropped dramatically by 12%, the 
first decline since 2003. Bank financing for films has all but ceased, 
over ten independent film companies either ceased doing business or 
consolidated their operations over the last 24 months, and the number 
of jobs lost by the film industry is estimated to be in the thousands.
    A public market for futures contracts based on domestic box office 
receipts will not by itself reverse these trends. However, DBOR 
contracts will provide a fully transparent and highly regulated 
marketplace where the risks of film investing can be shared and 
financing costs can be lowered.
    There are currently no mechanisms for firms in the motion picture 
industry to hedge risk associated with new film releases and, 
accordingly, there are no open and transparent markets for such 
transactions. A panoply of banks, institutional investors, and 
individuals place capital into various film financing vehicles and are 
exposed to unhedged box office risk. Other participants in the industry 
including distributors, theater owners and film studios themselves also 
have substantial un-hedged exposure to a film's box office performance.
    Investing in film production and distribution is extremely risky. 
Motion picture finance has failed to find a sustainable investor base 
due to the great uncertainty of film performance at the box office. 
Particularly in times of economic uncertainty, the high variability and 
risk of returns means that identifying sources of film financing 
quickly becomes difficult.
    The ability to finance films and manage the risks associated with 
film finance varies greatly. The major studios may be least affected by 
financial stress. Owned by large corporations, they benefit when fewer 
films are produced and there is less competition for movie goers, and 
they have the greatest leverage in negotiating revenue splits with 
theater owners.
    Weakest among the risk bearers include the financial investor who 
places capital in a multi-year film fund, the small theater owner who 
commits screens to major studios based solely on representations of 
those studios, and the production company that has little control over 
the marketing and distribution of its film. We submit that these 
commercial interests, combined with non-MPAA studios, represent a large 
enough and significant hedge community to meet the requirements for 
economic purpose under the Commodity Exchange Act.
    In addition to the extensive support for futures contracts we have 
identified amongst this section of the industry, there also is support 
by some of the larger players in the motion picture industry. Michael 
Burns, the Vice Chairman of Lionsgate, one of the leading independent 
film studios with a major presence in producing and distributing motion 
pictures, submitted a letter on April 16 to the House Committee on 
Agriculture in support of DBOR futures. Mr. Burns indicated that the 
regulated futures market proposed by Cantor Exchange ``would allow a 
diverse group of motion picture industry participants, including 
studios, film distributors, theater owners, investors and other 
financial intermediaries within the motion picture industry to manage 
their risk and exposure to new film releases.'' Mr. Burns added ``We 
believe a market in domestic box office receipts would substantially 
widen the number and breadth of financing sources available to the 
motion picture industry by lowering the risk inherent in such 
financing.'' We also understand that despite the National Association 
of Theater Owners signing various letters of objection, individual 
theater owners representing almost 20% of all theaters in America 
wished to see DBOR futures made available and not restricted as a 
result of any regulatory or legislative action.
    With respect to price discovery, the MPAA asserts in its March 23 
letter that DBOR contracts would not serve this public purpose; 
however, the MPAA subsequently submitted another letter on April 8 in 
conjunction with other film industry associations which explicitly 
recognizes that commercial transactions are affected by the pricing of 
film revenue contracts. Specifically, the April 8 letter stated that 
``[m]any prices for downstream licenses and other sources of revenue 
are driven in part by box office gross''.
    Transparency of information can only be a positive for any market. 
For eight years, Cantor Fitzgerald's virtual entertainment marketplace, 
the Hollywood Stock Exchange (``HSX''), has found that its hundreds of 
thousands of participants have not negatively impacted the virtual 
market domiciled on HSX.
    In contrast to unfounded claims by the MPAA, and because of the 
many economic interests and legitimate hedgers that have directly or 
indirectly expressed support for the existence of a market in box 
office futures, we submit that this market should be allowed and 
encouraged to exist.
Box Office Contracts Have Safeguards Against the Risk of Manipulation
    Cantor Exchange and its DBOR contracts will be monitored and 
policed like any other CFTC regulated market. To support its own 
compliance efforts, Cantor Exchange has engaged the National Futures 
Association (``NFA''), the industry-wide self-regulatory organization 
for the U.S. futures industry, to provide the exchange with self-
regulatory services to monitor trading and protect against market 
manipulation and other abuses. NFA has demonstrated its ability to 
safeguard and protect the public interest in markets as broad and 
diverse as carbon futures markets and the foreign exchange markets.
    The final settlement value of a DBOR contract represents the movie 
ticket purchases of millions of American consumers over a period of 
approximately four weeks. These purchases are reported by movie 
theaters, tabulated by Rentrak Theatrical, and published by studios. 
Therefore any effort to manipulate the DBOR contract's final settlement 
value would require tens of thousands of ticket sales to be under or 
over reported. It is hard to accept that such a large scale reporting 
gap could go undetected by all these commercial entities. For example, 
studios compare pop corn and soda sales to ticket sales as a check 
against under reporting. Even if such a fraud was attempted using box 
office futures, the beneficiaries of any such manipulation of the final 
settlement value would be quickly detected by Cantor Exchange, the NFA, 
and the CFTC. As Lionsgate's Mr. Burns indicated in his letter to the 
Committee, ``Lionsgate is comfortable that the market for futures on 
box office receipts can be adequately policed regarding material non-
public information and attempted market manipulation. The Cantor 
Exchange, under the CFTC's rules, will restrict trading by those with 
material non-public information relating to film releases.''
    Manipulation is often associated with trading on material, non-
public information. Clearly, certain institutions that may have an 
economic interest in hedging with DBOR contracts will have access to 
material non-public information relating to the underlying film title. 
This is not different from the situation in other public markets where 
trading activity is walled off from those who have material nonpublic 
information.
    Currently, the entertainment industry has no such barriers and has 
expressed concern about how such barriers might impact their 
operations. Cantor Exchange would like to emphasize three key points on 
this issue: (1) information barriers will not be required unless an 
entity is actively using the market; (2) having knowledge of the 
artistic content or prior viewing of a film does not constitute 
material non-public information; and (3) Cantor Exchange will work to 
assist any firm that wishes to prohibit its employees from trading. For 
example, Cantor Exchange does not permit trading by any employee of a 
FINRA or CFTC regulated entity unless that employee has the written 
permission of his employer's compliance department.
Commercial Value of DBOR Contracts
    As I noted, the financing and distribution of motion pictures is 
undergoing a period of enormous technical and financial change. Studios 
largely control the distribution of films and are uniquely able to fund 
the large advertising budgets so crucial to a film's box office 
success. Recently studios have abandoned many of their boutique 
divisions that distributed independent film, focusing instead on 
blockbusters.
    However, digital distribution of motion pictures will make it 
easier for movie theaters to show smaller independent films. The 
missing element for independent film makers and distributors is a means 
to evaluate the commercial potential of their film and secure financing 
against that potential. This is exactly the role that a futures market 
based on box office receipts can play.
    The financing of motion pictures is now coming from many new 
sources including corporate sponsors who may back individual film 
projects as part of their brand marketing. As the sources of film 
financing become more fragmented, the need for a regulated and 
transparent futures market increases.
    Hollywood studios have hedged their film making risk for many 
years, for example, by buying insurance against bad weather during 
outdoor filming. In spite of its glitz and glamour, the motion picture 
industry is relatively opaque. We suspect that the MPAA is primarily 
concerned that a transparent market in film revenues will detract from 
its influence and control of market information, hence its disingenuous 
claims that futures trading has no commercial value.
    We also recognize that the MPAA's concern seems to be a knee-jerk 
reaction to change, just as companies in the oil, aluminum and other 
industries initially opposed the establishment of futures markets, but 
now find them to be useful and customary aspects of their industry's 
commercial practices.
    There is no question that a public market for DBOR contracts will 
shine a brighter light on the motion picture industry. Allowing a 
greater number of market participants to signal their expectations 
about the market by allocating their capital will result in a more 
accurate assessment of value. We believe this greater transparency 
could benefit many participants in the industry. For example, 
purchasers of downstream licenses pay prices based on box office 
receipts or based on expected box office receipts if contracted in 
advance. DBOR contract pricing could constructively benefit those 
negotiations by providing new information to the downstream 
counterparty that currently has to rely on less public and less 
transparent sources.
Conclusion
    Enlarging the potential sources of film financing will lower the 
cost of making a film, help create American jobs, and contribute to 
stabilizing large and small members of the industry alike as they face 
the challenge of raising financing in the high-risk endeavor of film 
making. A marketplace that enables film makers to raise capital at a 
known price will reduce risk and increase the likelihood of bringing 
their product to market.
    The MPAA asserts that its objection to DBOR contracts is based on 
its belief that those contracts will not provide a genuine market for 
hedging risk or contribute to price discovery. As my testimony has 
shown, these critiques are misguided.
    It is ironic that while transparency in financial markets is widely 
endorsed in legislation and Congress is promoting regulated futures 
exchanges and centralized clearing, the MPAA's objections would result 
in less transparency, increased counterparty credit risk, and fewer 
financing options.
    Since the early stages of our process to establish the Cantor 
Exchange, we have actively sought out the input of a wide range of 
individuals and entities throughout the motion picture industry. Many 
of those we have reached out to have expressed interest in the concept 
of DBOR futures contracts. We have received considerable useful 
feedback and have continued to refine our business plans and strategy.
    An April 8, 2010 press release by the Futures Industry Association, 
the leading trade organization for the futures industry, urged that the 
potential introduction of film revenue contracts should be ``applauded 
rather than criticized''.
    We encourage the Subcommittee to ensure that the CFTC continues its 
diligent work to review and allow transactions to be executed and 
cleared in regulated and transparent venues. The legislation is already 
in place to allow Cantor Exchange to operate a futures market in DBOR 
contracts in accordance with the Commodity Exchange Act, and its 
application should be approved promptly.
    Greater transparency, reduced counterparty risk, and broader 
participation are precisely the benefits that Congress, economists and 
others have cited in recommending improvements in the financial 
markets. During the financial crisis of 2008-2009, most agree that the 
futures markets performed their function properly. We urge the 
Subcommittee to support creation of this new, constructive, federally 
regulated futures market that will enhance the motion picture 
industry's transparency, market integrity, and ability to effectively 
manage commercial risk.
    We believe our application for contract market designation and for 
approval of the futures contracts based on box office receipts is 
clearly in the public interest. Our innovative proposed futures 
contracts on box office receipts offer many in the motion picture 
industry the ability to hedge their commercial risks and will be used 
for price discovery purposes. Although not all interests in the motion 
picture industry may be inclined to trade box office contracts for 
these purposes, others stand to benefit greatly from their 
availability. This has often been the case at the time a new class of 
futures contracts was introduced.
    Prohibiting futures on motion pictures by changes to the Commodity 
Exchange Act or by new laws or regulations could deny this critical 
industry a tool available to manage capital and allocate risk more 
effectively. While all forms of financial innovation should be 
carefully assessed to determine their value to the marketplace and the 
public interest, we are extremely confident that the current Commodity 
Exchange Act and CFTC regulations fully and adequately address all the 
issues that have been raised by certain groups within the motion 
picture industry for the Subcommittee's consideration.
    On behalf of Cantor Exchange, thank you for this opportunity to 
discuss how our proposed futures contracts will bring new levels of 
risk management, transparency and financial flexibility to the motion 
picture industry.

    The Chairman. I now recognize Mr. Swagger, Chairman and 
Chief Executive Officer, Media Derivatives of Scottsdale. Mr. 
Swagger.

    STATEMENT OF ROBERT S. SWAGGER, CHAIRMAN AND CEO, MEDIA 
               DERIVATIVES, INC., SCOTTSDALE, AZ

    Mr. Swagger. Thank you, Chairman Boswell and Ranking Member 
Moran for inviting us here to testify. I am Robert Swagger, 
Chairman and CEO of Media Derivatives. Media Derivatives is a 
small, privately funded entrepreneurial business that has 
followed the processes and procedures established in the 
Commodity Exchange Act, and in so doing, has created jobs 
during a challenging time in the U.S. economy.
    As an individual who was born in the Midwest and has 
experienced the benefits of futures markets to the agricultural 
industry, and in particular, as an entrepreneur who helped 
found an ethanol plant that its very survival was a direct 
result of the use of futures contracts, I have founded MDEX for 
the purpose of creating risk management tools for the 
entertainment industry. Note, the concepts of creating such 
tools was a direct result of my and my team's extensive 
involvement in the entertainment industry. We believe that the 
development of such products is consistent with the major 
thrust of the Congress' enactment of the Commodity Futures 
Modernization Act of 2000 which sought to promote, among other 
things, innovation with respect to risk management tools and 
futures contracts.
    On September 25, 2009, MDEX filed its application to become 
a designated contracts market. At the time of its filing, MDEX 
agreed to separately file its proposed products for approval 
rather than self-certifying. In early March 2010, MDEX filed 
its first product for review. On the eve of the expiration of 
the CFTC's 180 day review period and more than 4 months after 
the close of the comment period for DCM application, various 
entertainment industry associations filed general objections. 
Most of the objections are the same objections that Congress 
and this Subcommittee in particular has heard for decades. The 
objections have been addressed by CFTC staff throughout the 
rigorous review process.
    The objectors have contended that the reputation and 
integrity of our industry could be tarnished by allowing 
trading in the movie futures contracts. This is patently false. 
MDEX has no interest in disparaging the reputation and 
integrity of Hollywood. The objector statements could apply to 
every industry that has a product upon which a futures contract 
is listed, such as U.S. Government and Treasury futures, the 
housing industry and housing futures, the insurance industry 
and weather futures, the listing of aluminum futures and the 
aluminum industry, the agriculture industry and the listing of 
corn, wheat, soybeans, and other futures.
    The notion that regulated futures contracts tarnish an 
industry and is tantamount to legalized gambling is outdated 
and baseless. MDEX is not seeking to establish an opaque OTC 
market such as what already exists, rather MDEX seeks to bring 
the same tested benefits of futures contracts such as 
transparency, price discovery, liquidity, and centralized 
clearing in a regulated environment.
    The contracts that MDEX seeks to list are not dissimilar to 
other futures and options contracts. The contracts allow 
parties with financial interests in the movie production and 
revenue chain to hedge the risks. Such groups include original 
screenplay owners, debt and equity investors, investment banks 
syndicating a financing slate, talent involved in the film, 
studios both MPAA and independents, banks and lenders, insurers 
of talent and movies, theaters, distributors and co-promotional 
marketing partners.
    The products proposed by MDEX would provide a viable means 
of broadening the financial tools available to a very 
significant segment of the economy in an efficient, reliable, 
and tested model.
    In designing its products, MDEX has worked closely with the 
CFTC staff to reduce if not eliminate the likelihood of 
excessive speculation in the retail use of its products. MDEX's 
contracts specifications require each contract to be fully 
funded. In other words, there is no leverage component; thus, 
reducing excessive speculation.
    At the same time, because they are fully margined and 
essentially cleared by a CFTC regulated clearinghouse, there is 
no credit risk. In all material respects, MDEX's contracts 
obviate risk, they do not create it.
    In working with the CFTC for over 11 months and approving 
MDEX's DCM application, the CFTC found that both MDEX and the 
CFTC, as well as the NFA have the expertise and resources 
necessary to conduct market surveillance and compliance with 
respect to futures based upon movie box office receipts.
    Finally, it is critical to note that today on Intrade, you 
can place trades on opening weekend box office results. The 
market is offshore, open to the public, unregulated and employs 
leverage. The greatest participants on Intrade are U.S. 
citizens.
    The unintended consequences of the objector's efforts is 
likely to result in continuing to push market participants to 
retail, leveraged markets that are subject to no oversight by 
CFTC or Congress. Rather than push market participants 
offshore, MDEX seeks to list and clear contracts in a fully 
regulated and transparent fashion subject to comprehensive CFTC 
oversight and sound risk management principles.
    MDEX thanks the Committee for the opportunity to 
participate in this hearing and answer any questions regarding 
a proposed product of the MDEX DCM.
    [The prepared statement of Mr. Swagger follows:]

   Prepared Statement of Robert S. Swagger, Chairman and CEO, Media 
                   Derivatives, Inc., Scottsdale, AZ
    I am Robert S. Swagger, Chairman and Chief Executive Officer of 
Media Derivatives, Inc., or ``MDEX.''
    Thank you, Chairman Boswell and Ranking Member Moran for inviting 
us to testify today. You have asked us to discuss our application to 
list futures and options contracts based upon movie box office 
revenues. We are pleased to offer our views on these important matters.
I. Introduction
    MDEX was founded three years ago for the purpose of creating risk 
management tools for the entertainment industry. MDEX is a small, 
privately-funded entrepreneurial business that is seeking innovative 
ways to manage risk, while attempting to create jobs in markets 
including Illinois, Indiana, Arizona and California, where our offices 
are located. One such risk management tool that we have developed, 
based upon market research and feedback, is that of regulated futures 
contracts based upon movie box office revenues.
    MDEX has developed such a tool not in an effort to impose a risk 
management process upon the entertainment industry, but in response to 
a demonstrable need for producers, distributors, financiers and others 
to hedge the enormous and rising costs--and thus risk--associated with 
producing, marketing and distributing a major motion picture. Given 
that a single motion picture can cost more than $100 million to 
produce, the movie industry would appear to be an especially viable 
candidate for risk management tools. We have taken extreme care to 
design these products to ensure fair and equitable trading of the 
contracts and the integrity of the final settlement process. MDEX also 
looks forward to the opportunity to offer other risk management 
contracts for the entertainment industry, which may relate to revenues 
associated with, for example, music, video games and books.
    We believe that the development of such products is consistent with 
a major thrust of Congress' enactment of the Commodity Futures 
Modernization Act of 2000, which sought to promote, among other things, 
innovation with respect to risk management tools such as futures 
contracts. The MDEX proposed products would encourage a transparent 
market place to establish increased liquidity for future financing of 
major films and other entertainment media.
II. Submission of Applications and Comment Periods; Bifurcation of DCM 
        and Product Applications
    On September 25, 2009, MDEX filed its application to become 
designated as a fully-regulated contract market, or ``DCM.'' As a 
courtesy and in an effort to be proactive, MDEX submitted a draft 
application to CFTC staff as early as May 18, 2009.
    Shortly after the formal submission of its application, the CFTC 
published the application for comment in the Federal Register on 
October 6, 2009 and the comment period remained open through November 
5, 2009.
    Over the course of the past 11 months, MDEX worked closely with 
CFTC staff to ensure that its products satisfy the statutory 
requirements of the Commodity Exchange Act (the ``CEA''), including the 
eight Designation Criteria set forth in CEA Section 5(b) and the 18 
Core Principles set forth in CEA Section 5(d). MDEX has also submitted, 
as part of and in support of its application, more than 100 documents, 
including a statement of compliance with the CEA, its rules, a Trading 
Facility and Disaster Recovery Plan, an agreement with the National 
Futures Association relating to the exchange's disciplinary program, an 
agreement with Minneapolis Grain Exchange (``MGEX'') relating to the 
clearing of the exchange's trades, a comprehensive regulatory chart, 
and many other documents requested by CFTC staff. MDEX commends the 
CFTC and CFTC staff for their tireless and thorough efforts, and we are 
pleased to say that, after an extraordinarily comprehensive review, 
CFTC staff recommended to the CFTC that MDEX's DCM application be 
approved, and the CFTC approved MDEX's DCM application on April 16, 
2010.
    Additionally, in a separate filing on March 4, 2010, MDEX requested 
the CFTC to approve an MDEX futures contract based upon Opening Weekend 
Box Office Motion Picture Revenues. Importantly, MDEX did not self-
certify the product listing. Rather, MDEX requested CFTC approval 
following publication and an opportunity to comment in the Federal 
Register. MDEX's product application remains under review by the CFTC, 
and we are working closely with CFTC staff to ensure that any concerns 
are adequately addressed.
    On the eve of the expiration of the CFTC's 180 day review period--
and more than four months after the close of the comment period for the 
DCM application--the MPAA and several other entertainment industry 
associations (the ``Objectors'') filed various general objections to 
the DCM and product applications and the notion of derivatives in the 
entertainment industry. Critically, if MDEX had learned of the 
Objectors' concerns four months ago, MDEX likely would not be 
testifying here today consuming additional taxpayer funds, as well as 
much-needed funds of a small business such as MDEX.
    Most of the objections are the same objections that Congress, and 
this Subcommittee in particular, has heard for decades, such as futures 
contracts are a form of ``legalized gambling.'' Other product-based 
objections may be more relevant, but nonetheless are misplaced or have 
been addressed with CFTC staff, as MDEX will detail below.
    Notably, the Objectors sought not only to challenge the product 
listing, but also the DCM application. We strongly believed, however--
and we are pleased that the CFTC agreed--that a DCM application should 
be viewed separately from any product application. To the extent that 
the Objectors have concerns about the products, such concerns should 
not have been levied in an effort to compel the CFTC to withhold its 
approval of the DCM application--especially when the comments arrived 
more than four months after the close of the comment period. We raise 
these concerns because we believe that Congress is and should be 
concerned equally about the process as well as the merits. From a 
credibility and fairness perspective, matters of procedure need to be 
honored if results are to be meaningful.
III. MDEX Seeks to Offer a Regulated, Transparent Risk Management Tool 
        to the Entertainment Industry
    The Objectors have declared that ``the reputation and integrity of 
our industry could be tarnished by allowing trading in the movie 
futures contracts in a manner which allows them to be viewed as the 
economic equivalent of legalized gambling on movie receipts.'' \1\
---------------------------------------------------------------------------
    \1\ Letter from Objectors to Chairman Gary Gensler, CFTC, dated 
March 23, 2010.
---------------------------------------------------------------------------
    Nothing could be farther from the truth, and MDEX has no interest 
in disparaging the reputation and integrity of Hollywood. Notably, the 
Objectors' broad and populist statement could apply to every industry 
that has a product upon which a futures contract is listed. It could 
apply, for example, to the U.S. Government and the listing of Treasury 
futures; the housing industry and the listing of housing futures; the 
insurance industry and the listing of weather futures; the listing of 
aluminum futures and the aluminum industry; and the agricultural 
industry and the listing of corn, wheat, soybean and other futures. The 
notion that regulated futures contract tarnishes an industry and is 
tantamount to ``legalized gambling'' is not only outdated, but 
parochial and baseless.
    In fact, as witnessed during the financial market turmoil of 2007-
2008, there is broad consensus that the futures markets not only 
performed admirably, but that futures contracts in no way contributed 
to the financial market turmoil. If anything, the consensus is that 
futures contract should serve as a more prominent risk management tool. 
Importantly, the Administration and many Members of Congress have 
proposed to require that standardized over-the-counter (``OTC'') 
derivative contracts be executed and/or cleared on an entity regulated 
by the CFTC.
    To be clear, MDEX is not seeking to establish a market for the 
trading of motion picture products in an opaque OTC market. Such a 
fragmented market already exists, albeit in a nascent form. In this 
market, participants bilaterally enter into hedges using OTC options. 
These transactions are unknown to other market participants, regulators 
or Congress. Rather, MDEX seeks to bring the demonstrable benefits of 
futures contracts--such as pricing transparency, liquidity and 
centralized clearing in a regulated environment--to the highly 
uncertain and variable outcome of movie box office revenues.
    As discussed more fully below, MDEX believes, based upon its market 
research that the need for such a risk management tool exists. The 
function of hedging or, more broadly, risk management, is a fundamental 
underpinning of the derivatives markets and is weaved into the fabric 
of the CEA. The legislative history of the CEA and its predecessor 
statute, the Grain Futures Act of 1922, is replete not only with 
references to the commercial importance of trading commodity futures, 
but that commercial parties should be able to look to properly 
functioning commodity futures markets for market information and 
products that facilitate marketing, financing and distribution 
decisions.\2\
---------------------------------------------------------------------------
    \2\ Grain Futures Act, ch. 369, 42 Stat. 998 (Sept. 21, 1922). See 
also, 73 Fed. Reg. 25669, 26672 (May 7, 2008); S. Rep. No. 93-1131, at 
12 (1974).
---------------------------------------------------------------------------
    Moreover, as a risk management tool, the economic efficacy of 
futures contracts, despite the recent financial market turmoil, remains 
beyond reproach. While futures contracts may involve risk--and 
particular types of derivatives and trading strategies may involve 
substantial risk--there is little doubt that derivatives can be used to 
perform critical hedging functions.
    MDEX sought to become a DCM to bring the benefits of futures 
contracts to the entertainment industry. In seeking to promote price 
transparency, liquidity and hedging opportunities, MDEX also seeks to 
ensure the protection of customer funds. In this respect, MDEX plans to 
use an intermediation model of transaction execution in which all 
customer trades are executed by CFTC-registered futures commission 
merchants (``FCMs'') and all customer funds are maintained in 
segregated accounts. Further, all transactions executed on MDEX will be 
cleared through a CFTC-registered designated clearing organization, the 
Minneapolis Grain Exchange.\3\
---------------------------------------------------------------------------
    \3\ As part of its regulatory responsibilities, the CFTC monitors 
FCMs and clearing organizations with respect to the financial integrity 
of the commodity futures and options markets.\3\ For example, CEA 
Section 4f(b) and the CFTC's financial and related record-keeping and 
reporting rules, such as CFTC Rules 1.20-1.30, 1.32, 1.36 and 1.49, are 
part of a system of financial safeguards that includes exchange and 
clearinghouse risk management and financial surveillance systems, 
exchange and clearinghouse rules and policies on clearing and 
settlements, and financial and operational controls and risk management 
employed by market intermediaries themselves. Two primary financial 
safeguards under the CEA include the requirement that FCMs segregate 
from their own assets all money and property belonging to their 
customers and the imposition of minimum capital requirements for FCMs 
and IBs.
---------------------------------------------------------------------------
    A transparent marketplace that allows institutional/professional 
traders to share in the substantial financial risks assumed by various 
participants in film financing would by no means cause harm to the 
integrity of the industry. Furthermore, there would be no increased 
costs for those Objectors who would choose not to participate in the 
exchange. Those studios that elect to participate in our markets will 
of course be subject to MDEX rules, including importantly, rules to 
assure that trading in our markets is fair and equitable. The costs a 
studio may incur to comply with exchange rules will likely be more than 
offset the financial benefits of prudent risk management using MDEX 
products. Markets in innovative new products should not be prevented 
due to unfounded fear and misunderstanding.
IV. Futures Contracts on Intangible Commodities are Permissible and 
        Already Exist
    Based upon the Objector's comments, there appears to be confusion 
as to whether the interests underlying MDEX's proposed contracts 
constitute a commodity on which a DCM may list contracts for trading.
    At the outset, it should be noted that the definition of 
``commodity'' in CEA  1a(4) covers ``services, rights, and interests'' 
in which futures contracts are or may be dealt. That broad definition 
covers the reported cumulative gross box office revenues for a movie 
through its opening weekend that would underlie MDEX's Opening Weekend 
Motion Picture Revenue Contracts. Although futures contracts are often 
linked to an underlying cash commodity market, there is no requirement 
that a cash market must exist, and the absence of an underlying cash 
market for the our opening weekend box office revenue contracts is not 
grounds to disqualify them from trading. To the contrary, the 
definition of ``excluded commodity'' in CEA  1a(13), which was added 
in 2000, expressly recognizes that a measure of economic or commercial 
return or value such as that underlying the opening weekend contracts 
is a permissible excluded commodity if it is based on one or more 
commodities that have no cash market.
    Intangible commodities have been based on a broad array of outcomes 
and contingencies. Today, for example, the CFTC regulated market of the 
North American Derivatives Exchange lists binary contracts based upon 
many and diverse economic events. Moreover, the U.S. Futures Exchange 
(``USFE''), as a DCM, listed binary event contracts regarding whether 
the CME would buy the CBOT; another contract regarded whether the 
InterContinental Exchange would buy the CBOT. Notably, in listing these 
contracts, the USFE ``self-certified'' that the contracts comply with 
the CEA, and CFTC staff did not take any action to abrogate the listing 
of the contracts. Other exchanges have listed similar contracts, such 
as total insurance claims filed for hurricane damage.
V. MDEX's Proposed Contracts Serve an Important Economic Purpose
    The contracts that MDEX seeks to list are not dissimilar to other 
futures and options contracts and, based upon MDEX's research with 
interested segments of the industry, portend to serve an important 
economic purpose in allowing parties with financial interests in the 
movie production and revenue chain to hedge the risks associated with 
producing a major motion picture. There is a broad group of potential 
participants with exposure to a film that are natural shorts, or even 
natural long hedgers, including:

   Original screenplay owners;

   Debt and equity investors;

   Investment banks syndicating a financing slate;

   Talent involved in the film;

   Studios;

   Banks and lenders;

   Insurers of talent and movies;

   Theaters;

   Distributors; and

   Co-promotional marketing partners whose results are 
        inherently tied to success at the box office.

    In addition, a host of other businesses stand to be impacted by the 
performance of movies and thus may have a legitimate need for such risk 
management tools.
    Traditionally, the entertainment industry has found ways to hedge 
the risk associated with delay or cost overruns in the production and 
delivery of film product, some more efficient than others, through so-
called ``completion bonds,'' and negative insurance. However, there 
have been very limited means to minimize and manage performance risk.
    Just as entertainment entities, like many businesses, have used 
foreign exchange and interest rate hedging to limit potential risks, 
the products to be offered by MDEX will provide a viable means of 
broadening the financial tools available to a very significant segment 
of the economy in an efficient and tested model. It is hard to imagine 
that the corporate parents of the studios do not have a keen interest 
in limiting the potential significant downside risk of a poorly 
performing picture. To spend $500,000 to create the floor for loss on a 
picture that is spending $65,000,000 in prints and advertising seems 
like a very reasonable business judgment.
    With respect to those who are involved in the financing of films, 
the box office future contract would provide senior debt lenders with a 
tool to hedge the potential under-performance of films. In today's 
financial climate, lenders are likely to be unwilling to take box 
office performance risk even on a large portfolio of films if tools 
exist to aid them. Traditionally, this has been performed through so-
called slate financings, a tool that has been severely limited by the 
current financial climate.
    The availability of risk management contracts can provide a level 
of confidence and free-up financing capacity. For instance, the opening 
weekend box office product would provide to these parties a tool to 
hedge performance of future films in the slate financing should the 
performance of the initial releases be at a level that is lower than 
anticipated in the financier's underwriting criteria. This would reduce 
the overall volatility of the slate and would encourage lenders to once 
again be lending. As lenders provide debt to film slate financing, it 
should improve equity returns and thereby encourage equity investors to 
enter the market. Additionally, equity investors would not only have 
the opportunity to hedge their positions in the way similar to that 
used by the senior debt investors, but they would also have the 
opportunity to improve their returns by ``going long'' on their film 
slate thereby boosting overall returns and attracting additional 
capital to what is currently a capital starved entity.
VI. MDEX's Futures Contracts Do Not Promote Excessive Speculation and 
        Do Not Rely Upon Leverage
    Over the past few years, much has been written about excessive 
speculation, and the Objectors have joined the general choir. In 
designing its product, however, MDEX has worked closely with CFTC staff 
to reduce--if not eliminate--the likelihood of excessive speculation 
and the retail use of its products.
    MDEX has created contract specifications that minimize such 
potential outcomes by specifying a relatively high notional value 
coupled with a requirement that each contract be fully funded, or fully 
margined. In other words, there is no leverage component. MDEX's 
contracts thus do not avail themselves to speculation. At the same 
time, because they are fully margined and centrally-cleared by a CFTC-
regulated clearing house, there is no credit risk. In all material 
respects, MDEX's contracts obviate risk; they do not create it.
VII. MDEX's Futures Contracts Are Not Susceptible to Manipulation
    The Objectors have raised a concern regarding possible insider 
influence on compiling the public box office figures in order to affect 
final settlement prices for MDEX products, as well as possible actions 
that a film studio or distributor might take on the use of a movie's 
advertising budget to influence daily pricing of the contracts.\4\ 
These concerns are relevant, but MDEX has addressed them through its 
product design, processes and procedures.
---------------------------------------------------------------------------
    \4\ See Letter from Objectors to Chairman Gary Gensler, CFTC, dated 
March 23, 2010.
---------------------------------------------------------------------------
    Clearly, a fundamental purpose of the CEA is to prevent 
manipulations in the commodity futures and futures options markets.\5\ 
With respect to exchanges, this purpose is embodied in CEA Section 
5(b)(2), Designation Criterion 2, which provides that the board of 
trade:
---------------------------------------------------------------------------
    \5\ See CEA  3(b) and 9(a)(2).

        shall have the capacity to prevent market manipulation through 
        market surveillance, compliance, and enforcement practices and 
        procedures, including methods for conducting real-time 
        monitoring of trading and comprehensive and accurate trade 
        reconstructions.\6\
---------------------------------------------------------------------------
    \6\ CEA  5(b)(2), 7 U.S.C.  7(b)(2).

    Further, CEA Section 5(d)(3), Core Principle 3, provides that the 
board of trade ``shall list on the contract market only contracts that 
are not readily susceptible to manipulation.'' \7\ In approving MDEX's 
DCM application, the CFTC has declared that both MDEX and the CFTC have 
the expertise and resources necessary to conduct market surveillance 
with respect to the commodities upon which MDEX seeks to list futures 
contracts. In working with the CFTC over the past 11 months, MDEX has 
taken the steps necessary to ensure that its opening weekend contracts 
will not be readily susceptible to manipulation. MDEX has satisfied 
these concerns through product design and various processes and 
procedures.
---------------------------------------------------------------------------
    \7\ CEA  5(d)(3), 7 U.S.C.  7(d)(3).
---------------------------------------------------------------------------
    With respect to product design, MDEX's proposed opening weekend box 
office products are short-term contracts that are only listed for 
trading four weeks in advance of a movie's release. Four weeks prior to 
a movie's release, the market has a significant amount of public 
information at its disposal to render trading decisions, and marketing 
plans are well into the execution phase. Theater screens are set for 
the showing of the movie and only minimally adjusted in the final weeks 
prior to opening. Movie theater screens are finite real estate, and 
with the competition among movies at any given point in time, large 
numbers of screens are simply not available for a last minute changes. 
Importantly, MDEX rules require that the opening weekend revenue 
products cease trading prior to a movie's release in theaters. This 
serves to remove the concern regarding the earlier availability of box 
office information to the studio/distributor than the public.
    Further, a key aspect of product integrity addressed by the CFTC 
and MDEX is the determination of the box office revenue figure used in 
establishing the products' expiration prices. In meetings that MDEX has 
held with major studios, it has been expressed to us that the studios 
are very sensitive to public expectations for box office revenues 
accuracy and reliability. In support of this studio position, MDEX 
presented information and developed rules and processes to ensure the 
integrity of its expiration prices. In particular, MDEX has developed a 
``Motion Revenue Contracts Box Office Revenues Validation and 
Verification Processes,'' which includes:

   Ensuring that the studio/distributor's publicly reported box 
        office number fits within a pre-set standard deviation derived 
        from data provided by the industry leading data provider--
        Rentrak--that collects box office revenue information directly 
        from the theaters;

   Maintaining up to date studio/distributor and Rentrak data 
        for all wide-release movies and using the data to periodically 
        adjust the standard deviation;

   Requiring the studio/distributor to provide evidence to 
        support its public box office number when it falls outside the 
        standard deviation level;

   Requiring MDEX to determine an appropriate box office level, 
        using Rentrak and studio/distributor data, in which to 
        establish the final expiration prices, when the studio/
        distributor cannot justify its box office number; and

   Weekly verification of the Rentrak process for collecting 
        theater box office data.

In addition, MDEX has adopted a series of Firewall and Restricted 
Participant Review protocols to prevent the improper use of 
information. Under the protocols:

   Communication is prohibited between the individuals 
        responsible for or having input into the studio/distributor's 
        decisions to trade such Contracts (the ``trading group''), on 
        the one hand, and its employees who are responsible for 
        compiling and/or computing the gross box office revenues 
        publicly disseminated by such studio/distributor for its motion 
        pictures regarding the studio/distributor's positions in any 
        such contracts or the trading group's decisions or discussions 
        with respect to establishment of such positions. The disclosure 
        prohibition on these employees also extends to disclosing the 
        information to any other parties, except as necessary, in 
        performance of the employee's responsibilities.

   Certain employees within a studio/distributor and companies 
        that collect box office revenues are prohibited from trading 
        MDEX box office products.

   Studios/distributors that participate in MDEX markets are 
        required to adopt procedures to monitor the communications and 
        enforce the trading prohibitions.

   MDEX will periodically review the studio/distributor 
        procedures and require them to attest that the procedures are 
        included in internal control reviews.

   MDEX will routinely review a studio's/distributor's expired 
        movie contracts for patterns between expiration prices and 
        positions to determine if there may be issues with firewall 
        procedures.

   When a party applies to the exchange for trading access, 
        MDEX will require the party and his clearing firm to identify 
        whether he may be subject to trading restrictions under the 
        MDEX rules.

    All of the foregoing procedures and processes have been 
painstakingly addressed and examined by CFTC staff. The staff, in 
recommending the approval of our application, understands and agrees 
with the efficacy of the procedures and processes.
    Moreover, from the perspective of investor protection, the CEA also 
strictly prohibits actual and attempted manipulations by market 
participants. The prohibitions against manipulation of prices are set 
forth in CEA Sections 6(c), 6(d) and 9(a)(2).\8\
---------------------------------------------------------------------------
    \8\ 7 U.S.C. 9, 13b, and 13(a)(2). CEA Sections 6(c) and 6(d) 
authorize the CFTC to issue a complaint if it ``has reason to believe 
that any person . . . is manipulating or attempting to manipulate or 
has manipulated or attempted to manipulate the market price of any 
commodity, in interstate commerce, or for future delivery on or subject 
to the rules of any registered entity.'' 7 U.S.C.  9, 13b. CEA 
Section 9(a)(2) makes it is unlawful for ``[a]ny person to manipulate 
or attempt to manipulate the price of any commodity in interstate 
commerce, or for future delivery on or subject to the rules of any 
contract market, or to corner or attempt to corner any such 
commodity.'' 7 U.S.C.  13(a)(2) (2002). Together, CEA Sections 6(c), 
6(d), and 9(a)(2) prohibit both manipulation and attempted 
manipulation.
---------------------------------------------------------------------------
    Notably, the CEA does not prohibit insider trading by market 
participants in the commodity futures and options markets, based upon 
the premise that barring insider trading would defeat the market's 
basic economic function of allowing traders to hedge the risks of their 
commercial enterprises.\9\ In other words, virtually every commercial 
hedger has some amount of inside information.
---------------------------------------------------------------------------
    \9\ See, e.g., Testimony of Commission Chairman Phillip McBride 
before the SEC/CFTC Jurisdictional Issues and Oversight: Hearings on 
H.R. 5447, H.R. 5515 and H.R. 6156 Before the Subcommittee on 
Telecommunications, Consumer Protection and Finance of the House 
Committee on Energy and Commerce, 97th Cong., 2nd Sess, Part 1 at 21 
(1982); A Study of the Nature, Extent and Effects of Futures Trading by 
Persons Possessing Material Non-Public Information (Sept. 1986). 
Trading on material non-public information is prohibited under the CEA, 
but only with respect to three general categories of persons. First, 
the statute prohibits CFTC Commissioners, employees and agents from 
trading on non-public information. CEA  9(a)(4), 7 U.S.C.  13(a)(4). 
The statute similarly prohibits CFTC Commissioners and CFTC employees 
from delivering nonpublic information to third parties with the intent 
to assist them in conducting trades; the CEA also forbids individuals 
who receive this information from trading on it. CEA  9(d), 7 U.S.C.  
13(d). Finally, the CEA prohibits employees and board and committee 
members of a board of trade, registered entity, or registered futures 
association, from willfully and knowingly trading for their own or on 
behalf of any other account, futures or options contracts on the basis 
of any material non-public information obtained through special access 
related to the performance of their duties. CEA  9(e), 7 U.S.C.  
13(e).
---------------------------------------------------------------------------
VIII. Contracts Based Upon Movie Box Office Currently Trade on 
        Unregulated Foreign Markets
    Finally, it is critical to note that, as we speak, unregulated 
foreign markets trade products based upon movie box office revenues and 
related measures. For example, on Intrade, a market based in Ireland, 
you can place trades on the opening weekend box office results of Iron 
Man 2 or Date Night. This market is open to the public, unregulated and 
employs leverage. The unintended consequence of the Objectors' efforts 
is likely to result in continuing to push market participants to 
retail, leveraged markets that are subject to no oversight by the CFTC 
or Congress.
    Rather than push market participants offshore, MDEX seeks to list 
and clear contracts in a fully regulated and transparent fashion, 
subject to comprehensive CFTC oversight and sound risk management 
principles.
IX. Conclusion
    MDEX has allocated substantial efforts and resources to develop its 
DCM and entertainment risk management products. MDEX recognizes--as 
many within the entertainment industry recognize--the unique and 
growing risk management challenges facing the entertainment industry. 
MDEX looks forward to the opportunity to allow market participants in 
the entertainment industry to determine whether MDEX's proposed product 
is suitable as a risk management tool.
    Media Derivatives, Inc. thanks the Committee for the opportunity to 
participate in this hearing and answer any questions regarding a 
proposed product of the MDEX DCM.

    The Chairman. Thank you.
    The chair would now like to recognize Mr. Pisano, president 
and interim Chief Executive Officer for Motion Picture 
Association of America.

   STATEMENT OF A. ROBERT PISANO, PRESIDENT AND INTERIM CEO, 
 MOTION PICTURE ASSOCIATION OF AMERICA, INC., WASHINGTON, D.C.

    Mr. Pisano. Thank you, Mr. Chairman, Mr. Moran, and Members 
of the Committee. Thank you very much for allowing us to be 
here today.
    I am appearing today on behalf of the six companies that 
are represented by the Motion Picture Association, but also on 
behalf of a really unprecedented coalition of members of the 
industry who are traditionally, frankly, warring parties. You 
have present at this table representatives of labor and 
management, representatives of exhibition and distribution, and 
representatives of large studios and small independent 
producers. To envision all of these groups together on a single 
issue is almost unimaginable, but it is this issue that has 
brought us together.
    The second thing I would like to say is I come before you 
as a representative of a trade association, but also as someone 
who has actually spent 25 years in the movie industry. I have 
been an executive at Paramount, MGM, I was head of the Screen 
Actors Guild. And in the course of my career in the industry, I 
have probably been associated with the production, financing, 
distribution and marketing of well over 200 films. And so I 
come at this from the standpoint of someone who has actually 
been in the industry and is deeply concerned about it.
    We have a way of marketing movies in the industry in which 
we say, ``From the producer up,'' or, ``The director up,'' and 
I am tempted to say this movie, this particular movie, this 
particular idea, should be marketed as from the producers who 
brought you the derivative debacle, and I don't mean that all 
derivatives are bad. What I do mean is this derivative falls in 
that category of synthetic, fictional instruments designed 
solely for speculation or gambling.
    My first point, and Congressman Goodlatte made it earlier, 
there is no market for movie box office receipts. In fact, 
movie box office receipts reporting were created by my company 
in the 1980s as a way of marketing our movies. We wanted to be 
able to say that we had the number one movie of the weekend. 
You can't buy them; you can't sell them; and equally important, 
you can't take delivery of them because nobody makes them 
available. They are simply an indication of public support.
    Second, as Congressman Goodlatte also pointed out, this is 
a unique product. The functional equivalent of writing a 
commodities contract in a traditional way would be to write 
that contract on a cow or an ear of corn. And I dare say if 
such a contract came before the CME, it would be excluded.
    So you have these two factors: No market, no buying and 
selling; a unique product, and to me that gives you the 
potential for manipulation because the very people who are 
buying and selling it are people who are not part of the 
industry, have no stake in it, and are only speculating. So 
that, in turn, raises the possibility of harm to the industry 
because a short position against a movie reported on an 
exchange with an aura of authenticity will become a self-
fulfilling prophecy. People will stay away from the box office 
because the price of the movie in the futures market has gone 
down. I submit to you that is both subject to manipulation; 
and, frankly, it is subject to hurting both the industry and 
the individual movie.
    I can speak about the injury to the industry, and my 
colleague, Mr. Harbinson, will speak about the harm to the 
creators, the people who actually create the movie, the 
directors, the writers, the actors. They work on one movie, and 
to have that subject to speculation and arbitrary trading in 
order to affect the outcome is something that should not be 
permitted.
    So we have no price, no market, a unique product, subject 
to manipulation, subject to harm. What do we have here? I 
submit to you we have wager, gambling over and under betting. 
That is something that more properly belongs in Las Vegas, no 
offense to Las Vegas, and regulated by the gambling laws. It 
should not be put in the clothing of a commodity.
    And so we urge the Committee to urge the CFTC to deny the 
applications for the contracts and we urge the Committee at 
conference to support the amendment in the Senate financial 
reform bill prohibiting trading in these kinds of agreements.
    Thank you very much, Mr. Chairman.
    [The prepared statement of Mr. Pisano follows:]

  Prepared Statement of A. Robert Pisano, President and Interim CEO, 
     Motion Picture Association of America, Inc., Washington, D.C.
    Thank you, Chairman Boswell and Ranking Member Moran, for the 
invitation to provide testimony before the Subcommittee on General Farm 
Commodities and Risk Management of the House Committee on Agriculture, 
regarding proposals to designate contract markets that will provide a 
mechanism for trading futures and option contracts in motion picture 
box office numbers. My name is Robert Pisano. I am appearing today and 
providing oral testimony on behalf of the Motion Picture Association of 
America, Inc. (``MPAA''). However, these prepared remarks are submitted 
as the collective views of The Directors Guild of America, Inc. 
(``DGA''), the Independent Film & Television Alliance (``IFTA''), the 
International Alliance of Theatrical Stage Employees (``IATSE''), and 
the National Association of Theatre Owners (``NATO''), as well as the 
MPAA and its member companies, Paramount Pictures Corporation, Sony 
Pictures Entertainment Inc., Twentieth Century Fox Film Corporation, 
Universal City Studios LLLP, Walt Disney Studios Motion Pictures, and 
Warner Bros. Entertainment Inc., which represent perspectives from all 
corners of the motion picture industry.
    I have spent virtually my entire career in the film business, first 
as a partner of a major law firm working on entertainment matters 
before joining Paramount Pictures as executive vice president and 
general counsel in 1985. At Paramount, I was responsible for all legal 
and legislative affairs, as well as labor relations and business 
development. I was a member of the Office of the Chairman and the 
Operating Committees of the studios' international theatrical, video, 
and pay television distribution and exhibition joint ventures. I left 
Paramount and joined Metro-Goldwyn-Mayer in 1993 as Executive Vice 
President and then became Vice Chairman, when I had the 
responsibilities of chief operating officer. Immediately before joining 
MPAA, I was National Executive Director and CEO of the Screen Actors 
Guild. My views, my opposition to futures trading in box office 
receipts, reflect not only the views of the MPAA and its members, and 
the film industry coalition allied with MPAA on this matter, but also 
my long experience engaged in the financial and business aspect of the 
film industry.
    The Commodity Futures Trading Commission (``CFTC'') currently has 
before it applications to approve or deny two proposed commodity 
futures contracts and a commodity option contract that are designed to 
allow the contracts' users to bet on the level of gross motion picture 
box office numbers for single and unique motion pictures (``the 
proposed contracts'' or ``the contracts''). We strongly oppose approval 
of these proposed contracts because they are nothing more than gambling 
contracts that lack any of the characteristics of legitimate futures 
contracts, fail to serve any public interest, and will harm all parts 
of the motion picture industry. Descriptions of the terms of the 
proposed contracts are included in Attachment A to these remarks.
    Legitimate commodity futures contracts invariably are designed to 
serve the interests of the industries that use the underlying 
commodities by providing a means to discover prices and hedge commodity 
price risks. Consistent with this, Congress has declared in Section 
3(a) of the Commodity Exchange Act (``CEA''), 7 U.S.C.  5(a), that 
transactions covered by the CEA ``are affected with a national public 
interest by providing a means for managing and assuming price risks, 
discovering prices, or disseminating price information.'' CEA Section 
3(b), 7 U.S.C.  5(b), further declares that it is the ``purpose of 
this Act to serve the public interests described in subsection (a) . . 
. .'' It is service of these public interests that distinguishes 
legitimate, lawful futures contracts from gambling contracts that are 
either proscribed as crimes by the Federal Wire Act or regulated by 
state gaming authorities.
    The proposed contracts, which are sponsored by Media Derivatives, 
Inc. (``MDEX'') and The Cantor Futures Exchange L.P. (``Cantor''), 
serve no public interest and, to the contrary, can significantly harm 
the motion picture industry and impose new, substantial costs that do 
not exist today. A Cantor affiliate currently operates a website known 
as The Hollywood Exchange that lets users of the site engage in make-
believe, non-monetary bets on the success of particular motion 
pictures. The request for CFTC approval of the proposed futures 
contracts is a transparent device to convert such make-believe, online 
betting into a for-profit wagering service, thereby circumventing the 
criminal proscriptions of the Federal Wire Act.
    The CEA, however, does not authorize the CFTC to license gambling 
contracts that fail to serve the public interests required for every 
lawful futures contract. And, in light of the existing significant 
strains on the CFTC's scarce resources in regulating legitimate futures 
and derivatives markets, those resources should not be diverted now to 
policing gambling on motion picture box office numbers.
A. The Proposed Contracts Provide No Price Discovery or Hedging Service 
        to the Motion Picture Industry; They Are Simply Betting 
        Instruments
    The motion picture industry is distinctly different from industries 
that have use for legitimate futures contracts. First, in the motion 
picture industry, there is no cash market in any ``commodity''--no 
articles or interests are traded among buyers and sellers for which a 
futures market is needed or desirable for price discovery.\1\ Second, 
the product of the industry is an artistic or entertainment product 
that derives its value not from any intrinsic utilitarian use, but from 
emotional sentiment. Whether a motion picture will connect with an 
audience has proven quite difficult to predict, and in some instances 
sentiment for a motion picture can prove to be quite fleeting. There is 
no set formula for success, which depends on the totality of such 
things as artistic intangibles, marketing, release date, opening 
locations, and the national mood, fears, and fascinations at a 
particular time. Significantly, studios must invest virtually all of 
their capital up front. Accordingly, post-production, studios have 
natural incentives to avoid any action that can threaten an audience's 
interest in or reception of a motion picture.
---------------------------------------------------------------------------
    \1\ Motion picture box office numbers are outside of the legal 
definition of a ``commodity'' under the CEA because (a) no rights or 
interests are traded in motion picture box office numbers, (b) such 
numbers (as announced by Variety) do not value any other traded 
article, good, right or interest, and (c) such numbers are not beyond 
the control of certain industry insiders. All of the commodities 
specifically enumerated in CEA Section 1a(4), 7 U.S.C.  1a(4), are 
traded in cash markets, and the requirement that futures prices reflect 
the legitimate forces of supply and demand of an underlying cash market 
further requires that futures contracts be permitted only to the extent 
that they reflect the valuation of articles, rights and interests that 
are traded. In addition, box office numbers are not within the CEA's 
definition of ``excluded commodity'' because they are within the 
control of or, at a minimum, highly influenced by, a small group of 
entities (i.e., producers, distributors and exhibitors) that control, 
among other things, the number and location of theaters in which a 
motion picture is shown, the number of screens and size of screens on 
which a motion picture is shown, and the marketing budgets for a motion 
picture. See CEA Section 1a(13)(iv)(I), 7 U.S.C.  1a(13)(iv)(I).
---------------------------------------------------------------------------
    Third, unlike most other products that are the subject of futures 
contracts, the value of an individual motion picture is not priced in 
open bidding among a large contingent of interested parties. Rather, a 
relatively small number of entities (the studio, the exhibitors, and 
marketers) have inordinate impact on the potential for box office 
numbers in the opening weekend and beyond for any particular motion 
picture. Their private decisions as to release dates, opening 
locations, number of theaters, number of screens, size of screens, and 
marketing budgets can significantly impact box office numbers in the 
early weeks of showings. Those decisions can be in flux up to the 
opening release and beyond, and much of the information regarding those 
decisions is closely held and protected from public dissemination. 
Fourth, unlike all other industries that use futures contracts, the 
motion picture industry has no constituents that would be natural long 
hedgers--no one has a risk of loss if a motion picture is wildly 
successful. Accordingly, there is no natural price competition in any 
purported ``market'' for box office numbers.
    Neither of the sponsors contends that their proposed contracts 
offer any price discovery function. Studios receive information on box 
office numbers directly from exhibitors and others, including Rentrak 
Theatrical (``Rentrak''), a private company that compiles information 
on box office numbers from many, but not all, exhibitors. The public 
generally receives estimates of gross box office numbers from reading 
stories in the general press based on figures announced by the studios 
and Rentrak.
    Moreover, the bets made on the proposed contracts would not be a 
reliable indicator of box office numbers, because much of the material 
information affecting such numbers is non-public. Bettors would not 
have access at any time to much of the material information affecting a 
motion picture's box office performance (e.g., marketing budgets, 
distribution agreements), because it generally is not publicly 
available. Trying to forecast box office numbers prior to a motion 
picture's release without the benefit of the non-public information 
that is closely held by studios and other motion picture industry 
insiders is arbitrary.\2\ Significantly, none of the means used to 
assess the legitimacy of futures pricing based on supply and demand 
would exist for the proposed contracts. Prior to the publication of 
estimates of box office numbers for the first weekend release, there is 
no cash market pricing, no additional months of futures market pricing, 
and no actual cash market transactions against which to measure the 
legitimacy of the futures price.
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    \2\ Marketing and distribution plans are never made public. Prior 
to release, traders could see trailers, TV spots, and print, online, 
and outdoor advertisements. However, the marketing spend itself and the 
break-down of spend by media are not public and would be difficult to 
determine as an outside observer, particularly as marketing varies by 
location.
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    Further, non-public business decisions regarding motion picture 
marketing and distribution plans that affect box office numbers can and 
do occur up to and throughout the release of the motion picture, with 
studios constantly adjusting their distribution patterns and marketing 
spend to take account of consumer acceptance of a film. Although a 
preliminary plan is prepared in advance of approving a motion picture 
for production (i.e., well before a release date is scheduled), the 
plan remains subject to change and in fact is continually adjusted 
until the motion picture is released and beyond. Marketing changes 
generally can be made within a day and in some cases almost 
immediately, in terms of changing marketing materials, their placement, 
or their relative frequency of use.\3\
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    \3\ The press does report the number of screens on which a motion 
picture will be released (but usually only within a week of release) 
and may report changes in screen count earlier if it becomes known that 
the scope of release has been significantly increased or decreased for 
a motion picture, but this information alone, without knowledge of 
other material, non-public information, is wholly inadequate to 
reasonably predict box office numbers.
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    The proposed contracts have no appeal or use with respect to the 
public interest criterion of hedging. Studios mitigate their financial 
risk at the pre-production stage or early in the production stage by a 
host of techniques, including partnering with other companies to share 
the risk, diversifying projects across different segments of the 
viewing audience, selling downstream rights early to cover costs, and 
raising capital in private and public markets to effectively syndicate 
the risks. Studios further mitigate their financial risk by balancing 
their slate of motion pictures with a variety of types of pictures (new 
films and remakes; low budget and high budget; teen and adult; comedy 
and drama and horror, etc.).
    Although it may appear in theory that establishing a short position 
in a futures contract could be a ``hedge'' against poor box office 
performance, in the reality of the marketplace, selling a motion 
picture ``short'' after production would invite catastrophic collateral 
consequences, both for the particular film's success and future 
relationships with financiers, directors, actors, exhibitors and 
others. Commercial interests involved in a motion picture will not run 
the risk of negative publicity by creating even the potential for 
accusations or rumors that it was ``betting against'' the success of 
its own picture by ``shorting'' it in a futures market. Moreover, there 
is a legal concern that such shorting transactions could generate 
claims of violating standard mutual covenants in industry contracts 
with exhibitors, directors, actors and others that prohibit 
disparagement of the work.
    For independent producers, whose films are often released in the 
U.S. by the major studios, which control marketing and release plans, 
mitigating financial risk may be even more difficult. Independent 
producers secure financing on a film-by-film basis with different 
investors for each film and rely heavily on the distribution 
commitments of foreign distributors before production of the film even 
begins. Those minimum commitments, along with any government incentive 
programs, are collateralized by financial institutions and other 
investors, which loan the producer the production budget. Independent 
producers rely on the proceeds of foreign distribution to pay back the 
production loan, and therefore any hedging by U.S. distributors could 
harm not only independent producers, but also the dozens of financial 
and commercial partnerships they must build worldwide to secure 
financing for each film.
    Theater owners similarly have no incentive to bet against a motion 
picture. They do not want to be perceived as betting against the 
product they will be offering and they have other means to mitigate 
risk. By virtue of the Paramount Antitrust Consent Decrees entered into 
with most of the major motion picture studios about 60 years ago, the 
studios license on a theater-by-theater and picture-by-picture basis. 
Motion picture licenses are not tied one picture to another. Doing so 
would be a violation of the Paramount Antitrust Consent Decrees and, in 
any case, also would raise antitrust considerations. Therefore, no 
exhibitor is obligated to license any motion picture. If an exhibitor 
chooses to license a motion picture, the rental for that license is 
negotiated separately, and any concern that the exhibitor may have 
regarding the public's interest in the motion picture (i.e., potential 
success) will be reflected by the percentage of the rental the theater 
owner agrees to pay based on those negotiations. Motion picture rental 
is paid as a percentage of the gross numbers of tickets sold.
    Significantly, underscoring the fallacy that the proposed contracts 
are even close to being legitimate futures contracts, the sponsors' 
contract rules effectively and, for Cantor's contracts, expressly, 
prohibit trading by studios and other insiders, thus precluding any 
potential for hedging whatsoever.\4\ These rules are unique among all 
futures contracts. They bear witness to the fact that the proposed 
contracts, unlike legitimate futures, do not in fact price 
``commodities'' that are traded in a market, but, rather, are bets on 
the value for a single product (the motion picture), which can be 
substantially influenced through the actions of relatively few 
insiders. The sponsors' rules suggesting the use of an ``Information 
Barrier'' as a means to avoid the proscription of insider trading 
provide no assistance in permitting hedging. Such a barrier requires 
futures traders for a studio to be cordoned off from any information 
within the studio that would provide the basis for determining hedging 
needs and strategy. Studio and other industry insiders who have the 
ability to materially affect the level of box office numbers also 
likely would be wary of trading in the proposed contracts in any event, 
because doing so increases the potential of incurring significant legal 
costs in having to respond to inquiries from governmental 
investigations and/or private claims if futures prices gyrate.
---------------------------------------------------------------------------
    \4\ Cantor's filing on April 14, 2010 with the CFTC of a proposed 
contract based upon ``The Expendables'' expressly prohibits any person 
in possession of material, non-public information from trading in the 
contract until the information has become public. Examples of such 
information cited in Cantor's rules include, but are not limited to, 
changes in release date or the promotion or advertising budgets, number 
of theaters showing the film, and actual box office receipt statistics 
following release. Cantor's rules purport to require studios and other 
entities to adopt policies to ensure that their officers, directors, 
employees, and agents, including authorized traders, do not trade on 
the basis of material, non-public information.
---------------------------------------------------------------------------
    As a practical matter, any decisions by a studio to hedge any risk 
would need to be cleared with senior management, who necessarily have 
intimate knowledge of all financial and contractual information 
relating to a motion picture and under the sponsors' rules would not be 
permitted to interact with traders. In this connection, box office 
numbers data are very important and sensitive information that is 
shared within a studio with, among others, key mid-level marketing 
personnel, the General Counsel's Office, and senior management. No 
studio is arranged or intends to reorganize itself so as to separate 
the management and reporting lines of persons with access to the box 
office numbers data and the persons who compile or compute those 
figures. It makes no sense to do so and would prevent a studio from 
utilizing the box office numbers data in the most efficient manner.
B. The Proposed Contracts Will Harm the Motion Picture Industry
    Currently, studio estimates of box office numbers do not impact 
anyone; they are of no consequence to the public's interests. However, 
the CFTC's approval of the proposed contracts will create: (a) burdens 
for motion picture financing by creating new, but unreliable and non-
economic, prognostications of a motion picture's success, (b) conflicts 
of interest for studio employees and independent contractors by 
creating a means to bet against the success of motion pictures, and (c) 
new legal risks for studios in, among other things, announcing 
estimates of box office numbers and having to police the use of inside, 
non-public information affecting box office numbers that could be 
material to bettors' trading decisions.
     The pricing on the proposed contracts creates a greater risk of 
depressed box office numbers because such pricing, although lacking any 
reliable economic basis, could harm a motion picture's prospects by 
negatively affecting financiers' and audiences' perception of it. 
Because the ultimate breadth of distribution can be revised up to the 
time of release and afterward, the proposed market could affect 
distributors' ability to secure screens if the pricing of contracts 
signals a sentiment of negative box office results. The harmful effect 
of negative publicity is not limited to theater showings. Many prices 
for downstream licenses and other sources of revenue are driven in part 
by actual box office receipts. Motion pictures slated to open in 
limited theaters (which can easily meet the threshold requirements of 
the proposed contracts of 600 theaters for MDEX and 650 for Cantor) and 
then broaden based on word of mouth could be ruined by futures pricing 
that casts them in the false light of a ``failed'' opening.
    The impact of piracy could be amplified by these contracts because 
trading in the proposed contracts also creates a new means to try to 
profit from theft of studios' confidential motion picture materials, 
thereby increasing the likelihood of such theft and exacerbating our 
industry's existing widespread motion picture piracy problems. For 
example, a person who steals a motion picture or motion picture 
creative materials, in finished or unfinished form, before its release 
could short the contract and then post it on the Internet to hurt box 
office numbers. Similarly, a person armed with critical inside 
information might use it to profitably trade in the proposed contracts. 
Nothing in the sponsors' publicly available materials about their 
contracts begins to suggest how either will be able to detect and 
prevent such manipulative conduct. Given the rise of the Internet and 
other technologies, piracy and leaks of confidential information are 
growing threats to the motion picture industry. The CFTC should not 
provide any additional incentives for motion picture piracy and 
stealing intellectual property by approving the proposed contract 
applications.
    Approval of the contracts also creates a whole host of new 
financial and legal costs and burdens that do not now exist. Once a 
contract is traded in box office numbers estimates, the announcement of 
such estimates has consequences for bettors. This, in turn, creates 
legal risk for studios in announcing their estimates--where none exists 
now--because mistakes that are currently meaningless could now be 
portrayed as impacting bettors' financial results from their contracts, 
thus giving rise to private claims for damages for negligence, 
misrepresentation, or even, given the minimal pleading requirements for 
commencing actions, manipulation. The cost of litigating even 
unmeritorious claims could be substantial and cause studios to cease or 
significantly alter the practice of public announcements.
    Approval of the proposed contracts also will require studios and 
all other industry participants that have the power to affect futures 
pricing to institute and police anti-insider trading compliance regimes 
for the proposed contracts. It is problematic whether any prohibition 
on insider trading would need to take into account inside information 
held by persons who are not subject to the control of the studios. In 
the event that the studio is distributing an independent film, the 
potential for many more insiders outside of the studio's control is 
enormous. There are many industry participants who have access to 
material, non-public information and could try to use that information 
to profitably bet on the proposed contracts. There are many insiders, 
for example, in studio marketing and distribution departments and upper 
management and in exhibitors' finance, marketing and contracting 
departments, who have access to such material, non-public information 
as actual box office data, internal forecasts, advertising strategies 
and spending, and release patterns.\5\ Exhibitors also have a right to 
see a motion picture prior to licensing it in the U.S.\6\
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    \5\ Other insiders who could possess material, non-public 
information range from financiers and their advisors, potential 
distribution partners, talent, crew, agents and other representatives, 
special effects and other post-production vendors, trailer houses, 
festival screening committees and the employees, families, and friends 
of all these people. Insider trading also could implicate insider 
trading proscriptions of the Federal securities laws, where a movie's 
box office success could be material to the market value of its 
producer's publicly traded securities. Also, the rise or fall of an 
independent production company's release could have a material impact 
on its future ability to function; trading in such a picture's 
prospects could doom not only that picture, but future pictures and, in 
the worst case, the entire company. The proposed contracts thus could 
be used by insiders as surrogates for their companies' securities in 
order to profit from inside information.
    \6\ Although certain members of the public may see a motion picture 
prior to its theatrical release, and their reactions may become public 
through social media and social networking technologies, much of this 
information remains non-public.
---------------------------------------------------------------------------
    Even if a studio's compliance system is designed and executed to 
perfection, it is possible that, at some point, the CFTC or the 
Department of Justice will investigate a suspicion of possible 
manipulation of the proposed contracts, causing large legal expenses 
for the industry. The studios would be put to great expense to comply 
with the investigation. Moreover, studios and other industry insiders 
would be natural targets for strike suits by disappointed traders. 
Further, the negative publicity that could flow from rumors or 
announcements of an investigation and from strike suits would be 
damaging to the industry parties involved. These are risks and costs 
that do not now exist and the industry will receive no benefits from 
the contracts to offset these substantial risks and costs.
    These essential public interests reflect a legislative intent that 
futures contracts provide economic value beyond pure speculation. 
Consistent with this, the contract market designation criteria and core 
principles requiring that contracts not be readily susceptible to 
manipulation and that a designated contract market (``DCM'') prevent 
manipulation are founded on the principle that futures contracts are 
tied to legitimate cash markets, serve an economic purpose for those 
markets, and that futures prices should reflect, in the CFTC's oft-used 
words, the ``legitimate forces of supply and demand'' in an underlying 
cash market. The Appendices to the CFTC's rules governing contract 
market designation specifically require, among other things, that a 
board of trade applying to be approved as a DCM shall submit a 
``description of the cash market on which the contract is based'' and 
the ``designated contract market should collect data in order to assess 
whether the market price is responding to the forces of supply and 
demand.'' Similarly, CEA Section 4(a), 7 U.S.C.  6(a), expressly 
condemns ``excessive speculation'' and authorizes the CFTC to prohibit 
it.
    These features of the CEA unambiguously demonstrate Congress's 
intent that, for futures contracts to be lawful, they must provide 
price discovery and hedging functions and not simply be an outlet for 
speculation. The Commodity Futures Modernization Act of 2000 may have 
relaxed the procedures for designating contract markets, but it did not 
extinguish or even change the statute's central requirement that 
regulated futures contracts meet those criteria.
    The proposed contracts cannot serve these public interests. It is 
undisputed that they will not provide a means of price discovery; 
indeed, MDEX and Cantor do not even argue that their contracts serve 
this public interest. Nor, as discussed below, will the proposed 
contracts in fact be used for hedging. Rather, they are simply a means 
by which the sponsors of the contracts seek to serve their own private 
interests and the private interests of persons who would like yet 
another outlet for speculative pursuits. Such activity should not 
receive the sanction of the Federal Government or take up any of the 
government's scarce regulatory resources especially where, as here, the 
contracts would be harmful to the industry they purport to serve.
C. Reports of Box Office Numbers Are Not Free From Error
    Box office estimates largely have been a marketing tool; they were 
not created to support financial trading. The practice in the motion 
picture industry is to report estimates of weekend gross box office 
numbers on Sunday, based on projections informed by numbers received 
for Friday and Saturday showings. Variety publishes those estimates on 
Monday, as do many major newspapers and media sources. Those estimates, 
which are generated by the studios, are based in part on non-public and 
undisclosed projections and assumptions that can vary from motion 
picture to motion picture and from studio to studio. Variety provides 
this disclaimer about the information it publishes:

        ``Variety publishes data compiled by Rentrak Theatrical, which 
        collects studio reported data as well as box-office figures 
        from North American theatre locations. Any information provided 
        by Rentrak has been obtained from sources believed to be 
        reliable.

        However, Rentrak does not make any warranties as to the 
        accuracy, completeness or adequacy of this information and 
        data. The user of this data agrees Rentrak, its officers and 
        employees will have no liability arising from the use or 
        disclosure of this information and data. To submit any 
        questions to Rentrak, please e-mail: 
        [email protected].''

See: http://www.variety.com/index.asp?layout=b_o_layout&dept=Film 
(emphasis added). Those estimates, as with estimates of all types, can 
be flawed, although traders rely on them--see the articles from Variety 
about errors in estimates of weekend box office numbers for the past 
two consecutive weekends in April 2010, which are attached hereto as 
Attachments B and C.
    The box office receipt information Rentrak compiles from the 
exhibitors that have agreed to provide that information to Rentrak is 
itself incomplete, and we understand that the percentage of the total 
box office numbers that is reported by exhibitors to Rentrak can vary 
materially from motion picture to motion picture depending on how many 
exhibitors within its universe of reporting exhibitors are showing a 
particular motion picture. We understand that many exhibitors record 
box office numbers electronically and then provide the aggregate 
information to Rentrak through an electronic feed, but also that many 
exhibitors tabulate their numbers manually. However, some exhibitors 
never report to Rentrak, either automatically or manually.\7\
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    \7\ Our understanding is that not all exhibitors provide 
information to Rentrak and, therefore, the completeness of Rentrak's 
tabulations for any particular motion picture for any particular 
period, as measured against the entire universe of box office numbers 
for a motion picture for that period, can vary based upon the number of 
screens on which it is shown by exhibitors that provide their 
information to Rentrak.
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    Typically, studios, upon receiving Rentrak exhibitor-based figures, 
in turn conduct their own information gathering and analysis to develop 
their estimates that may be publicly announced in the press. As 
Variety's disclaimer indicates, the studios' Sunday announcements of 
weekend motion picture box office numbers information in Variety 
include the studios' estimates. The studios' information gathering and 
analysis may vary from one company to another and is closely held 
proprietary information, but it can include, for example, communicating 
with some of the exhibitors that are not included in the Rentrak 
figures and even those exhibitors that are included in the Rentrak 
figures if their information appears to be potentially inaccurate or 
incomplete.
    Even the studios' box office estimates announced subsequent to the 
Sunday estimates are unaudited and never capture 100 percent of box 
office numbers. None of the data reported to Variety, the Rentrak 
compilations, or the studio estimates are used to settle transactions 
between exhibitors and distributors. Those transactions are settled by 
reporting of actual gross box office receipts between the contract 
parties, on a non-public basis, and subject to their contractual 
accounting and audit rights and obligations. In addition, it should be 
noted that neither Rentrak nor studio figures adjust for U.S./Canadian 
exchange rates. Further, studio-announced figures may include data 
reported to the studio by a third-party distributor where U.S. and 
Canadian theatrical rights are held by different entities.
D. The Proposed Contracts Are Susceptible to Manipulation and Price 
        Distortions
    In the first instance, the lack of any legitimate economic measure 
of valid pricing before the Rentrak numbers are announced prevents any 
ability to even identify a manipulated price. Further, the potential 
box office numbers for a single motion picture can be materially 
affected by individual industry participants in a variety of different 
ways that would be exceedingly difficult to detect. Exhibitors that 
contribute to the Rentrak numbers could, either intentionally or 
accidentally, misreport their data. A distributor could determine 
within the period following a motion picture's release to reduce or 
increase the number of theaters that would show the motion picture. A 
distributor for a variety of reasons could determine to substantially 
reduce or expand its marketing budget, which can materially affect box 
office numbers. A major exhibitor could decide to show the motion 
picture on smaller or larger screens, which can materially affect 
audience interest and capacity. We respectfully submit that the 
sponsors have no effective means to detect or prevent such conduct or 
to determine whether it was undertaken for valid business reasons, 
rather than to manipulate futures prices.
    Futures prices for individual motion pictures also are susceptible 
to manipulation by false market rumors. In the unique circumstances of 
the motion picture industry, it would be virtually impossible to 
identify the sources of such rumors or to prosecute any alleged 
manipulation by false rumors, because such rumors would typically be 
based on opinions relating to a motion picture's artistic or 
entertainment merit rather than verifiable facts. There already are 
plenty of rumor mills with respect to the quality of motion pictures 
and many of them are in the online environment. These range from 
reviews by members of the public who have attended screenings, 
professional reviewers, press reports relating to rumored or perceived 
``trouble'' on motion pictures (multiple writers, talent defections, 
re-shoots, postponed release dates, etc.), and reports of the quality 
of footage that have leaked pre- or post-release. There is no effective 
way to police such rumors or reliably determine their source. These 
sorts of rumors can depress or increase box office performance. 
Therefore, the ability to profit from rumors by trading in the proposed 
contracts would intensify any incentive to spread false rumors in a 
manner that the sponsors could neither detect nor control.
    I wish to thank once again Chairman Boswell and Ranking Member 
Moran for the invitation to provide testimony, and I will be happy to 
respond to questions from Members of the Subcommittee.
                              Attachment A
The Proposed Contracts' Terms
A. The Cantor Contracts
    The Cantor contracts are complicated, and to some degree uncertain, 
trading instruments, and their material terms can vary from one motion 
picture title to another and even without notice to traders at the time 
trading commences.\8\ Generally, however, the Cantor submission states 
that its contracts would provide a means to bet on gross domestic box 
office numbers of select motion pictures released in the United States 
and Canada, ``as compiled by Rentrak Theatrical and/or Nielsen EDI and 
published in Variety Magazine (or such other publicly available source 
or sources as may be designated by the Exchange from time to time).'' 
\9\ This description is confusing because the information about gross 
box office numbers as published by Variety Magazine is not the same as 
the information ``compiled by Rentrak'' from exhibitors. (Rentrak's 
compilations from exhibitors do not account for 100% of gross box 
office numbers, and the percentage of the total box office numbers 
reflected in the figures it collects from exhibitors can materially 
vary from motion picture to motion picture.)
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    \8\ See Cantor Rule I-1, Definition, ``First Trading Day'' (noting 
First Trading Day ``will be specified in each DBOR Contract''); Cantor 
Rule II-3(b) (discussing fluid DBOR Determination Period).
    \9\ See Cantor Rule I-1, Definitions, ``DBOR'' and ``Rentrak 
Theatrical.'' (Emphasis added.) Rentrak Theatrical is a unit of the 
Rentrak Corporation. See www.rentrak.com. Nielsen was acquired by 
Rentrak and no longer separately reports motion picture box office 
numbers. Accordingly, our comment will address reporting by Rentrak 
only.
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    The Cantor submission states that each motion picture will be the 
subject of its own separate contract, and Cantor will decide in its 
discretion the motion pictures for which it will list futures contracts 
on its platform.\10\ The Cantor contracts will call for traders to bet 
on the gross Domestic Box Office Receipts (``DBOR'') over the ``DBOR 
Determination Period.'' The DBOR Determination Period runs from the 
date of the motion picture's opening until 4 weeks after the motion 
picture first qualifies for ``wide release'' status as defined by the 
Cantor rules.\11\ Those rules define ``wide release'' status to occur 
once a motion picture is shown simultaneously on the same day in 650 
theaters.\12\ The ``Final Settlement Price'' will be a fractional 
equivalent of the gross DBOR over the DBOR Determination Period.\13\
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    \10\ Cantor Rule II-10.
    \11\ If the motion picture fails to achieve wide release status 
prior to the end of the 12th Release Week, the DBOR Determination 
Period will conclude at the end of the 12th Release Week. Cantor Rule 
II-3(b).
    \12\ Cantor Rule I-1, Definition, ``Wide Release.''
    \13\ Each contract will be settled at the equivalent of one 
millionth of the gross DBOR for the United States and Canada showings 
over the DBOR Determination Period--i.e., if the gross DBOR over the 
DBOR Determination Period are $56 million, the Final Settlement Price 
of the contract would be $56. Cantor Rule II-3(a). Upon settlement, 
each buyer of Cantor contracts who holds them to maturity will be 
entitled to receive, and each seller will be obligated to pay, one 
millionth of the gross DBOR for the DBOR Determination Period. Cantor 
provides the following example in Rule II-13(a): If an underlying 
motion picture title has earned a DBOR of $56,455,000 during the DBOR 
Determination Period, the Final Settlement Price would be calculated by 
dividing $56,455,000 by 1,000,000 (equaling $56.455), and then rounding 
such amount to $56.46.
    A trader's profit or loss on a long position held until contract 
expiration will equate to the difference between the contract price 
when the contract was entered into and the Final Settlement Price. 
Using the example above, if the buyer enters into a futures contract at 
a price of $50 and holds the contract until expiration, the buyer's 
profit would be the difference between $50 and $56.46. The seller of 
such a contract at the price of $50 would lose the difference between 
$56.46 and the $50 contract price. If a trader liquidates his or her 
contract position prior to contract expiration, his or her profit or 
loss will be the difference between the opening and liquidating 
contract prices.
---------------------------------------------------------------------------
    When trading on any particular Cantor contract will commence is not 
clear from the Cantor rules; it appears that, at Cantor's discretion, 
it could commence anytime between a year and one day before a motion 
picture's release and presumably start dates could vary from contract 
to contract.\14\ The time period of the DBOR Determination Period might 
not be knowable at the time trading commences--that period could span 
from 4 to 12 weeks, depending on if and when a motion picture first 
qualifies as a ``wide release.'' \15\ Accordingly, at the time trading 
commences, traders would not even have notice of the terms of their 
bets. It also is unclear when trading will end. The chart accompanying 
the latest Cantor contracts submission (for ``The Expendables'') states 
that ``The longest trading period for a DBOR contract is a period of 
four Release weeks.'' If trading must cease no later than four release 
weeks after the opening, trading could be limited to a shorter time 
period than the DBOR Determination Period. For example, theoretically, 
trading would end 4 weeks after the opening, but the DBOR Determination 
Period could be the first 6 weeks following release, if a motion 
picture fails to qualify as a ``wide release'' until the third week 
after its release. This can cause substantial uncertainty for pricing 
and perhaps invite gaming. In contrast, the definition of ``Last 
Trading Day'' in the Contract Terms and Conditions states that ``the 
Last Trading Day shall under no circumstances be any earlier than the 
Tuesday following the close of the DBOR Determination Period.'' 
Pursuant to this definition, trading could last as long as 12 weeks for 
a motion picture that fails to achieve wide release status. 
Significantly, under this definition, trading potentially could extend 
beyond the DBOR Determination Period--after the settlement price is 
known publicly or by those with inside information.
---------------------------------------------------------------------------
    \14\ It is not clear when trading will commence in relation to the 
opening release, but it appears that there will be an Opening Auction 
on the first trading day to determine an ``Equilibrium Price'' for the 
commencement of trading. Cantor Rule II-11. The description of the 
Opening Auction has changed during various iterations of the DBOR 
Contract, and it is unclear exactly how the auction will work. While a 
contract is open for trading, traders will be permitted to execute 
trades 24 hours a day, seven days a week. Cantor Rule II-12.
    \15\ See Cantor Rule II-3(b). For example, if a motion picture is 
released in 500 theaters in Week 1, but is shown in 650 theaters in 
Week 2, the DBOR Determination Period will be six weeks long, because 
``wide release'' status will not have occurred until the second week, 
and the Determination Period will conclude at the end of the fourth 
week after wide release is achieved. If a motion picture never achieves 
``wide release'' status, the DBOR Determination Period will be the full 
first twelve weeks following the opening, and the Final Settlement 
Price will be based on the DBOR over the full 12 week period.
---------------------------------------------------------------------------
B. The MDEX Contracts
    MDEX's proposed Opening Weekend Motion Picture Revenue Contracts 
(``the MDEX Contracts'') include a binary option and collared futures 
contract. The MDEX contracts are designed to provide a means to profit 
from bets on the box office numbers of the opening weekend for ``major 
releases.'' MDEX's proposed binary option contracts would be issued 
over a series of strike prices (tied to the level of first weekend box 
office numbers as reported by Rentrak) that would be exercisable only 
upon expiration (European style) and only if the strike price for the 
reported first weekend box office numbers is reached. Upon successful 
exercise, the purchaser would be entitled to receive $5,000 per option 
contract.
    MDEX's proposed ``collared futures'' contracts also would offer 
exposure up to $5,000 to the outcome of a particular revenue period, 
but are not binary and, therefore, offer a range of exposure for each 
contract from $0 to $5,000. Instead of the strike price present in the 
binary option contracts, collared futures contracts are based on a 
range of Rentrak's tabulations of box office numbers, with any payouts 
based on numbers falling below that range (paying nothing), within that 
range (paying according to a preset formula), or above that range 
(paying $5,000). If a movie's box office revenue comes within the range 
of a collared futures contract, the revenue number is converted into a 
revenue unit by dividing that range into \1/4\ increments, from 0 to 
100, and then multiplying by $50.
                              Attachment B
Variety
April 13, 2010
`Titans' victorious at weekend box office
Final figures put 3D epic on top of `Date Night'
By Andrew Stewart

    When the dust settled on Monday, Warner Bros.' 3D epic ``Clash of 
the Titans'' had edged out 20th Century Fox's ``Date Night'' domestic 
B.O. debut.
    Preliminary estimates had ``Date Night'' winning the weekend, with 
$27.1 million; Fox revised the figure downward to $25.2 million.
    Meanwhile, ``Clash'' earned a revised $26.7 million, down slightly 
from Warner's $26.9 million estimate. The 3D epic dropped 56% in its 
soph sesh and has cumed $110.2 million.
    Paramount and DreamWorks Animation's ``How to Train Your Dragon'' 
followed closely, with $24.9 million. The toon slipped only 14% in its 
third frame, for a total haul of $92.1 million.
    ``Dragon'' scored 65% of its weekend take from 2,165 total 3D 
locations, while ``Clash'' saw approximately 50% from 1,632 3D runs. 
``Clash,'' which isn't playing on Imax 3D screens, was able to top the 
box office even with a substantial number of filmgoers opting for the 
2D version.
    Fox originally had predicted a 34% drop for ``Date Night'' from 
Saturday to Sunday, but said the comedy ended the weekend with a steep 
49% decline. Studio attributed the drop to the final day of the Masters 
on Sunday, saying the golf tourney siphoned auds from the comedy's 
targeted older demo.
    Most of the frame's other adult-oriented films, including 
Lionsgate's ``Why Did I Get Married Too?'' and ``The Bounty Hunter'' 
also took steep hits on Sunday.
    The Masters played heavily to older auds, skewing toward male 
viewers, but also with a surprisingly strong femme aud. The ``Date 
Night'' demo was similar, with 52% females to 48% males, and about 60% 
of the aud over 25.
    Despite its second place finish, ``Date Night'' is off to a solid 
start, with the popularity of stars Tina Fey and Steve Carell helping 
it exceed ``The Bounty Hunter's'' $20.7 opening weekend on March 19.
    Family pics like ``Dragon'' fared best on Sunday, with the toon 
slipping 38% that day. ``Dragon'' may lose auds as kids head back to 
school after spring break, but Par said it expects the toon to hold 
steady until the studio launches 3D ``Shrek Forever After'' on May 21.
                              Attachment C
`Kick-Ass' slays `Dragon'
Another swap at B.O. top
By Andrew Stewart (http://www.variety.com/
index.asp?layout=bio&peopleID=3844)

    For the second consecutive week, the top two spots at the domestic 
box office have swapped places, with this week's No. 1 position going 
to Lionsgate's superhero comedy ``Kick-Ass.''
    Pic's revised weekend figures held steady on Monday at $19.8 
million, while Paramount and DreamWorks Animation's 3D toon ``How to 
Train Your Dragon'' dropped from its estimated $20 million to a revised 
$19.6 million.
    The B.O. shuffle comes a week after Warner Bros.' ``Clash of the 
Titans'' was renamed the B.O. champ with its weekend actuals, ousting 
20th Century Fox laffer ``Date Night.''
    In its soph sesh, ``Date Night'' saw a solid hold of 34%, claiming 
the No. 3 spot with $16.7 million, while actuals for ``Clash'' totaled 
$15.5 million. Cume for ``Date Night'' stands at $48.7 million; 
``Clash'' has reached $132.6 million in its third frame.
    Without any major tentpole releases entering the market in the past 
two weeks, solid holdovers have been pitted against aud-specific debuts 
like ``Date Night'' and ``Kick-Ass.''
    ``Kick-Ass,'' about an average teenager who dons a superhero 
persona, played best among young males, with a 60-40% male-female 
split. The pic's healthy launch could bode well for ``Kick-Ass'' in 
repeat frames, as Lionsgate hopes fanboy enthusiasm will help fuel 
strong word of mouth among wider demos.
    `` `Kick-Ass' is fantastic, highly original entertainment, and our 
marketing and distribution teams have brilliantly positioned it for a 
long and successful run,'' Lionsgate prexy Joe Drake said in a 
statement. ``That kind of run is precisely what we are seeing on the 
international front, where `Kick-Ass' has demonstrated a very strong 
hold at the box office.''
    The film has grossed some $13.8 million internationally, since its 
early bow overseas April 2.
    Meanwhile, ``Dragon'' saw a strong hold in its fourth frame, 
slipping just 21%. The toon's 3D component helped boost holdover 
potential, which accounted for 65% of the weekend take on 56% of the 
total location count.
    ``Dragon,'' whose cume reached $158.3 million as of Monday, should 
have a clear playing field until Par/DWA's ``Shrek Forever After'' is 
released May 21.

    The Chairman. Thank you. We would like now to recognize Mr. 
Harbinson, international representative, International Alliance 
of Theatrical Stage Employees and on behalf of the Directors 
Guild of America.

          STATEMENT OF SCOTT HARBINSON, INTERNATIONAL
           REPRESENTATIVE, INTERNATIONAL ALLIANCE OF
  THEATRICAL STAGE EMPLOYEES, ELLICOTT CITY, MD; ON BEHALF OF 
                   DIRECTORS GUILD OF AMERICA

    Mr. Harbinson. Thank you, Mr. Chairman. I am very happy to 
be here. Chairman Boswell and Ranking Member Moran, I 
appreciate this opportunity to appear before you. My name is 
Scott Harbinson, and I am an International Representative for 
the International Alliance of Theatrical Stage Employees. I am 
here today representing both IATSE and the Directors Guild of 
America.
    I hope my presence, along with that of others in the 
industry, will underscore the grave concern we have about the 
impact of movie futures contracts which are pending before the 
CFTC.
    IATSE is a labor union that represents 110,000 technicians, 
artisans and craft persons in the entertainment industry who 
work in live theater, motion picture production, and trade 
shows. The DGA represents over 14,000 directors and members of 
their directorial teams who work on feature films, scripted 
television, news, sports, commercials, documentaries, and new 
media both here and abroad.
    The realities of our business are not easily deciphered by 
those outside of it. The glitz and glamour of the international 
blockbusters give rise to misperceptions about our industry. So 
let me just begin with a few of the realities which I hope will 
shed light on our concerns about the MDEX and Cantor Exchange 
futures applications.
    The majority of the people working on the creative side of 
our industry earning middle class incomes do not hold regular, 
full-time Monday-Friday jobs. Ours is a freelance business. 
People move from one employer to another, and from one 
production to the next. Our business model recognizes and 
accounts for that significant uncertainty by providing another 
form of security to help people in between jobs either directly 
or through contributions to our multi-employer health and 
pension plans. This takes the form of residuals which come from 
the exploitation of our work in secondary markets such as DVDs, 
free and pay television, and new media.
    Not surprisingly, there is a high correlation between box 
office success and downstream revenues, and hence the residuals 
generated in these markets. The ability to trade on a film's 
box office receipts through movie futures exchanges, exchanges 
where shorting a film can be extremely lucrative, puts the 
commercial success of the film at even greater risk. This new 
risk will not be generated by people who spend years and 
invested millions of dollars in making the film; rather, it 
will be generated by those who are likely to have no real stake 
in seeing a film succeed. Their goal is simply to make money 
for themselves.
    What will follow will be diminished downstream revenues. 
When that happens, it is our members and their health and 
pension contributions that suffer. Additionally, the lower film 
revenues dampen reinvestment which leads to decreased 
production and fewer jobs in the future. The image of 
speculators profiteering on our industry to the detriment of 
working men and women has an uncomfortably familiar ring to it.
    The people who work on a film put a great deal of talent, 
craftsmanship, time and energy into making motion pictures. 
Directors, in collaboration with many other talented 
individuals, can spend years of their lives putting a film 
together. While the studios have a slate of films each year, a 
director only has a single film. It is highly improbable that a 
director would purposely seek to undermine his own work by 
shorting it, and most directors have no need to bet the over on 
their pictures because their personal service agreements 
generally contain provisions for awarding strong box office 
performance.
    Other talented individuals who collaborate on the making of 
a motion picture also have a similar commitment to the final 
work--the cinematographer, the editor, the production designer, 
just to name a few. A successful film is recognition of their 
talent and hard work as well. And with the funding of their 
pension and health plans dependent on the picture's success, 
they too have no reason to bet against their own work.
    Movie making already has enormous appeal outside of the 
industry, and to introduce this new exchange would simply be 
encouraging mischief at best and criminal conduct at worst. It 
is not hard to envision certain people approaching individuals 
working on a film to try to secure potentially material 
nonpublic information, information that they will use to shape 
the value that they assign to that movie's contracts in the 
future. Films, both big and small, would be adversely affected 
by the exchanges in different ways. Larger productions, with so 
much riding on them, are often being worked on until the very 
last moment, making them especially vulnerable to a sudden 
blast of negative publicity. Smaller films have little 
financial cushion and the impact of rumor and negative 
speculation can be ruinous to these worthwhile projects.
    In this business, there is no magic formula for success, 
regardless of the hard work and talent involved. For every 
unexpected hit, there is a corresponding flop. That is the risk 
that both those who finance motion pictures and those who 
create them acknowledge on each and every film, but at least 
those assuming the risk have a bona fide relationship with the 
work and a stake in the successful outcome of a film. Those 
involved in the exchanges will not.
    In closing, we understand what the existing legal standard 
is for establishing a futures market. But as a matter of public 
policy, if the stakeholders large and small have no interest in 
hedging the risk through a futures market, which admittedly 
serves no price discovery function, then the government 
shouldn't sanction it. If the stakeholders have no intention of 
participating in these futures markets, then the markets will 
be left to the gamblers. If the CFTC does not have the 
authority to deny the applications to create movies futures 
contracts, then we believe Congress should act to address this 
issue directly. Thank you for your consideration.
    [The prepared statement of Mr. Harbinson follows:]

 Prepared Statement of Scott Harbinson, International Representative, 
  International Alliance of Theatrical and Stage Employees, Ellicott 
           City, MD; on Behalf of Directors Guild of America
    Thank you, Chairman Boswell and Ranking Member Moran for this 
opportunity to appear before you. My name is Scott Harbinson and I am 
an International Representative of the International Alliance of 
Theatrical and Stage Employees (IATSE). I am here today representing 
both IATSE and the Directors Guild of America. I hope my presence, 
along with that of others in the industry, will underscore the grave 
concern we have about the impact of the ``movie futures contracts'' 
which are pending before the Commodity Futures Trading Commission.
    IATSE is the labor union that represents technicians, artisans, and 
craftspersons in the entertainment industry, including live theater, 
motion picture and television production, and trade shows. IATSE was 
formed in 1893 and has over 110,000 members. Through its international 
organization and its autonomous local unions, IATSE represents the 
behind-the-camera crafts on over 90% of all motion pictures with 
budgets over $1.5 million produced in the United States.
    The Directors Guild of America represents over 14,000 directors, 
and members of what is called their directorial team, who work in 
feature films, scripted television, news and sports, commercials, 
documentaries, and in new media. DGA members live and work throughout 
the United States and abroad.
    Ours is perhaps the most heavily unionized industry in the country, 
providing good, middle-class jobs with pension and health benefits for 
tens of thousands of Americans. Our industry is also one of the few 
that can be counted on to turn in an international trade surplus year-
after-year.
    However, the realities of our business are not easily deciphered by 
those outside of it. The glitz and glamour, the international 
blockbusters, can give rise to misperceptions about our industry. I 
fear that the misperception that there is easy money to be made in 
Hollywood is what we are addressing today. So let me begin with just a 
few of the realities, which I hope will help shed light on our concerns 
about the MDEX and Cantors Future Exchange applications.
    First, the majority of people who work on the creative side of our 
industry, earning middle class incomes just like most of your 
constituents, do not work as regular full-time staff at a Monday 
through Friday job. Ours is a freelance business--people move from 
employer to employer and from production to production, often on a 
daily or weekly basis, and always with an eye on their next job. Our 
business model recognizes and accounts for the reality of significant 
uncertainty and insecurity by providing for another form of security to 
help people in-between jobs, either directly or through our industry 
health and pension plans. This takes the form of payments, called 
residuals, which come from the exploitation of our work in secondary 
markets such as DVDs, free television (including broadcast and basic 
cable), pay television, and most recently new media. Not surprisingly 
there is a high correlation between box office success and downstream 
revenues, and hence residuals, generated in these markets.
    Unlike other business ventures, the commercial success of a motion 
picture defies quantification or reduction to a formula. Introducing a 
large new variable into the production equation poses a significant 
danger. The ability to trade on a film's box office receipts through 
movie futures exchanges--exchanges where the creation of a negative 
perception of a film can be extremely lucrative to those ``shorting'' 
it--puts the commercial success of the film at an even greater risk. 
And, this new risk would not be generated by the people who spent years 
and invested millions making the film, rather it would be generated by 
those who are likely to have no real stake in seeing the film succeed 
so they can share in the reward--their goal is to make money for 
themselves. Looking further down the line, if this ``manufactured'' 
negative perception succeeds in hurting the film's box office, then 
what follows will be diminished downstream revenues. When that happens, 
it is our members, the individual employees and their health and 
pension plans that suffer. Additionally lower film revenues dampen 
reinvestment which leads to decreased production and fewer jobs in the 
future. So, at the end of the line, people who have no stake in the 
vitality and economic health of the industry will make money and the 
working people who invested their talents will bear the greatest 
impact. The specter of speculators pillaging our business to the 
detriment of working men and women has an uncomfortably familiar ring 
to it in today's economy. We hope this will not be set in motion 
against our industry on your watch.
    Second, a film on the screen--from conception to post production--
is a complex and hard won process. The people who work on a film put a 
great deal of talent, craftsmanship, time and energy into making that 
motion picture. Let me offer some perspective on the roles of the 
director and the craftspeople and technicians. It is universally 
recognized that feature film is a director's medium and for that reason 
the director's investment is unique. Directors can spend years of their 
lives putting a film together, in collaboration with many other 
talented individuals. While the studios have a slate of films each 
year, the director only has his or her single film. So of course the 
success or failure of an individual film can have a huge impact on the 
director--not just economically but also in terms of their reputation 
and stature, both now and in the future. Outside of sports franchises, 
few businesses are so clearly identified with a single individual. So 
when derivatives are sold one identifiable person is not as greatly at 
risk as they are here.
    From this perspective, it is highly improbable that a director 
would purposely seek to undermine his/her own work at the exact time 
when there is the greatest at stake in its success. And, most directors 
have no need to ``bet the over'' on their pictures because their 
personal services agreements generally contain provisions rewarding 
strong performance at the box office, whether in the form of box office 
bonuses or profit participation, or both. This is in addition to 
enhanced residuals income driven by better box office performance.
    While other talented individuals who collaborate in the making of a 
motion picture might not have quite the same stake as the Director, 
most have a similar commitment to the final work. The Cinematographer 
who shot the film, the Editors who put hundreds of thousands of frames 
together, the Production Designer who brings the ``look'' of the film 
to life, just to name a few--the film is also a recognition of their 
talent and hard work as well. And, with the funding of their health and 
pension plan dependent on a film's success they too have little reason 
to ``bet against'' their work.
    A film employs hundreds of people at any given point in time. 
Movies most closely resemble the military in terms of their precise, 
highly regimented structure. And, as you would expect with the process 
of creating something from nothing, there are disruptions all along the 
way . . . and most people have limited or incomplete information about 
what is going on. Movie making already has great appeal to 
``outsiders,'' and to introduce this new exchange into the mix you are 
simply encouraging mischief at best and criminal conduct at worst. It 
is not hard to envision certain people approaching individuals working 
on a film to try to secure potentially material non-public 
information--information they will use to shape the value they assign 
(or give others to assign) to that movie's contracts in the future.
    In addition it is common industry practice to hold screenings/
previews of a film to which members of the public are invited before 
the film is finished. Hundreds of people view the incomplete film and 
make comments. It is easy to see how a preview that does not go well 
can become a factor in ``betting'' on its box office--and tanking a 
film before it even gets to the screen.
    It is the bigger movies--the very ones that will be on the most 
screens--that are the most likely to be worked on until the very last 
moment. The bigger the movie, the bigger the anxiety, the later the 
final okay is given. Because so much is riding on them and because of 
this they have a very high vulnerability. At the other end of the 
spectrum, the lower and mid-size budgeted films--the Junos, the Hurt 
Lockers, the Little Miss Sunshines--have a different but equally as 
important vulnerability. They have little margin of error--with tight 
financing and schedules, they face their own unique ``ups and downs'' 
throughout production and it is far easier to harm their financial 
success through misplaced rumors or perception that they are worth 
betting against at the box office. In short, the possibilities these 
exchanges create for mischief and even disruption of the filmmaking 
process are unlimited--and in our warp-speed Internet age--impossible 
to control.
    Third, it is well understood in our business that there is no hard 
and fast ``formula'' for success regardless of the hard work and talent 
involved--in fact success for any motion picture is never a foregone 
conclusion. All of the percentages and numbers these two groups present 
to discuss the viability of their exchange obscure an important fact--a 
film is not a fully-formed object created in a vacuum. Each one is 
different and unique and nobody knows going in if it will connect with 
the audience. For every unexpected hit there is an unexpected miss. 
That is the accepted risk that both those who finance motion pictures 
and those who create them recognize and undertake with each and every 
film. But at least everyone involved in that risk has an actual 
relationship to the work and a stake in its success. Those involved in 
these exchanges will not. These exchanges are in effect the same as 
trading in wheat from a single farm. You bet against the farm and you 
burn it down. We are hard pressed to think of any other commodity for 
which the hedging actually threatens the underlying product itself.
    Such futures contracts would be childishly easy to manipulate or 
corrupt to increase the value of short positions. This is particularly 
true for risky, low-budget motion pictures where there are many 
individuals who would be able to materially affect the success of the 
film. There is no such corollary in any other futures market that I am 
aware of.
    We understand what the existing legal standard for the 
establishment of a future market is. As a matter of public policy, if 
the creators, craftspeople, theatre owners and producers--both large 
and small--have no interest in hedging their risk through a futures 
market, which also admittedly serves no price discovery function, then 
the government should not sanction it. If the commercial and creative 
interests in the film industry have no intention of participating in 
these futures markets, then the markets will be composed of gamblers--
many of whom will be playing with a card up their sleeve--wagering 
against the success of a film. If the Commodity Futures Trading 
Commission does not have the authority to deny the applications to 
create these two futures exchanges and contracts, we believe Congress 
should address this issue directly. Thank you again for your 
consideration and for listening to our perspective.

    The Chairman. Thank you. We have just been notified there 
will be votes, but we will finish your presentation and get 
into some questions.
    We now recognize Mr. Schuyler Moore, partner, Stroock & 
Stroock & Lavan, LLP.

STATEMENT OF SCHUYLER M. MOORE, ADJUNCT PROFESSOR, UCLA SCHOOL 
                OF LAW; ADJUNCT PROFESSOR, UCLA
  ANDERSON SCHOOL OF MANAGEMENT; PARTNER, STROOCK & STROOCK & 
                   LAVAN LLP, LOS ANGELES, CA

    Mr. Moore. I am here in my role as an academic, not as a 
partner at Stroock & Stroock & Lavan. I am an Adjunct Professor 
at the UCLA School of Law, and I am Adjunct Professor at the 
UCLA Anderson School of Management. I am an author of the book 
called The Biz which is about the financing of the film 
industry and a book called Taxation of the Entertainment 
Industry. And I plead guilty to perhaps starting this entire 
concept in an article I wrote 7 years ago about this precise 
concept, about structuring investment based on box office 
results.
    It is my belief that this is an absolutely standard, run-
of-the-mill necessary technique for film financing. It is the 
next step in a long evolution, and the first thing I want to 
get out of the way is every investment in film is gambling. The 
studios gamble. Investors gamble. That is the industry. We all 
accept that. It is legal. Film is gambling. We should put that 
beyond us.
    Second, the studios have hedged film risk for 30 years. It 
is what I do for a living. Co-productions, split rights 
transactions, presales, slate financing. In the last 8 years 
alone, there have been over $10 billion of slate financing and 
every single one is a way for the studio to get off risk and 
unload the risk on investors. Every single one. This is what 
the studios have done for years and years. Every technique I 
have mentioned, co-productions, split right transactions, 
presales, slate financing is all to get off risk.
    What this exchange offers is an efficient, transparent way 
for the studios to get off risk. When they figure it out, when 
they understand it, they will do it and they will do it in 
droves, just like they do the current slate financing in 
droves. For the same reason that they did $10 billion of slate 
financing, they will be doing $10 billion of hedge financing. 
They always resist what is new. They resisted television. They 
resisted video. They resisted video on demand. New things scare 
people. The government itself objected when interest rate swaps 
were first suggested, and now it is a trillion-dollar-a-day 
market. So there is a fear of something new, but the truth is 
this is the way the world has been working.
    I read an MPAA submission that said the studios won't do 
it, and they do do it. That is what they do. I read one 
position that said they couldn't do it because they have anti-
disparagement clauses in their contracts. Every time they do a 
hedge transaction on the slate deals, they are betting against 
their film. This isn't new, okay.
    From the investors' perspective, it is absolutely needed 
because there is a pullback in investment in Hollywood due to 
the fear of opaque Hollywood accounting, whether it is true or 
not. It is the image.
    You can't stop investors from investing in films. They are 
investing in films. You are worried about investors gambling, 
they are doing it now on a single film basis, on a slate basis. 
They are buying stocks in film companies. They are gambling. 
All this does is it creates an efficient, transparent market 
where they can look up in the paper and figure out what their 
investment is worth the next day, just like they look up and 
see what the stock price is the next day. This is absolutely 
needed. It will create a huge market for the studios. They will 
come to appreciate this once they understand it.
    I have heard arguments against it based on manipulation. 
First of all, the first comment is studios can ignore all 
manipulation if they don't want to be in the market. What do 
they care if it is being manipulated, right, just stay out of 
the market. If they are in the market, the only ones, the real 
ones that can manipulate it is the studios by shorting their 
own film and tanking it, like the film The Producers. I don't 
think that is something that will happen. I think the studios 
would lose more on the film and in good will and on their stock 
price than they would make by shorting their own film. I have 
no fear of that.
    The other thing I have heard, oh, my God, Dr. Evil will 
sneak into the lab and steal a print to go on the Internet to 
ruin box office receipts. That risk is so--it is as much a risk 
as Dr. Evil will put smoke bombs in theaters to keep down 
attendance. It is just not realistic. So I don't think 
manipulation is a serious issue.
    Insider trading is a bugaboo. There is no legal impediment 
on insider trading on a commodities exchange, period, or a 
farmer wouldn't be able to trade corn futures, right, because 
as an insider he knows his crop is bad. It is the same thing in 
the industry. There is this firewall that I frankly think they 
shouldn't have done. The actual reporting of box office is 
self-regulating. There is an efficient mechanism in place. 
There shouldn't be a firewall because that has gotten people 
off into this red herring of oh, my God, insider trading. There 
should be absolute, no prohibition on insider trading in my 
view. And certainly there is no legal prohibition on it.
    I would like to address the real reason why everyone is 
against this is the singular focus that, oh, my God, it is 
going to trade back. When you look it up, there will be bad 
trading. Oh, my God, bad buzz about a film and therefore, no 
one will go to it and the industry will fall apart.
    Number one, there is already so much buzz about a film the 
moment it starts production. There is a website called 
aintitcool.com. There is a website called rottentomatoes.com. 
There is a Hollywood Stock Exchange that has been around for 10 
years that hasn't affected a single box office result. They use 
play money but you can look up and see how a film is tracking. 
There are real exchanges that do this offshore where you can 
look up and see how a film is tracking. So there is not just a 
buzz now but a roar of prerelease publicity news information 
about a film, and this is going to be a drop in the bucket.
    What they are overlooking is how about the good news when a 
film is tracking well? By the way, it should be tracking more. 
I would think overall most films better than flat, and so maybe 
that will spur attendance and so it will turn out to be a wash. 
So I don't think this whole bugaboo of bad films is warranted.
    [The prepared statement of Mr. Moore follows:]

Prepared Statement of Schuyler M. Moore, Adjunct Professor, UCLA School 
           of Law; Adjunct Professor, UCLA Anderson School of
  Management; Partner, Stroock & Stroock & Lavan LLP, Los Angeles, CA
    1. I am an adjunct professor at the UCLA School of Law and the UCLA 
Anderson Business School, teaching film financing. I am the author of a 
book called The Biz: The Basic Business, Legal, and Financial Aspects 
of the Film Industry and a treatise called Taxation of the 
Entertainment Industry.
    2. I may have started this box office exchange (the ``Exchange'') 
concept in an article I wrote titled ``Raising Film Financing by 
Betting the Box,'' that was published in the Entertainment Law Reporter 
in May 2003. A copy of that article is attached.
    3. Value of the Exchange for Hedging for Studios
    3.1  Hollywood has hedged performance risk a myriad of ways for 
many years.

        (a) Co-Productions among studios (sharing the budget and 
        splitting the world between domestic and foreign);

        (b) Split-rights transactions, where all foreign rights are 
        pre-sold to a consortium of foreign distributors;

        (c) Pre-sales, where film rights are sold for up front fixed 
        payments (and less on the back end); and

        (d) Slate financing transactions, where investors co-finance 
        50% of the cost of a slate of films for 50% of the profits.

    3.2  This Exchange offers a transparent, efficient hedging 
technique. It will vastly lower hedging transaction costs. Once the 
studios understand it, they will embrace it strongly in lieu of 
inefficient hedging techniques they currently use.
    3.3  One of the submissions by the MPAA stated that the studios 
would not use the Exchange to hedge due to contractual and practical 
constraints on disparaging their own film, and hedging would be viewed 
as disparagement. However, this identical argument could be made with 
respect to every form of hedging, and as set forth above, the studios 
have used various hedging strategies for years.
    4. Value of the Exchange for Investing in Hollywood
    4.1  Investors have been taking the significant risk (for both 
profit and loss) of investing in films for many years:

        (a) Investing in stock of film companies, including options, 
        calls, etc.;

        (b) Investing in particular films;

        (c) Investing in slate financing transactions (over $10 billion 
        of such investments were done from 2002-2008).

    4.2  This Exchange offers a transparent, efficient investing 
technique. It will vastly lower investing transaction costs. Most 
importantly, it completely eliminates the fear of opaque ``Hollywood 
accounting,'' even if unjustified. Just as an owner of public stock can 
look in the paper to see the value of their shares, the owner of a 
position on the Exchange could look at the box office results in the 
paper and know if the value of their investment.
    4.3  The Exchange is not gambling, since investors can make 
informed decisions based on what they think of the prospects of a 
particular film. It is no more gambling than owning stock is.
    5. True Reason for Studio's Objection to the Exchange
    5.1  I believe that the real reason for the knee-jerk opposition of 
the studios to the Exchange is their fear that there' will be widely 
publicized ``criticism'' of a film in the form of the quoted price on 
the Exchange. If a film is trading ``low,'' the public might not want 
to go see that film.
    5.2  The answer to this concern is that there is already widely 
available ``buzz'' (if not a roar) of public criticism (good and bad) 
on films, including numerous popular blogs (aintitcool.com and 
rottontomatoes.com) and, most importantly, the Hollywood Stock Exchange 
(hsx.com), which has run exactly this type of Exchange for years (but 
with no real cash), and Intrade runs this type of Exchange for actual 
cash. Thus, there has always been and will always be a plethora of 
publicly available criticism (both good and bad) on films. In all 
events, fear of bad buzz is not grounds for stymieing new, efficient 
means of investment.
    5.3  In addition, any unwanted bad publicity from short positions 
on some films will be made up for by good publicity from long positions 
on other films.
    6. Alleged Fear of Manipulation
    6.1  The studios have mentioned fear of manipulation as a grounds 
for objection, but this can't be their real concern since they don't 
have to participate in the market at all, so they could be completely 
indifferent to manipulation. Indeed, when the issue is raised at all, 
the risk is that the studios, not the public, will manipulate the 
Exchange.
    6.2  The only possible manipulation would be if a studio went short 
on the Exchange and then intentionally tanked its own film (e.g., ``The 
Producers''). But this will not happen in practice, since it is highly 
unlikely that the studio will make more profits on the Exchange than it 
loses on the film and in future good will (and its stock price).
    7. Alleged Fear of Insider Trading
    7.1  The studios have mentioned fear of insider trading as a 
grounds for objection, but once again, they don't have to participate 
in the market at all, so they could be completely indifferent to any 
alleged insider trading.
    7.2  In any event, I don't believe that insider trading laws apply 
to futures exchanges, and for good reason; oil and studio executives 
really don't have much better information than what is otherwise widely 
known and available, and their guesses of future oil or box office 
prices are often wide of the mark. The truth is that no one knows how 
well a film will perform before it opens. As the great screenwriter 
William Goldman said, ``No one knows anything,'' and that certainly 
goes for the prognostication of box office results.
    7.3  If insider trader laws applied here, then farmers would not be 
able to trade corn futures, since they would be ``insiders.''
    8. Alleged Fear of Increased Piracy
    8.1  One of the objections raised was that someone buying a short 
position would attempt to pirate the film in advance and put it on the 
Internet to reduce box office results. The actual impact on box office 
results of such piracy are so miniscule that no one would be seriously 
tempted to attempt piracy for this reason.
                               Attachment
Raising Film Financing by Betting the Box
By Schuyler M. Moore

    This article suggests a model for film companies to (a) limit their 
risk on films and (b) raise film financing. But first, some background: 
Many film companies want to reduce their risk on films, particularly 
large budget ones. Reducing risk avoids the company going down for the 
count if the film flops, and it permits the company to spread precious 
cash over a wider number of films. Perhaps the most common way to 
achieve risk reduction at present is to enter into split-rights 
transactions, where two or more companies co-finance a film, with one 
taking domestic rights, and one or more taking foreign rights. Even 
when these deals involve a sharing of profits between the two 
territories, the net result is to give valuable distribution rights, 
and about half the profits, to competitors. This approach has become 
widespread, including for ``Titanic,'' ``Cast Away,'' ``The Hours,'' 
``Tomb Raider,'' ``XXX,'' and ``Terminator 3.'' While this approach 
achieves the desired goal, it is somewhat like selling off the family 
jewels as a hedge against volatility in the diamond market. Film 
companies are in the business of owning and exploiting film rights, and 
if there were a logical way to reduce risk while keeping the rights, 
they would jump at it.
    Historically, a great way to hedge risk while retaining film rights 
was to raise equity through public or private film funds, starting with 
Silverscreen for Disney in the 1980's. But these funds have long gone 
the way of the dinosaur. While it is common to blame the demise of 
these funds on the loss of the tax deduction for ``passive losses'' 
under the 1986 tax act, the passive loss rules generally do not apply 
to corporate investors; if the transactions made sense, there would 
still be a well-funded market for them. The true reason for the absence 
of these funds is that most funds felt victimized by opaque Hollywood 
accounting. Just watch investment bankers shudder when you offer them a 
share of a film's net profits. Eddie Murphy's great quip--calling a 
share of net profits ``monkey points''--best summarizes the vast public 
perception of what it means to invest in films. It is for this reason 
that the U.S. equity market for film financing has dried up.
    Yes, there are still some equity investors out there, but they are 
far and few between, ranging from random rich star-struck investors to 
German or U.K. film funds. But because of Adam Smith's immutable law of 
supply and demand, these equity sources often ask for more than film 
companies are willing to pay. It behooves film companies to come up 
with a solution that vastly increases supply, bringing prices down, 
rather than muddling through looking for needles in haystacks. The 
strong film companies can, of course, raise debt financing, but aside 
from outright default, debt does not shift risk. What is needed is 
equity financing.
    So here's a suggestion for an approach that might revitalize the 
U.S. equity market for films: End the accounting miasma, and tie the 
investors' return directly to a percentage of the gross domestic box 
office receipts to the theaters (``Domestic Box'') for the film. This 
approach raises the curtain of negativity and doubt that surrounds 
Hollywood accounting and leaves a spotlight on the glamour and thrill 
of ``owning a piece'' of a film. Talk about transparent accounting--all 
the investor would have to do is open the trades. Accounting statements 
and audits would be history. The film company would pay the investors 
the specified percentage of Domestic Box, even though there is only an 
indirect link between Domestic Box and the film company's ultimate net 
profits. From the film company's perspective, this transaction hedges 
risk, which is exactly what it wants to do. To some extent, the 
transaction resembles a simple wager about the box office results of a 
film, and this is something everyone can understand to the point of 
being common coffee klatch chatter, so it would open the investment 
door to the general public. There is even an on-line service 
(BetWWTS.com) that allows the public to place bets on the Domestic Box 
of large films, and film companies should be tapping into this 
potential financing source. It could be done across a slate of films or 
film-by-film, with investors placing their bets on particular films of 
their choice. Once the market became efficient, investors could place 
their bets and invest up to perhaps the day before a film's release.
    A simple example may best illustrate this suggestion: Assume that a 
studio wants to produce a $100 million film, but it wants to limit its 
risk to $50 million. One approach would be to sell off all foreign 
rights to one or more other film companies for $50 million, but it will 
lose foreign rights forever to competitors and with it about half the 
potential profits from the film. Instead, it raises $50 million of 
equity with a film fund that provides the investors with a payment 
equal to 50% of the Domestic Box. If the film flops and comes in with a 
Domestic Box of $10 million, the studio pays the investors $5 million, 
keeps the $45 million balance of the investment, and is happy. If the 
film has a Domestic Box of $100 million, the studio pays the investors 
a break-even payment of $50 million, and the studio is happy because it 
will keep worldwide rights and profits to a successful film. If the 
film scores big and has a Domestic Box of $200 million, the studio will 
pay the investors $100 million, and the studio is still happy because 
paying an extra $50 million to the investors is cheaper than losing all 
foreign rights and half the profits on this blockbuster forever to 
competitors, which was the alternative.
    More good news all around is the accounting and tax treatment of 
the transaction. For accounting purposes, the investment will be 
treated either (a) as a reduction in the cost of the film, with any 
payment owed to the investor being added to the cost of the film when 
accrued or (b) as equity, thus lowering the film company's debt/equity 
ratio, which is an even better result than off-balance sheet financing, 
which has no impact on the company's debt/equity ratio. For tax 
purposes, the investment should be treated as a tax-free equity 
contribution. There is some risk of the transaction being treated as a 
taxable sale of a future income stream, but this result can be avoided 
by structuring the transaction as a partnership for tax purposes with 
the film company. Any loss should be deductible to the investors as an 
ordinary loss, although any profit should be taxable as ordinary 
income, not capital gain.
    In all cases, the transaction will be treated as the offering of 
``securities'' by the film company, so it must be careful to comply 
with the securities laws. This is the one significant hurdle to 
creating enough volume for an efficient market. In the beginning, the 
easiest approach is to use only ``private offerings'' to ``accredited 
investors.'' If the market and size of the offering justifies it, the 
next step would be to do a registered offering, perhaps even with 
public trading. (Imagine having to add ``Film Futures'' to the Chicago 
Exchange.)
    In order for these transactions to work, the investment must be 
refundable with interest if the film does not end up with the promised 
key cast and director or does not get a theatrical release on a minimum 
number of screens by a specified date. Because the film company will be 
required to make payments to the investors (whether due to the film not 
meeting the promised conditions or based on Domestic Box) regardless of 
actual net profits received by the film company, the company will have 
to either (a) have a strong enough balance sheet to make the investors 
happy or (b) hold the investment in escrow until the Domestic Box 
results are in, precluding the investment from being used to cash flow 
production. Even if the investment is escrowed, the investors still 
will be relying on the film company to pay any amounts owed to them in 
excess of the investment if the Domestic Box is high enough. These 
factors militate toward making this transaction easier for the studios 
(the rich get richer), but it is not beyond the reach of well-heeled 
independents.
    Would it work? Bet on it.

    The Chairman. Mr. Moore, you are very much into this. Thank 
you. We will have an opportunity to continue this during the 
questions. We appreciate your testimony and thank you very 
much.
    I will just ask one quick question before we recess for 
votes. I will address this to the first two witnesses. If the 
big movie houses would stay true to their word and refuse to 
participate, would your contract be viable?
    Mr. Jaycobs. Yes. The answer is yes. There is an enormous 
investor class that actually has investments, and to Mr. 
Moore's comments, actually has investors here, and we think 
that makes a very legitimate market all by itself.
    We also have the Lionsgate letter that says if not the MPAA 
members, the other smaller studios will participate. I was 
recently at a film conference with small film producers who 
were very enthusiastic about the concept.
    I think the MPAA has done a very good job of bringing a 
group together, but it doesn't represent the entire industry 
and we will have a very successful market.
    Mr. Swagger. To add to what Mr. Jaycobs shared, a notable 
Hollywood individual once said, ``Where there is smoke, there 
is a smoke machine.'' We believe that is certainly the case 
here. There is viable use for this product and a wide group of 
recipients looking forward to using this product.
    The Chairman. Thank you. We are going to recess now until 
these votes are completed. Sometimes they drag out a little 
bit. The first one is a 15 minute vote, and there will be 5 
minute votes. We will come back as soon as we can and try to 
finish at that time. I apologize for the inconvenience, but 
like you I have no control over that. We are in recess.
    [Recess.]
    The Chairman. We will call the hearing back to order. Mr. 
Moran will be here shortly, and he said it is okay to commence 
without him, so we will, in the interest of time. And I have a 
couple more questions and then we will yield. So back again to 
our first two presenters. Mr. Jaycobs, Mr. Swagger, how far 
ahead of a movie premiere will you offer the contract on that 
movie's receipts?
    Mr. Jaycobs. In the case of the Cantor Exchange, the 
provision is up to a year, but we expect it will be 6 months.
    Mr. Swagger. In the initially proposed application, we are 
looking at 4 weeks.
    The Chairman. Okay. Who will be using these markets for 
price discovery purposes or bona fide hedging, in your opinion?
    Mr. Jaycobs. Again, to reiterate in my opening comments 
many deals are negotiated on the basis of what a box office 
potential will be. The amount of advertising that is justified 
by a film will be reflected by the expectation of that box 
office; the number of theater screens and seats that are 
allocated to it will be based on that sort of decision.
    So, again, I think of it in the farm context: If the price 
of soybeans or cotton is high or low, there is an allocation 
question that the farmer uses. And in our case we see those 
same decisions being made here. If you know the box office in 
advance, theater screens, advertising budgets, investments 
decisions can be made using those prices.
    Mr. Swagger. In fact, to add what Mr. Jaycobs shared. One 
of the reasons for starting off with the box office weekend 
product, is the sheer fact that there are so many contractual 
obligations tied to the success of the box office, to the 
television and satellite providers, what do they pay for that 
and who gets the contract, to the DVD distributors and such. 
There is a lot tied to the success of the box office. And, 
again, the list of natural users, the original screenplay 
owners, debt and equity investors, the investment banking 
syndicates, the talent involved in the film, studios, both MPAA 
and the other many studios, banks and lenders, insurers of 
talent movies, theaters, distributors, and the promotional 
marketing partners.
    The Chairman. Thank you. Mr. Pisano, you heard me ask Mr. 
Berkovitz about the Iowa Electronic Markets and the futures. 
These markets are admittedly small, but they exist nonetheless. 
And all your objections could apply to these contracts. 
However, our democracy has managed to survive these election 
markets. If we as Members of Congress could continue to spike 
contracts where people invest on our elections, why cannot you? 
And why are movies more special than elections?
    Mr. Pisano. Well, first of all, I was unaware of the Iowa 
situation. And I am advised that that has been the subject of a 
No Action letter because of its educational purpose. As I 
understand, it is part of the curriculum of the University of 
Iowa.
    The Chairman. Well, when it started out that was the 
purpose. But then they let others invest in it. So that is 
probably the reason for the question.
    Mr. Pisano. Sir, first of all, betting on the outcome of an 
election is a time-honored tradition in American politics and 
British politics. And so I distinguish that from the situation 
we have here, which is an attempt to cloak in the legitimacy of 
a futures market something that is highly speculative and 
something that has as its base, as its index, something that 
doesn't exist. In an election, you know how many votes are cast 
ultimately when the votes are tabulated.
    One of the things I like to point out in terms of how the 
movie box office reporting works, I think you asked the 
question of Mr. Berkovitz. There are no real numbers reported. 
What is reported are estimates based upon surveys and 
electronic feeds from theaters. And, indeed, the very tracking 
service that the exchanges propose to rely on, Rentrak, which I 
am very familiar with, for a number of years has in its terms 
of service a disclaimer in terms of the use of the information 
and the reliability of the information, because it is just 
that: It is an estimate, a pretty accurate estimate. But no 
money changes hands anywhere in the industry based on what is 
reported in Variety by Rentrak. Also, no money changes hands in 
terms of the contracts that are downstream based on what is 
reported in Variety. Indeed, those downstream contracts, for 
example, television contracts, pay television contracts, those 
are negotiated years in advance and they are based on film 
rentals, which is the individual share between the theater 
owner and the studio when it is ultimately settled up. And that 
is never reported publicly because that is personal private 
information between the two contracting parties.
    The Chairman. Well, thank you. At this time I would like to 
recognize Mr. Marshall.
    Mr. Marshall. I was struck by your testimony, Mr. Moore. It 
was, as the Chairman described to me anyway, enthusiastic and I 
thought probably pretty authoritative. I don't think we are 
really competent to make this judgment. I think it is something 
that needs to be left to the CFTC and the experts within the 
CFTC. And I certainly think it is clumsy at best, probably 
inappropriate, for us to just start listing different products 
that are not to be subject to futures.
    What I am interested in is sort of general guiding 
principles. And you mentioned that you didn't think it was such 
a good idea to have the firewall so insider information, no 
matter where it comes from, is available. You don't worry that 
the effect of that will be to cause manipulation in 
inappropriate ways and effectively undermine the attractiveness 
of the investment from the perspective of people who, ``Know 
doggone well they are not going to be the ones, they are going 
to get the insider information and know which way this thing is 
going to move.'' They will be dumb and they will be the chumps 
at the other end of the deal.
    So without the firewall and with the presence of insider 
information, in such a narrow rifle shot kind of inquiry, what 
is going to be the success of this particular venture? Would 
there be a market at all?
    Mr. Moore. I believe there would be. I believe that the 
same comment could be made with respect to every market: That 
there are people with more information and some with less. And 
that is, in fact, the basis for our capitalistic system. That 
is the basis for a free market exchange. The same could be said 
with respect to farmers being insiders because they know on the 
ground whether or not there are crop infections, whether there 
is infestation of locusts or something that before the----
    Mr. Marshall. So your basic response would be, look, this 
has been a valuable tool available to other kinds of investment 
decisions. Make it available. Either the market will take 
advantage of it or it wont. If the presence of narrowly focused 
insider information with regard to the end result where box 
office receipts are concerned for a particular product is a 
worry, then the investors won't step up. Let the market figure 
out what?
    Mr. Moore. Yes. I would say there are two separate issues. 
One is up until the release of the film. And there has been 
confusion among the Members on this issue, so I would like to 
be precise.
    As to insider trading prior to release of the film, I 
believe strongly there should just be no limits at all. That 
is, let the market decide. And I believe that you want to 
disseminate the information through pricing. And that is the 
point. And in particular, number one, the truth is there are no 
secrets in Hollywood. The moment that a film has some trouble 
with it, it is instantly on the blogs, it is instantly in the 
trades.
    Second, the truth is in Hollywood nobody knows anything. 
Nobody knows what that box office will do. The top executives 
at the studio who have all the inside information in the world 
are often wildly wrong on whether a film will flop or not. 
There are just endless, countless examples of films that have 
flopped that people thought were going to be huge and vice 
versa. No one could have predicted Paranormal Activity, a 
$200,000 film, doing as big as it was.
    So as to that answer, let it go.
    Mr. Marshall. Are these products essentially available now 
in the OTC market offshore?
    Mr. Moore. Yes, they are.
    Mr. Marshall. And are they robustly traded?
    Mr. Moore. I don't know whether they are robustly traded. 
There is a company called Intrade that is offshore that is 
unregulated, not governed by any U.S. laws that is permitted 
box office betting going on right now.
    Mr. Marshall. Mr. Jaycobs, Mr. Swagger, how about that? The 
OTC market. Are there swaps, derivatives that do essentially 
what you are proposing to do on the regulated markets?
    Mr. Jaycobs. I mean, I don't draw the comparison quite as 
closely with Intrade. I think that the statements that were 
made earlier are more consistent with what we have seen, which 
is that the hedging that is happening now is by transfer of 
risk through the securities market, not through the futures 
market. That is the mechanism we have seen.
    Mr. Swagger. I completely agree with that. And the notion 
that a CEO would not use this hedge; quite honestly, in our 
work directly with many of the very constituents at the MPAA, 
not only were they interested in this initial product, but they 
were interested in working on the development of different 
products that would also meet economic needs that they have. 
And the ability to collect data was not available 5, 6 years 
ago in the relative form that it is today. And I think that if 
there is a concern about the value of that data that is being 
collected, that is a greater concern than something that has to 
do with CFTC regulation. If we are understanding from Mr. 
Pisano that the MPAA is saying that his studios manipulate data 
that is put in 10-Q reports for large corporate conglomerates 
that own studios, that would be of great concern.
    Mr. Marshall. Thank you, Mr. Chairman.
    The Chairman. Thank you. The chair recognizes Mr. Moran.
    Mr. Moran. Mr. Chairman, thank you.
    I heard Mr. Jaycobs talk about CFTC and the public utility 
of this exchange. And yet, we heard the General Counsel talk 
about that is not one of the criteria in which the CFTC looks 
at. So I want to explore with you and others on the panel, what 
is the public utility? What is the public benefit of this 
exchange and this kind of product?
    Mr. Jaycobs. Well, it is twofold. There is the--what we 
call in this industry the price discovery function. But what 
other folks would say is, what is the box office going to 
generate from an economic value point of view? And as we have 
heard here, many decisions are made on whether that box office 
is going to be strong or weak, or whether you take the risk of 
that or not. And it is investment decisions made by individuals 
in advance of even knowing what films would be produced with 
the money that they have invested. It is screen allocations. It 
is the budgets for advertising. There are a number of business 
decisions that are being linked to that box office value.
    Mr. Moran. And I assume, then, that the theory would be 
that the market would then become much more efficient. 
Investment decisions, location of theaters, decisions would be 
made that were based upon more information.
    Mr. Jaycobs. That is exactly right. If you have more 
information. And, equally important, that that information can 
be acted on in a financial transaction. So you can not only 
have an opinion about the value, but you can actually take an 
action to ensure that value. You put those together, and in 
every other instance where we have futures markets, that has 
been a great benefit to the underlying industry.
    Mr. Moran. Mr. Pisano, do you have a counter argument to 
that point?
    Mr. Pisano. As I said earlier, Mr. Moran, nothing in the 
movie business today is linked to the reports of box office. As 
I said, those are simply estimates that we release--our studios 
release and others, principally for marketing purposes. They 
are not reported in the financial statements of the companies. 
They are not reported to the SEC. They are estimates based on 
the Rentrak system.
    And, in addition, no one that I know of--and I have been in 
this business for 25 years--makes the decision as to how much 
money we are going to spend on a movie or how many screens are 
going to get booked based on some artificial estimate of what 
the box office will be based on a futures trade. So there is an 
unreality to this market not linked in any way to how the 
business actually works. And that is, to me, is part of the 
danger of this proposal in that what it really does is invite 
speculation.
    In addition, according to the phone book-size set of rules 
that the exchanges have published, the very people that would 
have some information and might be able to rely on it are 
prohibited from acting on it. So what--to put it in its 
simplest terms--what we have is a market in search of a product 
that the people who actually participate in the industry don't 
want, but, perversely, it is going to impose liability, 
reporting, and regulatory responsibilities that we don't want 
and don't currently have, and even questionably whether the law 
as it is written today has the power to impose it on the motion 
picture producers and distributors.
    Mr. Moran. Mr. Moore, I assume that you have an observation 
about both of those answers. In addition to that, I wanted to 
add the question about increased or decreased investment in the 
movie industry. I think you indicate that, as a result of this 
additional transparency of information, that we would see an 
increase in investment. And I want you to explore that a bit 
with me. But also, if someone could walk me through. Supposedly 
we have some investor in my home State of Kansas who wants to 
invest $100,000 in making a movie. How would this help or hurt 
him or her's effort to make that investment decision.
    Mr. Moore. I can tie all of this together and answer that. 
It is the perfect question. I guarantee you that there will be 
an enormous flood of financing into the industry for the 
studios to create jobs for Mr. Harbinson and IATSE, to create 
jobs for the guilds, to create more film production if there is 
an exchange that permits trading based on box office results. 
Because, number one, if you tell me the box office result of a 
film, I can tell you with statistical certainty what the total 
income to the studio will be from DVD and TV, because there is 
a correlation between box office and the other revenue.
    What I would say to your investor in Kansas is right now 
they have a choice to put $100,000 down and invest it in either 
a particular film, or they could invest in a slate of films. 
And they are going to look at you and they are going to say, in 
exchange for what? And the answer you will give them is, net 
profits. And net profits is a very opaque accounting term in 
Hollywood with a lot of ambiguity and a lot of litigation 
behind it and a lot of uncertainty. And that uncertainty holds 
back investment. That is what holds back investors.
    If your investors in Kansas could hedge their risk in a way 
that they could know with certainty that if the box office was 
X, and they could look it up in the paper and they know what 
they have earned the next day with certainty, they would have 
that much more comfort, they would become free of the fear of 
Hollywood accounting, and there would be a flood of funds of 
financing for the market. I represent--this is what I do for a 
living, and I can tell you I have had talks with my private 
equity funds who would flood this market with financing if 
there was a hedging opportunity available that they could 
protect themselves. And, I mean, they have told me this. And, I 
mean, hundreds of millions of dollars. There is no question 
about it.
    Mr. Moran. Thank you all very much. Thank you, Mr. 
Chairman.
    The Chairman. Mr. Kissell, questions?
    Mr. Kissell. Thank you, Mr. Chairman.
    Mr. Jaycobs--and I am probably going to repeat some of the 
questions that have already been asked, but I am trying to once 
again just understand this, and I kind of agree with Mr. 
Marshall, that this is--while it is interesting to hear your 
comments and your positions, this seems to be a decision best 
left to the CFTC and their expertise of understanding this at 
much greater levels than I would.
    But, Mr. Jaycobs, why do you want to invest? Why do you 
want to set this market up? These guys don't seem to want you. 
Why not take your money somewhere else?
    Mr. Jaycobs. Well, Cantor has had a well over 10 year 
commitment to try to develop financing vehicles for the 
entertainment business, broadly speaking. So this is part of 
that commitment. We think that--very much to the Professor's 
comments, we think that it is the transparency in a public 
marketplace that enables us to do financing of films. Without 
that, we are trying to create investment under the cloak of a 
market where valuations are being determined arguably by Mr. 
Pisano's organization as they assess what films are valuable 
and what films are not valuable. So we think that having a 
public, transparent marketplace is a predicate to doing all 
forms of other investments. And, in that sense, I agree with 
the Professor.
    Mr. Kissell. And Mr. Pisano, and I know we have talked 
about this. But why don't you want their help? They seem to 
have some money there. The equity would seem to be something 
that might leverage your investments. Why don't you want the 
help?
    Mr. Pisano. Speaking just for my members, we have perfectly 
adequate tools to finance our motion pictures. And all those 
tools have been discussed, so I won't go into it.
    What we don't want to do, what we don't want to do is to 
participate in a highly speculative, unreal, basically gambling 
casino effort to raise money. That is not good for our 
industry, it is not good for our companies. And, as Mr. 
Harbinson said, it is not good for the creators who are 
involved in the picture individually.
    And, while one could postulate, theoretically, that new 
financing opportunities are a good thing, I think they are a 
bad thing when they are like the synthetic derivatives that 
have driven down and basically almost destroyed the financial 
structure. This is nothing more than synthetic speculation. I 
am perfectly happy to have people make money who are 
speculators, but there has to be a broad economic purpose. And 
we simply don't see that here. But we do see opportunity for 
abuse, manipulation, and the kind of financial chicanery that 
has gone on in this country for the last 5 years, and that is 
why we are opposed to it.
    Mr. Kissell. Thank you, gentlemen, for your patience while 
we were voting. Thank you for being here today. Mr. Chairman, I 
yield back.
    The Chairman. Thank you. Mr. Marshall, you had another 
question?
    Mr. Marshall. Mr. Moore, you alluded to reasons why MPAA 
would not be interested in having this kind of credit facility 
available. You say that the effect of this would be to enhance 
dramatically the amount of investment that is available to fund 
films; so, hence, it would be boom times in the film industry. 
Besides just saying they are wrong in their evaluation of this, 
which you clearly think they are, are there things about how 
MPAA has structured the existing order of things that would be 
disrupted by this, some sort of vested interest that is being 
protected that you could perceive and share with us?
    Mr. Moore. No. I really do believe that it is simply the 
fear of bad tracking, and the fear that that will lower 
attendance to a film. I think it is a fairly myoptic view, 
without taking into account that there is going to be good 
tracking that will increase attendance, and kind of ignoring 
all the other benefits. And I also think it is just the fear of 
what is new. I think that has been a historical trait of the 
MPAA and the studios. I think they would ultimately come to 
embrace this.
    Mr. Marshall. So you don't see any attempt to defend turf 
that exists right now, those sorts of things that--concerns 
that sometimes come up when new products are offered?
    Mr. Moore. I don't believe so.
    Mr. Marshall. Mr. Jaycobs, Mr. Swagger?
    Mr. Jaycobs. I can only rely on the comments Mr. Pisano 
just made, that the major studios don't need this. They have 
plenty of financing. They have very deep corporate pockets 
standing behind them. I would point out that they have closed 
several, New Line, Vantage, Miramax were closed, distribution 
units that did small films underneath bigger studios. And if 
you have a public marketplace that creates greater public 
financing, the independent folks that we talked to, Lionsgate 
is just an example of that. But it goes down to production 
companies, they will all have the ability to get access to 
funds that right now for the most part can come only from the 
MPAA or its members.
    Mr. Marshall. Mr. Swagger.
    Mr. Swagger. I am sorry. Would you mind repeating the 
question?
    Mr. Marshall. Well, actually it is the same question I just 
asked Mr. Moore. I am just wondering, in your opinion, Mr. 
Moore, Mr. Swagger, Mr. Jaycobs, you are in favor of doing 
this, making this credit facility available. Is there something 
that you perceive MPAA is trying to protect, some existing 
order of things, that would be disrupted by this that explains 
why MPAA would be concerned?
    Mr. Moore says no. He thinks it is a legitimate worry about 
what would happen to the prediction of success or failure where 
a movie goes, and the existing order would prefer to leave that 
to critics and whatever else is presently around and not add 
yet another thing speculating on success or failure. Mr. 
Jaycobs is suggesting that there is a little more to it; that 
MPAA would be perfectly happy with the existing order of 
things, since financing is available for it but not for the 
smaller ventures. This would create more financing for the 
smaller ventures.
    Mr. Swagger. I would completely agree with that statement. 
If there is an action taken to prevent these products, the 
action is really just saying there are six studios we want to 
protect and we don't want to protect the rest of the jobs, the 
rest of the talent that is out there. We have great people on 
our board that have been involved with film financing, and this 
is certainly a move--if indeed the constituents of the MPAA are 
all really supporting this. What we have learned in directly 
working with those constituents, they are very open to not only 
this product but other products. So I would even disagree with 
Mr. Pisano's statement that they are all opposed to this is a 
direct conflict of what our experience has been.
    Mr. Marshall. And in fairness, Mr. Pisano, if you could 
give your perspective here.
    Mr. Pisano. I was speaking on behalf of the MPAA member 
companies. But we have in the record already a statement from 
the Independent Film and Television Producers Association, 
which represents 150 independent producers of film and 
television. In fact, in terms of that organization, that is 
probably the majority--the majority of the films produced every 
year by their members, and they are opposed to it for all the 
reasons which they have set out in their filing and I won't 
repeat them. So it is not just the six studios who are opposing 
this. It is the Independent Film Association representative 
that are opposing it, also, for the very reasons set forth.
    Mr. Marshall. Mr. Harbinson.
    Mr. Harbinson. Well, I am a little different than the rest 
of the panelists. I am a working person that represents working 
men and women, so I bring a different perspective to this. But 
from the perspective of the people I represent, it looks very 
much like the Wall Street guys are trying to do for the motion 
picture industry what they did for the real estate and mortgage 
banking industry, and we don't want it. We don't want any part 
of it. It has been very well articulated by the MPAA, it has 
been articulated by us, and it has been articulated by the 
independent producers. And I am hoping that the Committee sees 
it that way and realizes that all this is is gambling for a 
select few to make money at the expense of those of us who make 
motion pictures.
    Mr. Marshall. Mr. Moore, last word here in response to Mr. 
Harbinson? We keep hearing this is just gambling, and Wall 
Street and the reference to synthetic CDOs.
    Mr. Moore. I hear it. But in truth and in fact, it will--
and I wrote this article 7 years ago and it is attached to the 
material that I submitted to the Committee, that I believed it 
then and I believe it now that we desperately need a 
transparent, efficient market to generate substantial financing 
for this industry. The wave of equity from New York and the 
private equity funds for the last 5 years has dried up. It was 
a total of $13 billion. It is gone.
    Film--Mr. Harbinson should know that film production is way 
down. Salaries are down. Prices are down. Profits are down. 
Films are going bankrupt. MGM--Miramax is being sold at a--and 
there are a number of other companies that are on the verge of 
bankruptcy in the entertainment industry. They need financing. 
This is a viable, efficient, transparent approach to bringing 
substantial financing to Hollywood. It will help the unions, it 
will help the guild, and it will help the studios.
    Mr. Marshall. Thank you, Mr. Chairman.
    The Chairman. Mr. Pomeroy, any questions?
    Mr. Pomeroy. Yes, Mr. Chairman. Let me acknowledge at the 
outset I know nothing about the motion picture industry or how 
it is financed. I have been interested in the concept of the 
futures trading relative to potentially assisting in adding 
security to the investing, the highly risky investing in motion 
pictures. To me, it seems like this could work fairly nicely. 
You would have basically a hedge, you would put it out there, 
and you would basically be able to put a block on your downside 
exposure. This technique could bring more investors to the 
party because they are going to have a position that they can 
secure. They know their risk isn't unlimited.
    Mr. Harbinson, I guess I would direct this one to you. It 
seems to me like more participation in the investing in movies 
would be to the interest of your members, and yet you have 
taken a position against this proposal. Have you evaluated 
whether or not this might be a means to get more investing, 
and, therefore, more opportunity and, indeed, more 
independence? I have a theory, utterly baseless other than my 
own conjecture, that possibly some of the opposition from the 
Motion Picture Association is because they are the bigs. And if 
you have a backstop on risk, well, you have more potential 
investing, you are going to maybe have more little ones. And 
that is more competitive, in my argument. But, for your 
members, that might be more work. I am puzzled with this issue 
in that way. I would like your response on behalf of your 
members, and then maybe toss it around a little bit.
    Mr. Harbinson. I will answer you as best I can. As I said, 
I am a union representative, and my normal bailiwick is 
negotiating and enforcing collective bargaining agreements and 
processing grievances, that sort of thing. So this is all kind 
of new to me, and I am trying to get up to speed as best I can.
    I think that our fundamental objection is that we are 
practical people. If it looks like a duck and quacks like a 
duck, it is a duck. If it looks like gambling, it smells like 
gambling, it is gambling. We don't want to be--and you are 
right. Mr. Moore was right. You know, the industry has 
suffered, and it has suffered as a result of the financial 
crisis that is now being dealt with. It may come as a surprise, 
but we don't have great confidence in Wall Street to create new 
wonderful things for our industry, particularly when we see 
just how variable a motion picture's success could be. We are 
concerned about the process being corrupted. We are concerned 
about the process being manipulated. We have grave, grave 
concerns over that. Would we like more work? Yes, sir.
    Mr. Pomeroy. I hear you. I think there could hardly be a 
worse time to consider a new realm of futures trading in light 
of the abuse that has taken place in this whole arena. On the 
other hand, it has long served a useful risk management role in 
the marketplace for lots of things that are otherwise hard to 
evaluate risk and how you price risk protection. So you do it 
basically in an open exchange traded way, and the marketplace 
determines how you reach a valuation and puts a valuation in 
place.
    I would like to hear from Mr. Jaycobs--and I know, I see my 
time is up or just about, you have about a minute left to bring 
your perspective to my conjecture here.
    Mr. Jaycobs. Well, that is exactly our view. Is history--
this would be the only case in history where that result was 
not achieved. And we have great appreciation for Mr. 
Harbinson's guild and the other guilds. The decline in 
production has been dramatic. The studios have shifted their 
production to blockbuster type pictures away, as I just 
mentioned, from the smaller films. And we also--I had the 
pleasure to meet with some folks at the Directors Guild and we 
had an opportunity to present our side of the story. Up to that 
time, we hadn't. The folks at the Directors Guild explained to 
us--and I thought it was a very simple concept. If we believe 
that this will raise more money, and there are good arguments 
for the industry and there are good arguments in that 
direction. We would have to be convinced that there was not a 
reputational risk that because a market was sold off unfairly, 
that that reputational risk would look bad for our people. And 
I fully understand that. I think that is where the CFTC's role 
is so important here, is that we have to make sure for the 
investors in the market, for the creative people involved in 
the process, we have to make sure that we have a level playing 
field for the entire market. The CFTC is expert in that role, 
and we trust their judgment in working with us to come up with 
a product that will achieve the greater good.
    Mr. Pomeroy. I did think that reputational risk is an 
interesting element. And, again, not having a background in the 
industry, I thought the point made by Motion Picture 
Association was interesting that you would have basically Wall 
Street Journal coverage of the first weekend box office, the 
shorts hit in terms of the futures, and basically you have 
destruction of the picture in its first few weeks in the 
marketplace. It would compound the risk already experienced by 
a weak opening box office or maybe critical reviews. So I 
understand that. I don't know that that is determinative, 
though, on the question of whether or not this might be a 
useful way to backstop risk for purposes of inducing additional 
investment in U.S. produced films. We will continue to reflect 
on it.
    One question maybe to just--this is a quickie. As we look 
at futures and exchange trading, do we sort through the many 
facets of our economy and say, ``Well, you can futures trade 
this one, you can't futures trade that one; you can futures 
trade tire futures, but you can't future trade some other''--
you know what I mean, in that way? Is this a common approach? 
As a Member of the Agriculture Committee now for many years, I 
have not seen legislation that would identify an industry and 
say, well, you can't do it for this one. Sure.
    Mr. Swagger. I think Rich can add to this as well. From our 
perspective, no new exchanges can start and be successful 
unless they are into a new product market. Working at UBS as a 
banker, working with one of the very constituents actually of 
the MPAA, they were asking us if we would do slate financing, 
which is let's finance maybe ten films in a package. And the 
challenge with slate financing is simply you don't get the best 
of the films in there. It is not economically a position that 
we wanted to take when I was with UBS. In that same discussion 
with that same studio, who is a member of the MPAA, to which 
our name was derived from, we started talking about futures 
contracts, opening up that dialogue, helping them to understand 
there may be some new tools.
    So personally, as an entrepreneur, I felt this was an 
opportunity to take my hard-earned dollars--and Mr. Harbinson, 
I am a working man myself, grew up on a farm and spent many 
years of hard work, and also went through Officer Candidate 
School in the Marine Corps. And my family grew up in the 
automotive industry. I have created new jobs to serve a 
specific market, the entertainment market. And the concepts 
that we came out with are concepts that were brought from the 
entertainment industry itself.
    Now, granted, I don't have the years of experience Mr. 
Pisano has in the entertainment industry. What I have is the 
ability to bring talented people together. One of the top 
people in movie financing from one of the top banks serves on 
our team. One of the top producers who produced a lot of great 
movies that each of you would know serves on our board. One of 
the top individuals who built the most modern studio in 
Hollywood is serving on our board and manages $200 million 
revolving loan funds. We have a lot of talented individuals. 
Pete Warzell, who works for us who had to step out used to be 
the former Chairman of the National Association of Theater 
Owners, NATO, one of the organizations that is supposedly 
against us.
    Before that, he was at AMD building a live program, he was 
a president of United Artists and the chief operating officer 
and said, I wish we would have had these products before.
    Mr. Pisano and I were talking right before we came back 
here. We were talking about an area called Century City. 
Century City in L.A. is the result of a studio almost gone 
bankrupt, a major studio, one of the MPAA constituents nearly 
going bankrupt and having to sell off their whole entire back 
lot. Had there been futures products to protect that industry, 
not only would it have prevented something like that from 
occurring, but it would indeed inject capital to help build and 
create jobs. And at the end of the day, if the six constituents 
at the MPAA don't want to use the product, that is fine. I am 
willing to live or die on that sword. But we know--I didn't 
start a business and invest millions of dollars on pure 
speculation that a field of dreams, ``I am going to build it 
and I hope they come.'' We build it on foundational knowledge 
that there was a dynamic need for this industry.
    Mr. Jaycobs. I don't know if we are over our time, but I 
did want to answer. I think your question was history. I have 
been a 25 year futures industry veteran, and so I have seen a 
lot of new markets get created. And what I can say is common 
among all of them is the industry that was--energy comes to 
mind in particular, where a new futures product is introduced 
and there is significant industry opposition. If we go back to 
the early 1980s, the Seven Sisters were--and this has been 
documented in a book. The Seven Sisters were opposed to the 
idea of creating a NYMEX futures market even on a small scale 
in the financial markets there was opposition, substantial 
opposition to creating a 5 year futures contract for Treasury 
bonds when there was a ten and a different one. And even those 
interests all aligned to say we shouldn't have such a thing.
    The only case in history that I can think of and is well 
documented where Congress has stepped in and now started to 
carve out is the 1958 case where it occurred in onions.
    Mr. Pomeroy. Onions. If it weren't for onions, we would 
pretty well let markets determine what makes sense or not 
relative to the futures.
    Mr. Jaycobs. That is correct. The philosophy always was, if 
the product is poorly designed--again, dealing with the very 
important issues of we cannot have manipulation, we must have a 
fair playing field. But the commercial success, the question of 
whether they will come or they will not come to the field of 
dreams in Iowa has always been left to the--basically, to the 
marketplace to determine.
    Mr. Pomeroy. Thank you very much. And Mr. Swagger, very 
strategic getting your farm boy background in before the 
Agriculture Committee. We are way over time, you guys.
    Mr. Swagger. May I just clarify one issue? There is a lot 
of confusion with this smoke about gambling.
    Mr. Pomeroy. Can you clarify this issue in 20 seconds? 
Because the Chairman is about to gavel us down here.
    Mr. Swagger. Absolutely. Thank you, Chairman Boswell.
    Gambling, somebody takes on a risk. That is the studios. 
That is people who finance the movies. Futures market, you 
assume and spread out the risk. It is not gambling. It is 
taking the risk that is there and existing and spreading that 
out. And that is what a futures market has been, has always 
been, and is in this situation as well.
    Mr. Pomeroy. Thank you.
    The Chairman. Well, thank you. It has been a very, very 
informative discussion. But before I go to closing remarks, I 
would like to recognize my Ranking Member, Mr. Moran.
    Mr. Moran. Mr. Chairman. Thank you very much. Perhaps many 
of us came here with preconceived ideas. I thought it was a 
very useful hearing, something that we ought to do more in 
Congress is get a perspective so that we can make correct 
decisions. And I appreciate the witnesses' testimony and you 
conducting this hearing today, and I look forward to analyzing 
what I heard during the testimony. Thank you.
    The Chairman. All right. Thank you. And I concur. I think 
it has been very informative, and I appreciate the efforts you 
made to come and inform us and share with us. We likely will 
have some more questions as we go forward. It has been a 
learning experience. And thank you for giving us your time 
today. We apologize for the interruption for the votes, but 
those things happen.
    So at this point I would share that under the rules of the 
Committee, the record of today's hearing will remain open for 
10 calendar days to receive additional material and supplement 
the written responses from the witnesses to any question posed 
by a Member. This hearing of the Subcommittee on General Farm 
Commodities and Risk Management is adjourned. Thank you.
    [Whereupon, at 1:30 p.m., the Subcommittee was adjourned.]
    [Material submitted for inclusion in the record follows:]
      
     Submitted Statement by Independent Film & Television Alliance
    Thank you, Chairman Boswell, Ranking Member Moran and Subcommittee 
Members, for the opportunity to provide a written statement to the 
Subcommittee on General Farm Commodities and Risk Management of the 
House Committee on Agriculture, regarding the applications currently 
before the Commodity Futures Trading Commission (``CFTC'') to approve 
or deny two proposed commodity futures contracts and a commodity option 
contract sponsored by Media Derivatives, Inc. (``MDEX'') and the Cantor 
Futures Exchange L.P. (``Cantor'') that are designed to allow the 
contracts' users to bet on the level of gross motion picture box office 
receipts on individual motion pictures (``the proposed contracts'' or 
``the contracts''). The Independent Film & Television Alliance (IFTA) 
opposes these proposed contracts because they serve no legitimate 
public interest, would impose new and substantial burdens on small to 
medium sized businesses and provide little, if any, of the so called 
``benefits'' of hedging; thereby causing disproportional harm to the 
countless business, financial and creative partnerships which make up 
the independent motion picture industry.
    IFTA is the nonprofit trade association for the independent film 
and television industry worldwide. IFTA Members consist of over 150 
independent production and distribution companies, as well as sales 
agents, television companies and financial institutions from around the 
world, the majority of which are U.S.-based producers and exporters.\1\ 
Over the last seven years, independent production companies have 
produced nearly 80% of all U.S. feature films and producing on average 
500 feature films per year. Since 1982, IFTA Members have been involved 
with the financing, development, production and distribution of 64% of 
the Academy Award Winning Best Pictures' including The Hurt 
Locker, Slumdog Millionaire, No Country for Old Men, The Departed, 
Crash, Million Dollar Baby, Braveheart, Lord of the Rings, Dances with 
Wolves and Gandhi. In the past year, IFTA Members films have also 
included The Twilight Saga: New Moon, The Last Station, Inglorious 
Basterds and Tyler Perry's Madea Goes to Jail, to name just a few.
---------------------------------------------------------------------------
    \1\ For a complete list of IFTA Members, visit www.ifta-online.org.
---------------------------------------------------------------------------
    IFTA Members' collective worldwide sales for 2008 totaled over $2.8 
billion, of which approximately $2.3 billion came from foreign (non-
U.S.) revenue; and $503 million from U.S. revenue, which is 
approximately 18% of total worldwide revenue. Of the amount for export 
revenue, $1.7 billion was generated from Europe, $129 million from 
Latin America, $222 million from Asia.
    IFTA is also a member of a coalition opposing these proposed 
contracts that includes the Directors Guild of America, Inc. (DGA), the 
International Alliance of Theatrical Stage Employees (IATSE), and the 
National Association of Theatre Owners (NATO), as well as the Motion 
Picture Association of America (MPAA) and its member companies 
(``Coalition''). The Coalition has submitted a separate written 
statement outlining its opposition of these proposed contracts and 
Coalition members will participate at the April 22, 2010 hearing. IFTA 
is filing this Statement individually to underscore the specific 
concerns of the independent motion picture industry with respect to the 
proposed contracts.
    As a background, independent producers are those companies (apart 
from the MPAA studios) that assume the majority of the financial risk 
for the production of a film or television program and control its 
distribution in a majority of territories worldwide. Independent 
producers secure financing on a film by film basis with different 
investors for each film and rely heavily on the distribution 
commitments of foreign distributors before production of the film even 
begins. For independents and MPAA studios alike, film distribution is 
not a ``one shot deal'' as may be the case with agricultural futures--a 
picture's long term revenue prospects (especially in foreign 
territories) can be severely damaged by publicity generated around 
artificial expectations of the performance of these contracts, which 
looks at only a small window and only the U.S. release. Therefore, any 
pre-release hedging by U.S. distributors (which are separate, 
unaffiliated companies) could harm not only the independent producer, 
but also the dozens of financial and commercial partnerships they have 
built worldwide to secure financing for each film.
    Despite statements to the contrary from proponents of these 
schemes, most independent pictures would not be the subject of proposed 
contracts because the picture will not meet the criteria such as a 
simultaneous release in 600 or 650 U.S. theaters. Moreover, most 
independent films are first theatrically distributed in the U.S. and 
are released by the MPAA studios which control the marketing and 
release plans including determining what type of a release (i.e., 
limited, platform, wide) will launch a motion picture; the independent 
producer does not control the factors on which these exchanges base 
qualifications. Even in the event that the independent picture meets 
such criteria, since independent producers must pay back production 
loans based largely on foreign revenues which are earned after the U.S. 
theatrical release and could be harmed by negative publicity, they are 
unlikely to engage in hedging that could jeopardize their previously 
established financing and distribution relationships.
    Further, these proposed contracts may not appeal to independent 
producers as a risk management tool since independent producers already 
exercise risk management in their financing and distribution models by 
securing pre-production commitments from foreign distributors worldwide 
known as ``minimum guarantees.'' Those minimum commitments by foreign 
distributors along with any government incentive programs are 
collateralized by financial institutions and other investors which loan 
the producer the production budget. The financial institution or other 
investors are granted an assignment of the copyright in the motion 
picture until the production loan is paid back.
    Any hedging by the U.S. distributor (again, a separate company 
which is not affiliated with the independent production company) could 
harm the long term prospects for a picture's worldwide distribution. 
Since only about 18% of worldwide sales revenue is derived from U.S. 
distribution and only a portion of that from U.S. theatrical 
distribution, independent producers must rely on the proceeds of 
foreign distribution to pay back the production loan and other 
investors and so are unlikely to hedge on the U.S. theatrical release. 
The existence of such schemes would place independent producers in the 
difficult position of assuring their overseas distributors that the 
foreign revenues will not be jeopardized by the U.S. distributor, but 
could never guarantee that hedging would not occur or negatively impact 
the long term potential of the Picture.
    ``Split rights'' deals in which one company controls U.S. 
distribution and another company takes foreign rights are common in the 
industry. A market that allows hedging on the domestic side creates 
significant risk of harm to the company controlling the foreign rights 
and damages the long term prospects for the picture. In the case of 
split rights licensing arrangements in which an MPAA studio control 
exclusive U.S. distribution rights, and another studio, or in the case 
of independents, a network of distributors control the exclusive 
foreign distribution rights, any hedging by the U.S. distributor could 
critically damage the picture's foreign distribution rights. Any 
negative publicity will disproportionally harm independent producers 
and their foreign distributors, who are unlikely to avail themselves of 
U.S. based hedge funds.
    Any such exchange requires that insider knowledge and trading be 
controlled in order to ensure integrity of market. Compliance 
compatible with such controls may be impossible in the worldwide 
reaches of the independent motion picture industry due to the sheer 
number of potential insiders. Since many times foreign distributors are 
investors in a picture prior to production and release, potential 
insiders could be spread worldwide preventing enforcement of insider 
manipulation or trading. Approval of the proposed contracts also will 
require MPAA studios, independent production companies and all other 
industry participants that have the power to affect futures pricing to 
institute anti-insider trading compliance regimes for the proposed 
contracts and this may ultimately impact the MPAA studios relationship 
with independent producers to supply programming. In the event that the 
studio is distributing an independent picture, the potential for many 
more insiders outside of the studios' control is enormous. There are 
many industry participants who have access to material, non-public 
information and could try to use that information to profitably bet on 
the proposed contracts.
    Futures prices also are susceptible to manipulation by false market 
rumors. ``Hollywood'' is referred to as a ``company town'' and there is 
no shortage of media and speculation about this industry's main 
product--motion pictures. There already are plenty of rumor mills with 
respect to the quality of motion pictures and many taking place online. 
In this environment it would be impossible to identify the sources of 
such rumors or to prosecute any alleged manipulation by false rumors, 
because such rumors would typically be based on opinions relating to a 
motion picture's artistic or entertainment merit rather than verifiable 
facts. What was once industry ``talk'', idle gossip or opinion could 
have a more profound impact on our creative industry. For the 
independent industry and its worldwide participants, there is no 
effective way to reliably determine the source of such rumors. It also 
remains unclear what legal duties and liabilities apply and for whom if 
the base data fails to fully report or gather accurate data or if a 
studio makes an inaccurate announcement of receipts. If an independent 
motion picture is subject of a proposed contract and manipulation is 
asserted, defending such suits would be financially devastating for an 
independent producer.
    It is for the reasons stated in this Written Statement and in the 
Coalition's Written Statements that IFTA opposes such proposed 
contracts. Thank you once again for the opportunity to outline the 
critical concerns of the independent motion picture industry in 
connection with these proposed contracts. IFTA respectfully urges that 
they be denied.
                                 ______
                                 
   Submitted Statement by Don M. Chance, Ph.D., C.F.A.; on Behalf of 
                           Cantor Fitzgerald
    My name is Don M. Chance and I am Professor of Finance and holder 
of the James C. Flores Endowed Chair of MBA Studies at Louisiana State 
University. I have been asked by Cantor Fitzgerald to provide a 
statement and document to the United States Congress that would support 
its request for approval of a new futures exchange in which contracts 
would be based on the box office revenues of movies. While I am being 
compensated for my service, I had independently established this 
opinion as evidenced by my co-authorship of two articles over the last 
two years on a similar financial instrument. In the spirit of full 
disclosure, I provide the caveat that these remarks are my own and do 
not necessarily represent the views of my employer, Louisiana State 
University.
Qualifications
    I hold a Ph.D. in finance from Louisiana State University and am a 
CFA (Chartered Financial Analyst) charterholder. I have been an 
internationally recognized scholar and consultant in the area of 
financial derivatives for nearly 30 years. I formerly taught at 
Virginia Tech, and I have authored three books on financial 
derivatives, including one widely-used textbook currently in the 8th 
edition, and another that is the required reading for the CFA 
examination program, which is taken by over 120,000 candidates 
worldwide each year. I have authored nearly 100 published articles, 
most of which deal with derivative instruments. I have conducted 
training programs for UBS, Thomson Financial, The German Society of 
Financial Analysts, the International Federation of Banking of 
Luxembourg, Goldman Sachs, and the World Bank. I am an advisor to 
IndexIQ, a New York-based creator of exchange-traded funds, and to The 
Governance Fund, a Minnesota-based investment advisor. Prior to my 
academic career, I spent four years in commercial banking.
    My specific qualifications for this matter derive from two articles 
I co-authored. The first, ``Pricing an Option on Revenue from an 
Innovation: An Application to Movie Box Office Revenue,'' was published 
in 2008 in Management Science (Vol. 54, No. 5, pp. 1015-1028), a 
prestigious interdisciplinary scholarly journal with extremely high 
publication standards. The second paper, which extended some of the 
work in the first paper and was targeted more toward practitioners, 
appeared in Risk magazine (Vol. 22, May, 2009, pp. 80-86) and was 
entitled ``Pricing Options on Film Revenue.'' Both of these articles 
were co-authored with Professors Eric Hillebrand of Louisiana State 
University and Jimmy Hilliard of Auburn University.
    These two papers emanated from a long-term interest I have had on 
how the entertainment industry has pursued means of hedging the 
significant risk it faces in the music and films it produces. I will 
provide a brief review of this subject in this document. The papers 
demonstrate how to capture the statistical properties of revenues from 
a movie and how to use that knowledge to create options that would pay 
off based on how a movie performs. Although the instruments being 
proposed by the new exchange are futures contracts, the essential 
characteristics of options and futures are sufficiently similar such 
that any differences in the context of this matter are trivial.\1\
---------------------------------------------------------------------------
    \1\ By way of clarification, an option enables a party to claim the 
value of an asset or the payoff of an asset by paying a fixed amount of 
money at a certain date. For this right, the buyer pays a fixed sum of 
money, the option price, at the start to the counterparty or seller. 
The counterparty/seller receives the up-front payment from the buyer 
and must be willing to provide the payment or asset demanded by the 
buyer, if the buyer so chooses. A futures is an agreement in which one 
party commits to claiming the value of an asset or the payoff of an 
asset by paying a fixed price at a certain date. The counterparty, or 
seller, in a mirror image, agrees to deliver the asset or pay the value 
of the asset to the buyer on the given date. Whereas an option is a 
right held by the buyer and granted by the seller, a futures is an 
obligation on the part of both buyer and seller.
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    This statement will be followed by a white paper at a later date 
(see Attachment).
Futures Markets and Contracts as Regulated Risk Management Tools
    Futures markets have operated successfully in the United States 
since the middle of the 19th century. They provide a facility for the 
trading of standardized contracts to buy and sell a specified 
underlying asset at a fixed price at a future date. Commonly traded 
assets are stocks, bonds, currencies, metals, energy, and commodities. 
The market is used extensively by various parties to transfer risk and 
adjust their wealth exposures to levels that are suitable for their 
risk tolerances. Futures markets provide an absolute credit guarantee 
that is enabled by the existence of a clearinghouse that stands between 
each party to a futures contract and guarantees payment to the party 
that profits that it will pay if the party that loses defaults. 
Clearinghouses have existed since around the 1920s, and no party has 
ever suffered a credit loss from failure of a clearinghouse. In my 
opinion futures markets have performed exceptionally well during 
periods of market stress. In particular, during the crash of October 
19, 1987, on which U.S. stocks lost nearly a fourth of their value a 
single day, U.S. futures markets led the rally that stopped the 
carnage.
    Futures markets exist alongside other markets for similar 
instruments, some of which trade in standardized regulated markets and 
some of which trade exclusively in the largely unregulated over-the-
counter market. Options, for example, which can often be used with or 
in place of futures, exist in both exchange-traded markets and over-
the-counter markets. Swaps and forwards, which are even more closely 
related to futures, trade only in over-the-counter markets. These 
instruments are part of the larger family of instruments called 
derivatives. As noted, they are often substitutable and their existence 
and use is nearly always for similar purposes.
    Futures markets are regulated by the United States Commodity 
Futures Trading Commission (CFTC). In its history, the Commission has 
approved over 700 futures contracts. The CFTC has tended to take the 
view that futures contracts should be allowed to be offered and succeed 
or fail on their merits. Futures exchanges are highly competitive and 
aggressively compete by offering similar products. A sign of a healthy 
market is a low success rate and indeed U.S. futures markets are 
healthy. My research has shown that only about one in four new 
contracts is successful.
A Market for Futures Contracts on Movie Revenues
    Cantor Fitzgerald has proposed a new type of futures contract, one 
in which traders would enter into agreements to pay a fixed sum of 
money for the right to receive a variable sum of money that would be 
determined by the financial performance of a movie. These ``movie 
futures'' are, in my view, long overdue and should be permitted. There 
is a long history of discussion about this type of instrument and 
indeed, the film industry itself has a track record of attempting to 
create similar instruments. Regardless of what views have been conveyed 
by the entertainment industry on the matter of this new proposed 
exchange, it is apparent that this industry is interested in means of 
shedding some of its risk.
    Based on my research, I believe the first such effort was the 
issuance of a $400 million, 7 year bond by the Walt Disney Company in 
1992. This bond specified that the interest would be determined by the 
revenues from a package of 13 movies to be released in Europe. Hence, 
Disney was laying off some of the risk of the performance of these 
movies to the investors who bought the bond. In 1997, Pullman LLC 
offered what came to be known as the famous ``Bowie Bonds,'' a $55 
million issue purchased by Prudential in which the interest payments 
were determined by David Bowie album sales. Similar bonds have since 
been offered based on royalties generated by James Brown, the Isley 
Brothers, the songwriting teams of Ashford and Simpson as well as 
Holland, Dozier, and Holland, and by revenues from movies of Dreamworks 
SKG. Many of these instruments are created through a process known as 
securitization, whereby investors can obtain equity returns as well as 
interest payments. Thus, the entertainment industry has clearly 
indicated a desire to eliminate some of its risk.
    There appears to be considerable demand on the part of investors 
for opportunities to trade derivative instruments based on film 
revenues. This interest is fueled by two factors. One is that 
professional investors are constantly looking for new opportunities in 
asset classes that have little to no correlation to the more 
conventional asset classes, such as stocks, bonds, and real estate. 
This lack of correlation improves the efficiency of investment 
portfolios, leading to higher expected returns for a given level of 
risk. Movie revenues are indeed the very type of asset class that 
appeals to such investors. As my research shows, movie revenues have 
virtually no correlation with the stock market.
    The second factor is the sheer interest in movies. One of the 
important characteristics for the success of a futures contract is that 
there must be a significant interest in the asset or value on which the 
contract is based. Movies are not only appealing for their 
entertainment value, but the financial performance of a movie is a 
much-watched statistic to many Americans. Each week, a news story 
discusses how new releases did over the weekend. There are several 
successful websites that track the performance of movies and the 
revenue generated by stars. While the performance of a movie is 
probably not as widely followed as sports scores and the stock market, 
it does, nonetheless, garner considerable attention, which passes the 
litmus test of a successful futures market--there must interest.
    Discussions of the creation of exchanges for standardized trading 
of financial instruments based on entertainment revenues have a long 
history but little success to date. There has been far more talk than 
action, and none appear to have been structured within the regulated 
environment of futures markets. The Cantor proposal, set up within the 
U.S. regulatory structure, is the first one I believe that has a 
reasonable chance of success. And if it is not successful, movie 
revenue futures will go the way of the 75% of other futures contracts 
that were launched and failed. That is the American way.
    I understand that the film industry objects to the Cantor proposal. 
I believe it has expressed the view that it is not likely to use these 
contracts to hedge. I respectfully disagree, based on my observations 
that the entertainment industry has for many years sought means of 
laying off this kind of risk. It may well take some time, but I believe 
the industry will warm up to this product. In particular, the 
independent film makers who do not have access to the tremendous 
resources of the major studios could make substantial use of this 
contract. Providing these small companies with such opportunities would 
help them be more competitive with the larger studios. This could also 
have the effect of stimulating more independent film production, which 
can only be good for the American public. If the industry ultimately 
does fail to use it, however, it is unlikely that this new exchange 
will be successful. The losers will be only Cantor Fitzgerald. In my 
view, Cantor should be allowed to try and if it cannot make a success, 
it should fail. That is how we do it in this country and indeed that is 
what makes America great.
    The industry has also opined that no one is likely to buy these 
contracts, inasmuch as it sees no party that would be harmed by 
outstanding performance of a movie. It seems to me, however, that 
parties that negotiate DVD and television rights, the rights to 
manufacture and market other products with tie-ins to movies and 
characters, and international distribution rights would be buyers. 
Better performing movies are far more expensive to these parties, and 
they could greatly benefit from the use of these futures to keep their 
costs more predictable, which is the main benefit of hedging.
    The industry has also argued that the data on which payoffs are 
made is subject to manipulation. I find this a rather strange response 
for two reasons. It is as if a company objects to the trading of 
derivatives on its stock because the company could manipulate the 
financial information it releases. Moreover, if the industry would 
manipulate its own data, it sounds like an admission that the industry 
would use the contract. But in any case, financial regulations permit 
trading of derivatives on the company's stock, whether the company 
objects or not. If the data are subject to manipulation, it is almost 
surely no more than the manipulation that is possible by corporations 
operating within Generally Accepted Accounting Principles. This leads 
to my last reason for wanting to see this contract.
    I suspect the industry does not want financial analysts and 
professional investors studying the finances and accounting for movies. 
I believe, however, that the financial industry can serve a valuable 
public purpose in bringing more transparency to the film industry. 
Perhaps the data are already being manipulated. Manipulation will be 
harder if financial analysts and professional investors are watching 
over the industry, as they will if these futures contracts are allowed 
to trade. Thus, this new market can help improve the quality of the 
information that originates from this industry.
Conclusions
    I urge the United States Congress to grant the petition of Cantor 
Fitzgerald to create this new futures market. Your concern should be 
what is good for the public and in that regard, I see no real risk to 
the public. Cantor Fitzgerald is not large enough to present a systemic 
threat, and this project is not large enough that its failure would 
destroy the firm. Therefore, if this exchange fails, the only losers 
are the owners of Cantor Fitzgerald.
    There is yet another reason why this Congress should approve this 
proposal. I suspect that if we do not allow this kind of market in the 
regulated U.S. futures environment, it will create itself either within 
the unregulated over-the-counter market, as it has done on a small 
scale already, or it will be created and succeed overseas. With almost 
all of the successful movies being produced in this country, it would 
be quite a shame if movie futures markets exist only in foreign 
countries.
                               Attachment
   michael s. pagano, ph.d., c.f.a., professor of finance, villanova 
                school of business, villanova university
The Potential Effects on the Movie Industry of Futures Trading on Film 
        Revenues \1\
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    \1\ To better inform those parties interested in understanding the 
role of futures trading on first-run movies, Cantor Exchange, Inc. 
commissioned the author to write this report describing the new 
potential market for enabling investors to manage risk and trade these 
new contracts. This article presents my analyses and opinions only and 
does not necessarily represent the opinions of the sponsor of this 
project. The author retained full editorial control over the content 
and conclusions of this report.
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I. Executive Summary
    This report addresses the key questions that have recently been 
raised about the introduction of a contract such as the proposed 
Domestic Box Office Receipt (DBOR) futures instrument and the 
associated Cantor Exchange. The report has three key components that 
address this important issue from several perspectives.
    First, using classic financial principles that describe what 
effective futures contracts and financial markets should contain, I 
find that the DBOR contract and Cantor Exchange meet these criteria and 
thus this contract market represents a legitimate and effective vehicle 
to conduct futures trading in the area of first-run movies. In 
addition, the role of speculators within a futures market is clarified 
using the U.S. Commodity Futures Trading Commission's (CFTC) own 
description of these market participants. Contrary to some of the 
recent media coverage, speculators are not ``gamblers'' or ``evil'' and 
thus these investors provide a useful economic role in ensuring 
liquidity and greater price transparency within a futures market.
    Second, this report also demonstrates how the introduction of a 
DBOR market can benefit not only the direct participants in such a 
futures market but also help other players in the movie industry such 
as consumers and the movie studios. The main benefits of introducing a 
DBOR futures market are:

    (1) Better risk management for investors and other participants in 
        the movie business,

    (2) Increased new investment in the movie industry from current 
        film investors,

    (3) Additional investment from new investors that are now attracted 
        to the film industry, and

    (4) Greater transparency which yields useful price signals for the 
        entire economy.

    The report also examines two potential costs of such a market 
related to the possibility of market manipulation and/or insider 
trading. However, the financial incentives of the Cantor Exchange and 
the clear mandate of the CFTC to ensure that futures markets are fair 
to all participants indicate that both of these organizations have the 
proper motivation to actively employ the necessary surveillance and 
enforcement systems in order to mitigate the possibility of market 
manipulation and/or insider trading.
    Lastly, this report also reviews the academic literature on this 
subject and I find that there is both sound financial theory and solid 
empirical evidence that support the notion that the benefits of 
introducing a futures market can greatly outweigh the potential costs 
noted above. Empirical evidence over the past two decades not only in 
the U.S. but also more recent evidence from numerous countries around 
the world confirm the positive effects of introducing a futures market 
in terms of increasing price transparency, providing better risk 
management, reducing price volatility, and increasing the liquidity of 
financial markets.
II. Introduction/Background
    This report examines the potential benefits and costs associated 
with introducing a set of futures contracts based on the revenues of a 
first-run movie's initial 4 week box office revenues. To begin, it is 
helpful to review the classic principles that underlie all effective 
financial markets and futures contracts. In addition, this section 
explains the fundamental role that traders who are not hedging an 
underlying exposure (typically referred to as speculators) can play 
within a properly functioning financial market.

    Key attributes of a financial market:

    There is a well-established set of academic literature on the role 
of financial markets within an economy. In particular, seminal work by 
Hayek (1945), Debreu (1959), and Arrow (1964) show that an effective 
financial market can serve two economically important functions: (1) 
the market can help investors allocate and share risk via trading and 
hedging activities, and (2) the market can communicate, via public 
disclosure of price and volume data, important information about the 
value of financial securities to all members of society (not just the 
counterparties to the transaction). This latter function is extremely 
useful because all participants in the economy (not just the specific 
financial market) can use these price and volume data as signals of the 
relative supply and demand for the relevant securities which, in turn, 
allows all members of society to make more informed economic decisions.
    Given the proposed market structure of the Cantor Exchange, it 
meets the above criteria of an effective financial market because it 
will: (1) allow investors to hedge their exposure to the financial 
performance of specific movies, and (2) provide 24/7 trading 
opportunities and real-time reporting of transactions via a web-based 
data dissemination service. Thus, investors in this exchange will be 
able to trade, hedge, and observe the price and volume activity in a 
transparent manner.

    Key attributes of a futures contract:

    For a futures contract to be a viable, effective tool for risk 
management and trading, it should have the following qualities:

   An objectively verifiable ``commodity'' that is to be traded 
        (i.e., the contract's value can be independently and 
        objectively determined by market participants).

   Standardized terms (documentation that states exactly what 
        is the amount of the contract, expiration months, last trading 
        day, settlement procedures, etc.).

   Clearing mechanism (a clearinghouse reduces counterparty 
        credit risk and improves price transparency so that all market 
        participants can observe the prices and quantities of the 
        contract that have been traded on a daily basis).

   Margin system (this enables all futures positions to be 
        marked to market on a daily basis and thus reduces the overall 
        counterparty credit risk within the clearinghouse and between 
        the rest of the market participants).

   Low transaction costs (this encourages greater trading 
        activity and thus higher levels of liquidity that benefit all 
        market participants).

   Open, easy access to the futures market (by permitting 
        direct access to the market for all investors, the market's 
        liquidity can be maximized).

    The DBOR futures contract, as proposed by the Cantor Exchange, 
Inc., meets all of the above criteria for a futures contract.

    The role of speculators in a futures market:

    Although the popular press and other parties might portray 
speculators in the futures markets as ``gamblers'' or ``evil,'' the 
economic and financial reality is that speculators play an important 
role within a futures market (see Appendix 1 for some brief excerpts 
from recent media coverage of this issue). In particular, speculators 
provide much-needed liquidity to the market by, for example, taking the 
other side of a transaction in which a person wants to hedge. For 
example, a consumer of corn such as a cereal producer might want to 
hedge against increases in the price of corn and thus might want to buy 
corn in the futures market. If there is no one who owns corn (such as a 
farmer) who is willing to sell corn in the futures market, then the 
speculator can step in and play an key role by selling the corn on 
speculation that the price will fall. The speculator's trade enables 
the cereal producer to hedge its position and thus help this firm 
manage its risks more efficiently.
    In fact, the CFTC itself recognizes this important role that 
speculators play, as shown by the following excerpt from their web site 
(www.cftc.gov):

    The Role of the Speculator
        A speculator is one who does not produce or use a commodity, 
        but risks his or her own capital trading futures in that 
        commodity in hopes of making a profit on price changes. While 
        speculation is not considered one of the economic purposes of 
        futures markets, speculators do help make futures markets 
        function better by providing liquidity, or the ability to buy 
        and sell futures contracts quickly without materially affecting 
        the price. Long and short hedgers may not be sufficient to 
        create a liquid futures market by themselves. The participation 
        of speculators willing to take the other side of hedgers' 
        trades adds liquidity and makes it easier for hedgers to hedge.

    In sum, using the fundamental criteria noted above that define what 
effective futures contracts and financial markets should possess, I 
find that the DBOR contract and Cantor Exchange meet all of these 
criteria and, accordingly, create a valid means of providing both 
hedgers and speculators with an effective way to conduct futures 
trading in the area of first-run movies. The above discussion also 
dispels the belief that speculators are inherently bad for a financial 
market and the economy in general.
III. The Main Benefits and Costs of Film-Related Futures Contracts
    Film-related futures contracts have four main benefits and two 
potential important costs, as noted below.

    Benefit 1. Better Risk Management for Investors and other 
Participants in the Movie Industry

    When discussing the role of a futures contract such as the Domestic 
Box Office Receipt (DBOR) contract, it is most important to keep in 
mind the hedging, or risk management, feature of these contracts. The 
use of DBOR futures allows existing parties with material investments 
in the success of a movie to hedge their risks (e.g., not only the 
financial investors in the film but all of the movie theater operators 
around the world can be at risk of having a large number of empty seats 
in their theaters if a film is unsuccessful). Thus, there is a genuine 
need for these investors to hedge some of the risk associated with 
their investments in time, money, and other resources associated with a 
specific movie.
    Retail consumers of movies could also benefit by participating in 
the market for DBOR contracts. For example, if their trades in this 
market are profitable, then this can offset the cost of purchasing 
movie tickets, DVDs, and other movie-related goods and services. This 
type of interest on the part of retail consumers could also spur 
greater consumption of movies, DVDs, etc., as these individuals might 
be more interested in going to additional upcoming movies that they 
would not have otherwise been aware of.

    Benefit 2. Stimulates New Investment from Current Investors in the 
Movie Industry

    By enabling both large film investors/financiers and theater 
operators to hedge in the DBOR market, another benefit is created, 
namely, this hedging capability can stimulate additional investment 
from these existing participants in the movie business. Thus, by using 
DBOR futures to hedge, say, half of a film investor's investment in one 
movie, this investor could then invest in a second, additional movie 
and hedge half of his/her investment in this second film. In this way, 
the investor can invest in two movies for the same amount of net risk 
exposure as he/she would have normally done for one movie when there 
was no DBOR market. Consequently, more investment capital can be 
provided by current film investors/financiers to the movie studios that 
produce these films. So, both investors and the movie studios can 
benefit through the increased amount of capital available for 
investment in the movie industry. Consumers who purchase movies can 
also benefit from this additional investment if the movie studios 
produce films of greater quality, quantity, and variety.

    Benefit 3. Attracts Additional Investment from New Investors to the 
Movie Industry

    Another side benefit of an active DBOR futures market is that a 
``positive externality'' can exist between this futures market and 
potential new film investors and theater operators.\2\ For example, the 
hedging and trading activities of existing investors and theater 
operators can have a positive effect on individuals and firms that are 
not currently involved in the film business. The economics of positive 
externalities, sometimes referred to as ``network effects,'' indicates 
that the creation of an active DBOR market can encourage new investors 
and other firms to become interested in investing in the movie business 
(either by investing directly in first-run movies, building new 
theaters/DVD stores, or trading in the DBOR market).
---------------------------------------------------------------------------
    \2\ A ``positive externality'' is a benefit that some individuals 
or firms receive without paying the full cost for this benefit due to 
the economic activities of other unrelated parties. For example, if two 
people own cell phones, then a third person can benefit by calling 
these individuals even though he/she might not own a cell phone. In 
turn, the benefit to this third person for purchasing a cell phone 
might be greater than the phone's cost because he/she can now call 
several other people in a more convenient way.
---------------------------------------------------------------------------
    In the past, these investors and firms might have been interested 
in the movie business but deemed it too risky to invest in. However, 
these potential participants may now invest in the movie industry 
because the DBOR contract provides these players with a cost-effective 
way to mitigate some of their movie-specific risk. This will have the 
positive effect of stimulating greater investment in not only first-run 
movies but also the entire movie business infrastructure (theaters, 
stores, rental kiosks, etc.). In turn, this can help stimulate 
employment in various areas such as the film studios, theater 
operators, DVD rental stores, and even the construction industry to 
some extent.

    Benefit 4. Greater Transparency yields Useful Price Signals for the 
Entire Economy

    By developing an active DBOR market, not only do the market 
participants benefit from the greater ``price discovery'' created by 
trading this futures contract but also non-participants can benefit 
because they can use the transaction price and trading volume data as 
useful ``price signals'' about the anticipated supply, demand, and 
growth prospects for various films.\3\ This information, for example, 
can be useful to a movie studio which does not even participate in the 
DBOR market because the price and volume data from this market can help 
the studio decide to invest more in, say, 3D movies because the DBOR 
futures market might be showing strong price gains for contracts 
related to current 3D films. By monitoring prices and volume in the 
movie futures market, the relatively scarce economic resources of any 
one film studio can then be allocated in a more efficient manner. This, 
in turn, benefits the entire economy because better price and volume 
signals from the futures market can lead to more effective investment 
decisions by studios, theater operators, retail DVD stores, and 
consumers. Given the relatively flat/stagnant trend in movie box office 
receipts and ticket sales over the past decade, the ability to make 
better investment decisions should help stimulate growth and innovation 
in the U.S. movie industry (see the table in Appendix 2 for more 
details).
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    \3\ By ``price discovery,'' I mean the process by which traders 
submit orders to buy and sell in order to identify the ``true'' 
equilibrium price for the security (i.e., where supply equals demand 
for a film's expected revenues). Interestingly, it could be that the 
film studios are concerned that they will lose their monopoly position 
on this price discovery process because information about various 
movies will be published by the futures exchange which all market 
participants can then observe and analyze. This is the type of 
information that is currently held privately by the film studios and 
thus some of these firms might be concerned with losing their 
informational edge to non-Hollywood participants in the futures market.

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    Potential Cost 1. The Possibility of Market Manipulation

    The biggest ``cost'' (as opposed to benefit) of the proposed DBOR 
futures contract is the possibility that the market could be 
manipulated by one or more traders for their personal gain by 
artificially pushing prices up or down and then profiting from a sudden 
reversal in prices. In any market (not just futures contracts) where 
there is low liquidity, this risk is present. The key to minimizing 
this risk and lowering the potential ``cost'' associated with DBOR 
futures trading is through diligent monitoring and active enforcement 
of the rules established by the CFTC and the Cantor Exchange itself. 
Otherwise, investors will not want to trade on an exchange where it is 
perceived that prices are easily manipulated and thus the market is 
``rigged'' against these investors.
    Since the Cantor Exchange has a strong and direct incentive to 
maximize the DBOR market's trading volume and the CFTC's role is to 
ensure that all futures markets are fair to all investors, both of 
these parties are motivated to ensure that the participants in the DBOR 
market are acting in a responsible and fair manner. Thus, the Cantor 
Exchange has set up monitoring/surveillance systems which can thwart 
the efforts of potential price manipulators and ban them from the 
trading system. In addition, the CFTC has its own sophisticated 
surveillance and enforcement systems and staff which will be monitoring 
the trading activity in the DBOR market and can impose severe penalties 
for those parties that attempt to distort market prices.

    Potential Cost 2. The Possibility of Insider Trading

    Another potential cost associated with not only the proposed DBOR 
futures market but any financial market is the problem related to 
insiders trading on material, non-public information. For example, some 
have voiced concern that employees of film studios, studio sub-
contractors, or other individuals would exploit their inside 
information about the prospects for a film via the DBOR futures market. 
However, this problem is no different than the problem faced by the 
employees of a large consumer of corn (e.g., a cereal maker) or the 
corn farmer himself, for that matter, who potentially has inside 
information on the supply and demand for corn which could be exploited 
in the corn futures market. Thus, the CFTC has decades of experience 
dealing with this issue and has demonstrated that it can effectively 
monitor this issue to ensure a fair and level ``playing field'' for all 
futures market participants. In addition, the Cantor Exchange itself 
has strong financial incentives to ensure the DBOR market is one of 
high integrity.
    In sum, the four primary benefits noted above are quite powerful 
while the two potential costs can be properly mitigated by effective 
surveillance and enforcement systems operated by both the Cantor 
Exchange and the CFTC. Overall, the main benefits described above 
appear to clearly outweigh the potential costs associated with 
introducing the DBOR futures contract. Next, I turn to the academic 
literature to see what effect prior introductions of derivatives 
markets have had on existing financial markets. This review of both 
finance theory and empirical evidence can help inform us about how the 
introduction of the DBOR market might affect the movie industry in the 
future.
IV. Review of the Relevant Literature on the Impact of Introducing a 
        Derivatives Contract into an Existing Financial Market
    Theoretical Models of Derivatives Introduction

    Given the above discussion of the key features of well-designed 
financial markets and futures contracts, as well as an assessment of 
the key benefits and costs of introducing the DBOR contract, it is 
instructive to review the relevant theoretical and empirical academic 
literature. In this way, one can see how prior introductions of 
derivatives contracts have affected the efficiency of an underlying 
``cash'' market (also referred to as a ``spot'' market). By doing so, 
one can gain greater confidence regarding how the introduction of the 
DBOR contract could affect the existing market for first-run movies.
    Although, strictly speaking, there is no cash, or spot, market for 
the secondary trading of movie tickets, there is clearly a large market 
for the primary sale of movie tickets by theater operators.\4\ That is, 
there is no active market for consumers to trade movie tickets amongst 
themselves in a secondary market but, as the table in the Appendix 2 
shows, there is a $10 billion annual market for the primary sale of 
movie tickets by theater operators. Thus, one can view this market as a 
primary ``spot'' market for movie tickets.
---------------------------------------------------------------------------
    \4\ A primary market is one where a security is sold for the first 
time such as the initial public offering (IPO) of common equity in a 
new company. A secondary market is one which trades securities that 
have been previously issued. In addition, a ``cash'' or ``spot'' market 
is one in which an investor can purchase or sell a security today (as 
opposed to sometime in the future, as in a futures market).
---------------------------------------------------------------------------
    Initial theoretical work on the impact of derivatives contracts on 
underlying cash/spot financial markets builds upon the seminal work by 
Kyle (1985). In Kyle's model, asymmetric information is present in the 
financial market, which meant that some traders have better information 
(i.e., they are ``informed'' traders) while others have less 
information (they are described as being either ``uninformed'' traders 
or serving as a single ``market maker'' in the financial asset).
    The above issue of asymmetric information is an important attribute 
of a real-world financial market because it is clear that some traders 
are more sophisticated and better-informed about the future value of a 
security (e.g., mutual fund or hedge fund managers) than other traders 
(e.g., small retail investors and market makers). Since informed 
traders, by definition, know more than the uninformed traders, the 
less-informed traders will typically lose, on average, when they trade 
with their better-informed counterparts. Since an uninformed trader 
such as a market maker knows this, this person will try to infer the 
presence of informed traders by carefully observing the flow of orders 
submitted to the financial market.
    Based on the Kyle model, the bottom line is that asymmetric 
information can lead traders to behave strategically and can ultimately 
affect the pricing of financial assets, as well as the trading volume 
and price volatility associated with these assets. In general, 
investors will typically pay less for an asset if it is traded in a 
market with high levels of asymmetric information and uninformed 
investors are also less likely to participate or trade in such a 
market. The practical implication of the model is that well-designed 
financial markets such as the Cantor Exchange's proposed DBOR market 
can reduce the problems associated with asymmetric information by 
promoting greater price transparency and increasing the public 
disclosure of information related to the financial asset. In turn, this 
can lead to greater liquidity, lower price volatility, and greater 
trading volume in both the futures and cash markets.
    Building upon Kyle (1985), research articles such as Grossman 
(1988), Detemple and Selden (1991), Subrahmanyam (1991), Jarrow (1994), 
Huang and Wang (1997), and Cao (1999), among others, examined how 
asymmetric information and traders' strategies are affected when a 
derivatives market is introduced for a corresponding spot market. In 
addition, without relying on an asymmetric information model, Silber 
(1985) shows that a futures market can potentially enhance the 
efficiency of a spot market by enabling market makers in the cash asset 
to hedge more effectively.
    By focusing on the hedging capabilities of a derivatives market, 
Grossman (1988) demonstrated that the introduction of a derivatives 
contract can help people aggregate all information related to 
investors' hedging strategies which can then reduce the level of 
asymmetric information in the overall market. In turn, this reduction 
in asymmetric information can reduce the price volatility of both the 
derivative contract and underlying cash asset.
    Detemple and Selden (1991) examine how the introduction of a call 
option market can increase the underlying price of the cash asset due 
to the simultaneous pricing of both the call option and this cash 
security. Cao (1999) examines the incentives to collect information on 
the underlying cash asset and finds that investors have greater 
motivation to gather this information and thus cash prices are higher 
and volatility is lower when a derivatives market exists. In general, 
all of these models suggest that the introduction of a derivatives 
market can be positive in terms of raising the value of the cash 
security and reducing price volatility. In addition, a side benefit of 
these two positive effects is that it encourages more investors to 
participate in these markets, thus making them more liquid and 
efficient. Thus, a ``virtuous'' cycle between the derivatives and cash 
markets can be created due to the above effects.
    In contrast to the above models, Subrahmanyam (1991), Jarrow 
(1994), and Huang and Wang (1997) cast a more ambiguous light on the 
effects of a derivatives market. For example, Subrahmanyam (1991) 
compares the introduction of a stock index futures market to the cash 
market for the securities that comprise this stock index. The author's 
focus is on where discretionary traders choose to trade. In the model, 
there are some traders who have discretion over where and when to trade 
and thus these individuals face a choice of whether to trade in the 
cash or derivatives markets.
    The model suggests there is a trade-off between trading in the 
index futures market where there is potentially less asymmetric 
information (because a stock index will diversify away some of this 
information-related risk) and the cash market where there might be 
greater liquidity (because larger, informed traders might prefer to 
trade in this market). Thus, the model shows that the effect on the 
underlying cash asset's price is ambiguous and is dependent on the 
discretionary traders' choices based on the above trade-off. For 
example, if the discretionary traders all send their orders to the 
derivatives market, the liquidity in the cash market might dry up and 
cause the cash price to fall and become more volatile. Conversely, if 
these traders choose to route their orders to the cash market, then 
cash prices will be higher and volatility lower. In this context, it is 
ultimately an empirical question as to which effect dominates.
    Huang and Wang (1997), using a different theoretical framework, 
come up with a similar conclusion in that the incentives to collect 
information are greater when a derivatives market is present but this 
positive effect is counter-balanced by the fact that increased levels 
of trading activity can result in noisier price signals in the cash 
market. Thus, once again, the question of which effect is predominant 
becomes an empirical one.
    Jarrow (1994) approaches the problem from a different perspective 
by examining an investor's incentives to manipulate prices when an 
options market is introduced for an underlying cash asset. The model 
demonstrates that investors might try to manipulate prices to take 
advantage of arbitrage opportunities between the cash and options 
markets. However, Jarrow (1994) also proves how this type of 
manipulation can be easily avoided by applying a properly specified 
variant of the conventional binomial option pricing model. Thus, by 
using the appropriate option pricing model, the author shows that the 
incentives to manipulate prices can be effectively eliminated.
    Summing up the theoretical literature, one can see that all of the 
models explain how the introduction of a derivatives market such as the 
DBOR futures contract can improve the welfare for society by providing 
more accurate price signals about the supply and demand for the 
underlying cash asset, as well as by reducing price volatility and 
increasing market liquidity. However, as noted above, some theoretical 
models indicate that there may be a trade-off between these benefits 
and other factors such as the decisions of discretionary traders and 
the level of trading activity in the underlying cash market. 
Accordingly, I now turn to a review of the relevant empirical 
literature to see which effects are dominant in real-world financial 
markets.

    Empirical Tests related to Derivatives Introductions

    Early empirical research related to the effects of derivatives 
contracts on cash financial markets typically focused on how the 
introduction of a futures contract on a stock index such as the S&P 500 
affected the price volatility of the underlying cash market for the 500 
stocks that were actively traded in secondary markets such as the New 
York Stock Exchange (NYSE) and NASDAQ. In general, this initial 
research showed that futures markets can increase trading activity but 
the effect on price volatility is somewhat muted except on the 
expiration day of the futures contract (and even then, the increase in 
volatility is short-lived, e.g., within one trading day). For example, 
Stoll and Whaley (1987, 1988), Edwards (1988), and Harris (1989) all 
study the S&P 500 futures contract and its impact on the cash market 
for the stocks that comprise this index.
    Edwards (1988) finds that stock price volatility has been lower 
since the introduction of stock index futures contracts while Harris 
(1989) observed no economically significant change in volatility. In 
contrast, Stoll and Whaley (1987) document that trading volume and 
price volatility can increase at the time of the futures contract's 
expiration but this effect is temporary and is actually less than the 
impact of a typical ``block trade'' in the underlying cash market.\5\ 
In a follow-up article, Stoll and Whaley (1988) summarize the important 
role that a financial market (in this context, a market for stock index 
futures) can play in terms of communicating relevant information to all 
members of society: ``Financial markets serve as the economy's 
messenger. . . . Index futures expand the number of routes through 
which messages can travel.''
---------------------------------------------------------------------------
    \5\ A ``block trade'' is typically defined as a trade of 10,000 
shares or more in a single stock.
---------------------------------------------------------------------------
    Overall, the early empirical evidence based on U.S. markets 
supports the notion that price volatility and trading volume in the 
underlying cash market can be affected but not in an economically 
significant way during normal market conditions. Thus, this initial 
strand of the literature suggested that, on average, the effect of 
introducing a futures market on stock prices was neutral in that it 
created neither unusually greater nor lower volatility.
    After the first wave of empirical studies during the mid to late 
1980s, more sophisticated empirical tests were performed during the 
1990s and the most recent decade. For example, Detemple and Jorion 
(1990) find significant positive support for Grossman's (1988) 
prediction that the introduction of options can increase underlying 
stock prices and reduce volatility. In contrast, tests of 
Subrahmanyam's model in Jegadeesh and Subrahmanyam (1993) show an 
economically insignificant increase in the average proportional bid-ask 
spread for a set of stocks that included the securities that comprise 
the S&P 500. The authors also report an insignificant increase in level 
of asymmetric information within the cash market. In general, these 
relatively insignificant results indicate that the S&P 500 futures 
market does not harm the cash market for S&P stocks and thus provides 
neutral, or mixed, evidence in support of the positive effects espoused 
by many of the theoretical models noted above.
    Easley, O'Hara, and Srinivas (1998) examine the market of stock 
options in the U.S. to determine the informativeness of this 
derivatives market vis-a-vis the underlying cash market for these 
stocks. Consistent with the theories that show a positive role for 
derivatives markets such as Grossman (1988), Detemple and Selden 
(1991), and Cao (1999), Easley et al. (1998) report that option trading 
volume can be a leading predictor of cash stock prices. The authors 
conclude that this result could be due to the possibility that informed 
traders prefer to trade in the options market and thus these option 
traders' actions help reveal useful information that can enhance stock 
prices in the cash market for all investors.
    Most notably, Hasbrouck (2003) studied the market for the S&P 500 
stock index by analyzing which of the following cash and derivatives 
markets contributed the most information to setting prices for the cash 
value of this index (i.e., floor-traded index futures contracts, 
exchange-traded funds (ETFs), electronically traded, small-denomination 
futures contracts (E-minis), and sector ETFs that sub-divide the index 
into sub-industry portfolios). The author finds that the S&P 500 index 
(as well as the Nasdaq-100 index) receives its most informative price 
signals from the E-mini futures market.
    The above empirical finding is another important example of the 
positive benefits associated with the introduction of a futures market 
that were predicted by the theoretical models of Grossman (1988), 
Detemple and Selden (1991), and Cao (1999). It is also particularly 
striking that the smaller E-mini futures market leads the way in terms 
of setting prices in the market because these contracts were 
specifically designed to attract smaller, retail investors who cannot 
generally afford the larger, more expensive floor-traded futures 
contract. Thus, the results are also consistent with Subrahmanyam's 
model because the evidence suggests the positive effects of trading 
with a futures contract outweigh the potentially greater liquidity in 
the cash market (and so even retail investors prefer the futures market 
over the cash market in this case). In turn, this suggests the positive 
effects of introducing a futures market dominate the potential negative 
factors of such a market.
    The results of Hasbrouck (2003) have also spawned somewhat of a 
global search to see if Hasbrouck's findings can be replicated in 
other, non-U.S. markets where futures contracts have been introduced. 
For example, Illueca and Lafuente (2008) applies Hasbrouck's approach 
to a foreign market which introduced a retail-oriented stock futures 
contract. Specifically, the authors examined the effect of introducing 
the Ibex 35 mini-futures contract in the Spanish stock market. By 
allowing retail investors to participate more actively in the futures 
market for this Spanish stock index, Illueca and Lafuente find prices 
in this new futures market are highly informative and underlying stock 
price volatility does not increase.
    Most importantly, the above results are not isolated to the U.S. 
and Spain. For example, additional results reported in recent research 
studies such as Bhaumik and Bose (2009), Drimbetas, Sariannidis, and 
Porfiris (2007), and Ozun and Erbaykal (2009), among others, show that 
derivatives trading can be beneficial to cash markets in many non-U.S. 
markets such as India, Greece, and Turkey. Thus, these additional 
results not only replicate Hasbrouck's earlier U.S. findings but also 
provide empirical evidence on a global scale in support of the positive 
theories of derivatives markets noted in the prior sub-section of this 
report.
    In sum, both finance theory and empirical tests of real-world 
derivatives markets demonstrate that the benefits of introducing a 
derivatives security such as the DBOR futures contract can have a 
positive impact on an economy by fostering greater information 
disclosure, lower volatility, and greater liquidity. All of these 
factors, in turn, can benefit society in general by allowing people to 
make more efficient financial and economic decisions.
V. Conclusion
    This report has shown how the introduction of a contract such as 
the proposed DBOR futures instrument and the associated Cantor Exchange 
might affect the market for first-run movies. Using the classic, 
fundamental criteria that describe what effective futures contracts and 
financial markets should possess, I find that the DBOR contract and 
Cantor Exchange meet these criteria and thus represent a valid vehicle 
to conduct futures trading in the area of first-run movies. In 
addition, the role of speculators within a futures market is clarified 
using the CFTC's own description of these market participants. Contrary 
to the belief of some, speculators are not ``gamblers'' and thus these 
investors provide a useful economic role in ensuring liquidity and 
greater price transparency in a futures market.
    This report also demonstrated how the introduction of a DBOR 
futures market can benefit not only the participants in such a market 
but also help other players in the movie industry such as consumers and 
the movie studios. The main benefits of introducing a DBOR futures 
market are:

    (1) Better risk management for investors and other participants in 
        the movie business,

    (2) Increased new investment in the movie industry from current 
        film investors,

    (3) Additional investment from new investors that are now attracted 
        to the film industry, and

    (4) Greater transparency which yields useful price signals for the 
        entire economy.

    Two potential costs of such a market related to the possibility of 
market manipulation and/or insider trading are also examined. However, 
the financial incentives of the Cantor Exchange and the clear mandate 
of the CFTC to ensure that futures markets are fair to all participants 
indicate that both of these organizations have the proper motivation to 
actively employ the relevant surveillance and enforcement systems in 
order to mitigate the possibility of market manipulation and/or insider 
trading.
    This report also reviewed the academic literature on this subject 
and I find that there is both strong financial theory and robust 
empirical evidence that support the notion that the benefits of 
introducing a futures market can outweigh the potential costs noted 
above. Empirical evidence over the past 2 decades not only in the U.S. 
but also more recent evidence from several countries around the world 
confirm the positive effects of introducing a futures market in terms 
of increasing price transparency, providing better risk management, 
reducing price volatility, and increasing the liquidity of financial 
markets.
References:
    Arrow, K. 1964. The role of securities in the optimal allocation of 
risk-bearing. Review of Economic Studies 31, 91-96.
    Bhaumik, S., and Bose, S. 2009. Impact of Derivatives Trading on 
Emerging Stock Markets: Some Evidence from India. Comparative Economic 
Studies 51(1), 118-137.
    Cao, H.H. 1999. The effect of derivative assets on information 
acquisition and price behavior in a rational expectations equilibrium. 
The Review of Financial Studies 12, (1); 131-163.
    Debreu, G. 1959. Theory of Value. New Haven, CT: Yale University 
Press.
    Detemple, J., and Jorion, P. 1990. Option listing and stock 
returns: An empirical analysis. Journal of Banking & Finance 14(4), 
781-801.
    Detemple, J. and Selden, L. 1991. A General Equilibrium Analysis of 
Option and Stock Market Interactions. International Economic Review 
32(2), 279-303.
    Drimbetas, E., Sariannidis, N., and N. Porfiris. 2007. The effect 
of derivatives trading on volatility of the underlying asset: evidence 
from the Greek stock market. Applied Financial Economics 17(2), 139-
157.
    Easley, D., O'Hara, M., and Srinivas, P.S. 1998. Option volume and 
stock prices: Evidence on where informed traders trade. The Journal of 
Finance 53 (2), 431-465.
    Edwards, F.R. 1988. Does futures trading increase stock market 
volatility? Financial Analysts Journal 44 (January-February), 63-69.
    Grossman, S.J. 1988. An analysis of the implications for stock and 
futures: price volatility of program trading and dynamic hedging 
strategies. Journal of Business 61, 275-298.
    Harris, L. 1989. S&P 500 cash stock price volatilities. Journal of 
Finance 44, 1155-75.
    Hasbrouck, J. 2003. Intraday price formation in U.S. equity index 
markets. The Journal of Finance 58(6), 2375-2399.
    Hayek, F.A. (1945) The use of knowledge in society. American 
Economic Review 35, 519-530.
    Huang, J. and Wang, J., 1997, Market structure, security prices, 
and informational efficiency, Macroeconomic Dynamics 1, 169-205.
    Illueca, M., and Lafuente, J.A. 2008. Introducing the mini-futures 
contract on Ibex 35: implications for price discovery and volatility 
transmission. Spanish Economic Review 10(3), 197-219.
    Jarrow, R.A. 1994. Derivative securities markets, market 
manipulation, and option pricing theory. Journal of Financial and 
Quantitative Analysis, 29(2), 241-261.
    Jegadeesh, N., and Subrahmanyam, A. 1991. Liquidity effects of the 
introduction of the S&P 500 index futures contract on the underlying 
stocks. Journal of Business 66, 171-182.
    Kyle, A.J. 1985. Continuous auctions and insider trading. 
Econometrica 53: 1315-1335.
    Ozun, A. and Erbaykal, E. 2009. Detecting risk transmission from 
futures to spot markets without data stationarity: Evidence from 
Turkey's markets. The Journal of Risk Finance 10(4), 365-376.
    Silber, W.L. 1985. The economic role of financial futures. In A.E. 
Peck (ed.), Futures Markets: Their Economic Role, 83-114. Washington, 
D.C.: American Enterprise for Public Policy Research.
    Stoll, H.R., and Whaley, R.E. 1987. Expiration day effects of index 
options and futures. Financial Analysts Journal 43 (March): 16-28.
    Stoll, H.R., and Whaley, R.E. 1988. Volatility and futures: Message 
versus messenger. Journal of Portfolio Management 14(2), 20-22.
    Subrahmanyam, A. 1991. A theory of trading in stock index futures. 
Review of Financial Studies 4(1), 17-51.
       appendix 1. excerpts from selected business media articles
Excerpt from Christian Science Monitor article on 3/29/10 (Gloria 
        Goodale and Dan B. Wood, ``Trading `movie futures' like pork 
        bellies? MPAA fights the idea.'')
    Speculation isn't inherently bad

    While the industry registers its protests, media and financial 
observers suggest that the issue is more complicated.
    ``The MPAA's concerns are a bit overblown--these claims against 
`evil' speculators [are] age-old and ring a bit hollow because [they] 
ignore potentially very useful price signals,'' says Michael S. Pagano, 
professor of finance at the Villanova University School of Business in 
Pennsylvania.
    ``Speculators are not, by definition, bad for society,'' he says. 
``In fact, they can be quite good by providing liquidity and price 
signals that would not exist if these players were not present in the 
market.''
Excerpt from Christian Science Monitor article on 4/9/10 (Dan B. Wood, 
        ``Big screen battle: Hollywood vs. box office speculators'')
    Legalized gambling?

    The Chicago-based firm, Veriana, carries on its website this 
rebuttal, written by the Futures Industry Association (FIA):

        ``The MPAA has asserted that futures trading is a form of 
        `legalized gambling' that has no commercial interest or value 
        to the public. Nothing could be further than the truth. Futures 
        markets have proven to be vitally important mechanisms for risk 
        management, as evidenced by the phenomenal growth in the use of 
        futures contracts by a wide range of commercial and industrial 
        enterprises, both here and abroad.''

    FIA also counters MPAA claims that these new contracts could lead 
to ``rampant speculation and financial irresponsibility. . . . It is 
clear that the MPAA is not familiar with the futures markets or the 
regulatory framework within which they operate.''
    Industry observers similarly line up on both sides of the issue. 
``I agree wholeheartedly with the MPAA and the movie industry who hold 
that this is pretty much a thin veil for basic gambling,'' says Chris 
Lanier, president of Motion Picture Intelligencer, a box office 
prediction firm. ``If you want to lose all your money that badly, why 
not just go to Las Vegas?'' And Douglas Gomery, a retired professor of 
the economics of cinema at Maryland University, has called the idea 
``gambling, pure and simple.''
    But Michael S. Pagano, professor of finance at the Villanova 
University School of Business, says there can be some legitimate 
reasons to have such an exchange.

    New investors, more capital

    ``In particular, the trading of these contracts gives useful 
information to all market participants about the demand, profitability, 
and growth potential of various types of movies, including the film 
studios,'' Pagano says. ``The exchanges can aid in the movie industry 
because film investors will now have a way to hedge their investments 
which, in the end, can attract new investors and generate more capital 
from existing investors.''
    He surmises other reasons for the vehement industry resistance.
    ``It could be that the film studios are concerned that they will 
lose their monopoly position on information about various movies 
because the futures exchange will publish information which all market 
participants can then observe and analyze,'' says Pagano. ``This is the 
type of information that is currently held privately by the film 
studios and thus they could be fearful of losing their informational 
edge to non-Hollywood players.''
    As debate continues to heat up prior to the CFTC's decision, Pagano 
says one concern of the film studios that is correct pertains to market 
manipulation.
    ``It is crucial that the exchange operator . . . create a set of 
trading rules and monitoring systems to ensure the market is a level 
playing field for all participants,'' he says. ``Because if it is 
perceived to be a rigged market, then retail investors and possibly 
other market participants can be taken advantage of and this could also 
be disruptive to the film studios' operations.''
  appendix 2. historical data on movie ticket sales and revenue (1995-
                                 2010)
Annual Ticket Sales



        Note 2: in order to provide a fair comparison between movies 
        released in different years, all rankings are based on ticket 
        sales, which are calculated using average ticket prices 
        announced by the MPAA in their annual state of the industry 
        report.

        Data source is the movie industry data website: www.the-
        numbers.com/market
                                 ______
                                 
  Submitted Letter by Charles R. Plott, Professor of Economics and The
    Edward S. Harkness Professor of Economics and Political Science,
Division of the Humanities and Social Sciences, California Institute of 
                               Technology
April 29, 2010

Hon. Collin C. Peterson,
Chairman;

Hon. Frank D. Lucas,
Ranking Minority Member,

Committee on Agriculture,
House of Representatives,
Washington, D.C.

Re: April 22, 2010 Committee Hearing on Application of Cantor Futures 
Exchange, L.P.

    Dear Chairman Peterson and Ranking Member Lucas:

    I am a Professor of Economics at the California Institute of 
Technology. I have published extensively (over one hundred and fifty 
scientific papers) in the areas of market organization, risk, finance 
and information. I am a member of the National Academy of Science, 
American Academy of Science, and I am the recipient of numerous awards.
    The Commodity Exchange Act recognizes that futures contracts serve 
the national public interest because the contracts are used for hedging 
and price discovery. From their earliest days, futures contracts have 
been used by farmers to help finance their purchase of seed and to 
facilitate their sale of crops. Futures contracts allowed farmers to 
lock-in all or a portion of their grain price to assure their bank that 
they can repay their loans and lock-in a profit regardless of the price 
of grain at the time of its sale. Over the decades, use of futures 
contracts have provided similar benefits for other physical commodity 
players, banks and others exposed to interest rate and currency 
fluctuations, investors concerned about stock prices and others 
interested in hedging exposures.
    The benefit of any futures market is derived from risk sharing and 
the associated pricing of risk. The basic principle applies to films 
for the same reasons that it applies to any other futures market. Just 
as producers of grains base hedging on the resulting size of a crop, 
the investors and producers of films can base hedging off the size of 
the box office of a film. Through a focus on this key event the market 
is designed to accommodate the uncertainty that accompanies production 
efforts. It allows the sharing of risk and rewards and removes the full 
burden of risk from the producer while facilitating the removal of risk 
from commerce and contracts related to the production of films. The key 
to the success is the identification of the risky event, which allows 
the building of risk sharing contracts conditional on the event. In the 
case of the movie industry, there seems to be little doubt that a major 
source of risk is the box office earnings of a film.
    To date, the benefits of hedging and price discovery have not been 
available to the entertainment industry. The Cantor Futures Exchange's 
offering of Domestic Box Office Receipt futures will allow studios and 
others exposed to movie performance risk to hedge a portion of that 
risk. Just as agricultural futures have helped farmers, DBOR futures 
will allow studios to obtain financing on favorable terms and develop 
new sources of capital. DBOR futures also will allow professional and 
retail customers to take a position on the success of individual movies 
thereby providing an important source of price discovery and liquidity 
for the movie industry.
    Consistent with the fundamental purposes of any futures market, the 
Cantor Futures Exchange, by facilitating hedging and risk shifting, 
will provide a new means of connecting the suppliers of capital and the 
demanders of capital. This provides studios and financial investors in 
film with more funding and less risky opportunities for producing 
films. The economic function of the Cantor Futures Exchange is to 
channel capital into productive use from the hands of those who own 
capital into the hands of those that can productively use the capital. 
The Exchange does this by crafting instruments that allow hedging and 
the removal of individual risk. In addition, the Exchange will create 
instruments that aggregate information, making success or failure more 
predictable and in doing so will remove risk from the system and 
encourage greater investments. The DBOR contract is an important part 
of this effort.
Existing Barriers to Efficient Capital Flows
    Today there is an obvious absence of a broad-based capital flow 
into the entertainment field. Many barriers exist. Currently, the only 
ways through which an investor can participate in the profit potential 
of individual films are (i) invest in a studio, which is actually a 
portfolio of films and other assets or (ii) participate as a partner/
owner of a film with a studio. Alternative (i) does not permit the 
investor to specialize investment strategies to the particular films 
about which the investor might have some information or opinions. The 
investor's funds are applied to the priorities as seen by the studio. 
Alternative (ii) involves many risks. First, the risks are large and 
concentrated. Each film is an expensive undertaking about which the 
uncertainty is great. The film requires a large investment while at the 
same time there is poor information about likely success. Such risks 
loom large for the studios, much less the individual investor, who 
faces even greater uncertainty due to an inherent moral hazard. 
Ownership is in terms of shares of profits but the individual investor 
might have little control over or information about costs. Contract 
monitoring and enforcement are expensive and requires specialized 
expertise, skills, and experiences.
Improving Economic Efficiency: The Cantor Futures Exchange
    Through a combination of new organizational relationships, 
specially crafted financial instruments and the establishment of an 
efficient system for exchange, the Cantor Futures Exchange serves to 
remove the major barriers to economical capital flows to the 
entertainment industry.
    One barrier has been the absence of easily verifiable measures on 
which returns to capital can be based. Profits would be the natural 
measure except costs are difficult to measure, verify and attribute to 
interrelated business activities. The Cantor Futures Exchange solves 
that problem through a focus on domestic box office receipts.

   Box office receipts are a verifiable, quantitative measure 
        of success.

    By developing a measure of success of a movie and by crafting 
special financial instruments based on that measure, the success can be 
decomposed into smaller measures and distributed among more 
participants. Instruments that are based on a proportion of box office 
receipts can be sold in smaller lots and thus provide access to broader 
participation. As a result, the risk can become more diffused and 
spread across a larger number of entities.

   The Cantor Futures Exchange DBOR futures contracts 
        facilitate both diffusion and a broader sharing of risk, 
        thereby increasing the economic attractiveness of movie 
        investments.

    Bringing together the suppliers of capital and demanders of capital 
is no simple task. Economic issues exist between the studios and the 
investing public and economic issues also exist among members of the 
investing public. After the capital has been transferred to the 
studios, following the initial investments, various members of the 
investing public using DBOR futures contracts will now have an 
opportunity to lay off some of that risk in an efficient marketplace.

   The Cantor Futures Exchange will increase market efficiency 
        by supporting the portfolio adjustment needs of asset holders 
        such as:

                (i) pricing and price discovery;

                (ii) clearance and settlement--trades made by trusted 
                parties (institutional and individual customers); and

                (iii) new physical environments to conveniently bring 
                investors and speculators together.

    A major function of markets is the reduction of risk through the 
aggregation of information and beliefs. Markets are known to have the 
capacity to aggregate and merge the different opinions and information 
that is dispersed across the experiences of many people. Prices in a 
properly functioning market can more efficiently reach balanced levels 
through the improved flow of information. The futures market will 
provide indices that help investors become aware of events that are 
known to others and thus help investors avoid the unexpected. This 
improved flow of information will be of use to both the studios and the 
investing public.

   The Cantor Futures Exchange DBOR futures market will improve 
        market efficiency by improving the information and thereby 
        reducing uncertainty.

    The introduction of DBOR futures serves several functions. First, 
such contracts allow appropriate hedging by the individual investors, 
thereby allowing them to achieve the efficiency advantage of a 
portfolio. Second, DBOR futures carry information about both future 
events and the likely movement of spot prices. Both are central to 
uncertainty reduction.
    Market risks are not the only risks that investors face. Today's 
investors have become very sensitive to corporate misbehavior. The 
perceived risk dampens appetites for new investments and inhibits the 
flow of capital to the producers of assets.

   The Cantor Futures Exchange DBOR futures contracts 
        inherently protect the participating public's interests.

                (i) Information about box office receipts is reported 
                independently of those who have raised the revenue (the 
                studios). Thus, the system does not depend upon the 
                good faith of the studios who would otherwise have a 
                potential conflict of interest;

                (ii) Contracts are structured such that potential 
                conflicts of interest between the studio and 
                participants are removed; and

                (iii) The exchange prohibits participation by certain 
                insiders holding material non-public information.

    Cantor has a clear interest in supporting a successful market. 
Misbehavior by studios will be detrimental to Cantor's interest. To 
protect that interest, Cantor has employed the skills and procedures 
developed through decades of successful operations in asset markets.
    The proposed market is structured to be efficient. Cantor has the 
capacity to support hundreds of different contracts trading at the top 
velocities experienced by markets throughout the world. Price movements 
are efficient and natural. The mechanism proposed for the initial sale 
of futures, the one price auction, is known to be the most efficient of 
the call auction forms.

   The market architectures of the Cantor Futures Exchanges are 
        the most efficient known. The Exchange will operate in a manner 
        that is fair to all participants and efficient.

    In summary, the Cantor Futures Exchange's offering of DBOR futures 
is based on the traditional goals of any futures exchange: hedging and 
price basing. The Exchange will allow a broad range of investors and 
others with interests in movie performance to manage their risk. By 
permitting these hedging opportunities, DBOR futures will facilitate 
the efficient flow of capital from investors interested in a movie's 
success to studios interested in raising low cost capital and reducing 
their exposure to a movie's performance. At the same time, speculators 
and others with an opinion on a film's box office receipts will be able 
to purchase or sell DBOR futures, allowing the market to be an 
efficient location for price discovery. In these important respects, 
DBOR futures will serve a valuable economic purpose for the 
entertainment industry.
            Sincerely,
            
            
             The Edward S. Harkness Professor of Economics and 
                                 Political Science.
                                 ______
                                 
Submitted Letter by Ann Rutledge, M.B.A., Adjunct Associate Professor, 
 Department of Finance, Hong Kong University of Science and Technology
New York, April 30, 2010
 Hon. Collin C. Peterson,             Hon. Frank. D. Lucas,
Chairman,                            Ranking Minority Member,
Committee on Agriculture,            Committee on Agriculture,
House of Representatives,            House of Representatives
Washington, D.C.;                    Washington, D.C.

Re: April 22, 2010 Committee Hearing on the Cantor Futures Exchange, 
L.P.

    Dear Chairman Peterson and Ranking Member Lucas:

    My name is Ann Rutledge, and this is an unsolicited letter of 
support for the Cantor Fitzgerald Cantor Futures Exchange. I am an 
adjunct assistant professor in the Hong Kong University of Science and 
Technology department of finance.
    With Sylvain Raynes, I co-authored two books on the structured 
finance market, The Analysis of Structured Securities: Precise Risk 
Measurement and Capital Allocation (2003) and Elements of Structured 
Finance (2010), both published by Oxford University Press. I am also 
the co-founder of R&R Consulting, an early critic of structured finance 
ratings and highly regarded credit risk measurement service provider.
    In the last 15 years, my professional focused has been structured 
finance and asset securitization, but in the early 1990s I headed J.P. 
Morgan's Asian prime brokerage business and consulted to the Hong Kong 
Futures Exchange (now part of HKEX, on clearinghouse reform, new 
listings, including the successful Hang Seng Option, plus some failed 
contracts) and managing external relations with Chinese reformers 
studying the role of exchanges in improving the circulation of 
information and goods through the Chinese economy.
    Most of the arguments I have read for and against DBOR are standard 
arguments about the risks and benefits of futures exchanges or new 
contract markets, generally. They do not specifically address the risks 
and benefits of film futures. Certainly such arguments are still 
relevant to the case of DBOR because all futures markets have certain 
attributes in common, namely--

   They allow the commercial producer or processor to manage 
        the risk of its business flows by hedging (taking the opposite 
        side of their natural position);

   They have the backing of a clearinghouse to manage price 
        volatility and counterparty risk;

   They have a central administration to design the contract 
        market and make the rules and regulations for membership, 
        trading, reporting, disciplinary action and other key 
        functions, which they enforce.

    It may be difficult for the layman to understand how these points 
relate to film production, which, at first blush, seems to have nothing 
in common with agriculture or finance. Film studios, like any other 
commercial institution, must sell what they produce at a profit. 
Although they have managed to convince the public that film economics 
cannot be rationalized, studios nevertheless manage to run profitable 
businesses.
    In the lingo of futures, a film studio that makes films is a 
natural ``long.'' The existence of a futures market in films gives 
studios an ability to sell contracts on unmade films at an internal 
target to hedge their price risk. A distributor of these films, or 
rights to them, is a natural ``short.'' Distributors can lock into 
profits by taking the other side of the trade, i.e., selling contracts 
on the unmade films. If the long and short interest is in balance, 
liquid interest will develop around the futures contract, which will 
encourage further buying and selling by smaller, speculative 
institutions that give the contract market liquidity. This enables the 
commercials to rebalance their positions flexibly as they require. The 
availability of a symmetrical risk management tool is expected to have 
a salutary effect on the film industry generally as it shifts the focus 
of film studios and distributors from extracting surpluses from each 
other to monetizing the films they make and distributing them at fair 
value.
    From the foregoing explanation, it should be easy to understand why 
commercial producers are almost always the slowest to accept a futures 
market. They have a powerful information edge over the rest of the 
market, and they believe they lose far more by opening up their price 
advantage to competitive bidding than they gain from access to a risk 
transfer mechanism. This is how banks originally viewed financial 
futures, and film studios are no different. It is as natural for them 
to resist the establishment of film futures in the 2000s as it was for 
banks in the 1970s to reject financial futures, even though they later 
adopted financial futures wholesale. The adverse response of the 
studios is not simply a maneuver to hide the industry's accounting 
games, as Dr. Chance suggests in his testimony, though that may be part 
of the motivation as well.
    The second and third bullets above are further reasons to consider 
the timeliness and advisability of creating a film futures market. As 
Dr. Chance mentions, the studios have dabbled in the nascent OTC 
securitization market for film since 1996, when the credit rating 
agencies began rating royalty receivable backed transactions. (Sylvain 
Raynes developed the method for Moody's.) In this decade, some studios 
used the film slate deal format to lay off the risk of failed films on 
to unsuspecting investors at a price that did not reflect intrinsic 
value.
    As we are learning from the Subprime Crisis, the OTC market format 
lacks key controls of a formal exchange. Credit rating agencies fulfill 
some of the roles of the administrator in the OTC market, but they do 
not ensure continuous price (rating) feeds or clearinghouse protection 
from the impact of counterparty defaults. Given that the studios are 
already using financial engineering to redistribute the risks of the 
films they make, bringing this activity into an organized exchange 
offers investors better protection and may to some extent curb the 
production of bad movies that get made because they can be fraudulently 
off-loaded.
    Many people doubt that the studios could actually engage in adverse 
selection because they do not believe film revenue cannot be estimated 
reliably. R&R disagrees. We have devoted considerable internal 
resources to developing a predictive algorithm for the revenues of 
independent film in the $7-$20 MM category at script stage (i.e., 
before the first box office weekend), and the revenue estimates from it 
achieve an R2 of over 90% when compared to a database of 
over 500 films. While these results do not provide an open-and-shut 
case for revenue certainty, they do provide evidence that revenue 
benchmarking is possible in the indie category, and that trading in an 
exchange venue could be quite robust because the variance could be 
small enough to attract a tradable bid-asked spread.
    Finally, Dr. Chance is right to observe that the DBOR market may 
fail on its own, even if Congress approves it. Then, no one will be the 
worse off, because very little trade will have taken place and the risk 
exposures will be de minimus. On the other hand, if DBOR is a good idea 
but the industry needs time to come around to it, we may be worse off 
if Congress votes it down. It is not common knowledge that the Chicago 
Mercantile Exchange's wildly successful Eurodollar market, built in the 
1970s, stumbled for a decade until banking system and capital reforms 
in the 1980s gave U.S. banks a motivation to join. Yet the Eurodollar 
market laid the foundation for swaps and other engineered products that 
put the U.S. financial system in the driver's seat of change and 
progress. It is easy to overstate the unintended negative consequences 
of change, but the unintended negative consequences of delaying 
inevitable change may be much more costly.
            Sincerely,
            
            
                                 ______
                                 
                          Submitted Questions
Questions Submitted by Hon. Leonard L. Boswell, a Representative in 
        Congress from Iowa
Dan M. Berkovitz, General Counsel, Commodity Futures Trading Commission
    Question 1. You acknowledge that the Commission has recognized that 
media contracts may require special review to ensure that the contracts 
are consistent. Why is that?
    Answer. Staff reviewed the contracts to determine whether the 
contracts satisfied (are consistent with) core principles applicable to 
contracts--primarily Core Principle 3 (Contracts Not Readily Subject To 
Manipulation) and Core Principle 5 (Position Limitations Or 
Accountability). Staff gave heightened review to the motion picture 
revenue contracts under these core principles due to the unique and 
novel nature of the contracts. Staff determined that the terms and 
conditions of the motion picture revenue contracts from both Exchanges 
appeared to meet the standards for cash-settled contracts.

    Question 2. What is the price discovery function or aspect to these 
markets?
    Answer. The futures contract provides a market-determined estimate 
of the motion picture revenues over the defined revenue periods. 
Assuming that the proposed contracts develop a reasonable amount of 
trading volume, the futures contracts could provide a price discovery 
mechanism where there currently is no such mechanism.

    Question 3. Please provide your views on proposed Senate language 
that would ban movie futures contracts by amending the Commodity 
Exchange Act to read that no exchange be allowed to offer contracts 
based on ``motion picture box office receipts (or any index, measure, 
value, or data related to such receipts).''
    Answer. Congress excluded motion picture box office receipts 
related contracts from the definition of commodity in the Dodd-Frank 
Wall Street Reform and Consumer Protection Act enacted on July 21, 
2010. The Commission, of course, will enforce that law.
Response from Robert S. Swagger, Chairman and CEO, Media Derivatives, 
        Inc.
    Question 1. You cite an existing opaque over-the-counter market for 
trading of motion picture products. Could you elaborate on this? Who 
engages in it? How large is it?
    Answer. The Trend Exchange, Inc., also known as Media Derivatives, 
Inc. (``MDEX''), appreciates the opportunity to respond to the two 
questions raised by Chairman Boswell.
    As we testified at the hearing, MDEX is not seeking to establish a 
market for the trading of motion picture products in an opaque over-
the-counter (``OTC'') market. Based upon conversations with 
entertainment industry participants, we understand that a fragmented 
private financing market already exists. In this market, participants 
attempt to manage risk using various techniques, including the 
equivalent of collateralized loan obligations (``CLO'') and OTC 
options. Given the opacity of the OTC market, we are not aware of the 
size of this market.
    We understand that approximately $20 billion of production capital 
is expended annually on the creation of motion pictures in the United 
States. Approximately $15 billion of this amount is raised from studios 
using their balance sheets, often through partnerships with large 
private equity investors or syndicates of equity investors. The 
remainder is raised through a combination of single picture financing 
and so-called ``slate financing'' that does not involve major studios, 
but includes private investors and financial institutions. A 
significant portion of this financing is raised outside of the United 
States and is inclusive of tax benefit driven structures.
    The process of raising slate financing is similar to that of a CLO, 
which some characterize as a form of OTC derivative. CLOs are 
originated by investment banks and investors in tiered investment 
structures comprising of senior debt, mezzanine debt and equity debt. 
There is a very limited secondary market for these interests that are 
traded from time to time between this small group of participants. All 
of this financing--which is significant by any measure--occurs solely 
outside of the public view and subject to no Congressional or agency 
oversight. MDEX simply seeks to bring the demonstrable benefits of 
futures contracts--such as pricing transparency, liquidity and 
centralized clearing in a regulated environment--to the highly 
uncertain and variable outcome of movie box office revenues.
    Moreover, as of this writing, a form of unregulated offshore 
trading in movie box office futures occurs in foreign markets. Most 
notably, on Intrade, a market based in Ireland, you can place trades on 
the opening weekend box office results of major U.S. motion pictures. 
The Intrade market is open to the public, including U.S. citizens which 
trade in the market, is unregulated and relies upon leverage. We 
believe that an unintended consequence of the box office ban will be to 
push U.S. movie production and financing market participants to 
offshore potentially retail, leveraged markets that are subject to no 
oversight by the CFTC or Congress.
    Rather than push market participants offshore, MDEX seeks to list 
and clear contracts in a fully regulated and transparent fashion, 
subject to comprehensive CFTC oversight and sound risk management 
principles.

    Question 2. Please provide your views on proposed Senate language 
that would ban movie futures contracts by amending the Commodity 
Exchange Act to read that no exchange be allowed to offer contracts 
based on ``motion picture box office receipts (or any index, measure, 
value, or data related to such receipts).''
    Answer. We strongly oppose the language in the Senate bill that 
would ban futures contracts based upon movie box office receipts (the 
``box office ban''). The box office ban is both unnecessary and 
unprecedented since the creation of the Commodity Futures Trading 
Commission (``CFTC'') in 1974. On a sole occasion in 1958--prior to the 
creation of the CFTC--Congress banned the listing of futures contracts 
on onions.
    Rather, we believe that the CFTC is the proper forum for resolving 
the review and analysis of the product, and Congress should reject any 
attempt to subvert the regulatory process. The CFTC has the expertise 
and resources necessary to conduct market surveillance with respect to 
the commodity upon which MDEX seeks to list futures contracts, and the 
CFTC has demonstrated its expertise during periods of extreme market 
stress, such as during 2007-2009.
    As you may know, the movie box office ban in the Lincoln-Dodd 
compromise amendment to S. 3217 was added to the bill with no notice, 
knowledge or discussion with our exchange or many others in the futures 
community. While MDEX has sought strictly to adhere to the requirements 
of the Commodity Exchange Act (``CEA''), our transparent and open 
efforts have unfortunately been met with an attempted subversion of a 
well-established, Congressional mandated regulatory process.
    We understand that the box office ban is based partly upon the 
misplaced notion that such futures contracts may damage the 
entertainment industry and amount to ``illegal gambling.'' This notion 
is without demonstrable support. As we testified, over the past several 
decades, numerous industries have made the same claim with respect to 
futures contracts only to find that such products ultimately provide a 
critical risk management tool, which include the U.S. Government and 
the listing of Treasury futures; the housing industry and the listing 
of housing futures; the insurance industry and the listing of weather 
futures; the aluminum industry and the listing of aluminum futures; and 
the agricultural industry and the listing of various agricultural 
futures.
    In fact, derivatives are widely used today in virtually all 
industries to manage risk. According to Professor Rene Stulz, 29 of the 
30 companies that comprise the Dow Jones Industrial Average--i.e., 
America's ``blue chip'' companies--use derivatives.\1\ Further, in 
2009, ISDA conducted a survey on the use of derivatives by Fortune 
Global 500 companies and found that 94 percent of these companies use 
derivatives to manage business and macroeconomic risks.\2\ We believe 
that the notion that regulated futures contract tarnishes an industry 
and is tantamount to ``legalized gambling'' is patently outdated and 
uninformed.
---------------------------------------------------------------------------
    \1\ Rene M. Stulz, In Defense of Derivatives, Wall Street Journal, 
April 6, 2009, at A15.
    \2\ ISDA Research Notes, No. 2 (2009), at 1.
---------------------------------------------------------------------------
    Further, we oppose the box office ban because we believe that the 
development of movie box office futures and related risk management 
products is consistent with a major thrust of Congressional legislative 
history which seeks to promote, among other things, innovation with 
respect to risk management tools such as futures contracts. To the 
extent that Congress permits the movie box office ban to remain in the 
Senate bill, it would severely discourage the development and 
investment in innovative risk management tools while telegraphing that 
an industry may on a piecemeal basis attempt to subvert the CFTC's 
regulatory process.
    Finally, we believe that a box office ban would continue to push 
U.S. investors to foreign leveraged markets that are not subject to any 
oversight by the CFTC or Congress. As we testified, unregulated foreign 
markets trade products based upon movie box office revenues and related 
measures. This market is open to the public, unregulated and employs 
leverage.
    Rather than push market participants offshore, MDEX seeks to list 
and clear contracts in a fully regulated and transparent fashion, 
subject to comprehensive CFTC oversight and sound risk management 
principles.
    We thank you for the opportunity to respond to these questions.
Response from A. Robert Pisano, President and Interim CEO, Motion 
        Picture Association of America, Inc.
    Question 1. You have indicated that your members would not use 
these exchanges to hedge and that one of the characteristics of 
legitimate commodity futures contracts is that they are designed to 
serve the interests of the industries that use the underlying 
commodities by providing a means for price discovery and hedging. If 
investors in your studios or other entities in the film industry were 
to indicate that they would use the product to hedge their financial 
risk, would that change the association's position even if your studios 
themselves would not participate?
    Answer. We do not believe that the proposed contracts can be used 
as hedging vehicles. If someone tries to do so, we believe that they 
will not find the contracts to be useful hedges. In any event, the MPAA 
would remain opposed to the contracts for the reasons stated in my 
testimony.

    Question 2. How do you respond to concerns that if these exchanges 
are not approved and regulated in the United States, they will simply 
be used offshore and without the regulatory mechanisms we currently 
have in place?
    Answer. The Commodity Exchange Act has permitted trading in over-
the-counter swaps among sophisticated ``eligible contract 
participants'' for the past ten years. No over-the-counter swap market 
in anything like the MDEX or Cantor contracts has developed. There is 
no reason to believe one would now. Underscoring our views is the fact 
that these contracts are gaming contracts that are prohibited by the 
Wire Act from being bought and sold over-the-counter. That is why the 
Hollywood Stock Exchange allows only make believe betting on such 
contracts now--no money changes hands. We are not aware of any 
proposals before foreign futures regulators to trade futures in motion 
picture box office receipts. We would oppose any such proposals as 
vigorously as we oppose the current proposals in the U.S. We believe 
that prohibiting such contracts in the U.S. will send a clear and 
strong message around the world that such contracts should not be 
permitted.

    Question 3. Please provide your views on proposed Senate language 
that would ban movie futures contracts by amending the Commodity 
Exchange Act to read that no exchange be allowed to offer contracts 
based on ``motion picture box office receipts (or any index, measure, 
value, or data related to such receipts).''
    Answer. We fully support that language and the ban. Motion picture 
box office receipts are not a commodity. There is no cash market for 
them; they are not bought and sold. Nor do they provide a valuation of 
any cash commodity. Industry contracts that are tied to box office 
receipts are governed by actual receipts, not Rentrak numbers or studio 
estimates. The contracts do not provide a price discovery function and 
they are not useful for hedging. Accordingly, it is not appropriate 
that they be within the definition of commodity.
Response from Scott Harbinson, International Representative, 
        International Alliance of Theatrical and Stage Employees; on 
        behalf of Directors Guild of America
    Question 1. You have pointed out the effect that negative box 
office predictions could have on residuals, which have a direct 
financial impact on your members. However, Facebook and Twitter have 
already revolutionized the way people communicate about movies, notably 
by spreading bad reviews more quickly further damaging a movie that 
might have made some minimum amount on opening weekend or opening 
night. Have you seen an impact from this information exchange on box 
office revenues, and therefore, your members' residuals?
    Answer. Social media is simply a broader extension of film reviews 
by newspapers, blogs and entertainment shows. Twitter and Facebook are 
relatively new outlets and we are not in a position to measure their 
ultimate impact, if any, on residuals payments to our members, 
especially given the lag time between the theatrical release of a movie 
and when residuals are generated from downstream revenues. 
Additionally, demonstrating such cause and effect specifically 
attributed to such social media is difficult given all of the other 
variables involved in determining box office receipts.
    Comparing the impact of new social media participation to the 
potential impact that movie futures contracts could have on the film 
industry is not an apt comparison. Participation in social media today 
(i.e., ``tweeting'' opinions about a particular film) is not motivated 
by an underlying financial interest to disseminate negative information 
to make money by ``shorting'' that particular movie's future contract.
    We are aware of a recent study conducted by two researchers at HP 
Labs that analyzed millions of ``tweets'' on movies over a three month 
period. That study included two preliminary findings:

    1. The volume of tweets (no matter if positive or negative) 
        correlated to the box office success for the opening weekend, 
        and

    2. The ratio of positive to negative tweets, combined with the 
        volume of tweets, correlated to box office success in the 
        following weekend (i.e., if more positive than negative the 
        better the results).

    Thus, we would be most concerned about potential manipulation of 
social media outlets and the adverse impact that could have on box 
office receipts if movie futures contracts are approved.

    Question 2. You have indicated that if the CFTC does not have the 
authority to reject these applications, then Congress should act. Would 
you support acting even if that means that these exchanges still occur, 
but on foreign, unregulated markets?
    Answer. Yes, we would support Congress acting to prevent such 
commodities exchanges from being created. Currently such trading with 
``play money'' (Hollywood Stock Exchange) or on foreign owned websites 
(Intrade, which is based in Ireland) does not have the same potential 
to harm the industry on the scale a U.S. Government-sanctioned trading 
platform would create. Because of the scope, number of films released, 
financial investments and other defining features of the American film 
industry, these newly proposed exchanges could have far greater 
detrimental impact on a film's success. While there other nations 
allowing on-line gambling, that does not seem a justifiable reason for 
it to be approved in the United States.

    Question 3. Please provide your views on proposed Senate language 
that would ban movie futures contracts by amending the Commodity 
Exchange Act to read that no exchange be allowed to offer contracts 
based on ``motion picture box office receipts (or any index, measure, 
value, or data related to such receipts).''
    Answer. We believe such a blanket exemption is necessary. We also 
believe it is narrowly crafted to make clear the Congressional intent 
that while derivatives futures trading in box office receipts or 
related data would be prohibited, the language would not hinder the 
creation of other types of legitimate derivatives in the future.
Response from Schuyler M. Moore, Adjunct Professor, UCLA School of Law; 
        Adjunct Professor, UCLA Anderson School of Management; Partner, 
        Stroock & Stroock & Lavan LLP
    Question 1. You have indicated that the exchanges will enhance 
transparency. However, with one exchange beginning sales 6 months from 
a movie's release and the other proposing to begin sales just 4 weeks 
from a movie's release, that doesn't seem like a lot of time to shed 
light on the market. Is that sufficient to add more transparency to 
this industry or would longer timeframes have added value?
    Answer. The value of transparency is having the value of a film 
investment be directly based on the film's box office results, since 
that alone eliminates all the lunacy of normal Hollywood accounting. 
Thus, it really doesn't matter how much earlier than release the 
exchange starts; what matters (for transparency) is that the investors 
will get paid based on box office results.

    Question 2. Please provide your views on proposed Senate language 
that would ban movie futures contracts by amending the Commodity 
Exchange Act to read that no exchange be allowed to offer contracts 
based on ``motion picture box office receipts (or any index, measure, 
value, or data related to such receipts).''
    Answer. This language was added at the request of the MPAA for the 
reasons I mentioned at the hearing: (a) fear of anything new and (b) 
fear that the public won't go to a film that is tracking badly on the 
exchange. I think these fears are misguided (for the reasons I stated 
at the hearing), and I am hoping for the sake of the industry--
including the studios--that this language gets deleted from the bill. 
The odd part of the MPAA knee-jerk objection is that the box office 
exchange concept will bring badly needed capital to the studios.
    I sincerely thank Chairman Boswell for taking the time to study 
this issue.

Schuyler M. Moore.
Response from Richard Jaycobs, President, Cantor Futures Exchange, L.P.
    Question 1. You mention that settlement of the contract is based on 
the box office receipts as reported by the distributor of the film and 
captured by Rentrak. Aren't there incentives for the distributors of a 
film to report inaccurate figures or to inflate figures?
    Answer. It is generally true that studios have an incentive to 
report inaccurate or inflated box office figures. However, Cantor 
Exchange will compare the studio released numbers to Rentrak's 
electronically tabulated numbers on a weekly basis in order to identify 
any situation where the studio numbers appear to be inaccurate. In the 
event the Exchange detects a material difference between a 
distributor's reported number and the electronic tabulation, the 
exchange Compliance Department will conduct an investigation together 
with the National Futures Association and, if necessary, the CFTC to 
determine if any manipulation had, in fact, occurred. In addition, if 
the studio released numbers were found to be inaccurate or inflated, 
Cantor would modify its contract specification to settle its DBOR 
contract to Rentrak's electronically captured number.

    Question 2. In your testimony, you mention seeking input of a wide 
range of individuals and entities throughout the motion picture 
industry while you were structuring your business model. What kind of 
feedback did you receive? What were the most common concerns voiced by 
the industry insiders? Did you receive any indication before the MPAA 
letter that those in the film industry were opposed to the markets?
    Answer. Cantor openly and widely discussed its box office contract 
over a period of almost 2 years to a broad range of motion picture 
industry participants. During this process, Cantor learned of potential 
concerns, but there was no indication before the MPAA letter that it 
would oppose the contract market or attempt to make it illegal through 
legislation.
    There were three concerns identified by the industry during the 
process of developing the market: (1) would the market have sufficient 
size and depth to be useful as a hedging tool; (2) would studios be 
viewed negatively or suffer legal consequences if investors lost money 
to studios who chose to `short movies'; and (3) would studios suffer 
legal consequences because of their unique position as distributors of 
film?
    Our response to these concerns was generally (1) while there can be 
no assurance of liquidity in launching a new market, based on Cantor 
Fitzgerald's long record of enhancing market efficiency, the company 
would make every attempt to facilitate an effective hedging platform; 
(2) that the motion picture industry had a long history of benefiting 
from the sale of interests in film titles to outside investors; and (3) 
that the exchange rules would be crafted to provide sufficient safe 
harbors for industry participation.

    Question 3. Please provide your views on proposed Senate language 
that would ban movie futures contracts by amending the Commodity 
Exchange Act to read that no exchange be allowed to offer contracts 
based on ``motion picture box office receipts (or any index, measure, 
value, or data related to such receipts).''
    Answer. Cantor opposes a legislative ban on futures contracts based 
on motion picture box office receipts for the following reasons:

  --Under the current law, the CFTC has sufficient legal authority to 
        determine whether a public market in box office contracts 
        serves the public interest;

  --The proposed ban would set a unique precedent of Congressional 
        intervention in determining the appropriateness of a market 
        before the regulatory process has been allowed to conclude;

  --The proposed ban is a rush to judgment at the request of a certain 
        group of market participants. Despite a two year process with 
        the CFTC and over 200 filed documents, proponents of movie box 
        office futures were not provided an opportunity to present 
        support for their position with the Senate;

  --The proposed ban will support the entrenched interests and 
        competitive monopoly position of the major studios because 
        smaller entities in the motion picture industry will continue 
        to depend on major studios for financing and distribution.
Questions Submitted by Hon. Blaine Luetkemeyer, a Representative in 
        Congress from Missouri
    Question 1. Please explain the process for evaluating an 
application or request to create a new derivatives market (or series of 
contracts). Describe the questions and then the answers that Media 
Derivatives and Cantor Exchange provided that led the CFTC staff to 
recommend approval of the application. Include a timeline on the entire 
process as well (application received, length of q/a process, letter of 
approval, etc.).
    Answer. An interdivisional team was assembled to review the MDEX 
and Cantor applications for compliance with 8 designation criteria and 
18 core principles. To that end, each exchange submitted substantial 
documentation including, among other things, rulebooks, compliance 
manuals, governance documents and regulatory charts and also provided 
trading and system demonstrations at their respective headquarters. The 
staff evaluated all the information and made a recommendation to the 
Commission to approve the application for designation which was 
accepted by the Commission.
    MDEX submitted draft documentation as early as October 2008 and 
formally submitted its application in September of 2009. MDEX was 
designated on April 16, 2010.
    Cantor submitted draft documentation as early as June 2008 and 
formally submitted its application in November 2008. Cantor was 
designated on April 20, 2010.

    Question 2. What are the most important factors that led the review 
team to make its decision? For example, was the CFTC focused on 
evaluating whether the new contract(s) being proposed would have a 
legitimate business purpose (for say, risk management)? What other 
questions or answers were also viewed as central to the application?
    Answer. The contract approval determination primarily addresses 
whether the proposed contract would be readily susceptible to 
manipulation. Staff was satisfied that both MDEX and Cantor had 
developed product rules, systems and safeguards in order to reasonably 
assure that the contracts were not readily susceptible to manipulation.

    Question 3. In 2008, the CFTC issued a request for comments about 
whether and how it should regulate prediction markets. Please summarize 
the questions asked, the comments received, and any new processes or 
plans that resulted within the CFTC for how to regulate prediction 
markets and/or process these sorts of applications.
    Answer. The Commission previously requested comment on the 
appropriate regulatory treatment of financial agreements offered by 
markets commonly referred to as event, prediction, or information 
markets (event contracts) in 2008. The Dodd-Frank Wall Street Reform 
and Consumer Protection Act provides the Commission with authority to 
prohibit listing of certain agreements, contracts, or transactions 
based on commodities contrary to the public interest (e.g.,  contracts 
on terrorism, assassination, war or gaming). The Commission will 
consider the new legislation prior to enacting regulations regarding 
event contracts.

    Question 4. In reviewing the applications by Media Derivatives and 
Cantor Exchange, how did or does the CFTC view these proposed 
businesses as distinct from the Iowa Electronic Market (and the 
previous ``no action'' letter that they received)? Is the difference 
more than just who has access to trade these contracts or the dollar 
amount of the contracts?
    Answer. The University of Iowa requested no-action relief for its 
Iowa Electronic Markets (IEM). The IEM is an electronic trading market 
organized as an academic research and experimental program conducted at 
the University. The Division of Trading and Markets of the Commission 
extended no-action relief (that included limits on participation and 
dollar amounts) for the operation of the Political Market and the 
Economic Indicator Market on February 5, 1992 and June 18, 1993. Had 
the IEM not requested and been extended no-action relief, they likely 
would have had to apply to the Commission for designation as a contract 
market (just as MDEX and Cantor did) if they proposed to offer these 
contracts to the retail public.

                                  
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