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S. HRG. 113–375 

REGULATING FINANCIAL HOLDING COMPANIES 

AND PHYSICAL COMMODITIES 

HEARING 

BEFORE THE

SUBCOMMITTEE ON 

FINANCIAL INSTITUTIONS AND CONSUMER 

PROTECTION 

OF THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED THIRTEENTH CONGRESS 

SECOND SESSION 

ON 

EXAMINING NONFINANCIAL ACTIVITIES CURRENTLY BEING PERMITTED 

UNDER THE BANK HOLDING COMPANY ACT AND THE ECONOMIC IMPACT OF SUCH ACTIVITIES ON THE PHYSICAL COMMODITY AND ENERGY MARKETS AS WELL AS THE SAFETY AND SOUNDNESS OF THE 

NATION’S BANKING SYSTEM. 

JANUARY 15, 2014 

Printed for the use of the Committee on Banking, Housing, and Urban Affairs 

( 

Available at: http://www.fdsys.gov/ 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

TIM JOHNSON, South Dakota, Chairman 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

KAY HAGAN, North Carolina 

JOE MANCHIN III, West Virginia 

ELIZABETH WARREN, Massachusetts 

HEIDI HEITKAMP, North Dakota 

MIKE CRAPO, Idaho 

RICHARD C. SHELBY, Alabama 

BOB CORKER, Tennessee 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

JERRY MORAN, Kansas 

TOM COBURN, Oklahoma 

DEAN HELLER, Nevada 

CHARLES YI, Staff Director 

GREGG RICHARD, Republican Staff Director 

DAWN RATLIFF, Chief Clerk 

TAYLOR REED, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS AND CONSUMER PROTECTION

SHERROD BROWN, Ohio, Chairman 

PATRICK J. TOOMEY, Pennsylvania, Ranking Republican Member 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

JON TESTER, Montana 

JEFF MERKLEY, Oregon 

KAY HAGAN, North Carolina 

ELIZABETH WARREN, Massachusetts 

RICHARD C. SHELBY, Alabama 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

JERRY MORAN, Kansas 

DEAN HELLER, Nevada 

BOB CORKER, Tennessee 

GRAHAM STEELE, Subcommittee Staff Director 

TONNIE WYBENSINGER, Republican Subcommittee Staff Director 

(II)

C O N T E N T S 

WEDNESDAY, JANUARY 15, 2014 

Page 

Opening statement of Chairman Brown ................................................................ 1 

Opening statements, comments, or prepared statements of: 

Senator Reed ..................................................................................................... 3 

WITNESSES 

Norman C. Bay, Director, Office of Enforcement, Federal Energy Regulatory 

Commission ........................................................................................................... 3 

Prepared statement .......................................................................................... 26 

Responses to written questions of: 

Chairman Brown ....................................................................................... 38 

Vincent McGonagle, Director, Division of Market Oversight, Commodity Futures Trading Commission .................................................................................. 5 

Prepared statement .......................................................................................... 31 

Responses to written questions of: 

Chairman Brown ....................................................................................... 41 

Senator Toomey ......................................................................................... 47 

Michael S. Gibson, Director, Division of Banking Supervision and Regulation, 

Board of Governors of the Federal Reserve System .......................................... 6 

Prepared statement .......................................................................................... 33 

Responses to written questions of: 

Chairman Brown ....................................................................................... 48 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Letter from the Commodity Futures Trading Commission submitted by Chairman Brown ........................................................................................................... 63 

Statement submitted by the North American Die Casting Association .............. 66 

(III)

(1) 

REGULATING FINANCIAL HOLDING 

COMPANIES AND PHYSICAL COMMODITIES 

WEDNESDAY, JANUARY 15, 2014 

U.S. SENATE, 

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS AND

CONSUMER PROTECTION, 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, 

Washington, DC. 

The Subcommittee met at 2:02 p.m., in room SD–538, Dirksen 

Senate Office Building, Hon. Sherrod Brown, Chairman of the Subcommittee, presiding. 

OPENING STATEMENT OF CHAIRMAN SHERROD BROWN 

Chairman BROWN. The Subcommittee will come to order. Thank 

you to the witnesses, thank you to Senator Reed for joining us. I 

will make a brief opening statement, then Senator Reed, and a couple other Senators are going to be joining us. Ranking Member 

Toomey could not make it but was helpful, and I thank him and 

his staff for working with us on this important hearing. 

For years, U.S. banking laws drew sharp lines between banking 

and commerce, and Congress and regulators and the institutions 

respected that separation. In 1999, things changed. Congress weakened these laws, and over the last decade regulators have been interpreting and implementing this law, financial institutions have 

expanded into new and varied lines of business. 

As I have said many times, the sixth largest U.S. bank holding 

companies have 14,420 subsidiaries. The sixth largest U.S. bank 

holding companies have more than 14,000 subsidiaries; 19 of them 

are traditional banks. Today we will learn more about the rules for 

all of these nonbanking activities like trading commodities, owning 

physical assets, how these rules are applied. 

The Fed’s proposal yesterday was a timid step. It was too slow 

in coming. There is still too much that we do not know about these 

activities and investments. We have still yet to see U.S. regulators 

address concerns about the aluminum, zinc, and copper markets. 

Although the London Metal Exchange, the LME, has adopted 

new warehouse rules, industrial end users are unconvinced that 

these reforms will address the problem as premiums and queue 

lengths have only grown since they were announced. 

We are also here to seek answers to some fundamental questions. 

Let me go through those briefly. 

First, what is the appropriate role for banks in the commodities 

markets? 

2 

If their commodities activities provide benefits to customers, do 

those benefits outweigh the risks and the costs of market manipulation and other harmful practices? 

Regulators in Europe and the U.S. have either investigated, or 

settled with, institutions for manipulating rates in the LIBOR, silver, gold, electricity, and oil markets. 

On Monday, it was reported that the FBI suspects that traders at one U.S. bank earned between $50 and $100 million through 

market manipulation by ‘‘front-running’’ interest rate derivatives 

orders by Fannie and Freddie. 

Today it was reported that the world’s largest foreign exchange 

dealer has suspended several traders suspected of manipulating 

currency prices. That is one of at least 13 traders at four banks 

that have been suspended for activities that took place through a 

group known as ‘‘The Cartel’’ and ‘‘The Bandits’ Club.’’ 

Tim Weiner from MillerCoors testified before this Subcommittee 

in July that actions by banks in the aluminum market have cost 

that company tens of millions of dollars in excess premiums over 

the last several years and cost aluminum users a total of $3 billion 

last year alone. 

Second question: Why are banks allowed to own physical assets? 

Most experts that have met with my office agree there is no clear 

benefit to the economy from banks owning assets like warehouses 

and tankers and pipelines and coal mines. 

Even analyst Dick Bove, author of the book ‘‘Guardians of Prosperity: Why America Needs Big Banks’’, has said that ‘‘banks went 

a little bit too far with the Fed’s authorization to get into the commercial side of [the] commodities business[.]’’ 

If everyone but the banks agree, then why are regulators allowing them to do it? This Subcommittee believes that the problems 

of ‘‘too big to fail’’ are still with us. 

Last year, Chairman Bernanke said ‘‘too big to fail’’ is ‘‘not solved 

and gone. It is still here.’’ 

Perhaps most importantly, the market believes that ‘‘too big to 

fail’’ is still with us. 

Finally, what are the risks to our financial system, and entire 

economy when ‘‘too big to fail’’ banks engage in commercial activities? 

The Fed’s proposal cites the Deepwater Horizon spill; an explosion of a PG&E pipeline; an explosion at a natural gas plant in 

Middletown, Connecticut; the tsunami and subsequent meltdown at 

the Fukushima Daiichi nuclear power plant; the derailment of a 

crude oil cargo train in Quebec; and older disasters like Three-Mile 

Island and Exxon Valdez. 

This morning, the Wall Street Journal reported that crude oil 

railroad shipments have dramatically increased and that cities like 

Albany and Chicago and Denver and New Orleans may be unprepared to deal with an accident involving this explosive substance. 

Morgan Stanley’s CEO reportedly told employees that an oil 

tanker spill at one of its shipping units is ‘‘a risk we just can’t 

take.’’ And it is a risk that taxpayers cannot afford to take. 

The ultimate question is who pays for mistakes or manipulation 

that occurs at financial institutions. The answer should be these institutions, their executives, their employees. It should not be cusVerDate Nov 24 2008 10:22 Oct 30, 2014 Jkt 046629 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 L:\HEARINGS 2014\01-15 REGULATING FINANCIAL HOLDING COMPANIES AND PHYSIC
3 

tomers or taxpayers, but too often that has been the case. It is time 

for a change. 

Thank you again to the witnesses. Senator Reed. 

STATEMENT OF SENATOR JACK REED 

Senator REED. Well, thank you very much, Mr. Chairman, for 

holding this hearing. It is an extraordinarily important issue, and 

one aspect that you have alluded to is the energy field. And I can 

tell you that high energy costs are hurting my constituents. Many 

of them are struggling just to pay the bills. And according to the 

U.S. Energy Information Administration, the average wholesale 

price for natural gas at the New England Trading Point increased 

75 percent in 2013 compared to 2012, while the rest of the country 

saw a 30-percent increase. And EIA’s most recent monthly data 

shows that electricity prices in Rhode Island are nearly 45 percent 

more than the national average for residential users, 35 percent 

more for commercial users, and 77 percent more for industrial 

users. So this is a tremendous burden, and this is one of the things 

that is inhibiting our growth. Consequently, we have a 9-percent 

unemployment rate. 

So there are many factors involved—infrastructure challenges, 

pipelines, distribution systems—but I am certainly concerned about 

the potential for manipulation in the financial markets and the 

physical natural gas and electric markets. That is why I am looking forward to this hearing. 

We already know from the experience in California that it is possible to manipulate energy markets, and we have to be incredibly 

watchful, and that is why the coincidence of owning physical assets 

and then participating in trading and other activities has to raise 

these questions, and I am delighted that the Chairman has seen 

fit to have this second hearing. 

Thank you, Mr. Chairman. 

Chairman BROWN. Thank you, Senator Reed. 

Let me introduce the panel. Mr. Norman Bay is the Director of 

the Office of Enforcement at the Federal Energy Regulatory Commission. Welcome. Thank you for your service, Mr. Bay. 

Vince McGonagle is the Director of the Division of Market Oversight at the CFTC, Commodity Futures Trading Commission. 

Thank you for your service to our country. 

Mr. Michael Gibson is the Director of the Division of Banking 

Supervision and Regulation for the Board of Governors at the Federal Reserve System. Thank you also, Mr. Gibson, for your service 

to our country. 

Mr. Bay, if you would begin. 

STATEMENT OF NORMAN C. BAY, DIRECTOR, OFFICE OF ENFORCEMENT, FEDERAL ENERGY REGULATORY COMMISSION 

Mr. BAY. Chairman Brown and Members of the Subcommittee, 

thank you for inviting me to testify today. My name is Norman 

Bay. I am the Director of the Office of Enforcement at the Federal 

Energy Regulatory Commission. I appear before you today as a 

staff witness, and the views I present are not necessarily those of 

the Commission or of any individual Commissioner. I have also 

submitted prepared testimony that responds to the Subcommittee’s 

4 

questions, and so in my remarks today, I will provide a brief overview of the work of the Office of Enforcement. 

In a sense, my office is a legacy of the Western power crisis from 

2000 to 2001, and you have alluded to that crisis, Senator Reed. 

During the crisis Enron and other entities manipulated energy 

markets in California and the West and ripped off consumers. At 

the time FERC did not have a general antimanipulation authority, 

and its penalty authority was limited to $10,000 a day. Thus, a manipulator could manipulate the market every day for a year and 

face a penalty of $3.65 million, which was hardly even a rounding 

error for an Enron. 

In the Energy Policy Act of 2005, Congress fixed the weakness 

in FERC’s regulatory authority. Congress gave FERC a broad 

antimanipulation authority based on Rule 10(b)(5) in the Securities 

and Exchange Act of 1934. Congress also provided a penalty authority of up to $1 million per day per violation. These tools have 

been critical to FERC’s efforts to protect consumers from market 

manipulation in the wholesale natural gas and power markets. 

After receiving its antimanipulation authority, FERC has also 

built up its enforcement capabilities. By way of comparison, during 

the Western power crisis, there were 20 staff in the Office of General Counsel who did enforcement work. We now have around 200 

staff in a stand-alone office, the Office of Enforcement. We have 

staff with expertise in the markets who are economists, accountants, and auditors; former traders analysts with highly quantitative skill sets, including mathematics, engineering, statistics, 

and physics. We also have lawyers who are former prosecutors or 

who have extensive litigation experience in private practice with 

some of the finest law firms in the country. 

Our staff is organized into four divisions: the Division of Investigations; the Division of Audits and Accounting; the Division of 

Energy Market Oversight, which focuses on energy market fundamentals, including important trends and developments; and the 

Division of Analytics and Surveillance, which provides technical 

support on investigations and which creates and runs automated 

screens to detect potential market manipulation. These screens are 

critical to our oversight of the energy markets because, otherwise, 

there is simply too much data, given the many trading hubs and 

markets and products, for an analyst to be able to examine that 

data on a manual basis. 

Since receiving its EPAct authority in 2005, FERC has collected 

about $873 million in civil penalties and disgorgement. One of the 

top priorities of the office is fraud and market manipulation. Some 

of our most significant enforcement actions to date include actions 

against Constellation, which settled for $245 million in 2012 for 

manipulating the electricity markets in New York; JPMorgan, 

which settled for $410 million in 2013 for manipulating the electricity markets in California and the Midwest; and Barclays in 

which the Commission issues a penalty assessment in July of 2013 

of $453 million. Barclays has challenged that assessment, and we 

are currently litigating the matter in Federal district court in the 

Eastern District of California. 

In summary, the antimanipulation authority Congress provided 

FERC in 2005 has been critical in our efforts to police the energy 

5 

markets and to detect and to deter and punish market manipulation. You should know that we are committed to doing our best to 

protect consumers and to further the public interest. Indeed—and 

I often say this—I am honored and humbled to be working with the 

many dedicated, talented, and hard-working staff at FERC, particularly in the Office of Enforcement. 

In conclusion, I wish to thank the Subcommittee for this opportunity to testify today, and I look forward to answering any questions you might have. 

Chairman BROWN. Thank you, Mr. Bay. 

Mr. McGonagle, welcome. 

STATEMENT OF VINCENT MCGONAGLE, DIRECTOR, DIVISION 

OF MARKET OVERSIGHT, COMMODITY FUTURES TRADING 

COMMISSION 

Mr. MCGONAGLE. Good afternoon, Chairman Brown and Members of the Subcommittee. Thank you for the opportunity to appear 

here today. I am Vince McGonagle, and I am the Director of the 

Division of Market Oversight for the Commodity Futures Trading 

Commission, CFTC. 

The Commodity Exchange Act serves the public interest by permitting derivatives markets, both futures and swaps, to be used to 

manage and assume price risks, discover prices, or disseminate 

pricing information. Under the CEA and its mission statement, the 

CFTC is charged with fostering transparent, open, competitive, and 

financially sound markets. At the same time, CFTC protects the 

public and market participants from fraud, manipulation, abusive 

practices, and systemic risk related to derivatives, while working to 

ensure the protection of customer funds. 

To fulfill these roles, the Commission oversees designated contract markets, swap execution facilities, derivatives clearing organizations, swap data repositories, swap dealers, futures commission 

merchants, commodity pool operators, and other intermediaries. 

The CEA has for many years required that futures transaction, 

subject to certain exemptions, be conducted on or subject to the 

rules of a board of trade on a designated contract market. With the 

passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, DCMs were also permitted to list swap contracts, and 

various new substantive DCM requirements were established. In 

addition, the Dodd-Frank Act established an entirely new regulatory scheme for swaps trading and a new category of exchange 

for swap execution facilities dedicated exclusively to the trading of 

swaps. 

Under the CEA and the Commission’s contract and rule review 

regulations, the terms and conditions of all products are submitted 

to the Commission before implementation. In listing a new contract, DCMs and SEFs are legally obligated to meet certain core 

principles. One of the most significant core principles prohibits the 

listing of contracts readily susceptible to manipulation. 

Under this core principle, a DCM or swap execution facility that 

lists a physical delivery contract must ensure that the contract is 

designed to avoid any impediments to the delivery of the commodity. 

6 

The Commission’s responsibilities under the Commodity Exchange Act also include mandates to deter fraud and manipulation 

of commodities in interstate commerce. Under that authority, the 

CFTC brings enforcement cases for manipulative activity in both 

cash and derivatives markets. Notably, the Dodd-Frank Act enhanced the Commission’s enforcement authority over manipulative 

and deceptive actions and expanded that authority to the swaps 

markets. 

The Dodd-Frank Act also established a registration regime for 

foreign boards of trade who seek to offer U.S. customers direct access to their electronic trading system. An applicants for registration must demonstrate, among other things, that it is subject to 

comprehensive supervision and regulation by the appropriate governmental authorities in its home country, and that its regulator’s 

oversight of the platform is comparable to the supervision and regulation to which Commission-designated contract markets are subject. 

As part of our cooperative enforcement program, the CFTC routinely provides assistance to and coordinates with other domestic 

financial regulators. In addition, the Commission recognizes that 

commodity markets are, of course, international in nature and, accordingly, regularly consults with other countries’ regulators. 

Thank you for the opportunity to appear before the Subcommittee. I will be pleased to respond to any questions. 

Chairman BROWN. Thank you very much, Mr. McGonagle. 

Mr. Gibson, please. 

STATEMENT OF MICHAEL S. GIBSON, DIRECTOR, DIVISION OF 

BANKING SUPERVISION AND REGULATION, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM 

Mr. GIBSON. Chairman Brown and other Members of the Subcommittee, thank you for the opportunity to testify at today’s hearing. Today I will discuss the history of bank and bank holding company engagement in physical commodity activities, the Federal Reserve’s approach to supervising financial institutions engaged in 

physical commodity activities, and our policy review of commodity 

activities and investments of bank holding companies. 

Prior to the Gramm-Leach-Bliley Act in 1999, bank holding companies were authorized to engage in only a limited set of commodity activities that were considered to be closely related to banking. Under the GLB Act, Congress created the financial holding 

company framework, which allowed certain bank holding companies to engage in expanded activities under three different provisions. 

The first provision, referred to as ‘‘Section 4(k) authority,’’ authorizes a financial holding company to engage in an activity that 

the Board finds to be complementary to a financial activity, but 

only if the activities do not pose a substantial risk to the firm’s 

safety and soundness or the financial system and the benefits to 

the public outweigh possible adverse effects. 

Second, the GLB Act’s merchant banking authority permits a financial holding company to invest in companies that are engaged 

in activities not otherwise permitted for financial holding companies. 

7 

In a third provision of the GLB Act, referred to as ‘‘Section 4(o) 

authority,’’ Congress grandfathered certain commodity activities 

that are not permissible for bank holding companies if the company 

was engaged in those activities as of September 1997. No approval 

or notice is required for a company to rely on this authority for its 

commodity activities. In contrast to the firms that rely on the 

Board’s authorizations under 4(k) authority, the 4(o) grandfathered 

firms are also able to engage in the transportation, storage, extraction, and refining of commodities. Only two financial holding companies currently qualify for these grandfathered rights—Goldman 

Sachs and Morgan Stanley. 

The Federal Reserve is the consolidated supervisor of bank holding companies and financial holding companies. As a supervisor of 

financial holding companies that engage in commodity activities, 

the Federal Reserve aims to ensure that firms manage the risks of 

those activities, have strong capital, and have adequate controls 

over their commodity activities. 

The scale and complexity of commodity activities of financial 

holding companies expanded in 2008 as a number of securities 

firms with significant commodity activities either became bank 

holding companies or were acquired by bank holding companies. As 

a result, the Federal Reserve expanded the scope of its examination 

and review of physical commodity activities. However, the Federal 

Reserve has no direct role in overseeing the commodity markets 

generally. The CFTC regulates commodity futures and option markets and over-the-counter commodity derivative markets. Other 

agencies, such as FERC, also regulate segments of the physical 

commodity market. 

The Federal Reserve has been conducting a detailed policy review of the commodity activities and investments of financial holding companies. The scope of our review covers all of the 4(k), merchant banking, and 4(o) authorities I listed earlier. Yesterday the 

Board issued an Advance Notice of Proposed Rulemaking, or 

ANPR, to seek public comment on a range of issues related to the 

commodity activities of financial holding companies. 

In particular, the ANPR discusses the unique tail risks of commodity activities exemplified by the recent Deepwater Horizon oil 

spill and many other incidents that you mentioned, Senator Brown, 

in your opening remarks. The ANPR discusses the additional contagion risks that commodity activities may pose to systemically important financial institutions, the Board’s concern that current 

safeguards and safety and soundness considerations may not be 

adequate to address those risks, recent evidence that commodity 

activities may not be as complementary to banking as was previously believed, and what further prudential restrictions or limits 

on commodity activities are warranted to mitigate these risks. 

I look forward to answering any questions you may have. 

Chairman BROWN. Thank you, Mr. Gibson. Thank you to all of 

you. 

Mr. Gibson, the Fed, as you have pointed out, sought public comment yesterday to help inform its consideration of physical commodity activities conducted by these financial holding companies. It 

is encouraging to see the Fed rethinking the issue. These exemptions have existed since 1999. The first complementary order was 

8 

2003. Some of the disasters cited by your ANPR we just talked 

about—for example, the Exxon Valdez—are not recent events. So 

the questions are: Why now? Why did it take so long? Aside from 

the vote on the ANPR, have there been any other Board-level discussions or deliberations or meetings about physical commodities? 

Mr. GIBSON. I think that the staff and the supervision staff have 

been working on the issue of banks’ and financial holding companies’ physical commodity activities since 2008 when, as I mentioned, we got a lot more authority over securities firms that either 

became bank holding companies or were acquired by bank holding 

companies, and that dramatically expanded the scope of commodities activities. We started doing more in-depth review at that 

point, and following on from that, which raised a number of concerns, and is discussed in the ANPR, really the question of whether 

certain risks such as the unique tail risks that certain commodities 

pose, along with the expanded activities, as well as the lesson from 

the financial crisis that contagion risks of systemically important 

financial institutions can pose a risk to financial stability, those 

were some of the factors that made us take another look at the 

risks and have led to the process up to issuing the ANPR. 

We have had a number of meetings over the years that have 

worked on this issue and led up to the ANPR, not open Board 

meetings, but staff-level meetings. 

Chairman BROWN. I still am a bit incredulous about the speed 

at which this was done. Professor Omarova, who came to this Subcommittee in July, stated that there is ‘‘no meaningful public disclosure of banking organizations’ assets and activities related to 

physical commodities and energy.’’ A fundamental difficulty with 

this type of inquiry seems to be opacity, a lack of knowledge about 

the size and scope of commodities held by banks and other traders. 

None of us knows the quantities and the extent of this. 

Commissioner Bart Chilton—Mr. McGonagle is one of his 

bosses—sent me a letter that I got today saying that he has been 

trying for months to obtain useful ownership information from the 

Fed about physical commodities—now, this is another regulatory 

agency—but got not response. 

Tell me, if you would, how much aluminum does Goldman Sachs 

hold? 

Mr. GIBSON. I do not know off the top of my head exactly the answer to your question. 

Chairman BROWN. Does the Fed know? 

Mr. GIBSON. What we do require banks to disclose on their quarterly financial reports, that are public regulatory reports, they do 

disclose the amount on their balance sheet of physical commodities 

that they hold, and that is a required public disclosure. 

Chairman BROWN. So the answer is yes, the Fed knows. But does 

the Fed release that to anybody? 

Mr. GIBSON. That is available publicly. You can download it from 

our Web site. 

Chairman BROWN. So why would—— 

Mr. GIBSON. But that is an aggregate number, all commodities. 

It does not break it out by individual commodities. 

Chairman BROWN. So how can we comment on this ANPR? I 

mean, it just seems to me the process is stacked in favor of the 

9 

banks, that the information is not forthcoming. The Fed has moved 

extraordinarily slowly on this. Another regulator of equal stature, 

as far as I am concerned, cannot get information. How are we going 

to begin to exercise effective oversight when this information is 

simply not forthcoming? 

Mr. GIBSON. In addition to the aggregate numbers that banks 

disclose in their public regulatory reports, as public companies, 

they file SEC quarterly and annual reports that disclose and discuss all their material risks. If a bank holding company has a material exposure to commodities, the commodities business, they are 

required to discuss those risks in their public SEC disclosures. So 

this is another public source of information. 

Chairman BROWN. So after this hearing, will the Federal Reserve 

be more—understanding some of this information is not delineated 

and broken down in the detail that I think other regulators and 

this Subcommittee and others that want to oversee this can understand and can get access to, but can you promise us that the Fed 

will be more forthcoming with this information in more detail, and 

if you do not have all the information, you will ask questions of 

these financial institutions? 

Mr. GIBSON. What we have done in the ANPR is asked a series 

of questions which we hope elicits some of the information that you 

are talking about. We have our own information that we get from 

the supervisory side, but we also are interested in the public comment, comments from the industry and others, to help us inform 

the discussions as we go forward. 

Chairman BROWN. I am not sure, though, that the public comment can be as helpful and as incisive in its questions and as illuminating as it could be if they—because they do not have access 

to enough of this information. So I implore you to make more of 

this available in a form that other regulators, like Bart Chilton and 

congressional oversight and all can see it. 

Let me ask you something else. Morgan Stanley currently has 

133 legal entities it holds under, you mentioned, the 4(o), including 

TransMontaigne, a wholly owned subsidiary that stores, refines, 

transports gas, gasoline fuels, crude oil, and other liquid products. 

Section 4(o) says that institutions that were not banks before 

Gramm-Leach-Bliley passage ‘‘may continue to engage in’’—this 

was the Morgan Stanley, Goldman Sachs, obviously, as you know, 

it turned out to be that—‘‘may continue to engage in or, directly 

or indirectly, own or control shares of a company engaged in activities related to the trading, sale, or investment in commodities and 

underlying physical properties’’ if they were engaging in ‘‘any such 

activities prior to 1997.’’ You know all this. 

A 2012 article by staff of the New York Fed, you know, the regional Federal Reserve Bank responsible for the largest U.S. banks, 

said, ‘‘The legal scope of the 4(o) grandfathered exemption is widely 

seen as ambiguous. It is unclear to what extent it allows firms to 

purchase new hard assets relating to an existing commodities business or to expand into new commodities markets.’’ 

This is staff from the largest—from the regional Federal Reserve 

Bank responsible for the largest U.S. banks. They say the law is 

ambiguous, 15 years since the law’s passage, more than 5 years 

after institutions have become eligible to use this provision. 

10 

Can you to this Subcommittee clear up this ambiguity by explaining the meaning of ‘‘any such activities’’? And can a financial 

holding company that was not a bank holding company, meaning 

these two, and was trading a single commodity like silver prior to 

1997 begin trading other commodities like zinc or electric generation or a whole host of other things? Would you answer those two 

questions? 

Mr. GIBSON. What is clear is that the authority that Congress 

granted under Section 4(o) which is currently being used by Goldman Sachs and Morgan Stanley as the authority to do a wide range 

of commodity businesses is very broad. It allows them to own the 

storage, transportation, refining, and extraction of physical commodities. And in contrast, the orders that the Board has granted 

under Section 4(k) authority are more limited, impose tighter limits, do not allow ownership of storage, transportation, extraction, 

and refining. So that is an important difference that we have taken 

into account in our review, and we describe this in the ANPR, the 

fact that—as we ask questions in the ANPR and look ahead to 

what the next step will be, there are different legal avenues we 

have to take more restrictive actions against activities that are 

done under the Section 4(o) authority compared with the Section 

4(k) authority. 

That is an important issue that we are trying to address in the 

ANPR, solicit comment on, and decide on the way forward. 

I am not a lawyer, so I cannot give you the legal interpretation 

of what exactly it means. I certainly expect we will get some public 

comment on that. You are right to focus in on the fact that there 

is an interpretation issue there, and it is one of the things that is 

an issue for our review. 

Chairman BROWN. You are not a lawyer, and neither am I, and 

a number of us up here I think are not. But you are enforcing the 

law, so that is pretty important. 

Are there limits, and what are they, on 4(o)? In other words, if 

a company—prior to 1997, one of these firms traded zinc, can they 

trade aluminum? If they did not own a warehouse, can they own 

assets like warehouses and pipelines and tankers under this provision? What are the limits of 4(o)? 

Mr. GIBSON. There is a limit under Section 4(o) that states that 

the aggregate amount of physical commodity assets can be no more 

than 5 percent of a firm’s total assets. But that is a very wide limit, 

and compared with the Section 4(k) authorities that the Board has 

granted, the Board has imposed a much tighter limit of 5 percent 

of Tier 1 capital. Since the capital is much smaller than the assets, 

the 4(k) limits are, in effect, much tighter than the 4(o) limits. So 

that is a big difference. 

In terms of what is the legal interpretation of the text in Section 

4(o) about activities that were engaged in in 1997, that is one of 

the issues that we are looking at in our review, and we have asked 

for public comment on that. 

Chairman BROWN. Thank you, Mr. Gibson, for your patience. I 

get the percentages, the 5 percent, but in terms of activities, so 

specifically if they traded in zinc prior to 1997, can they now trade 

in aluminum? If they had no warehouse, can they own a warehouse 

or own a pipeline or purchase and own an oil tanker? 

11 

Mr. GIBSON. You are not asking for a general answer, but starting with generally, they are restricted to activities that they were 

doing prior to Gramm-Leach-Bliley. 

Chairman BROWN. And zinc means zinc, zinc does not also mean 

aluminum? 

Mr. GIBSON. It is going to depend on the facts and circumstances 

of the particular case, so beyond saying that that is one of the 

things we are considering in our review, I think that is where we 

are at. 

Chairman BROWN. It really does seem like—and I hate cliches, 

but I am going to use one—the camel’s nose under the tent here. 

They qualify because they did some of this prior to 1997, but they 

are getting to do a whole lot more. 

But let me close with one other question, and then I will turn 

it to—then we will do another round if Senators really want to 

after Senators Reed and Merkley and Warren go. Section 5 authorizes the Fed to force a bank holding company to divest a nonbank 

subsidiary that ‘‘constitutes a serious risk to the financial safety, 

soundness, or stability of any of its bank subsidiaries.’’ The primary 

role of all of us is the safety and soundness and stability of our financial system. My editorial comment, of course. 

As I said in my opening statement, James Gorman—I did not say 

his name, but he reportedly told Morgan Stanley employees that an 

oil tanker spill in one of its shipping units is ‘‘a risk we just cannot 

take.’’ So my question is: Can the Fed use its general safety and 

soundness authority to curtail some of these 4(o) activities? Could 

it use Section 5 authority to force these financial holding companies to divest themselves of subsidiaries that expose it to undue 

risk—a huge oil spill, a tank explosion? Whether they are grandfathered or not, do you have the authority to force their sale of 

these activities, ceasing of these activities and sale of these commodities? 

Mr. GIBSON. We certainly have the authority under general safety and soundness considerations to impose restrictions, impose capital requirements, impose risk management requirements, and 

other requirements on those activities and any activities. And we 

also have, as you mentioned, authority under Section 5 to require 

a financial holding company to terminate certain activities if the 

activity constitutes a serious risk to financial safety, soundness, or 

stability and a number of other conditions. So we have both of 

those. 

Chairman BROWN. Have they ever been used? 

Mr. GIBSON. Section 5? I do not think so. 

Chairman BROWN. OK. It just seems that—— 

Mr. GIBSON. Again, I am not a lawyer, but my understanding is 

it is a high bar to use that authority. 

Chairman BROWN. Well, it is a high bar except when the CEO 

of one of these two says it is ‘‘a risk we cannot take.’’ When you 

think of the cost of any institution, you know, if it is owned by an 

oil company, it is an oil tanker, and there is a terrible problem, 

that is tragic for everybody involved. But it does not have the potential damage to our economy. These do because these are financial—these are bank holding companies or financial holding companies. And, I mean, you understand risk. And that the Fed in this 

12 

many years has never acted on the authority it has suggests to me 

that something is not right in our regulatory system. 

Mr. GIBSON. And the concern you mentioned is the same concern 

we have, that we described in our ANPR, and that we are confronting in our review. 

Chairman BROWN. It did not seem to be a concern that—it 

seemed to be a bit of a distant concern because of just the slowness 

of getting to this. OK. 

Senator Reed. 

Senator REED. Thank you, Mr. Chairman. 

We are talking about simply two categories, Mr. Gibson, 4(k) and 

4(o) operations. So let us look a moment at 4(k) complementary authority, which requires the Fed to make a determination that the 

activity is to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh 

possible adverse effects, such as undue concentration of resources, 

decreased or unfair competition, conflicts of interest, or unsound 

banking practices. 

Just as a specific interest point, how do you measure this issue 

of undue concentration of resources? 

Mr. GIBSON. When that net benefit test is looked at in connection 

with the 4(k) complementary authority, it is a general balancing of 

all of those issues and trying to get a sense of on balance do the 

benefits exceed the costs. But I do not think we have a specific 

methodology that produces a number that would be that specific. 

Senator REED. It is very subjective. 

Mr. GIBSON. Yes, it is subjective. 

Senator REED. So now you have made the determination under 

the 4(k) authority that it passes this subjective test. Do you continuously evaluate whether it continues to serve the public interest 

or do it on a regular basis? 

Mr. GIBSON. Generally, the way it works under the Section 4(k) 

authority is that a bank comes and requests permission to engage 

in a particular activity. 

Senator REED. Right. 

Mr. GIBSON. And then we do the review that is required. Once 

the approval is granted, then we are focused on the risks on an ongoing basis, safety and soundness considerations, making sure that 

the bank has adequate risk management and capital. 

Senator REED. So the public interest aspects of the test sort of 

go by the wayside, and the concentration is on simply the safety 

and soundness of the banking institution and risks that they might 

be taking. That is what you just said. 

Mr. GIBSON. That is what we focus on in our ongoing supervision. 

Senator REED. Yes. That is what you just said, so the public interest test, it is fire and forget. So you clear that first hurdle, and 

their activities over time, if they serve the public interest that is 

incidental to your interest. I mean, I am not putting words in your 

mouth, but it—— 

Mr. GIBSON. That is the way it is set up in the statute, but as 

part of our review, we have asked questions about what information people can give us on the net benefits and costs on those specific factors you mentioned. 

13 

Senator REED. So in this issue of being complementary, for example, it could be complementary for a financial holding company to 

own physical assets, which, through business decisions that are 

prudent, could increase the value of their financial holdings. Is that 

what we mean by—even though it would produce additional costs 

to the public, is that complementary? 

Mr. GIBSON. No. What is meant by complementary is that there 

is some activity that a bank is engaging in that is a financial activity where the physical commodity or other activity is closely related 

to it. That is what is meant by complementary. 

Senator REED. But you do not look at the interaction between 

holding that physical commodity in some way, shape, or form and 

the investment portfolio of the banks, the holdings of the banks, 

and what they are doing? If it is just generically, well, we trade in 

gold and we can own gold, is that the test? 

Mr. GIBSON. We would look at conflicts. We would expect banks 

to have policies and procedures in place to manage conflicts of interest that could arise from the fact that they might be trading 

something on one side and investing in something on another side. 

That is a general issue that we would always worry about and insist on. 

Senator REED. Sure. But I think the point—and this is one of the 

reasons why we have seen these problems that the FERC has reacted to, we all react to, is having a policy and that is what you 

look at as fine, but having the capacity to look on a fairly regular 

basis at what they are actually doing, do you have that capacity 

at the Fed? 

Mr. GIBSON. Yes, we do look at what they are actually doing. 

Senator REED. So you are looking at their trading activity, is it 

in any way related to decisions by their commodities subsidiary in 

terms of pricing, in terms of access to materials in the marketplace? Do you make those judgments? 

Mr. GIBSON. We are generally looking at the activities that the 

firms are engaging in, the risks, the risk management that they 

have around those activities, and the capital. So—— 

Senator REED. But you are not looking at the effect on the market in terms of, for example, the brewers, that the price of aluminum is going up dramatically, that you have people that are 

dealing in financial matters and also dealing in the commodities, 

you are not concerned about that, or you do not do that? 

Mr. GIBSON. We are not the regulator of commodity markets, so 

if there is market manipulation that is going on in commodity markets, it is not our primary—— 

Senator REED. I know, but when things happen, they come to 

you. And you also are responsible for the management of all of 

these companies, that they have the capacity to manage it, that 

they just do not have risk policies in place but they are actually 

doing things that are, according to the 4(k) order at least, in the 

public interest. 

Mr. GIBSON. And we have seen a lot of problems at banks recently with having inadequate compliance functions and inadequate controls. 

Senator REED. And what steps have you taken besides reporting—— 

14 

Mr. GIBSON. We take supervisory measures, and we take enforcement actions. And this is broader than just commodity activities. 

We have seen—— 

Senator REED. I understand that, but what enforcement actions 

have you taken with respect to commodity activities? 

Mr. GIBSON. Well, again, with respect to commodity market manipulation, that would not be our province because we are not the 

market regulator. With respect to—— 

Senator REED. Well, then, what do you do when you discover it? 

Mr. GIBSON. With respect to banks having inadequate controls or 

compliance functions—— 

Senator REED. No, no. When you discover—your people who are 

in those banks every day, unlike FERC, what happens when you 

suspect that there is something amiss? 

Mr. GIBSON. If we find a problem, the first thing we would do 

is raise it and require the bank to fix the problem. And if it requires an enforcement action, then we would take that extra step 

to do an enforcement action, put it in writing, and follow it to make 

sure the problem gets fixed. 

Senator REED. And how many enforcement actions have you 

taken in this regard? 

Mr. GIBSON. I do not have a particular count of exactly how 

many enforcement actions—— 

Senator REED. Can you—— 

Mr. GIBSON. We can find out. 

Senator REED. Thank you. I appreciate that. 

And then, again, two, in the 4(k) realm, I am under the impression that in this process, which is not unusual or unique to the 

bank holding company or financial holding company, there are certain representations that are made with respect to what they will 

do. Are you checking those? For example, I have been informed 

that in order to own some of these ships, the financial holding company represented, that they put age limitations on vessels that are 

carrying oil and requiring such vessels to carry maximum insurance for oil pollution. Do you regularly check that? 

Mr. GIBSON. Yes, we do. There are a number of limits that are 

imposed as part of the 4(k) orders that we have done. And as part 

of our follow-up supervision, we look at those, and we follow up on 

those. 

Senator REED. Just a final point because my time is expiring. 

One of the issues that becomes so clear from 1999 here to today 

is that the vision of these integrated companies that provide services to their clients, and some of it in a more cost-effective way and 

a more efficient way, is a good vision. But the presumption is that 

the company itself has the managerial capacity to do it well, and 

that Federal regulators have the managerial capacity to supervise 

them. And there is always this dogging question in my mind of 

whether you have the capacity—I think you have the intent; I 

think all of you have the intent, but whether you have the capacity 

both legally and operationally, with personnel, et cetera, to do this 

and are doing it on a regular basis so that you can assure not only 

myself and my colleagues but, more importantly, people that you 

are on it. For example, those energy prices that are very, very high 

are not the result of decisions that are being made in these organiVerDate Nov 24 2008 10:22 Oct 30, 2014 Jkt 046629 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 L:\HEARINGS 2014\01-15 REGULATING FINANCIAL HOLDING COMPANIES AND PHYSIC
15 

zations that control both the physical resource and have huge financial levers to move markets. 

Can you give us that assurance? Do you have that capacity? 

Mr. GIBSON. Our mission in bank supervision is to make sure the 

banks operate in a safe and sound manner. 

Senator REED. Well, see, there is a difference with safety and 

soundness. I think we found that out. There can be a lot of safe 

and sound institutions that are not providing significant public 

benefits versus private benefits which they are earning, which goes 

to the safety and soundness. A lot of the decisions that were made 

prior to the collapse were simply because regulators were more concerned about safety and soundness than they were about consumer 

protections, fair market operations, you know, et cetera. So the notion of that, ‘‘Well, we make sure they are safe and sound,’’ that 

is somewhat reassuring, but that is not the entire scope. 

Mr. GIBSON. Yes, I understand, and I already explained others 

are focused more on market oversight and market manipulation. 

But we do pay attention to compliance and controls. 

Senator REED. I appreciate your response, and thank you. 

Thank you, Mr. Chairman. 

Chairman BROWN. Senator Merkley. 

Senator MERKLEY. Thank you very much, Mr. Chairman. 

Mr. Gibson, the AE–10 notice that the Fed put out yesterday, 

what is behind the timing of this? 

Mr. GIBSON. The timing of the ANPR that we put out yesterday? 

We have had a review underway for a while now on the risks associated with financial holding companies’ commodity activities, and 

we felt like we were at the stage where it was the right time to 

put out to the public what our concerns were with the risks, what 

the structure of the legal authorities that we have talked about 

here today is, and ask for public input on what actions or remedies 

might be desirable. 

Senator MERKLEY. So this conflict between commodities and 

holding and trading has been in existence a long time. Why not 4 

years ago? 

Mr. GIBSON. It was in 2008 when the Fed got oversight for a lot 

of commodity activities that were previously done in securities 

firms that became bank holding companies or were acquired by 

bank holding companies. So after that, we really staffed up in our 

supervisory function to look at some of these new activities that 

had not previously been that significant within financial holding 

companies. Based on what we started to learn with the examination starting in 2009 and going forward, that built up then into the 

policy review that took us to yesterday putting out the ANPR detailing the concerns and asking for public input. 

Senator MERKLEY. There have been various articles saying that 

the FERC was really paying a lot of attention to these types of 

issues and that the Fed was asleep. Is that a fair characterization? 

Mr. GIBSON. Which type of issues? 

Senator MERKLEY. They were paying a lot of attention to commodities issues, particularly the trading of electricity, which is in 

their jurisdiction, but the Fed in its area had been asleep. Is that 

a fair characterization, the Fed just woke up? 

Mr. GIBSON. No. I would say that FERC—— 

16 

Senator MERKLEY. OK. Let me ask you this question: Firms 

argue that they have a Chinese wall, that they can own vast 

amounts of commodities, including the means for delivering those 

commodities, in one part of their firm. Another part of the firm 

that is deeply involved in trading through their market making, 

through their wealth management, that no information travels 

back and forth, there is no advantage. Do you believe that that is 

the case? 

Mr. GIBSON. Well, we require firms to have policies around—— 

Senator MERKLEY. No, not policies. Do you believe that a Chinese 

wall is a perfect creation? And let me just remind you, the public 

has been following not only what happened in the case of power 

manipulation with Enron but power manipulation with Goldman 

Sachs—excuse me, JPMorgan. They have been following the 

LIBOR manipulation, the hard currency manipulation. Does a Chinese wall—is it a powerful separation in firms that no information 

passes back and forth? 

Mr. GIBSON. I think there have been a lot of problems in some 

of the firms that you mentioned around market manipulation, and 

we have seen a lot of investigations, and we have seen a lot of enforcement actions—— 

Senator MERKLEY. OK. Let me ask all three of you the same 

question. It is a pretty simple yes or no. Is a Chinese wall a perfect 

instrument and we should rest easy that you can do these two 

things in the same firm without information passing back and 

forth? Mr. McGonagle, is it a perfect instrument, the Chinese wall? 

Mr. MCGONAGLE. When people are involved, no instrument is 

perfect. 

Senator MERKLEY. Thank you. 

Mr. Bay. 

Mr. BAY. I would hesitate to rely on that alone, Senator Merkley. 

Senator MERKLEY. Thank you. 

Mr. Gibson, one more chance to answer the question. 

Mr. GIBSON. No, no Chinese wall is perfect. 

Senator MERKLEY. OK. So since under your 4(k) authority you 

are supposed to be looking out for the soundness of the financial 

system generally, is this an area you—you are seeking information 

from the outside, you know, comment if you will. But is there—why 

allow this to exist? If you were in a policy mode, would you say this 

is a good policy to allow these two activities to take place where 

a firm with enormous assets can control the supply and demand of 

a product while at the same time trading on the product? Is that 

a good policy strategy if you were advising us on what Congress 

should pursue? 

Mr. GIBSON. What we have highlighted in our ANPR that is asking for comment is the fact that there are a lot of risks which are 

difficult to size, difficult to dimension, could be very large, associated with some of the commodities activities that financial holding 

companies are engaged in now. And we learned in the financial crisis about the fragility and contagion risks that those companies are 

subject to, and that is one of the factors that is making us rethink 

the current situation. 

Senator MERKLEY. OK. Let me ask you about the 4(o) portion. If 

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17 

rently banks, why should new groups that were, if you will, outside 

the commercial banking world but then get a commercial banking 

license, why should they be allowed to do the activity? Why should 

Goldman be allowed to do it, why should Morgan Stanley be allowed to do it, if other entities in that space are not allowed to do 

it? 

Mr. GIBSON. Congress created the 4(o)—— 

Senator MERKLEY. I understand. I am asking a policy question. 

I am not asking a history lesson. 

Mr. GIBSON. I think it is a good question why some companies 

should have different authority than others, and broader authority. 

Senator MERKLEY. So it is reasonable to assume that if the risks 

are such that this rule applies to some groups, that risk would inherently exist for the other firms that are coming in through a 

doorway that bypasses that restriction. 

Mr. GIBSON. Yes, and we talk about in our ANPR the fact that 

some of the risks are the same. But the limits and restrictions are 

different because of the different authorities. 

Senator MERKLEY. Does the trading—does the fact a firm might 

hold a lot of aluminum warehouses and proceed to control the supply and demand of aluminum or in any other commodity like that, 

is that kind of equivalent to a tax on the financial system by inflating the costs that the end user pays? 

Mr. GIBSON. Are you asking me? 

Senator MERKLEY. Yes. 

Mr. GIBSON. I would not call it a tax. I would call it—the way 

the companies choose to organize themselves, they are dealing with 

their customers and they are providing the service to their customers. And what we look at is more are they doing it in a safe 

and sound manner, do they have enough capital to back up the 

risks that they are taking as they provide those services. 

Senator MERKLEY. But aren’t you also supposed to look at the 

impact on the financial system generally? 

Mr. GIBSON. Yes. 

Senator MERKLEY. And does it impose higher costs on—does everyone buying aluminum cans to put their beer in pay a little bit 

higher price because of that type of control over supply and demand? 

Mr. GIBSON. I do not know the answer to that question. 

Senator MERKLEY. Would anyone else like to comment on this 

and whether there are costs passed on to the end user as a result 

of some of these conflicts of interest? 

Mr. MCGONAGLE. Certainly for the CFTC, one thing that we 

would be evaluating and trying to get a handle on, market position 

or price impact, is the size of a position that any trader might hold, 

and concentration of a position can lead to concerns about impact 

on price. So that is going to be an area that we would be focused 

on. 

Senator MERKLEY. Thank you, Mr. McGonagle. 

And, Mr. Bay, in the case of electricity trading, do you see an impact on the end user? 

Mr. BAY. Anytime there is fraud or manipulation, there is an impact on the end user, and, invariably, that cost is borne by consumers. 

18 

Senator MERKLEY. Thank you all very much. 

Chairman BROWN. Thank you, Senator Merkley. 

Senator Warren. 

Senator WARREN. Thank you, Mr. Chairman. Thank you for holding this hearing and for your leadership in this area. I think your 

focus on this set of issues has already benefited consumers and 

helped some small businesses. I think you are starting to move 

things. And I want to echo your comments about the Fed’s decision 

yesterday, certainly a step forward but a meager one. 

I think we already have ample evidence that the Fed needs to 

place additional restrictions on how banks trade and warehouse 

physical commodities to reduce systemic risk and to protect consumers from market manipulation. And I hope once the public comment period ends that the Fed will act quickly to put those restrictions in place. 

You know, the Fed history here is very troubling. We still have 

not recovered from the failures of the Fed and the other banking 

agencies to limit systemic risk and protect consumers leading up to 

the 2008 financial crisis. And as important as it is for the Fed to 

put time and resources into monetary policymaking, we have 

learned the hard way that there is also a need for the Fed to pay 

a lot more attention on the front end through their regulatory functions and to better protect us all. 

So let me just start with a quick question for Mr. Gibson. If we 

reinstituted the protections of the Glass-Steagall Act, as the bill I 

introduced with Senators McCain, Cantwell, and King would do, 

would the Fed still be in the position where it had to decide whether trading in zinc is OK but trading in aluminum is not, or how 

much insurance an oil tanker should carry? Mr. Gibson. 

Mr. GIBSON. I do not know the detailed provisions of your bill, 

but there certainly would—if the authorizations that financial holding companies have to do these commodities activities were removed, then, no, we would not have to worry about that. 

Senator WARREN. So the Fed would not be in that business? 

Mr. GIBSON. Right, because it would not be a permitted activity, 

period. 

Senator WARREN. That is right. Well, I have to say that sounds 

pretty appealing to me. 

I want to turn to the enforcement side of this issue as well. Senator Markey and I sent a letter to FERC in July with some questions about the settlement with JPMorgan over claims of energy 

market manipulation. And I appreciated the very prompt and very 

thorough response that I received back from the FERC Chairman, 

and I have a few follow-up questions about FERC and the FTC— 

FCTC—I am saying it backwards—the CFTC’s coordination in this 

area. 

So in its response to my letter, FERC said that it needed access 

to the CFTC’s large trader report so that it could effectively look 

for possible manipulation in the energy markets. And the large 

trader report identifies individuals and institutions that have made 

large transactions in the futures market. 

Mr. Bay, could we start by having you explain briefly why access 

to the large trader report is so important to FERC’s efforts to monitor the energy market and energy market manipulation? 

19 

Mr. BAY. Thank you, Senator Warren. So FERC receives data on 

the physical gas and power markets, and the Commission has 

issued a number of rulemakings over the years to get even more 

data. That data has been very helpful for us in terms of beefing up 

our market surveillance. But the regulatory construct behind FERC 

and the CFTC was fashioned years ago when there was basically 

a physical market for energy and then there was a very, very small 

financial market. 

For example, the first oil derivative was not issued by NYMEX 

until 1978. The first natural gas futures contract was not issued on 

NYMEX until 1990. The first electricity derivatives was not issued 

on NYMEX until sometime after that. 

But what has happened is that whereas at one time the physical 

market was much bigger than the financial market, that is, the derivatives market, the converse has now occurred. And with respect 

to cross-product manipulation, you can think of them as having 

three components: there is a tool, there is a target, and there is a 

benefiting position. 

Typically the tool is some sort of trading activity that affects the 

value of a physical commodity product, right? So you do something, 

you trade maybe in a way that is even uneconomic with respect to 

the physical transaction, but you are doing that because you are 

trying to move prices. 

But then, to complete the manipulation, you need to have a benefiting position, and that benefiting position invariably in the investigations that we have done involving cross-product manipulation 

has involved a financial product. 

And so if we had access to more financial data, it would allow 

us to create both more sophisticated but also more sensitive and efficient algorithms, screens that we would run against the data that 

we receive. 

I am pleased to say, however, that FERC and the CFTC entered 

into an MOU in which the CFTC agreed to provide data to us for 

surveillance purposes, and we look forward to having discussions 

with the CFTC to get that data. 

Senator WARREN. Well, so that was actually my question in this 

because I wanted to follow up about the coordination between the 

two agencies. It is not just that you decided to do it. Dodd-Frank 

required that the CFTC and FERC agree on principles for sharing 

data, so the two agencies together could more effectively monitor 

market manipulation than either one of you would be able to do 

alone. 

It took 31⁄2 years for you to work this out, but I understand that 

it was 2 weeks ago that you just entered into an agreement for how 

to share data. But as I understand it, the CFTC at that point did 

not commit to share the large trader report with FERC. So I am 

concerned about this and just want to make sure that I understand 

this. 

Mr. McGonagle, I am concerned if the CFTC is unwilling to 

share this piece of information. Is it right that you have not yet 

agreed to that? And if so, can you explain why? 

Mr. MCGONAGLE. Thank you, Senator. With respect to surveillance, access to information, we have invited FERC staff to come 

to CFTC premises while we work out a protocol that ensures that 

20 

the information that we receive within our records and rules, as 

mandated by Congress for confidentiality concerns, that that information can be transferred and shared in a way that satisfies our 

obligations. And so in the interim, we have offered to work with 

FERC staff so that they can have access to the information. 

I should also point out that certainly since 2005 and before, as 

part of the 2005 Memorandum of Understanding that we have with 

the FERC, and just as an overall matter, our cooperative enforcement relationships with all other Federal regulators, when it comes 

to information sharing, particularly with respect to enforcement investigations, we have worked very diligently with FERC, received 

information from FERC as well, as we do with other agencies. And 

so this is one additional aspect, surveillance, layered onto what I 

view as an already strong, cooperative enforcement relationship. 

Senator WARREN. So let me just make sure that I understand 

this, Mr. McGonagle. I do not want to miss this. So you are making 

the large trader report available to FERC people in any investigation. They have to come to your place to do it, but it is available? 

Is that right? 

Mr. MCGONAGLE. That is right, and then—— 

Senator WARREN. Fully available? 

Mr. MCGONAGLE. Fully available. 

Senator WARREN. OK. And that is your understanding, too, Mr. 

Bay, that it is now fully available? 

Mr. BAY. We sent staff to the CFTC last week, and they were 

able to access the large trader report. That was a step forward. 

What we are hoping to receive at some point—and this is a detail 

to be worked out under the MOU. We believe that the MOU supports this. What we are hoping to receive is an ongoing live data 

stream of the relevant financial data for the gas and power markets from the large trader report. 

Senator WARREN. OK. And, Mr. McGonagle, I understand from 

you that the only reason this has not been done is that you have 

concerns about working out the details about confidentiality. That 

is what I thought I heard in your answer, that there is more that 

FERC needs to do in order to reassure you about the confidentiality 

of the data they are receiving? Is that right? 

Mr. MCGONAGLE. That is effectively correct. The FERC has guaranteed that they would maintain the confidentiality provisions that 

we are also obligated to under Section 8. The questions—there are 

questions sort of around data transfer issues, and the technical 

personnel need to work those things out, and that process is ongoing. 

Senator WARREN. I am sorry. So you are saying that the confidentiality issues have been worked out, but you have still got 

some technical data issues. Forgive me for pushing on this, but I 

think it is a really important point. Market manipulators do not respect jurisdictional boundaries between agencies. In fact, they try 

to exploit those boundaries and take advantage of gaps in oversight 

and in data sharing. And that is why it is absolutely critical that 

the Commodity Futures Trading Commission be willing to share 

these data on an ongoing, timely basis with FERC. 

And so the reason I ask about this is I want to hear that we are 

going to protect consumers, we are going to protect the public by 

21 

making sure that these data are shared. I will follow up on this, 

but I sincerely hope I will not need to because all of this is resolved 

and that those data are going smoothly and quickly over to FERC 

as well. Thank you. 

Thank you, Mr. Chairman. 

Chairman BROWN. Thank you, Senator Warren. 

Before we move on, I want to ask unanimous consent that the 

following two documents be included in the record of today’s hearing: the letter which I cited from Commissioner Chilton and a 

statement from the North American Die Casting Association, which 

has been affected by this issue. Without objection, so ordered. 

Mr. Gibson, back to you. You give 4(k) orders. You can take them 

away, right? 

Mr. GIBSON. Yes, that is right. 

Chairman BROWN. OK. There is an old adage that it is easier to 

ask forgiveness than it is to get permission. That seems to be the 

way that Wall Street has approached this in a number of cases. Let 

me give you an example. 

In 2005, JPMorgan requested the authority to engage in complementary activities, requesting the ability to ‘‘make or take physical delivery of, and in some instances store, certain commodities.’’ 

The Board’s 4(k) complementary order for JPMorgan said it is not 

authorized to own, operate, or invest in facilities for the extraction, 

transportation, storage, or distribution of commodities to protect 

the bank from storage risk, transportation risk, and legal and environmental risk. They cited—in this complementary order they cited 

the risks. 

Five years later, JPMorgan Chase—or JPMorgan, excuse me, 

purchased assets from RBS Sempra, including the Henry Bath 

Company, which owns an LME warehouse. We still do not know 

the outcome, but we do know that they were turned down for a 

complementary order in 2005, but in 2010 it still seems to be pending, the 5-year clock not expired by using a different legal provision. Instead of complementary, they are using merchant banking. 

But if the risks are there, the risks exist to the financial system 

that JPMorgan wanted to purchase something in 2005, the risks 

were there under the complementary order, why would the Fed 

allow this to happen under the merchant banking provision? 

Mr. GIBSON. The risks of certain activity exist regardless of 

which authority a financial holding company is using, but as we 

talk about in the ANPR, the restrictions that we can impose and 

the legal treatment are different, depending on which authority 

they are using. One of the things we have to evaluate going forward as we look for what actions to take is we might have an ultimate goal that might require different actions with respect to 4(k) 

authority or with respect to merchant banking, and we already 

talked about 4(o) authority gives us even less ability to impose restrictions. 

Chairman BROWN. So 4(k), under 4(k) authority, you do not have 

an ability to find a way to minimize that risk to JPMorgan in this 

case, but under merchant banking you might be able to minimize 

the risk for the same purchase of the same entity? 

22 

Mr. GIBSON. We have the most ability and have imposed the 

most limits on the 4(k) authorities that we have granted, and we 

have imposed, as you mentioned, tight limits—— 

Chairman BROWN. I said it backwards. 

Mr. GIBSON. Oh, OK. Under merchant banking there is pretty 

broad authority granted in Gramm-Leach-Bliley, which does not require any approval, to invest in nonfinancial businesses. Now, one 

of the limits that is imposed on that is there is a time limit, so it 

is a 10- or 15-year time limit for merchant banking investments. 

The company is not allowed to manage or operate it. And we do 

have capital requirements, which are relatively tough, on merchant 

banking investments. 

Chairman BROWN. And under the merchant banking provision, 

you expect them to buy it and sell it. That is the purpose of the 

merchant banking provision. 

Mr. GIBSON. Yes. 

Chairman BROWN. And they have 10 years to do that. 

Mr. GIBSON. That is right. 

Chairman BROWN. And they bought this in 2010, and you have 

not yet given them retroactive, for want of a better word, permission, correct? 

Mr. GIBSON. You are talking about Henry Bath? 

Chairman BROWN. Yes. 

Mr. GIBSON. They purchased it in 2010. It was part of a larger 

acquisition, as you mentioned, and the way we look at acquisitions 

like that is that if the bulk of the acquisition is a permissible activity, they are allowed to include a small amount of impermissible 

activities, but then they are required to divest it. And that is the 

basis on which they purchased the Henry Bath business. They 

have not been given any authorization to permanently hold it, and 

they are in the process of divesting it. 

Chairman BROWN. They are in the process of divesting it. What 

does that mean? 

Mr. GIBSON. It means we have given them a time limit, and they 

are giving us quarterly reports on their progress at divestiture. 

They have presented a plan for how they are marketing the business, and we are having quarterly updates from them, monitoring 

their progress on the plan, and they have an ultimate time limit. 

Chairman BROWN. And leading up to this hearing, a number of— 

a couple three reporters said, well, is this still an issue? Because 

these financial institutions are starting to sell some of these commodities and some of these things they own, but there is no real 

evidence that they have actually sold them, which sort of begs the 

question how hard it is to do this. The Fed’s order, 2005 order, limited JPMorgan to only exchange-traded derivatives to prevent investments in things like real estate that, in the Fed’s words, 

‘‘lacked fungibility and liquidity.’’ Now that they own fiscal assets, 

there are reports that the process of selling these warehouses has 

been awkward and challenging, which isn’t that the exact risk the 

Fed was trying to avoid, to prevent these institutions from investing in things like real estate? Isn’t that—I mean, why do we allow 

these acquisitions when there is some likelihood that they will be 

very hard to divest themselves of at some point in the future? 

23 

Mr. GIBSON. Again, the different authorities allow financial holding companies to do different things. Under merchant banking authority, firms are typically investing in whole companies, which are 

not very liquid, and that is why there is a long holding period attached to that, because it is intended to be a long-term investment. 

Under the 4(k) authorities that we have granted for ownership 

of physical commodities, those have been limited to a small number 

of commodities that are judged to be liquid, which the general 

standard is traded on an exchange or futures exchange. Under 

those authorities it is a limited set, and it is intended to be liquid. 

We have turned down applications for certain commodities to be 

added to the list because they were deemed not liquid enough. But 

that is separate from the merchant banking authority, which is for 

long-term investments that could very well be illiquid. 

Chairman BROWN. OK. Mr. Gensler—I am sorry, Mr. McGonagle. 

It is Chairman Gensler. Sorry about that. In 2013, then-Chairman 

Gensler testify before the Senate Banking Committee that the 

CFTC ‘‘has clear authority to police markets for fraud, manipulation, and other abuses.’’ After Goldman Sachs and other financial 

companies bought LME warehouses, aluminum delivery queues increased, as we discussed in the hearing in July, and as the New 

York Times wrote about, increased from approximately 7 months in 

2011 to more than 550 days last year. This Subcommittee heard 

testimony from an aluminum consumer who described a variety of 

unnatural market forces driving up delivery times, increasing the 

price of aluminum. The LME in its report said it found the fundamental role of the queues is to increase premiums. The evidence 

shows that as queues increased, so did premiums, 10 cents per ton, 

roughly, to a record high 19 cents per ton last week. 

Do you agree that with the LME, queues increase aluminum 

prices? 

Mr. MCGONAGLE. Thank you, Chairman. I agree that the issue 

is something that requires some degree of evaluation by CFTC, 

particularly as it relates to the fact that the LME has applied for 

registration as a foreign board of trade. And so by doing that, they 

will represent and have to speak with us, and we are engaged with 

LME and with U.K. FCA, the LME’s regulator, with respect to how 

this warehousing issue, these questions concerning premiums, 

rents, incentives, where are the legitimate forces of supply and demand, and how is this activity consistent with commercial practices 

and potentially where is it not or where can it be fixed. 

You began your question by pointing to the former Chairman’s 

authority, discussion of authority for fraud and manipulation, and 

certainly with respect any price effect, to the extent that there is 

any conduct that interferes with the price of a commodity in interstate commerce, CFTC separately has jurisdiction for fraud and 

manipulation, and they would undertake that authority pursuant 

to a nonpublic investigatory process. 

Chairman BROWN. So do you consider this manipulation of 

queues which leads to higher premiums and higher aluminum 

prices, do you consider this commodities manipulation under the 

Commodities Exchange Act? 

Mr. MCGONAGLE. I consider the activity with respect to what is 

the basis for the premium and whether it is due to legitimate comVerDate Nov 24 2008 10:22 Oct 30, 2014 Jkt 046629 PO 00000 Frm 00027 Fmt 6633 Sfmt 6633 L:\HEARINGS 2014\01-15 REGULATING FINANCIAL HOLDING COMPANIES AND PHYSIC
24 

mercial activity as an area that can be explored by CFTC through 

the application process by LME for a foreign board of trade. Separately—and so I do not offer an opinion here whether there is information concerning any activity with respect to any commodity, 

frankly, that is not borne out by legitimate forces of supply and demand—that can be subject to an enforcement investigation. So I 

am not making that determination here. I have seen a lot of information certainly in connection with the warehousing study that the 

LME put forward in November and its proposals going forward, 

which we are evaluating from a regulatory standpoint within my 

Division. 

Chairman BROWN. Can you use the no-action letter and the 

FBOT approval process as leverage to force changes? Does that 

give you the authority to do that? 

Mr. MCGONAGLE. Ultimately we can revoke or suspend any noaction letter that is issued by the Division of Market Oversight. My 

expectation and hope would be, to the extent that we can effect real 

change short of revoking registration, that we would explore those 

opportunities. But that is certainly available as a remedy. 

Chairman BROWN. Commissioner Chilton said, ‘‘Frankly, my experience in this matter is there is surprisingly little CFTC interest, 

shockingly little interest in physical ownership of banks that could 

impact derivative markets.’’ 

Mr. MCGONAGLE. The focus of CFTC is for price discovery in connection with the derivatives market that we have direct oversight 

authority for. Our connection to cash markets authority is driven 

primarily through enforcement and ensuring that there is no fraud 

or manipulation with respect to commodities and interstate commerce. So to the extent that a bank, for example, has an ownership 

interest or a trading position on an exchange, they will have reporting obligations already to the CFTC, and we can get further information about their activity. If there is not a trading position, a 

regulatory sort of mandate about cash market activity I think is a 

different conversation for the Commission and for this body to consider with respect to what is our current focus, which are derivatives markets and price discovery versus oversight over particular 

entities in cash market positions. 

Chairman BROWN. Thank you. 

Senator Warren, other questions? 

Senator WARREN. No. 

Chairman BROWN. You are done? OK. Thank you. 

Thank you to the panel. I want to close with a couple comments. 

These activities have been justified during this hearing and in 

other ways by the benefits they are supposed to provide to individuals and companies in the real economy. We are told that they improve the markets that produce the cans that hold your drinks, the 

gas that fuels your car, the energy that lights your home. But in 

many ways, speculation in the commodities futures and derivatives 

markets has become an end in itself. The issue is as much about 

financial institutions becoming industrial businesses as it is about 

the financialization of the real economy. It is an important issue 

because it forces us to ask whom ultimately we want our economy 

to serve. In my mind, it is time for us to pick workers and consumers and taxpayers over the speculators, over the ‘‘too big to 

25 

fail’’ banks. I do not think we have done that yet. I think we know 

what our mission is. Thank you. 

Anyone that has some—please, if you would, any additional questions anybody on the panel asks, if they would send you letters, 

you would get answers back to those as quickly as you could. 

Thanks very much. 

The hearing is adjourned. 

[Whereupon, at 3:20 p.m., the hearing was adjourned.] 

[Prepared statements, responses to written questions, and additional material supplied for the record follow:] 

26 

PREPARED STATEMENT OF NORMAN C. BAY 

DIRECTOR, OFFICE OF ENFORCEMENT, FEDERAL ENERGY REGULATORY COMMISSION

JANUARY 15, 2014 

Mr. Chairman, Ranking Member Toomey, and Members of the Subcommittee: 

Thank you for inviting me to testify today. My name is Norman Bay. I am the Director of the Office of Enforcement of the Federal Energy Regulatory Commission 

(FERC or the Commission). I appear before you as a staff witness, and the views 

I present are not necessarily those of the Commission or any individual Commissioner. In the testimony that follows, I provide an overview of the Commission’s Office of Enforcement, focusing on our efforts to combat fraud and market manipulation, and in so doing will respond to the specific questions the Subcommittee asked 

me to address in its January 6, 2014, letter. 

The Commission’s core legal authority for investigating and enforcing Congress’s 

prohibition on fraud and market manipulation in FERC-jurisdictional electric and 

natural gas markets is the Energy Policy Act of 2005 (EPAct 2005) (which added 

a section prohibiting energy market manipulation to both the Federal Power Act 

and the Natural Gas Act). In this Act, passed in the wake of Enron’s manipulation 

of Western energy markets, Congress gave the Commission broad authority to protect energy market consumers from any type of fraud or market manipulation affecting FERC-regulated wholesale physical natural gas and electric markets. Congress patterned EPAct’s fraud and manipulation prohibition on the similarly broad 

antifraud and manipulation provisions in the Securities and Exchange Act of 1934— 

which the Securities and Exchange Commission (SEC) relies on to police misconduct 

in the securities markets. Shortly after EPAct 2005 was passed, the Commission implemented this statute through its antimanipulation regulations, codified at 18 CFR 

§1c. The Office of Enforcement relies on the antimanipulation statute and regulations to investigate potential fraud or market manipulation and, when a matter cannot settle on terms favorable to the public interest, bring enforcement actions 

against companies or individuals who engage in fraud or manipulation affecting 

FERC-regulated markets. 

Another key aspect of EPAct 2005 is its enhanced civil penalty provisions. Before 

EPAct 2005, maximum civil penalties for violations of many Commission rules, including acts of fraud and manipulation, were only $10,000 per violation per day. 

EPAct 2005 granted the Commission the authority to impose up to $1 million per 

violation per day for fraud and market manipulation (and other violations). To date, 

the Commission has imposed and collected approximately $873 million in civil penalties and disgorgement following EPAct 2005. This consists of approximately $577 

million in civil penalties, which goes to the U.S. Treasury, and approximately $296 

million in disgorgement of unjust profits. (This amount does not include fines in 

electric market manipulation matters to be reviewed in Federal court, for example, 

the approximately $453 million civil penalties assessed by the Commission in the 

Barclays market manipulation matter.) 

Now I would like to address the Subcommittee’s request for an assessment of the 

Commission’s ability to detect, investigate, and enforce violations of EPAct 2005’s 

fraud and antimanipulation rules. My view is that with EPAct 2005’s antifraud and 

market manipulation provisions and civil penalty authority, the Commission’s implementing regulations, and the Office of Enforcement’s enhanced surveillance and 

investigative capabilities (briefly summarized below), we do have the tools necessary 

to effectively police FERC-regulated markets to deter fraud and market manipulation. Of course, we continue to think about ways we can expand our capabilities. 

But we feel we are to up this important task that Congress has given us. 

Over the past few years, the Commission’s Office of Enforcement has substantially expanded its investigative and analytical capabilities and has developed extensive new surveillance tools. Among the most important achievements is the creation, 

in February 2012, of the Office of Enforcement’s Division of Analytics and Surveillance (DAS). DAS develops surveillance tools, conducts surveillance, and analyzes 

transactional and market data to detect potential manipulation, anticompetitive behavior, and other anomalous activity in the wholesale electricity and natural gas 

markets. DAS staff includes approximately 45 professionals, including, for example, 

economists, energy industry analysts, former traders, and former risk managers. 

For its surveillance efforts, DAS has created internal market screens—both for 

the electric and natural gas markets—that use behavioral and statistical measures 

and techniques to detect abnormal trading patterns. Statistical analyses are performed through automated market screens that employ disparate market data to detect anomalies and suspicious trading patterns. The data, both physical and financial, is gathered from numerous sources, and the Commission has taken significant 

27 

steps in rulemakings over the past few years to expand these sources. With more 

data, and experience learned from past and current investigations, DAS continues 

to enhance its surveillance screens. 

DAS staff also works hand in hand with the Office of Enforcement’s Division of 

Investigations—which houses the attorneys and other staff that conduct investigations, negotiate settlements, and bring enforcement actions. The Division of Investigations has strengthened its staff of attorneys in the past few years, and now has 

approximately 45 attorneys, including former Federal prosecutors as well as civil 

litigators and energy regulatory lawyers from top law firms. 

I know the Subcommittee is interested in learning more about fraud and market 

manipulation conduct by financial institutions that has occurred in FERC-regulated 

markets. As you have asked, let me provide a high-level description of the mechanics of potential manipulation involving the interplay between financial and physical 

energy markets. Although the mechanics of a manipulative scheme can be highly 

detailed and complex, and each investigation is different from the next, there is a 

general framework that cuts across many of the manipulation matters involving the 

trading of energy products that we have investigated and are currently investigating. 

A fundamental point necessary to understanding many of our manipulation cases 

is that financial and physical energy markets are interrelated: physical natural gas 

or electric transactions can help set energy prices on which financial products are 

based, so that a manipulator can use physical trades (or other energy transactions 

that affect physical prices) to move prices in a way that benefits his overall financial 

position. One useful way of looking at manipulation is that the physical transaction 

is a ‘‘tool’’ that is used to ‘‘target’’ a physical price. For example, the physical tool 

could be a physical power flow scheduled in a day ahead electricity market at a particular ‘‘node’’ and the target could be the day ahead price established by the market 

operator for that node. Or the physical tool could be a purchase of natural gas at 

a trading point located near a pipeline, and the target could be a published index 

price corresponding to that trading point. The purpose of using the tool to target 

a physical price is to raise or lower that price in a way that will increase the value 

of a ‘‘benefiting position’’ (like a Financial Transmission Right or FTR product in 

energy markets, a swap, a futures contract, or other derivative). 

Increasing the value of the benefiting position is the goal or motive of the manipulative scheme. The manipulator may lose money in its physical trades, but the 

scheme is profitable because the financial positions are benefited above and beyond 

the physical losses. Understanding the nature and scope of a manipulator’s benefiting financial positions—and how they relate to the physical positions—is a key 

focus of our manipulation cases. This is for the simple reason that our antifraud and 

manipulation rule (like the SEC’s) is an intent-based rule: a finding of manipulation 

requires proving that the manipulator intended (or in some cases, acted recklessly) 

to move prices or otherwise distort the proper functioning of the energy markets the 

Commission regulates. A company can put on a large physical trade that may affect 

market prices, but if the purpose of that trade is to hedge risk or speculate based 

on market fundamentals—rather than, for example, the intent to move prices to 

benefit a related financial position—this conduct, without more, would not violate 

our antifraud and manipulation rule. 

Another key point is that the physical trading (the tool) may and usually does 

occur in FERC-regulated markets, but the benefiting financial position may be held 

in a non-FERC regulated market such as a futures or swaps market exchange regulated by the Commodity Futures Trading Commission (CFTC). This is not always 

the case: for example, we have investigated manipulation in which the financial 

benefiting position is within FERC markets. But, often, the physical trading occurs 

in FERC markets and the benefiting position is established outside of FERC markets. 

We have numerous public examples of market manipulation that fit into this general description (and many others that remain nonpublic). The public matters are 

either in the form of settlements or ‘‘Order to Show Cause’’ proceedings in matters 

that have not settled and may be headed to trial. In either case, the settlement or 

other order sets forth a description of the facts and a discussion of why the Commission concludes that the facts support a finding of market manipulation. (In all instances, the settlement or order will be published on the Commission’s Web site, at 

www.ferc.gov.) 

A recent settlement fitting the manipulation framework above is our January 

2013 settlement with Deutsche Bank. See Deutsche Bank Energy Trading, LLC, 142 

FERC Par. 61,056 (2013). Let me briefly describe the mechanics of the manipulative 

scheme here. Deutsche Bank held a type of energy contract commonly used to hedge 

against, or profit from, the ‘‘congestion’’ on a transmission line that occurs when, 

28 

for various technical reasons, the line cannot carry all the electricity needed at a 

particular supply or delivery point on the grid. These contracts are often called Financial Transmission Rights or FTRs—though in the California Independent System Operator (CAISO) market at issue in the Deutsche Bank matter, they are called 

Congestion Revenue Rights (CRRs). In early 2010, Deutsche Bank began to lose 

money on its CRR contracts. The company initially sought to limit its losses by purchasing new CRRs in the CAISO market to reduce its exposure to congestion. But 

these new CRR purchases did not fully cover its losses. So Deutsche Bank energy 

traders devised and implemented a manipulative scheme that involved buying and 

selling physical electricity so as to alter congestion levels, and resulting market 

prices, at the same point corresponding to their CRR contracts. These physical 

transactions (in addition to violating the CAISO tariff) were unprofitable and inconsistent with market fundamentals, but did have the effect of increasing the value 

(i.e., by limiting losses) of Deutsche Bank’s CRRs. 

In short, to use the framework above, Deutsche Bank used a ‘‘tool’’ of physical energy transactions to ‘‘target’’ congestion levels and corresponding energy prices within CAISO in order to increase the value of CRR ‘‘benefiting positions’’—in violation 

of EPAct 2005 and the Commission’s antimanipulation rule. 

A recent order also fitting this framework is the Commission’s July 2013 Order 

Assessing Civil Penalties in Barclays. See Barclays Bank, PLC, et al., 144 FERC 

Par. 61,041 (2013). The Commission’s assessment of civil penalties and 

disgorgement in Barclays will be reviewed in Federal district court, so the litigation 

is ongoing and my comments will have to be limited. That being said, I can nonetheless provide a brief description consistent with published Commission orders. 

Barclays and its energy traders amassed substantial positions of physical electricity contracts through their transactions on the IntercontinentalExchange (ICE) 

trading platform. Barclays and its traders also assembled a financial swaps position 

at four important trading points in Western energy markets, whose value was 

pegged to published electricity price indices set by the physical electric contracts 

Barclays traded. The Commission found that Barclays engaged in manipulative 

physical trades to ‘‘flatten out’’ the physical electricity positions it had amassed on 

its trading books in a manner designed to influence the index prices that determined the value of its swaps. Barclays’s physical trading was uneconomic and not 

based on market fundamentals; indeed, the company often lost money in the physical markets. But Barclays’s physical trading nonetheless profited the company overall because its trades helped move the index price that set the value of its larger 

financial swaps benefiting position. 

Fraud and manipulation can take other forms, and many of our manipulation 

matters, including with financial institutions, do not neatly fit within the tool-target-benefiting position framework described above. A notable example is the Commission’s July 2013 settlement with a wholly owned subsidiary of JPMorgan which, 

among other terms, required JPMorgan to pay a combined $410 million in civil penalties and disgorgement to ratepayers. See In Re ‘‘Make-Whole Payments and Related Bidding Strategies’’, 144 FERC Par. 61,068 (2013). 

This settlement resolved the Office of Enforcement’s investigation into 12 manipulative bidding strategies designed to make profits from power plants that were usually out of the money in the marketplace. In these manipulative strategies, which 

are described in greater detail in the settlement agreement and order approving it, 

the JPMorgan subsidiary defrauded market operators in California (CAISO) and 

Michigan (MISO) by making bids into these markets that were not grounded in the 

normal forces of supply and demand, and were expected to, and did, lose money at 

market rates. The JPMorgan subsidiary’s purpose in submitting these bids was not 

to make money based on market fundamentals, but to create artificial conditions 

that would cause the CAISO system to pay the company outside the market at premium rates. Enforcement staff also determined that JPMorgan knew that the 

CAISO and MISO markets received no benefit from making these inflated payments 

and, thus, the company defrauded these market operators by obtaining payments 

for benefits they did not deliver. 

The Subcommittee has also asked whether there are regulatory limitations on the 

Commission’s antifraud and manipulation oversight efforts. There are two such limitations I would like to highlight today. The first concerns our ability to obtain certain financial data that is of great importance to our surveillance and investigation 

efforts. I have noted above that financial and physical natural gas and electric markets are interrelated—and have also noted that our surveillance screens, among 

other features, seek to detect anomalies in both physical and financial trading. But 

our surveillance program has limitations because we do not have access at present 

to certain financial data from the related financial markets. This missing financial 

29 

data creates a gap in the Commission’s ability to conduct effective and comprehensive surveillance of the natural gas and electric markets. 

Much of the relevant financial data we seek is traded on markets regulated by 

the CFTC. Despite negotiations over several years, the CFTC has not yet provided 

FERC with access to the financial information and data our Office of Enforcement 

needs, except on an ad hoc case-by-case basis. This obstacle prevents Commission 

staff from seeing the complete picture of what is occurring in its jurisdictional markets and from fully integrating the financial information into its automated screens. 

Although the Commission’s screening program is robust and has enabled Commission staff to detect potential manipulation, this program would be improved with access to the CFTC data. However, earlier this month, FERC and the CFTC signed 

a Memorandum of Understanding that is intended to result in broader information 

sharing than currently occurs and is, therefore, a first step toward sharing appropriate data in a timely manner. It will be essential for the agencies to work together 

and to make an institutional commitment to, as well as the resources necessary for, 

the day-to-day, nuts-and-bolts implementation of the concepts established in this 

Memorandum of Understanding. 

A second limitation follows from the decision by the U.S. Court of Appeals for the 

District of Columbia Circuit last year in Hunter v. FERC, 711 F.3d 155 (D.C. Cir. 

2013). In Hunter, the court ruled that the CFTC’s exclusive jurisdiction over futures 

contracts deprives FERC of authority to bring an action based on manipulation in 

the futures market, even if the activity affected prices in the physical markets for 

which FERC has exclusive jurisdiction. Although the Commission reads the Hunter 

decision as narrow in scope, some market participants interpret the decision more 

broadly to cover not only manipulation in the futures market, but also many additional transactions and products, including those squarely within FERC’s jurisdictional markets. Accordingly, a legislative fix to eliminate uncertainty on this matter 

could ensure that FERC has the full authority needed to police manipulation of 

wholesale physical natural gas and electric markets. 

The Subcommittee has also asked about the potential market risks and economic 

consequences of financial holding companies’ direct involvement in FERC-jurisdictional markets. The Commission has not taken any view on the participation in its 

regulated markets by financial holding companies (or any trading firm, bank, or 

other financial institution) versus more traditional energy companies like generators, utilities, or natural gas pipeline owners. Instead, the Commission’s general 

view has been that financial institutions of all kinds, as well as energy companies 

of all kinds, can benefit markets in numerous ways, for example, by providing liquidity to market participants who may want to hedge their risk. However, the 

Commission expects financial institutions, like all other participants in FERC-regulated markets, to have good compliance programs, transact in a manner that follows 

market rules in letter and spirit, work cooperatively with grid operators and the 

Commission when there are concerns, and self-report potential violations. The Subcommittee has asked for information about written guidance the Commission has 

issued internally or otherwise regarding the direct activities of financial institutions 

in the energy market. I am not aware of any specific rules under our Federal Power 

Act ratemaking authority that would apply uniquely to financial institutions that 

participate in Commission-jurisdictional markets. However, any rules that govern 

those markets would apply equally to financial institutions as well, such as the 

rules governing the eligibility for market-based rate authority, rules prohibiting 

market manipulation, creditworthiness rules in the organized markets, and any tariff rules governing the organized markets, including those regarding bidding into 

the markets. Further, financial institutions that are public utilities by virtue of 

their ownership or operation of jurisdictional facilities are subject to the requirements of section 203 of the FPA concerning the acquisition or disposition of jurisdictional facilities. 

With respect to whether there are emerging trends, including fraud and manipulation associated with financial institutions’ operations in the energy market, I note 

that banks and financial holding companies have generally played a role in the 

physical wholesale electric market. Based on year-to-date electric industry reports 

to the Commission, sales by banks and financial holdings companies represent 13 

percent of total revenues for energy and ‘‘booked out power’’ (energy or capacity contractually committed for delivery but not actually delivered because of an offsetting 

trade). Moreover, full year electric sales by financial institutions were approximately 

$15 billion in 2012, down from $45 billion in 2008 for those companies, when sales 

represented approximately 20 percent of the market. Combined bank and financial 

institution revenues from electricity sales have declined during this time by tens of 

billions of dollars; Commission electric sales data, however, do not include sales in 

the ElectricReliability Council of Texas, which are nonjurisdictional. 

30 

Banks and financial institutions also play a role in the direct ownership of physical electric assets—owning less than 4 percent of total U.S. generator nameplate 

capacity (basically, the maximum rated output of a generator) as of June 2013. 

(Banks and financial institutions may have greater economic rights to revenues 

from generators through leasing arrangements called tolling agreements; but the 

percentage of direct ownership has been relatively small.) 

Banks also play a role in the ownership of U.S. natural gas storage facilities and 

pipelines. For example, financial institutions own less than 1 percent of total U.S. 

natural gas storage capacity and about 14 percent of total U.S. natural gas pipeline 

miles (both intrastate and interstate). 

With respect to natural gas, FERC data shows that physical natural gas sales by 

banks represented about 6 percent of total U.S. reported sales in 2012, down from 

8 percent in 2011. This decrease may be due to a combination of low volatility and 

low prices in natural gas markets, which has caused banks and other financial institutions to shift their capital to more profitable opportunities in other markets. Sales 

by nonbank financial institutions represented only 2 percent of total reported sales 

in both 2011 and 2012. 

I would also like to note, because it is especially relevant to manipulative conduct, 

that the market share of a given bank or financial institution at a particular natural 

gas trading hub or electric market trading point could nonetheless be high and have 

a significant effect on the price formed at that hub or point. That is, banks and financial institutions as a whole may have a relatively lower percentage of sales and 

generation ownership interest compared to more traditional energy companies, but, 

as we have seen in our investigations, they may retain the ability to move prices 

in a manipulative manner. 

In response to the Subcommittee’s question about trends, I would also like to note 

that although the Commission has recently approved settlements and orders assessing civil penalties against banks and financial institutions, in a few of these matters 

the manipulative conduct occurred several years ago, including as far back as 2006– 

2007. Also, now that the Office of Enforcement has had several years to implement 

a robust enforcement regime following EPAct 2005, the Commission is in a better 

position to promptly detect, investigate, and seek sanctions against fraudulent and 

manipulative conduct. In particular, I would highlight the surveillance efforts and 

sophisticated staff we have developed, as discussed earlier in my testimony. Given 

that the Commission’s enhanced enforcement capabilities are relatively new, it is 

difficult for me to draw conclusions that there are emerging trends associated with 

financial institutions’ potential misconduct in FERC-jurisdictional markets. Our recently announced manipulation matters, in other words, may be as much a product 

of our enhanced detection and enforcement abilities over the past few years rather 

than any uptick in manipulative conduct by financial institutions or other market 

participants. 

The Subcommittee has asked for a description of our coordination efforts with 

other U.S. banking or financial market regulators. With respect to investigations, 

the Commission’s Office of Enforcement has coordinated or shared information regarding various matters with other Federal Government agencies, in particular, the 

Department of Justice and United States Attorneys’ Offices, the CFTC, the SEC, the 

Federal Trade Commission, the Federal Reserve, and the Environmental Protection 

Agency. Our coordination on investigations with the CFTC has been routine given 

the relationship between electricity and natural gas products traded on CFTC-regulated futures and derivatives markets and FERC-jurisdictional physical markets. 

Notwithstanding the above-noted concerns over the need for greater information 

sharing, FERC and CFTC enforcement staff have worked together on manipulation 

investigations involving improper trading conduct. We have also worked with the 

Department of Justice and the Federal Reserve in providing information about investigations involving financial institutions. And we have consulted with the SEC 

enforcement office, particularly relating to ‘‘best practices’’ in market surveillance 

and investigative techniques and procedures. The details of our coordination between FERC and these agencies, including the information we have provided, is 

nonpublic under Commission regulations, but we are happy to report to the Subcommittee that we have worked with these other Federal Government regulators 

and will continue to do so as a matter of good Government and for the good of our 

Nation’s energy markets. 

We are also happy to report that we are working with international regulators. 

In our discussions with them, they have commented on our innovation and leadership in market surveillance and oversight and in our use of sophisticated algorithmic screens to sift through vast amounts of trade data to detect potential manipulation in the wholesale gas and power markets. We have consulted with or provided technical assistance to regulators from a number of different countries, and 

31 

1 In addition to the provisions regarding listing of swaps on DCMs and SEFs, the Dodd-Frank 

Act provides that, unless a clearing exception applies and is elected, a swap that is subject to 

a clearing requirement must be executed on a DCM, SEF, or SEF that is exempt from registration under CEA, unless no such DCM or SEF makes the swap available to trade. 2DCM and SEF Core Principle 3 states, ‘‘Contract Not Readily Subject to Manipulation—The 

board of trade shall list on the contract market only contracts that are not readily susceptible 

to manipulation.’’ 3For example, while contracts can be submitted for approval, of the almost 5,000 contracts 

submitted by DCMs and SEFs since the Dodd-Frank Act was enacted, all were submitted on 

a self-certification basis, and over 2,000 contracts were certified in calendar year 2013 alone. 4 A DCM or SEF need wait only one full business day after the contract has been submitted 

to list the contract for trading. 

we are exploring information sharing MOUs with international regulators. That 

being said, we are always looking for ways to upgrade our capabilities and to do 

our best to protect and to advance the public interest. 

In conclusion, I want to thank the Subcommittee again for this opportunity to testify today. 

PREPARED STATEMENT OF VINCENT MCGONAGLE 

DIRECTOR, DIVISION OF MARKET OVERSIGHT, COMMODITY FUTURES TRADING

COMMISSION

JANUARY 15, 2014 

Chairman Brown, Ranking Member Toomey, and Members of the Subcommittee, 

thank you for the opportunity to appear before you today. I am Vincent McGonagle 

and I am the Director of the Division of Market Oversight of the Commodity Futures Trading Commission (CFTC). 

Background on Commodity Exchange Act and the CFTC Mission 

The purpose of the Commodity Exchange Act (CEA) is to serve the public interest 

by providing a means for managing and assuming price risks, discovering prices, or 

disseminating pricing information. Consistent with its mission statement and statutory charge under the CEA, the CFTC is tasked with protecting market participants 

and the public from fraud, manipulation, abusive practices and systemic risk related 

to derivatives—both futures and swaps—and to foster transparent, open, competitive, and financially sound markets. In carrying out its mission and statutory 

charge, and to promote market integrity, the Commission polices derivatives markets for various abuses and works to ensure the protection of customer funds. Further, the agency seeks to lower the risk of the futures and swaps markets to the 

economy and the public. To fulfill these roles, the Commission oversees designated 

contract markets (DCMs), swap execution facilities (SEFs), derivatives clearing organizations, swap data repositories, swap dealers, futures commission merchants, 

commodity pool operators, and other intermediaries. 

The CEA has for many years required that any futures transaction, unless subject 

to an exemption, be conducted on or subject to the rules of a board of trade which 

has been designated by the CFTC as a DCM. Sections 5 and 6 of the CEA and Part 

38 of the Commission’s regulations provide the legal framework for the Commission 

to designate DCMs, along with each DCM’s compliance requirements with respect 

to the trading of commodity futures contracts. With the passage of the Dodd-Frank 

Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), DCMs were 

also permitted to list swap contracts. Along with this expansion of product lines that 

can be listed on DCMs, the Dodd-Frank Act also amended various substantive DCM 

requirements, under CEA Section 5, and adopted a new regulatory category for exchanges that provide for the trading of swaps (SEFs). 1 The Commission revised its 

DCM regulations to reflect these new requirements, and also adopted regulations 

to implement the Dodd-Frank Act’s SEF requirements. 

Under the CEA and the Commission’s contract and rule review regulations, all 

new product terms and conditions, and subsequent associated amendments, are submitted to the Commission before implementation. In submitting new products and 

associated amendments, DCMs and SEFs are legally obligated to meet certain core 

principles; one of the most significant being the prohibition, in DCM and SEF Core 

Principle 3, on listing contracts that are readily susceptible to manipulation. 2 DCMs 

and SEFs self-certify most of their products to the Commission, as allowed under 

the CEA, 3 and self-certified contracts may be listed for trading shortly after submission. 4 The Commission has provided Guidance to DCMs and SEFs on meeting Core 

Principle 3 in Appendix C to Part 38 of the Commission’s regulations. Failure of a 

32 

5Deliverable supply means the quantity of the commodity meeting the contract’s delivery 

specification that reasonably can be expected to be readily available to short traders and salable 

by long traders at its market value in normal cash marketing channels at the contract’s delivery 

points during the specified delivery period, barring abnormal movement in interstate commerce. 6 Antidisruptive Practices Authority, 78 FR 31890 (May 28, 2013), http://www.cftc.gov/ucm/ 

groups/public/@lrfederalregister/documents/file/2013-12365a.pdf. 

DCM or SEF to adopt and maintain practices that adhere to these requirements 

may lead to the Commission’s initiation of proceedings to secure compliance. 

Among other things, a DCM or SEF that lists a contract that is settled by physical delivery should design its contracts in such a way as to avoid any impediments 

to the delivery of the commodity in order to promote convergence between the price 

of the futures contract and the cash market value of the commodity at the time of 

delivery. The specified terms and conditions considered as a whole should result in 

a deliverable supply that is sufficient to ensure that the contract is not susceptible 

to price manipulation or distortion. 5 The contract terms and conditions should describe or define all of the economically significant characteristics or attributes of the 

commodity underlying the contract, including: quality standards that reflect those 

used in transactions in the commodity in normal cash marketing channels; delivery 

points at a location or locations where the underlying cash commodity is normally 

transacted or stored; conditions that delivery facility operators must meet in order 

to be eligible for delivery, including considerations of the extent to which ownership 

of such facilities is concentrated and whether the level of concentration would 

render the futures contract susceptible to manipulation; delivery procedures that 

seek to minimize or eliminate any impediment to making or taking delivery by both 

deliverers and takers of delivery to help ensure convergence of cash and futures at 

the expiration of a futures delivery month. 

Commission staff utilizes considerable discretion and can request that DCMs and 

SEFs provide full explanations of their compliance with the Commission’s product 

requirements. Commission staff may ask a DCM or SEF at any time for a detailed 

justification of its continuing compliance with core principles, including information 

demonstrating that any contract certified to the Commission for listing on that exchange meets the requirements of the Act and DCM or SEF Core Principle 3. 

Expansion of CFTC Enforcement Authority Under Dodd-Frank 

The Commission’s responsibilities under the CEA include mandates to prevent 

and deter fraud and manipulation. The Dodd-Frank Act enhanced the Commission’s 

enforcement authority by expanding it to the swaps markets. The Commission 

adopted a rule to implement its new authorities to police against fraud and manipulative schemes. In the past, the CFTC had the ability to prosecute manipulation, 

but to prevail, it had to prove the specific intent of the accused to affect prices and 

the existence of an artificial price. Under the new law and rules implementing it, 

the Commission’s antimanipulation reach is extended to prohibit the reckless use 

of manipulative schemes. Specifically, Section 6(c)(3) of the CEA now makes it unlawful for any person, directly or indirectly, to manipulate or attempt to manipulate 

the price of any swap, or of any commodity in interstate commerce, or for future 

delivery on or subject to the rules of any registered entity. In addition, Section 4c(a) 

of the CEA now explicitly prohibits disruptive trading practices and the Commission 

has issued an Interpretive Guidance and Policy Statement on Disruptive Practices. 6

In addition, the Dodd-Frank Act established a registration regime for any foreign 

board of trade (FBOT) and associated clearing organization who seeks to offer U.S. 

customers direct access to its electronic trading and order matching system. Applicants for FBOT registration must demonstrate, among other things, that they are 

subject to comprehensive supervision and regulation by the appropriate governmental authorities in their home country or countries that is comparable to the comprehensive supervision and regulation to which Commission-designated contract 

markets and registered derivatives clearing organizations are respectively subject. 

CFTC Coordination with Foreign and Domestic Regulators 

The Commission recognizes that commodity markets are international in nature 

and, accordingly, regularly consults with other countries’ regulators. In particular, 

staff regularly consult with staff of the FCA (the LME’s home regulatory authority) 

as to market conditions with respect to products of mutual interest, including the 

LME’s recent introduction of warehouse reforms. The two agencies also participate 

in mutual information-sharing agreements for both market surveillance and enforcement purposes. 

Similarly, the Commission formally and informally consults and coordinates with 

other domestic financial regulators. For example, the CFTC and the Federal Energy 

Regulatory Commission (FERC) have had a memorandum of understanding (MOU) 

33 

1Section 4(c)(8) of the Bank Holding Company Act, 12 U.S.C. 1843(c)(8). 

2 12 U.S.C. 24 (seventh). 

3 In addition to the capital and management requirements, the GLB Act also requires the subsidiary depository institutions of financial holding companies to have at least a ‘‘Satisfactory’’ 

rating under the Community Reinvestment Act. The Dodd-Frank Wall Street Reform and Consumer Protection Act added a requirement that the financial holding companies themselves 

must be well capitalized and well managed. 4Many bank holding companies of various sizes are financial holding companies. The Board 

maintains a list of financial holding companies on its Web site at www.federalreserve.gov/ 

bankinforeg/fhc.htm. 

in place since 2005 that provides for information exchange related to oversight or 

investigations. Earlier this month, FERC and the CFTC signed two Memoranda of 

Understanding (MOU) to address circumstances of overlapping jurisdiction and to 

share information in connection with market surveillance and investigations into potential market manipulation, fraud or abuse. The MOUs allow the agencies to promote effective and efficient regulation to protect the Nation’s energy markets and 

increased cooperation between the agencies. 

Again, thank you for the opportunity to appear before the Subcommittee. I will 

be pleased to respond to any questions you may have. 

PREPARED STATEMENT OF MICHAEL S. GIBSON 

DIRECTOR, DIVISION OF BANKING SUPERVISION AND REGULATION, BOARD OF

GOVERNORS OF THE FEDERAL RESERVE SYSTEM

JANUARY 15, 2014 

Chairman Brown, Ranking Member Toomey, and other Members of the Subcommittee, thank you for the opportunity to testify at today’s hearing. First, I will 

discuss the history of bank and bank holding company engagement in physical commodity activities. I will then address the Federal Reserve’s approach to supervising 

financial institutions engaged in physical commodities activities. I will close my remarks by discussing the Federal Reserve’s ongoing review of the physical commodities activities of the institutions we supervise. 

History of Physical Commodities Authority 

Before the enactment of the Gramm-Leach-Bliley Act in 1999 (GLB Act), bank 

holding companies were authorized to engage in a limited set of commodities activities that were considered to be ‘‘so closely related to banking as to be a proper incident thereto.’’ 1 These activities included the authority to buy, sell, and store certain 

precious metals (for example, gold, silver, platinum, and palladium) and copper, 

which are activities that national banks were generally permitted to conduct at the 

time. Bank holding companies were also authorized to engage as principals in cashsettled derivative contracts based on commodities. In addition, bank holding companies were permitted to engage in commodity derivatives that allowed for physical 

settlement if the bank holding company made reasonable efforts to avoid delivery 

of the commodity. 

Additionally, under the National Bank Act, the Office of the Comptroller of the 

Currency (OCC) has authority to approve national banks to engage in commodityrelated activities under national banks’ authority to ‘‘exercise . . . all such incidental powers as shall be necessary to carry on the business of banking.’’ 2 The OCC 

has approved some national banks to engage in customer-driven, perfectly matched, 

cash-settled derivative transactions referencing commodities; certain types of commodity derivatives transactions settled by transitory title transfer; the purchase and 

sale of coin and bullion, precious metals, and copper; and the holding of physical 

commodities to hedge customer-driven, bank-permissible derivative transactions. 

Under the GLB Act, Congress created the financial holding company framework, 

which allowed bank holding companies with bank subsidiaries that are well capitalized and well managed 3 that elect such status to engage in expanded financial activities. 4 There are three provisions in the GLB Act that have enabled a limited 

number of financial holding companies to engage in commodities activities. The first 

provision—section 4(k)(1)(B) of the Bank Holding Company Act—authorizes a financial holding company to engage in any activity that the Board finds to be ‘‘complementary to a financial activity.’’ This provision in the GLB Act enables financial 

holding companies to engage in commercial activities that complement their financial activities, so long as the activities do not pose a substantial risk to the safety 

34 

5Section 4(k)(1)(B) of the Bank Holding Company Act, 12 U.S.C. 1843(k)(1)(B). 

6 12 U.S.C. 1843(j)(2). 

7This authority is generally limited to commodities for which derivatives contracts have been 

approved by the Commodity Futures Trading Commission for trading on a U.S. exchange. In 

a few cases, other commodities with comparable fungibility, liquidity, and other relevant characteristics have been approved. 8The financial holdings companies currently authorized by the Board to engage in complementary physical commodities activities are Bank of America Corporation, Barclays Bank 

PLC, BNP Paribas, Citigroup Inc., Credit Suisse Group, Deutsche Bank AG, JPMorgan Chase 

& Co., Scotiabank, Societe Generale, The Royal Bank of Scotland Group pie, UBS AG, and Wells 

Fargo & Company. The Board’s approvals regarding section 4(k) are publicly available. 9 12 U.S.C. 1843(k)(4)(H). The merchant banking authority permits a financial holding company to acquire or control any amount of shares, assets, or ownership interests of any company 

or other entity that is engaged in an activity not otherwise authorized for the financial holding 

company under section 4 of the BHC Act. 10 12 U.S.C. 1843(o). 

and soundness of depository institutions or the financial system generally. 5 In reviewing requests for complementary authority, the Board is required to consider 

whether performance of the activity can reasonably be expected to produce benefits 

to the public—such as greater convenience, increased competition, or gains in efficiency—that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest, or unsound banking 

practices. 6

Beginning in 2003, the Board issued a series of orders permitting individual financial holding companies to engage in specified commodities-related activities as 

4(k) complementary activities. These activities included physical settlement of commodities derivative contracts and spot trading of certain approved commodities. 7 A 

dozen financial holding companies currently have this 4(k) authority. 8

In addition, a subset of these companies has been granted additional authority to 

engage in energy tolling and energy-management activities. Energy tolling involves 

making fixed, periodic payments to power plant owners that compensate the owners 

for their fixed costs in exchange for the right to all or part of their plants’ power 

output. Energy-management activities are transactional and advisory services provided to power plant owners. 

The Board’s orders placed prudential limits on financial holding companies that 

engage in commodities activities under complementary authority. The Board limited 

the total market value of all commodities held under this authority, including periodic payments under tolling agreements, to 5 percent of the financial holding company’s tier 1 capital. In addition, the Board prohibited financial holding companies 

from owning commodity transportation, storage, extraction, or refining facilities 

under complementary authority. Moreover, firms are required to demonstrate riskmanagement processes sufficient to support their activities and to put in place additional risk mitigants, such as insurance. 

A second provision that Congress included in the GLB Act permits financial holding companies to make merchant banking investments, without prior Board approval, in companies engaged in activities not otherwise permitted for financial 

holding companies. 9 There are a number of conditions imposed by statute on merchant banking investments. These include restrictions on the ability of a financial 

holding company to routinely manage or operate a merchant banking portfolio company and requirements that merchant banking investments be held for a limited period. The Board’s regulations require merchant banking investments to be disposed 

of within 10 years after purchase (or within 15 years for investments made through 

a qualifying private equity fund). As a result, merchant banking investments must 

be limited in duration and generally must be passively managed. 

Congress included a third provision in the GLB Act that is relevant to the commodities trading activities of financial holding companies. Under section 4(o) of the 

Bank Holding Company Act, a company that is not a bank holding company and 

becomes a financial holding company after November 12, 1999, may continue to engage in activities related to the trading, sale, or investment in commodities that 

were not permissible activities for bank holding companies if the company was engaged in the United States in such activities as of September 30, 1997. 10 This 

grandfather provision allows these activities up to 5 percent of the company’s total 

consolidated assets. In contrast to section 4(k) complementary authority, this authority is automatic—meaning no approval by or notice to the Board is required for 

a company to rely on this authority for its commodities activities. Also, unlike the 

firms subject to 4(k), the 4(o) grandfathered firms are able to engage in the transportation, storage, extraction, and refining of commodities. And, the cap on activities 

under section 4(o) is 5 percent of the firm’s total assets, while the cap on comVerDate Nov 24 2008 10:22 Oct 30, 2014 Jkt 046629 PO 00000 Frm 00038 Fmt 6621 Sfmt 6621 L:\HEARINGS 2014\01-15 REGULATING FINANCIAL HOLDING COMPANIES AND PHYSIC
35 

plementary activities is much lower at 5 percent of tier 1 capital. Only two financial 

holding companies currently qualify for these grandfather rights—Goldman Sachs 

and Morgan Stanley. 

The commodities activities of financial holding companies expanded considerably 

as the composition of the banking sector shifted in the wake of the financial crisis. 

During 2008, several firms with significant commodities operations either became 

financial holding companies or were acquired by financial holding companies. Goldman Sachs and Morgan Stanley became bank holding companies and elected financial holding company status. Both companies claim the right to conduct commodities 

activities under the grandfather provision found in section 4(o). In addition, during 

this same period, JPMorgan Chase & Co. acquired Bear Steams and Bank of America Corporation acquired Merrill Lynch; both Bear Steams and Merrill Lynch engaged in a substantial amount of commodity trading activities. However, the range 

of permissible physical commodities activities of these companies is limited because 

they are not grandfathered under section 4(o). 

Federal Reserve Supervision of Commodities Activities 

The Federal Reserve has supervisory authority for State member banks, bank 

holding companies (including financial holding companies), and savings and loan 

holding companies, as well as foreign banks that operate branches or agencies in 

the United States. The Federal Reserve’s basic supervisory responsibility is to oversee the financial soundness of these institutions and their adherence to applicable 

banking laws. To this end, we monitor the largest of these institutions on a continuous basis and routinely conduct inspections and examinations of all of these firms 

to encourage their safe and sound operation. 

The Federal Reserve has no direct role in the supervision of the commodities markets generally. The Commodity Futures Trading Commission (CFTC) was created 

by Congress in 1974 as an independent agency with the mandate to regulate commodity futures and option markets. Congress significantly expanded the authority 

of the CFTC to regulate the over-the-counter commodity derivative markets in the 

Dodd-Frank Wall Street Reform and Consumer Protection Act. Additionally, the Securities and Exchange Commission (SEC) oversees our Nation’s securities exchanges 

and markets and disclosures by public companies, among other things. Other independent agencies, such as the Federal Energy Regulatory Commission (FERC), also 

regulate segments of the physical commodity market. 

The prudential supervision of the largest, most complex banking firms is a cooperative effort in which the Federal Reserve acts as the prudential regulator and supervisor of the consolidated holding companies, but with some of the principal business 

activities of such firms supervised by other functional regulators. The Federal Reserve’s supervisory program focuses on the enterprise-wide risk profile and risk 

management of those firms, with particular focus on financial strength, corporate 

governance, and risk-management practices and competencies of the firm as a 

whole. 

As a result of lessons learned from the financial crisis, the Federal Reserve has 

taken a number of steps to strengthen its ongoing supervision of the largest, most 

complex banking firms. Most importantly, we established the Large Institution Supervision Coordinating Committee (LISCC) to ensure that oversight and supervision 

of the largest firms incorporates a broader range of internal perspectives and expertise; involves regular, simultaneous, horizontal (cross-firm) supervisory exercises; 

and is overseen in a centralized process to facilitate consistent supervision and the 

resolution of challenges that may be present in more than one firm. The committee 

includes senior bank supervisors from the Board and relevant Reserve Banks as 

well as senior Federal Reserve staff from the research, legal, and other divisions at 

the Board and from the markets and payment systems groups at the Federal Reserve Bank of New York. To date, the LISCC has developed and administered several horizontal supervisory exercises, notably the capital stress tests and related 

comprehensive capital reviews of the Nation’s largest bank holding companies. The 

LISCC has also been actively engaged in the supervision of physical commodities 

activities. 

Bank holding companies that conduct commodities activities pursuant to either 

section 4(k) complementary, merchant banking, or section 4(o) grandfather authority 

are typically subject to continuous supervision by the Federal Reserve. That supervisory oversight, for example, includes review of internal management reports, periodic meetings with the personnel responsible for managing and controlling the risks 

of the firm’s commodities activities, and targeted examinations of those activities. 

The primary goals of our supervision of commodities activities are to monitor the 

management of risks of those activities to the financial holding company and assess 

the adequacy of the firms’ control environments relating to commodities. 

36 

As the scale and complexity of commodities activities of financial holding companies accelerated in 2008 in the wake of the financial crisis, the Federal Reserve expanded the scope of its examination and review of the firms engaged in physical 

commodities activities. Additional targeted reviews were completed by examination 

staff specializing in commodities risk management practices. During these reviews, 

the teams have examined exposures, valuations, and risk-management practices 

across all relevant firms, and conducted deeper reviews of the firms’ operational risk 

quantification methodologies. On an ongoing basis, supervisory experts have monitored the firms’ exposures and assessed the strength of the corresponding risk management and control processes. 

The Board requires financial holding companies that engage in commodities activities to hold regulatory capital to absorb potential losses from those activities. Financial holding companies have long been required to hold capital against the 

counterparty credit risk from commodity derivatives (and other types of over-thecounter derivatives) and against the market risk of all commodity positions. Moreover, following the financial crisis, the Board has strengthened its capital requirements for the credit risk and market risk of these transactions. Further, under the 

Basel III advanced approaches capital rules, financial holding companies would be 

required to hold capital against the operational risk of their activities, including 

their commodities activities. 

Federal Reserve Review of Physical Commodities Activities 

Firms engaged in physical commodities activities rely on a variety of legal structures that attempt to limit liability for catastrophic and environmental events, as 

well as on the purchase of insurance and the allocation of capital aimed at mitigating operational risk. However, physical commodities activities can pose unique 

risks to financial holding companies. Indeed, estimating probabilities and costs related to environmental or catastrophic incidents is an imperfect science at best. 

The Federal Reserve has been conducting a detailed policy review of the commodities activities and investments of financial holding companies. We are performing 

this review for a number of reasons. As I noted above, there has been a substantial 

increase since 2008 in the amount and types of commodities activities conducted by 

the firms we supervise. Moreover, recent catastrophic events involving physical commodities have increased concerns regarding the ability of companies to mitigate potentially extraordinary tail and other risks. Finally, the financial crisis demonstrated the effects of market contagion and highlighted the danger of underappreciated tail risks associated with certain activities. 

The scope of our ongoing review covers commodities activities and investments 

under section 4(k) complementary authority, merchant banking authority, and section 4(o) grandfather authority. The Federal Reserve recently sought public comment through an advance notice of proposed rulemaking on a range of issues related 

to the commodities activities of financial holding companies, and we expect to engage in additional rulemaking in this area. As the notice explains, we are exploring 

what further prudential restrictions or limitations on the ability of financial holding 

companies to engage in commodities-related activities as a complementary activity 

are warranted to mitigate the risks associated with these activities. Such additional 

restrictions on complementary commodities activities could include reductions in the 

maximum amount of assets or revenue attributable to such activities, increased capital or insurance requirements on such activities; and prohibitions on holding specific types of physical commodities that pose undue risk to the company. We also 

are exploring what restrictions or limitations on investments made through the merchant banking authority in companies engaged in physical commodities activities 

would appropriately address those or similar risks. 

The Federal Reserve is also considering whether additional restrictions on physical commodities activities grandfathered under section 4(o) could help ensure that 

such activities do not pose undue risks to the safety and soundness of financial holding companies and their subsidiary depository institutions, or to financial stability. 

However, our ability to address the broad scope of activities specifically permitted 

by statute under the grandfather provision in section 4(o) is more limited than it 

is for complementary and merchant banking activities. Further, the amount of exposure to commodities activities authorized by Congress under section 4(o)—which is 

up to 5 percent of the organization’s total assets—is much greater than the level 

of activity permitted by the Board under the section 4(k) complementary authority— 

which is up to 5 percent of tier 1 capital. 

Conclusion 

Our review of the commodity-related activities of our supervised firms is ongoing. 

We intend to do a careful and thorough assessment of the costs and benefits of fiVerDate Nov 24 2008 10:22 Oct 30, 2014 Jkt 046629 PO 00000 Frm 00040 Fmt 6621 Sfmt 6621 L:\HEARINGS 2014\01-15 REGULATING FINANCIAL HOLDING COMPANIES AND PHYSIC
37 

nancial holding company engagement in these activities. We are committed to using 

our supervisory and regulatory authorities to the maximum extent possible to protect financial holding companies and the financial system from the safety and 

soundness risks or other potential adverse effects of combining banking and physical 

commodities activities in a single corporate enterprise. 

38 

RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN BROWN 

FROM NORMAN C. BAY 

Q.1. To address market surveillance and interagency coordination 

issues, the CFTC invited the FERC to CFTC premises to gain access to market surveillance data while information sharing protocols are being finalized. The CFTC expressed concerns about confidentiality, specifically that information shared with the FERC is 

protected in a way that satisfies CFTC’s congressionally mandated 

confidentiality obligations. 

Please elaborate more specifically on these concerns and how the 

FERC is addressing them. 

A.1. We believe we have resolved any issues related to data confidentiality or creating a secure data transfer. On March 5, 2014, 

the CFTC made an initial transfer of data to FERC under the information-sharing MOU. FERC and the CFTC also announced the 

creation of an interagency surveillance and data analytics working 

group. 

Q.2. When will these protocols be finalized? 

A.2. We believe the protocols have been finalized. 

Q.3. Are there any obstacles in the way of finalizing the protocol? 

If there are, please describe what they are, and how are they being 

addressed? 

A.3. As noted above, we believe the protocols have been finalized. 

Q.4. A document released to the New York Times on FERC’s investigation into JPMorgan’s manipulative pricing schemes in California and Michigan’s electricity market revealed that FERC investigators believed that Ms. Blythe Masters, the head of JPMorgan’s 

commodities operation, had ‘‘falsely’’ denied under oath her awareness of the activities. Reportedly, the document also found that 

JPMorgan made ‘‘scores of false and misleading statements and 

material omissions’’ to FERC authorities. Ultimately, JPMorgan 

agreed to pay $410 million without admitting wrong doing, including Ms. Masters. 

Could you provide a copy of the document to Members of the 

Senate Banking Committee? 

A.4. FERC did not release any internal documents to the New York 

Times or any other media outlet. The only documents relating to 

FERC’s investigation of JPMorgan that were publicly released were 

the Commission Order approving the JPMorgan settlement and the 

settlement agreement itself. The Commission does not make staffs 

‘‘Wells Notice’’ public even after an investigation concludes. When, 

as occurred in the JPMorgan matter, the investigation leads to a 

settlement that the Commission finds to be in the public interest, 

the settlement agreement itself typically provides details about the 

conduct underlying the investigation. The JPMorgan settlement 

agreement contains stipulated facts about JPMorgan’s conduct, and 

both the settlement agreement and the Commission’s Order approving the settlement set forth conclusions reached by Enforcement staff and the Commission. If the Committee feels that it is 

necessary to obtain access to certain nonpublic materials from the 

investigation, we certainly would be willing to discuss the matter. 

39 

Q.5. Can you speak to the challenges associated with holding Wall 

Street executives individually accountable for their illegal actions, 

as was presumably the case in the JPMorgan settlement? Can you 

please explain the specific decision made in this case, including the 

process and rationale for this decision. 

A.5. Fraud and market manipulation cases, particularly against 

large, sophisticated institutions, can present challenges in holding 

the entity as well as its executives accountable. Similar to white 

collar matters, these cases can be challenging to investigate and 

litigate, particularly where the participants take steps to communicate in ways that are not memorialized or are otherwise difficult 

to discover. Notwithstanding these challenges, PERC’s Office of Enforcement has been and remains committed to holding entities and 

individuals accountable for fraud, manipulation, and other serious 

misconduct. 

Reflecting that ongoing commitment, the Commission is fully 

prepared to proceed against executives and individuals when that 

course of action is in the public interest. We have done so in the 

past in both enforcement actions and settlements, and will continue 

to do so. For example, the Commission is currently litigating the 

Barclays market manipulation matter in Federal district court and 

is pursuing claims and civil penalties not only against Barclays 

Bank PLC, but also against four individual traders. (See FERC v. 

Barclays Bank PLC, Daniel Erin, Scott Connelly, Karen Levine, 

and Ryan Smith, Case No. 2:13-cv-02093-TLN-DAD (E.D. Cal. 

2013).) 

In the JPMorgan case, however, the Commission determined that 

acceptance of the settlement was in the public interest as it provided a fair, equitable, and timely resolution of the investigation. 

In particular, the JPMorgan settlement: (a) guaranteed full and 

complete relief to California Independent System Operator (CAISO) 

and Midcontinent Independent System Operator (MISO) ratepayers 

through the disgorgement of $125 million, along with the assurance 

that CAISO ratepayers would not be exposed to additional claims 

from JPMorgan that CAISO calculates have a value of $262 million; (b) ensured that JPMorgan paid a civil penalty of $285 million, which goes to the U.S. Treasury; (c) sent a strong message to 

market participants about the types of behavior the Commission 

considers manipulative, through the inclusion of a detailed set of 

facts to which JPMorgan stipulated; (d) highlighted for market participants the consequences of engaging in manipulative activity; 

and (e) memorialized that the traders who engaged in the manipulative conduct would no longer participate in bidding in PERC-jurisdictional markets while employed by JPMorgan. The Commission concluded that, on balance, acceptance of the settlement containing these substantial, immediate benefits for ratepayers and 

the public was preferable to jeopardizing those benefits through the 

considerable delay and uncertainty posed by pursuing actions 

against individual JPMorgan employees. 

It is worth highlighting one aspect of the JPMorgan settlement 

agreement relating to the individual traders involved in the alleged 

misconduct. The agreement memorialized the fact that the traders 

who engaged in the bidding strategies at issue had been reassigned 

and were no longer participating in bidding generation into the orVerDate Nov 24 2008 10:22 Oct 30, 2014 Jkt 046629 PO 00000 Frm 00043 Fmt 6602 Sfmt 6602 L:\HEARINGS 2014\01-15 REGULATING FINANCIAL HOLDING COMPANIES AND PHYSIC
40 

ganized markets, or otherwise engaged in power market trading. 

Because the Federal Power Act does not give the Commission the 

authority to ban traders from electricity markets for market manipulation, this result could not have been achieved by taking the 

matter to trial. 

Q.6. How can regulators more effectively hold these firms, particularly individual executives, accountable in order to deter manipulative and fraudulent activities in markets that have a direct impact 

on consumers? 

A.6. In my view, there are several preconditions that must be met 

for an enforcement office to improve its capability to deter market 

manipulation and fraud. First, the agency must have the legal authority to pursue wrongdoing, with strong enforcement tools and a 

civil penalty authority that creates adequate deterrence. FERC received such an authority in the Energy Policy Act of 2005, which 

includes a broad antimanipulation authority based on Rule 1 Ob5 in the Securities and Exchange Act of 1934 and a penalty authority of up to $1,000,000 a day per violation. 

Second, the agency must have the resources and human capital— 

the technical and legal expertise—to detect, investigate, and prosecute market manipulation. These are not easy cases, and they require highly qualified staff who understand the markets and the 

products traded on them. FERC’s Office of Enforcement has almost 

200 staff and includes auditors and accountants, former traders 

and risk managers, economists, energy analysts with highly quantitative skill sets with backgrounds in engineering, statistics, mathematics, and physics, and lawyers who are skilled investigators and 

litigators, including former Federal prosecutors and lawyers with 

extensive litigation experience. 

Third, the agency must create a robust oversight and surveillance program that has the capability to track market fundamentals and to identify market anomalies. In order to create a surveillance program, the agency must receive the relevant trading data 

and devise algorithms to screen the data. This, in turn, requires 

technical staff who have the quantitative and analytical skill sets 

to create the algorithms, as well as the necessary IT support and 

infrastructure. FERC’s Office of Enforcement has created algorithms that it uses to screen the natural gas and electric markets 

for suspicious trading patterns, and it continually looks for ways to 

enhance its surveillance capabilities. 

Fourth, to further good Government and to better protect the 

public interest, the agency must work closely with other agencies 

and share information on matters of mutual concern. With respect 

to investigations, FERC’s Office of Enforcement has coordinated or 

shared information with other Federal Government agencies, including the Department of Justice, the CFTC, the SEC, the FTC, 

the Federal Reserve, and the EPA. We have also established relationships with international regulators and consulted with or provided technical assistance to them. 

Fifth, as a matter of policy, the agency must be committed to the 

core principle of holding wrongdoers accountable. This means that 

in appropriate cases individuals, and not just firms, are held responsible for their misconduct. To promote accountability and deVerDate Nov 24 2008 10:22 Oct 30, 2014 Jkt 046629 PO 00000 Frm 00044 Fmt 6602 Sfmt 6602 L:\HEARINGS 2014\01-15 REGULATING FINANCIAL HOLDING COMPANIES AND PHYSIC
41 

terrence, the agency should also shed light on unlawful conduct 

through detailed settlement agreements and Orders to Show Cause 

and bring enforcement actions when a settlement cannot be 

achieved that is in the public interest. FERC has sought to do all 

of that in its enforcement actions. A recent example is Barclays in 

which the Commission issued a penalty assessment of $453 million 

against the firm and four traders. The matter is currently being 

litigated in Federal court in the Eastern District of California. 

Finally, regulators must never become complacent in their market oversight and surveillance. Markets are not static constructs, 

and as they change, regulators must be aware of the change and 

their oversight and surveillance program must evolve as well. 

I am pleased to say that enforcement staff at FERC have worked 

hard to implement these measures since EPAct 2005, will do so in 

the future, and will continue to look for ways to improve our ability 

to detect and remedy fraud and manipulation. 

RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN BROWN 

FROM VINCENT MCGONAGLE 

Q.1. On the issue of market surveillance and interagency coordination, you stated the CFTC has invited FERC to CFTC premises to 

gain access to market surveillance data while information sharing 

protocols are finalized. You further shared the CFTC’s concerns 

about confidentiality, specifically that information is shared and 

protected in a way that satisfies CFTC’s congressionally mandated 

confidentiality obligations. 

Please elaborate more specifically on these concerns. 

A.1. Pursuant to section 8(e) of the Commodity Exchange Act, 7 

U.S.C. §12(e) (CEA), the Commission may furnish to any department or agency of the United States Government acting within the 

scope of its jurisdiction any information in its possession obtained 

in connection with the administration of the CEA. However, any information furnished under this provision cannot be further disclosed except in an action or proceeding under the laws of the 

United States to which the recipient agency or department, the 

Commission or the United States is a party. Accordingly, when undertaking to share nonpublic information with another Federal 

agency or department, the CFTC must satisfy itself that such information is received and used consistent with these confidentiality 

obligations. As a threshold matter, on January 2, 2014, the CFTC 

and FERC executed a Memorandum of Understanding Regarding 

Information Sharing and Treatment of Proprietary Trading and 

Other Information (Information-Sharing MOU) establishing the 

commitments of the two agencies with respect to the sharing of 

nonpublic material and the treatment of proprietary and/or privileged information, including appropriate restrictions on the onward 

sharing of such information. The Commission’s initial transmission 

of market data to FERC commenced on March 5, 2014. Pursuant 

to and consistent with the Information-Sharing MOU, this transmission was preceded by written undertakings by FERC, dated 

March 5, 2014, with respect to data transmission and logistics and 

management of CFTC confidential information. 

42 

Q.2. What protocols would alleviate the CFTC’s confidentiality requirements? 

A.2. The Information-Sharing MOU substantially addressed the 

Commission’s concerns related to its statutory confidentiality requirements and set forth the general terms and conditions for future information sharing. FERC’s initial information request to the 

CFTC under the MOU was accompanied by a letter dated March 

5, 2014, which: (1) articulated specific encryption protocols to be 

followed for the secure transmission of data from the CFTC to 

FERC; (2) included an undertaking by FERC to work with the 

CFTC to establish and maintain appropriate safeguards to protect 

the confidentiality of files for which access is granted and the information derived therefrom; and (3) included a specific commitment 

to keep confidential any information furnished by the CFTC, consistent with the provisions of the MOU and section 8(e) of the CEA. 

Q.3. When will these protocols be finalized? 

A.3. The above-described MOU was finalized on January 2, 2014; 

FERC provided associated written undertakings by letter dated 

March 5, 2014. 

Q.4. Are there any obstacles in the way of finalizing this protocol? 

If there are, please describe what they are, and how are they being 

addressed? 

A.4. The essential elements of the confidentiality protocols have 

been finalized and information sharing has commenced. 

Q.5. When asked about the CFTC’s jurisdiction over the London 

Metal Exchange (LME) aluminum warehouses, you stated, ‘‘the 

issue is something that requires some degree of evaluation by the 

CFTC, particularly as it relates to the fact that the LME has applied for registration as a foreign board of trade . . . we [CFTC] 

are engaged with LME and with the U.K.’s FCA [Financial Conduct Authority], the LME’s regulator, with respect to how this 

warehousing issue, these questions concerning premiums, rents, incentives . . . [and] where are the legitimate forces of supply and 

demand and . . . potentially where can it be fixed.’’ 

Please elaborate on the ‘‘degree of evaluation’’ the CFTC has 

taken on the LME aluminum warehouse issue. 

A.5. Under the registration regime established by the Dodd-Frank 

Act, registration as a foreign board of trade (FBOT) pertains to 

FBOTs who seek to offer U.S. customers direct access to their electronic trading and order matching system separate from other 

means of trading access; FBOT registration is not otherwise required. 

As part of the FBOT review process, Commission staff are examining LME’s aluminum warehouse operations including, among 

other things, how the warehouses operate, the relationships between LME and the warehouse operators, how storage policies and 

prices are determined, how effective the load-out rate is and the 

basis for incentives charged by warehouse operators. 

On November 7, 2013, LME provided notice to the market of its 

adoption of a 12-item package of measures, which it described as 

‘‘designed to further enhance the LME’s physical delivery network, 

optimize contract price convergence, and continue to deliver bestVerDate Nov 24 2008 10:22 Oct 30, 2014 Jkt 046629 PO 00000 Frm 00046 Fmt 6602 Sfmt 6602 L:\HEARINGS 2014\01-15 REGULATING FINANCIAL HOLDING COMPANIES AND PHYSIC
43 

in-class price discovery and hedging solutions for all market users.’’ 

(LME Notice 13/326 : A312 : W125) As provided by that Notice, the 

package was to take effect on April 1, 2014. These reforms and 

their associated reports can be accessed at the LME Web site: 

http://www.lme.com/trading/warehousing-and-brands/ 

warehousing/warehouse-consultation/. 

However, on March 27, 2014, in response to a complaint by 

United Company Rusal plc (Rusal), a U.K. High Court of Justice 

handed down a judgment in respect to one aspect of LME’s 12-item 

package—LME’s proposal to implement a linked load-in load-out 

rule, which was intended to address warehouse issues. Although 

metal buyers backed stricter rules to cut wait times for aluminum 

and other metals, some producers disagreed. And Rusal, a large 

aluminum producer, filed a U.K. lawsuit this past December that 

challenged LME’s changes to its warehouse policy. In its filing, 

Rusal described the changes as ‘‘irrational and disproportionate. 

The High Court decided to uphold certain aspects of Rusal’s complaint and so quashed the LME’s implementation of the linked 

load-in load-out rule. On April 7, LME stated that ‘‘the LME’s commitment to address queues, and their consequent impact on efficient price discovery, remains unchanged. The LME is taking legal 

advice to establish the quickest effective route by which action can 

be taken to reduce queue lengths at Affected Warehouses.’’ (LME 

Notice 14/121 : A117 : W056) 

While this decision prevented an April 1 implementation of the 

linked load-in load-out rule, it did not interfere with the implementation of the other items of LME’s package, which are also aspects 

of LME’s plan to improve warehouse operations. These other measures came into effect on April 1st of this year, and the Division is 

currently reviewing the impact of those changes. We are also considering what additional steps are appropriate in light of the delayed implementation of the linked load-in load-out rule. 

Q.6. Please describe how the CFTC has engaged the LME and the 

U.K.’s FCA, including the frequency with which the CFTC has communicated with the LME FCA and any outcomes from these meetings. 

A.6. Since July of 2013, staff has been in contact with LME on an 

ongoing basis to discuss LME’s plan to address the warehouse 

issues. More recently, staff met with LME and has had at least 

three telephone conferences since early January. Staff has also 

been in contact with the FCA on several occasions. Both the LME 

and the FCA have consistently voiced the desire to resolve the 

warehouse situation. 

Q.7. Have there been any challenges working with the FCA on this 

issue? 

A.7. The Division is satisfied that it has a good working relationship with FCA on this matter. 

Q.8. There is a no-action letter between the CFTC and the LME 

allowing the LME to operate in the U.S. country provided the LME 

ensures fairness to market participants. You stated that, ‘‘ultimately, we [CFTC] can revoke or suspend any no-action letter that 

is issued by the Division of Market Oversight.’’ 

44 

Do you view the current activities of the LME and the LME 

warehouses as consistent or inconsistent with the existing no-action letter? 

A.8. The existing no-action letter, issued on March 12, 2001, generally provides, in pertinent part, that subject to LME’s compliance 

with the terms and conditions stated in the no-action letter, the Division of Trading and Markets, (now the Division of Market Oversight) will not recommend that the Commission institute enforcement action against LME or its members solely based upon LME’s 

failure to seek designation as a DCM or registration as a DTEF 

pursuant to Sections 5 or 5a, respectively, of the CEA, if LME 

makes its electronic trading and order matching system, known as 

LMEselect, available to LME members in the U.S. (now referred to 

as direct access). Although the no-action letter policy for permitting 

direct access was superseded by the Dodd-Frank Act’s FBOT Registration policy, found in section 4(b)(1) of the CEA and Commission regulation Part 48, LME may continue to provide for direct access pursuant to the no-action letter until such time as the Commission addresses its application for registration. 

No-action letters such as the one issued to the LME were issued 

after a thorough evaluation of, among other things, the Exchange’s 

trading system, rule enforcement practices, disciplinary system, 

etc., to determine if persons in the U.S. could reliably and safely 

trade on the Exchange. 

In addition, there is a condition in LME’s no-action letter that 

states as follows: ‘‘The laws, systems, rules, and compliance mechanisms of the United Kingdom applicable to LME will continue to 

require LME to maintain fair and orderly markets; prohibit fraud, 

abuse, and market manipulation; and provide that such requirements are subject to the oversight of the FSA (now FCA).’’ In the 

U.K., the Financial Services and Markets Act 2000 (FSMA) prohibits market abuse including, among other things, misuse of nonpublic material information, the creation of false or misleading 

market impressions, and market distortion. As a Recognized Investment Exchange pursuant to the FSMA, LME is subject to a 

comprehensive regulatory regime in the United Kingdom which includes, among other things, reporting and record keeping requirements, procedures governing the treatment of customer funds and 

property, conduct of business standards, provisions designed to protect the integrity of the markets, and statutory prohibitions on 

fraud, abuse, and market manipulation. 

Q.9. You further stated that it was your expectation that the issue 

could be addressed without revoking the letter, and those opportunities were being explored. Can you please elaborate on the opportunities and solutions being explored by the CFTC? 

A.9. As with all no-action letters, the issuing Division, in its discretion, retains the authority to condition further, modify, suspend, 

terminate, or otherwise restrict the terms of the no-action relief 

provided. The Division is continuing to monitor the effectiveness of 

the steps that LME has taken to address the issue of warehouse 

congestion. Steps included: changes to LME’s Warehousing Agreement (giving LME enhanced powers to investigate the formation of 

queues, and to impose additional load-out obligations on wareVerDate Nov 24 2008 10:22 Oct 30, 2014 Jkt 046629 PO 00000 Frm 00048 Fmt 6602 Sfmt 6602 L:\HEARINGS 2014\01-15 REGULATING FINANCIAL HOLDING COMPANIES AND PHYSIC
45 

houses that have paid incentive fees in order to artificially create 

or maintain queues), and the formation of: (1) a Logistical Review 

group (to ‘‘provide LME with an independent view on reasonable 

operational expectations and requirements for the loading in, holding and loading out of metals’’); and (2) a Physical Market Committee (to ‘‘provide a forum for all sectors of the physical industry 

to represent their views to the Exchange’’). As noted above, LME’s 

intention to implement a ‘‘linked load-in load-out requirement’’ was 

blocked by a U.K. court on March 27, 2014. Going forward, the Division intends to review the steps LME takes in response to the 

court’s decision. 

The Division will also continue discussions with LME’s primary 

regulator, the U.K. FCA, regarding its review of the effectiveness 

of the warehousing steps. If the outcome of LME’s corrective measures is unsatisfactory, the Division may require additional or alternative measures to address warehouse congestion as a condition of 

its no-action relief. Moreover, as noted above, Commission staff is 

examining the current activities of LME and the LME warehouses’ 

operations as part of staff’s review of LME’s FBOT application. 

Q.10. At what point would revoking the no-action letter be an appropriate remedy to the LME aluminum warehouse issue? If you 

need more information to answer this question, what steps have 

you taken or do you need to take to get the information you need? 

A.10. Revoking FBOT no-action letters may be an appropriate remedy where there has been a determination that the FBOT no longer 

meets the conditions required in its no-action letter to retain relief, 

and where an FBOT is not responsive to Commission staff-suggested corrective measures. Commission staff is taking a number 

of steps to evaluate aluminum pricing within the United States as 

set forth in further detail above. 

Q.11. In 2006, the CFTC subpoenaed Platts, the leading provider 

of spot and contract prices in the global metals market, to investigate the accuracy of trade data submitted to Platts. McGraw-Hill, 

Platts’s parent company, publicly acknowledged that ‘‘some energy 

companies and individual traders have repeatedly attempted to 

manipulate the price indexes produced by publishers such as 

Platts.’’ In 2002, during another CFTC investigation regarding energy prices, two power companies ‘‘disclosed that some of their 

traders provided inaccurate pricing information to Platts.’’ Such 

benchmarks by ‘‘price reporting agencies’’ based on producer announcements, negotiations, or gathering of market information 

have come under scrutiny. The first thing that comes to mind is 

LIBOR. 

What was the outcome of the CFTC’s investigation into the 

Platt’s pricing mechanism? 

A.11. As part of its investigations of possible misconduct in the energy markets, including whether traders at certain energy companies submitted trade data reflecting manipulated prices to Platts 

for use in calculating index prices of natural gas published by 

Platts in order to benefit financial trading positions tied to the 

same index, the Commission filed four actions in the United States 

District Courts court to compel the McGraw-Hill Companies, Inc.’s 

production of energy reporting-related documents requested in an 

46 

administrative procedure. In each of these actions, McGraw-Hill 

was compelled by a Federal court, overcoming McGraw-Hill’s claim 

of privilege, to comply in substantial part with CFTC subpoenas directed to McGraw-Hill. See CFTC v. McGraw-Hill Companies, Inc., 

507 F. Supp.2d 45 (D.D.C. 2007); CFTC v. McGraw-Hill Companies, Inc., 390 F. Supp.2d 27 (D.D.C. 2005); CFTC v. Whitney, 441 

F. Supp.2d 61 (D.D.C. 2006); and CFTC v. Bradley, et al., Case No. 

05-cv-62, 2006 WL 2045847 (N.D. Okla. July 20, 2006). 

From December 2002 through July 2007, the Commission filed 

28 enforcement actions charging, in part, false reporting and attempted manipulation relating to natural gas price indexes in the 

energy markets, and obtained over $280 million in settlement of 

these matters. See In re Dynegy Marketing & Trade, et al., CFTC 

Docket No. 03-03 (CFTC filed Dec. 18, 2002) ($5 million civil monetary penalty); In re El Paso Merchant Energy, L.P., Docket No. 03- 

09 (CFTC filed March 26, 2003) ($20 million civil monetary penalty); In re WD Energy Services Inc., Docket No. 03-20 (CFTC filed 

July 28, 2003) ($20 million civil monetary penalty); In re Williams 

Energy Marketing And Trading, et al., Docket No. 03-21 (CFTC 

filed July 29, 2003) ($20 million civil monetary penalty); In re 

Enserco Energy, Inc., Docket No. 03-22 (CFTC filed July 31, 2003) 

($3 million civil monetary penalty); In re Duke Energy Trading 

And Marketing, L.L.C., Docket No. 03-26 (CFTC filed Sept. 17, 

2003) ($28 million civil monetary penalty); CFTC v. American Electric Power Company, Inc., et al., No. C2 03 891 (S.D. Ohio filed 

Sept. 30, 2003) ($30 million civil monetary penalty); In re CMS 

Marketing Services and Trading Company, et al., Docket No. 04- 

05 (CFTC filed Nov. 25, 2003) ($16 million civil monetary penalty); 

In re Reliant Energy Services, Inc., Docket No. 04-06 (CFTC filed 

Nov. 25, 2003) ($18 million civil monetary penalty); In re Aquila 

Merchant Services, Inc., Docket No. 04-08 (CFTC filed Jan. 28, 

2004) ($26.5 million civil monetary penalty); In re Calpine Energy 

Services, L.P., CFTC Docket No. 04-11 (CFTC filed Jan. 28, 2004) 

($1.5 million civil monetary penalty); In re ONEOK Energy Marketing And Trading Company, L.P., et al., Docket No. 04-09 (CFTC 

filed Jan. 28, 2004) ($3 million civil monetary penalty); In re 

Entergy-Koch Trading, LP, Docket No. 04-10 (CFTC filed Jan. 28, 

2004) ($3 million civil monetary penalty); In re e prime, Inc., Docket No. 04-12 (CFTC filed Jan. 28, 2004) (a wholly owned subsidiary 

of Xcel Energy, Inc.; $16 million civil monetary penalty); In re 

Knauth, Docket No. 04-15 (CFTC filed May 10, 2004) ($25,000 civil 

monetary penalty); In re Western Gas Resources, Inc., Docket No. 

04-17 (CFTC filed July 1, 2004) ($7 million civil monetary penalty); 

In re Coral Energy Resources, L.P., Docket No. 04-21 (CFTC filed 

July 28, 2004) ($30 million civil monetary penalty); In re Cinergy, 

CFTC Docket No. 05-03 (CFTC filed November 16, 2004) ($3 million civil monetary penalty); In re Mirant, CFTC Docket No. 05-05 

(CFTC filed Dec. 6, 2004) ($12.5 million civil monetary penalty); In 

re Dominion Resources, Inc., CFTC Docket No. 06-06 (CFTC Sept. 

27, 2006) ($4,250,000 civil monetary penalty); CFTC v. Foley, No. 

2:05 849 (S.D. Ohio filed Sept. 14, 2005, settled Sept. 28, 2006) 

($350,000 civil monetary penalty); CFTC v. McDonald, et al., No. 

1:05-CV-0293 (N.D. Ga. filed Feb. 1, 2005, settled Nov. 17, 2006, 

Nov. 7, 2007) ($750,000 total civil monetary penalties); CFTC v. 

47 

NRG Energy, Inc., No. 04-cv-3090 MJD/JGL (D. Minn. filed July 1, 

2004) ($2 million civil monetary penalty); CFTC v. Reed, et al., No. 

05-D-178 (D. Colo. filed Feb. 1, 2005, settled March 13, 2007, Nov. 

13, 2000) (total $2,075,000 civil monetary penalties); CFTC v. Richmond, No. 05-M-668 (OES) (D. Colo. filed April 12, 2005, settled 

March 20, 2007) ($60,000 civil monetary penalty); CFTC v. Bradley, et al., No. 05CV62-CVE-FHM (N.D. Okla. filed Feb. 1, 2005, 

settled May 25 and June 25, 2007) (Bradley $100,000 civil monetary penalty; Martin $25,000 civil monetary penalty); CFTC v. 

Johnson, et al., No. H-05-0332 (S.D. Texas filed Feb. 1, 2005, settled Nov. 7, 2007) (Johnson, Moore, Tracy, Harp and Dyer $1 million civil monetary penalty; April 24, 2008 judgment for Dizona); 

CFTC v. Whitney, No. H 05-333 (S.D. Texas filed Feb. 1, 2005, settled March 5, 2008) ($55,000 civil monetary penalty); and CFTC v. 

Energy Transfer Partners, L.P., et al., No. 3-07CV1301-K (N.D. 

Tex. filed July 26, 2007, settled March 17, 2008) ($10 million civil 

monetary penalty). 

Q.12. Why is this benchmark used to determine the price of aluminum? 

A.12. One benchmark used in the aluminum market is the LME 

futures price adjusted by the ‘‘Midwest premium.’’ As stated by 

Platts, the Midwest premium (or discount) is determined by an 

analysis by Platts of ‘‘physical spot deals, bids and offers reported 

through a daily survey of spot buyers and sellers, using a representative sample of producers, traders and different types of end 

users.’’ (See http://www.platts.com/IM.Platts.Content/ 

methodologyreferences/methodologyspecs/metals.pdf). 

According to Platts, some privately negotiated ‘‘floating’’ term 

contracts and swaps settle on the basis of the spot price as determined by Platts. (See http://www.apdtesting.com/wordpress/wpcontent/uploads/2012/11/2011-5- 

12lplattslkarenlmcBethlcopperlaluminumlmagnesium.pdf). 

Our understanding is that aluminum end users execute swaps 

that are priced off of a Platts reported price of the LME price plus 

an additional premium—the published Midwest premium—plus 

shipping to their specific location. The LME price is not locationspecific and delivery of LME stock can occur at any of their global 

warehouses. Therefore, end users who need aluminum at a specific 

location may use other instruments (swaps) that give them certainty of delivery location as well certainty of timing of delivery. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY 

FROM VINCENT MCGONAGLE 

Q.1. Is the CFTC working with the U.K. and European regulators 

to ensure that the LME proceeds with the transparency commitments announced late last year? Do you have a sense of the timetable? 

A.1. CFTC market oversight staff hold routine, periodic telephone 

conference calls with counterparts at the U.K. Financial Conduct 

Authority (FCA). During the course of these calls in 2013 and 2014, 

CFTC and FCA staff discussed concerns raised by aluminum market participants relating to slow load-out rates of metals stored in 

48 

1See, e.g., Board of Governors v. Dimension Financial Corp., 474 U.S. 361 (1986); Western 

Bancshares, Inc. v. Board of Governors, 480 F.2d 749 (10th Cir. 1973). The Board also has authority to take supervisory actions, including enforcement actions, to prevent or address unsafe 

and unsound practices. 12 U.S.C. §1818(b)(3). 

LME approved warehouses. The purpose of these conversations was 

to learn what steps the FCA was taking with regard to LME and 

the status of any reforms. We have not had any formal discussions 

with other European regulators in this regard, as the FCA is the 

only European regulator responsible for oversight of LME. 

In this regard, many of the reforms adopted by the LME following its 2013 consultation were, as noted above, implemented on 

April 1. These reforms and their associated reports, as well as 

LME’s statements of March 27 (LME Notice 14/106 : A103 : W046), 

and of April 7, 2014 (LME Notice 14/121 : A117 : W056), both 

issued in response to the decision of the U.K. High Court, can be 

accessed at the LME Web site: http://www.lme.com/trading/ 

warehousing-and-brands/warehousing/warehouse-consultation/. 

While most of the changes adopted by LME were implemented 

on April 1, 2014, timeline for the implementation of the linked 

load-in load-out rule, was, as noted above, affected by the March 

27, 2014, decision of the U.K. High Court, issued in response to the 

U.K. lawsuit filed this December 2013 by Rusal. According to its 

statement of April 7, ‘‘the LME’s commitment to address queues, 

and their consequent impact on efficient price discovery, remains 

unchanged. The LME is taking legal advice to establish the 

quickest effective route by which action can be taken to reduce 

queue lengths at Affected Warehouses.’’ (LME Notice 14/121 : A117 

: W056) 

RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN BROWN 

FROM MICHAEL S. GIBSON 

Q.1. In your testimony, you stated the FRB’s primary concern is 

the safety and soundness of individual financial institutions and 

the financial system as a whole, while market oversight is entirely 

the task of Commodity Futures Trading Commission (CFTC), Federal Energy Regulatory Commission (FERC) and other market regulators. 

What is the specific statutory language that explicitly relieves 

the FRB of broader oversight responsibilities given the FRB’s function as the consolidated regulator of Financial Holding Companies 

(FHCs) and systemic risk? 

A.1. The Board’s supervisory and regulatory authority regarding financial holding companies and systemic risk is limited to that 

granted by statute, in particular, the Bank Holding Company Act 

(BHC Act) and the recently enacted, Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). 1 The BHC 

Act directs the Board to monitor through reports and examination 

the operations and financial condition of bank holding companies 

and ‘‘compliance of the bank holding company and the subsidiary 

with (I) [the BHC) Act; (II) Federal laws that the Board has specific jurisdiction to enforce against the company or subsidiary; and 

(III) other than in the case of an insured depository institution or 

functionally regulated subsidiary, any other applicable provisions of 

49 

2 12 U.S.C. §1844. 3 Id. 

4 Id. 

Federal law.’’ 2 The BHC Act specifically includes within the definition of ‘‘functionally regulated subsidiary’’ ‘‘an entity that is subject 

to regulation by, or registration with, the Commodity Futures 

Trading Commission’’ with respect to activities subject to the 

CFTC’s jurisdiction. 3 In addition, the BHC Act specifically provides 

that, in exercising its authority, the Board must, to the fullest extent possible, rely on examination reports made by other Federal 

or State regulatory agencies and avoid duplication of examination 

activities, reporting requirements, and requests for information. 4

The authority to oversee the securities, derivatives, and commodities markets is vested in agencies such as the Commodity Futures 

Trading Commission, Federal Energy Regulatory Commission, and 

Securities and Exchange Commission, which have specific oversight 

authority including the jurisdiction to address market manipulation. In addition, these agencies have access to information regarding the practices of a wide range of market participants, whereas 

the Federal Reserve only has access to the activities of the participants that are banking firms. As a result, the agencies with direct 

market oversight authority are in the best position to tell whether 

certain practices deviate from market practices, including trading 

and pricing practices. 

However, if Federal Reserve staff suspects a problem as a result 

of its review, staff would refer and cooperate with the appropriate 

market regulator(s). 

Q.2. Independent of the FRB’s request for public comment on the 

issue of FHC ownership of physical commodities and energy assets 

through the Advanced Notice of Proposed Rulemaking (ANPR), 

does the FRB consider the ability of a FHC to combine its trading 

and dealing in commodity derivatives with direct ownership of the 

underlying physical commodity, such as ownership of the physical 

infrastructure to extract, store, deliver and transport commodities, 

as potentially systemically risky, unfair or dangerous from the 

viewpoint of market integrity, consumer protection, and macroeconomic stability? 

A.2. Because of its concern that ownership of the physical infrastructure to extract, store, deliver, and transport commodities may 

pose risks to the safety and soundness of bank holding companies, 

the Board has not approved bank holding companies to engage in 

these activities. Indeed, the Board’s exercise of authority under section 4(k) of the BHC Act permitting financial holding companies to 

engage in activities that are complementary to financial activities 

specifically prohibited financial holding companies from using that 

authority to engage in extraction, storage, delivery, or transportation of physical commodities. 

A limited number of financial holding companies engage in these 

activities under authority specifically provided by statute that does 

not require Board approval: grandfathering authority under section 

4(o) of the BHC Act and merchant banking authority under sections 4(k)(4)(H) and (I) of the Act. These authorities are broad and 

50 

5See 79 Fed. Reg. 3329, 3332-34 (January 21, 2014). 

place no limits on their combination with other authorities or activities. 

As part of the January 2014 advance notice of proposed rulemaking (ANPR), the Board will consider how to address the potential risks to safety and soundness and U.S. financial stability that 

may be presented by the activities authorized under sections 4(o), 

4(k)(4)(H), and 4(k)(4)(I) and whether additional prudential requirements such as capital, liquidity, reporting, or disclosure requirements, could help ensure such activities do not pose undue 

risks to the safety and soundness of the bank holding company or 

to financial stability. 

Q.3. You stated the FRB’s supervision staff held meetings to review 

FHCs’ physical commodity activities since 2008. According to your 

testimony, these reviews raised a number of concerns about certain 

risks systemically important financial institutions’ commodities activities can pose to financial stability. Many of these concerns are 

posed in the ANPR the FRB issued on January 14, 2014. 

Please publicly disclose the discussion minutes and any policy 

conclusions made at the staff-level meetings on the issue of FHC 

ownership of physical commodities. Specifically, elaborate on the 

FRB’s policy concerns beyond issues associated with the institutions’ safety and soundness to include a detailed list of the policy 

concerns discussed, and the number of meeting, with specific dates. 

A.3. Since 2009, Federal Reserve staff has conducted a series of 

horizontal examinations of the commodities activities of certain financial holding companies, including Bank of America Corporation, 

JPMorgan Chase & Co., Goldman Sachs, and Morgan Stanley. In 

2008, Goldman Sachs and Morgan Stanley became bank holding 

companies, and Bank of America Corporation and JPMorgan Chase 

& Co. acquired companies with substantial commodities activities. 

Ongoing continuous monitoring work on the commodities activities 

of the firms has also been conducted. 

The overall conclusions of these examinations helped to inform 

the ANPR, including the concerns reflected in the ANPR regarding 

the potential tail risk of physical commodities activities, the limitations of insurance and capital requirements to mitigate the potential risks of commodities activities, and the difficulty to quantify 

these risks. 5

The content of the meetings held, and examinations conducted, 

by Federal Reserve staff regarding physical commodities activities 

involves confidential supervisory information and trade secrets. 

Disclosure of this information could prejudice the examination 

process and is subject to protections from disclosure under Federal 

law. 

Q.4. Please describe the subsequent actions the Fed staff has taken 

to address each of these policy concerns, and demonstrate how the 

FRB communicated these concerns with the FHCs through orders 

granted or approval of specific activities or acquisitions in the 

course of supervising and monitoring FHCs’ commodities and energy activities. 

51 

A.4. In cases where Federal Reserve examiners identified risk management or other weaknesses as part of the horizontal examination 

of the firms involved in physical commodities activities, this information was communicated to each of the firms, and examiners 

monitored the firms to ensure that the firms were taking appropriate steps to remediate these weaknesses. For example, Federal 

Reserve examiners have required: 

• modification of value-at-risk calculations pertaining to commodities positions, 

• more granular risk limits for commodities positions, 

• consistent valuations of physical and derivative positions in the 

same commodity, 

• divestiture of impermissible commodity assets, and 

• a more robust compliance function for commodities activities. 

In the case of JPMorgan Chase & Co., Federal Reserve staff notified the firm that Henry Bath & Sons Ltd (Henry Bath) was not 

a bona fide merchant banking investment and consequently, 

JPMorgan Chase & Co. is required to divest its investment in 

Henry Bath. 

Q.5. Aside from the vote held by FRB Governors to approve the 

ANPR, are there any plans for any board-level meetings on this 

subject? If not, why has this issue not been considered or discussed 

by the Board? 

A.5. A key purpose of the ANPR is to provide the Board with additional information in order to determine the appropriate course of 

action to address the risks of physical commodities activities. The 

Board will consider appropriate additional steps to address these 

risks after the comment period on the ANPR concludes. Currently, 

the comment period is scheduled to close on April 16, 2014. 

Q.6. You stated in your testimony that FHCs publicly disclose in 

their quarterly filings with the FRB one metric directly related to 

their physical commodity holdings, which presents an aggregate 

market value of physical commodities on their balance sheet. 

How does this metric help the FRB and the public understand 

the specific physical commodity activities these institutions conduct, including the commodity and energy companies they own or 

control, or the influence the FHCs may, or may not, have on the 

prices of individual commodities? 

A.6. The Board’s Reporting Form Y-9C and its schedules provide 

disclosure on commodities, including commodity and other exposures, gross fair value of commodity contracts, gross fair value of 

physical commodities held in inventory, commodities specified according to derivative position indicators, and the notional principal 

amount of commodity contracts. This information helps the Board 

track compliance with the limits it has placed on the commodity activities of firms relying on complementary authority, but the Board 

does not solely rely on this information to understand the breadth 

of commodities activities that these firms conduct or the risks that 

those activities pose. This disclosure informs the public of the size 

of physical commodity activities that the institutions conduct. The 

ANPR solicits comments on a broad array of issues concerning 

52 

physical commodities’ impact on safety and soundness and what 

additional criteria the Board should consider concerning physical 

commodities, including whether the public has a need for more information in this area that exceeds the burden that would be imposed on the financial holding companies to supply that information. 

Q.7. Is the FRB considering other disclosure alternatives given this 

line item only provides an aggregate number of all commodities activities conducted by a single FHC? 

A.7. Yes, the Board inquires in its ANPR about the advantages and 

disadvantages of requesting additional reporting or disclosure requirements for bank holding companies and requests suggestions 

on how the Board should formulate such requirements. In addition, 

the Board specifically stated in the ANPR that it is considering a 

number of actions to address the potential risks associated with 

merchant banking investments, including enhanced reporting to 

the Board or public disclosures regarding merchant banking investments. 

Q.8. You also mentioned that FHCs disclose their physical commodities activities in their SEC filings. Bank holding company 

(BHC) disclosures are governed by Guide 3, a rule promulgated in 

the 1970s, well prior to the Gramm-Leach-Bliley Act. Guide 3 only 

requires disclosure of the securities held in a BHC’s investment 

portfolio. Should these rules be revised to provide better disclosures 

of commodities activities? 

A.8. The Board supports robust disclosures that result in transparency and encourage market discipline. The SEC’s Guide 3 governs certain types of required disclosures and may not govern all 

physical commodity activities or investments. The SEC is best able 

to determine whether Guide 3 is consistent with the mandate in 

the Federal securities laws. 

Q.9. The following questions address the process by which the FRB 

scrutinized, authorized, and continues to oversee the former investment banks’, i.e., Goldman Sachs and Morgan Stanley, physical 

commodities and energy holdings after their conversion from investment banks to FHCs: 

When Goldman Sachs and Morgan Stanley applied to the FRB 

to be registered as FHCs in the fall of 2008, did the FRB staff conduct a review of their existing commodities assets and investments? 

A.9. The Board approved applications by Morgan Stanley and Goldman Sachs to become bank holding companies in September 2008. 

In light of the unusual and exigent circumstances affecting the financial markets at the time, the Board determined that emergency 

conditions existed that justified expeditious action and waiver of 

public notice of the applications. In approving the applications, the 

Board considered all of the statutory factors required under the 

BHC Act. In connection with its review of the Morgan Stanley and 

Goldman Sachs applications, the Board did not conduct a targeted 

review of the commodities activities and investments of the two organizations. Section 4(a)(2) of the Bank Holding Company Act permits a newly formed bank holding company to retain any otherwise 

53 

impermissible activities for up to 2 years, with the possibility of 

three 1-year extensions. Moreover, section 4(o) of the BHC Act permits a qualifying financial holding company to engage in physical 

commodity activities without seeking or obtaining Board approval. 

Both Morgan Stanley and Goldman Sachs are section 4(o) qualifying financial holding companies. 

Morgan Stanley and Goldman Sachs also filed elections to become financial holding companies that ultimately became effective. 

Morgan Stanley’s election was filed in August 2008, Goldman 

Sachs’ in July 2009. These elections were considered under the factors enumerated in the Bank Holding Company Act and the 

Board’s Regulation Y at the time, including the requirement that 

all of the depository institution subsidiaries of the bank holding 

company be well capitalized and well managed. 

Q.10. If yes, please describe the scope of the review, and explain 

how this review found these institutions’ commodity holdings did 

not pose sufficient risks to the financial system? 

A.10. Please see response for Question 9. 

Q.11. If not, why wasn’t a review of these activities conducted? 

A.11. Please see response for Question 9. 

Q.12. Please describe any discussions between the FRB supervisors 

and representatives from Goldman Sachs and/or Morgan Stanley 

held between 2008 and present with respect to their ability to continue, and to expand, their pre-2008 physical commodity activities 

under any legal authority after their conversion into bank holding 

companies. For example, was the Fed aware of, and did it approve, 

Goldman Sachs’ acquisition of Metro International in 2010? 

A.12. As discussed more fully in the response to Question 9, the 

2008 Morgan Stanley and Goldman Sachs applications were processed using expedited procedures due to the emergency conditions 

that existed at the time. 

Goldman Sachs has indicated that it is holding Metro International under merchant banking authority. Merchant banking investments are not subject to prior approval of the Federal Reserve. 

The policies and procedures that Goldman Sachs employs to ensure 

that its merchant banking investments conform with the Federal 

Reserve’s merchant banking rules have been reviewed by supervision staff, as has the control framework that Goldman Sachs uses 

to minimize the financial and reputational risks posed by such investments. Subsequent to Goldman Sachs and Morgan Stanley becoming bank holding companies, supervision staff conducted extensive reviews of the commodities activities of both companies. The 

reviews catalogued the activities in which the two firms engaged, 

and assessed the control environment that the two firms utilize to 

manage their commodities business. Supervisory staff has periodic 

discussions with Goldman Sachs and Morgan Stanley regarding 

their physical commodities activities including the authorities 

under which they are engaging in the activities. 

Q.13. Please describe specific factors and reasoning for the FRB’s 

decision to allow JPMorgan to acquire Henry Bath, a metal warehouse business, and other commodity assets from RBS Sempra in 

2010. 

54 

6See 12 U.S.C. §§1842, 1843; 12 CFR225.11, 225.82. 

A.13. The BHC Act and the Board’s Regulation Y permit financial 

holding companies to make acquisitions of firms that engage in 

various activities that are financial in nature. Financial holding 

companies often seek to acquire firms that engage in financial activities, but are not subject to the BHC Act and its restrictions. 

These firms often engage in some amount of activities that are related to the firm’s financial business, but are not permissible for 

bank holding companies to conduct under the BHC Act. To address 

this, the Board’s Regulation Y permits a financial holding company 

to acquire a firm that is engaged in a mix of permissible financial 

activities and impermissible activities under certain conditions. In 

particular, at least 85 percent of the activities of the target firm (as 

measured by assets and revenues) must be permissible financial activities, and the acquiring financial holding company must divest 

or otherwise conform the impermissible activities within 2 years of 

the acquisition, unless a limited extension is granted by the Board. 

JPMorgan Chase & Co. acquired Henry Bath as part of the acquisition of the financial businesses and assets of RBS Sempra. The 

Board’s Regulation Y required JPMorgan Chase to conform, terminate or divest its investment in Henry Bath within 2 years of its 

acquisition, subject to limited extensions. 

In connection with the RBS Sempra acquisition, the Board approved JPMorgan Chase’s request to engage in energy tolling and 

energy management services as complementary activities under 

section 4(k) of the BHC Act. The Board did not approve the retention of Henry Bath under this authority. The Board subsequently 

informed JPMorgan Chase that its investment in Henry Bath 

would not qualify as a merchant banking investment. 

Q.14. If an investment bank applied to the FRB to be registered 

as a FHC under normal circumstances (i.e., not under the crisis 

conditions when Goldman Sachs and Morgan Stanley became 

FHCs), what would have been the review process of these institutions physical commodity and energy activities? Please describe the 

types of inquiries the Fed would have made, and specific criteria 

it would have used, to assess whether these applicants’ existing 

commodity activities complied with the requirements of the Bank 

Holding Company Act (BHCA) and were consistent with the public 

interest in preserving systemic financial stability in the long-term? 

A.14. A company seeking to become a financial holding company 

must make at least two filings with the Federal Reserve, an application to become a bank holding company (as a result of either acquiring a bank or converting an existing depository institution subsidiary into a bank) and a declaration stating that the company 

elected, and qualified for, financial holding company status. 6 In 

connection with these filings, the Federal Reserve would request 

that the applicant describe its nonbanking activities and the legal 

authority for conducting these activities. In approving a bank holding company application, the Federal Reserve is required to consider, among other things, the financial and managerial resources 

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7See 12 U.S.C. §1843(k)(1)(B). 8Section 4(o) also limits such activities and investments to 5 percent of the financial holding 

company’s total consolidated assets and prohibits cross-marketing activities between subsidiContinued 

pany’s commodities-related and energy-related activities, like its 

other activities, would be considered in this context. 

A company, such as Goldman Sachs or Morgan Stanley, that 

meets the requirements of section 4(o) of the Bank Holding Company Act may engage in commodities-related activities without the 

approval of the Board. By its terms, section 4(o) authorizes certain 

companies that become financial holding companies to engage in 

physical commodity activities that are not otherwise permissible for 

financial holding companies and have not been authorized by the 

Board. 

A financial holding company may also seek Board approval to engage in activities that are complementary to financial activities. 7

In connection with requests under this section, the Federal Reserve 

obtains information about the types and scope of the requested activities, the financial condition of the applicant, the programs for 

monitoring and limiting risk from the activities, and other relevant 

information. Based on all the information available to the Board, 

the Board then considers whether the proposed activity is complementary to a financial activity, would pose risk to the safety and 

soundness of depository institutions or the financial system, and 

whether the public benefits, such as greater convenience, increased 

competition, or gains in efficiency, outweigh the possible adverse 

effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interests, unsound banking practices, 

or risk to the stability of the United States banking or financial 

system. 

Q.15. The following are questions related to the FRB’s legal and 

supervisory interpretation and use of the Section 4(o)’s grandfather 

provision under the BHCA. During the hearing, you stated that 

you are not a lawyer and thus could not offer an interpretation of 

what section 4(o) means. 

How does the FRB’s legal staff interpret the scope of the commodity grandfathering provision in Section 4(o)? Does the term 

‘‘any such activities’’ permit an institution eligible for grandfathered treatment to engage in all commodities and physical asset 

trading an ownership of they were engaged in the ownership or 

trading of a single commodity or physical asset prior to 1997? 

A.15. Section 4(o) of the BHC Act provides that ‘‘a company that 

is not a bank holding company or foreign bank and becomes a financial holding company as of November 12, 1999, may continue 

to engage in, or directly or indirectly own or control shares of a 

company engaged in, activities related to the trading, sale, or investment in commodities and underlying physical properties that 

were not permissible for bank holding companies to conduct in the 

United States as of September 30, 1997, if the holding company, or 

any subsidiary of the holding company, lawfully was engaged, directly or indirectly, in any of such activities as of September 30, 

1997, in the United States’’ and certain other requirements 8 are 

met. 

56 

aries held pursuant to section 4(o) and affiliated depository institutions. 12 U.S.C. 1843(o)(2)- 

(3). 

Through this provision, Congress specifically authorized any 

company that becomes a financial holding company after November 

1999 to engage in physical commodities activities (i.e., the physical 

commodities activities authorized by the provision) that were not 

otherwise permissible for bank holding companies to conduct in 

September, 1997. Companies that qualify for this statutory grandfather provision may continue to engage in commodities activities 

to the extent permitted by that provision without obtaining the 

Federal Reserve’s approval. 

Prior to September 30, 1997, bank holding companies claiming 

grandfather rights under section 4(o) were engaged in a broad 

range of commodities related activities that the Board had not authorized for bank holding companies. These included trading, mining, storing or transporting coal, oil, natural gas, fertilizer, electricity, and various metals. Thus, even under the narrowest reading of the statute, grandfathered bank holding companies are permitted by statute to engage in a broad range of commodities-related activities. 

Some have argued that the statute is plain on its face that a 

grandfathered firm engaged in any commodity activity prior to the 

relevant date may engage after the relevant date in all of the commodities activities listed in the statute, namely ‘‘activities related 

to the trading, sale, or investment in commodities and underlying 

physical properties that were not permissible for bank holding companies to conduct in the United States as of September 30, 1997,’’ 

in addition to the activities noted above that these firms conducted 

prior to the grandfather date. This reading would permit a grandfathered bank holding company to expand its commodities activities after the grandfather date. 

As part of the ANPR, the Board will consider the scope of the 

grandfather provision in section 4(o). In addition, the Board will 

consider how to address the potential risks to safety and soundness 

and U.S. financial stability that may be presented by the activities 

authorized under section 4(o) and whether additional prudential requirements such as capital, liquidity, reporting, or disclosure requirements, could help ensure such activities do not pose undue 

risks to the safety and soundness of the bank holding company or 

to financial stability. 

Q.16. Does that provision impose any limitations—including limitations related to the nature, volume, range-on the relevant FHC’s 

physical commodities assets and activities? Would any such limitations help to limit potential risks presented by grandfathered commodity activities? 

A.16. In addition to the scope of the grandfathered activities and 

investments discussed above, section 4(o) imposes two requirements: (1) the attributed aggregate consolidated assets of the company held by the financial holding company grandfathered pursuant to section 4(o), and not otherwise permitted to be held by a financial holding company, must not be more than 5 percent of the 

total consolidated assets of the financial holding company; and (2) 

the financial holding company must not permit any company, the 

57 

shares of which it owns or controls pursuant to section 4(o), to offer 

or market any product or service of an affiliated depository institution or any affiliated depository institution to offer or market any 

product or service of any company, the shares of which are owned 

or controlled by such holding company pursuant to section 4(o). 

As the Board noted in the ANPR, financial holding companies 

grandfathered under section 4(o) may engage in a broader set of 

physical commodities activities than financial holding companies 

may otherwise conduct. Moreover, financial holding companies that 

engage in physical commodities activities under section 4(k)(1)(B) 

(complementary authority) or make merchant banking investments 

in companies engaged in physical commodities activities must conform to more restrictive prudential limitations than those of section 

4(o) described above. 

As noted in the ANPR, the Board is considering how to address 

the potential risks to safety and soundness and financial stability 

that may be presented by activities authorized under section 4(o). 

The ANPR seeks public comment on whether additional prudential 

requirements could help ensure that activities conducted under section 4(o) of the BHC Act do not pose undue risks to the safety and 

soundness of the bank holding company or its subsidiary depository 

institutions, or to financial stability. 

Q.17. Please describe any internal discussions among the FRB 

staff, between 2008 and now, on the proper interpretation of the 

scope and purpose of Section 4(o). Were there any competing interpretations and, if so, what was the basis for the current view to 

prevail? 

A.17. As noted in the response to question 5, part a, there are multiple possible interpretations of section 4(o) of the BHC Act. The 

Board will consider this matter in connection with its review of 

physical commodities activities. 

Q.18. What type of research and analysis did the FRB staff conduct 

to arrive at its current interpretation? 

A.18. The scope of section 4(o) of the BHC Act is an issue of statutory interpretation. Therefore, staffs research and analysis employed the tools associated with statutory interpretation, which included the language of section 4(o), applicable maxims of statutory 

construction, the legislative history of the Gramm-Leach-Bliley Act 

(GLB Act), and the purpose of the GLB Act and the BHC Act. 

Q.19. As we discussed, Section 5 of the Bank Holding Company Act 

authorizes the FRB to force the sale of a nonbank affiliate if it 

threatens the safety and soundness of an insured depository institution. If a particular grandfathered activity poses a serious risk to 

the safety and soundness of the FHC, its deposit-taking subsidiary, 

or long-term stability of the U.S. financial system, would the Fed 

be both justified and obligated to use its powers under Section 5 

of the Bank Holding Company Act, including its power to order the 

relevant institution to terminate such an activity? 

A.19. Section 5(e) of the BHC Act permits the Board, under limited 

circumstances, to require a bank holding company to either terminate an activity or terminate the company’s control of its subsidiary bank(s). The Board may require action under section 5(e) 

58 

‘‘notwithstanding any other provision of [the BHC] Act,’’ which 

would include section 4(o) of the BHC Act. 

As noted, the circumstances under which the Board may act 

under section 5(e) are limited. The Board must have ‘‘reasonable 

cause to believe that the continuation by a bank holding company 

of any activity or of ownership or control of any of its nonbank subsidiaries, other than a nonbank subsidiary of a bank, [(1)] constitutes a serious risk to the financial safety, soundness, or stability of a bank holding company subsidiary bank and [(2)] is inconsistent with sound banking principles or with the purposes of [the 

BHC] Act or with the Financial Institutions Supervisory Act of 

1966.’’ Section 5(e) requires the Board to make both findings. Moreover, the first required finding (i.e., ‘‘a serious risk to the financial 

safety, soundness, or stability of a bank holding company subsidiary bank’’), is focused on risk to the subsidiary bank.Section 

5(e) also includes procedural requirements; the Board must provide 

the bank holding company due notice and an opportunity for a 

hearing and consider the views of the bank’s primary supervisor. 

Moreover, section 5(e) leaves the bank holding company, not the 

Board, the choice whether to divest the activity or divest the affiliated depository institution. 

Finally, section 5(e) does not obligate the Board to act. Rather, 

section 5(e) provides an additional authority by which the Board 

may choose to address serious supervisory concerns with a bank 

holding company. The Board has successfully addressed a range of 

concerns related to the safety and soundness of bank holding companies and their subsidiary depository institutions, as well as financial stability concerns, through other authorities such as Board 

supervision, applications functions, and lesser enforcement actions. 

Q.20. The following are questions related to the FRB’s legal and 

supervisory interpretation and use of the Section 4(k)’s complementary provisions under the BHCA: 

Please describe how exactly the FRB monitors and supervises 

FHCs’ physical commodity activities and investments made under 

the ‘‘complementary’’ authority. 

A.20. Similar to other aspects of its program for prudential supervision, the focus of the Federal Reserve’s assessment of physical 

commodities activities is the risk management framework that supports them. The primary goals of the Federal Reserve’s supervisory 

oversight of commodities activities are to (1) monitor the management of risks of those activities to the financial holding company, 

and (2) assess the adequacy of the firms’ control environments relating to commodities. The supervisory oversight, for example, includes a review of internal management reports, periodic meetings 

with the personnel responsible for managing and controlling the 

risks of the firm’s commodities activities, and targeted examinations of the activities. Supervisory staff also reviews policies and 

procedures, risk limits, risk mitigants, and internal audit coverage 

at institutions relating to physical commodities activities. 

The Federal Reserve has a number of supervisory staff with 

knowledge and expertise in physical commodities activities. These 

experts work to understand the exposures, risks, risk management, 

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sively. They evaluate the different manner in which commodities 

could present risks to financial holding companies, including from 

a market, operational, legal and reputational risk perspective. 

Staff has conducted horizontal reviews on physical commodities, 

based on the greater involvement of the largest financial holding 

companies in commodities activities, to better compare risks and 

practices across institutions, providing feedback to institutions 

where appropriate. During these reviews, the teams have examined 

exposures, valuations, and risk management practices across all 

relevant firms, and conducted deeper reviews of the firms’ operational risk quantification methodologies that relate to commodities. 

Financial holding companies that engage in commodities activities also must hold regulatory capital to absorb potential losses 

from those activities. Financial holding companies have long been 

required to hold capital against the market risk of all commodity 

positions. Moreover, following the financial crisis, the Federal Reserve strengthened its capital requirements for the credit risk and 

market risk of these transactions. Further, under the Board’s advanced approaches capital rules (12 CFR part 217, subpart E), financial holding companies subject to these rules are required to 

hold capital against the operational risk of their activities, including their commodities activities. 

As stated previously, the Federal Reserve is seeking public comment in the ANPR on the sufficiency of its current supervisory and 

regulatory framework for constraining the risks in the physical 

commodities activities of financial holding companies. 

Q.21. How does the FRB supervisory staff ensure that such policies 

and procedures are, in fact, effective in addressing all of the potential risks posed by such activities? 

A.21. Please see response for Question 20. 

Q.22. In your testimony, you stated the FRB has the authority to 

rescind any previously authorized ‘‘complementary’’ powers to any 

individual FHC. 

On what grounds can the FRB rescind a 4(k) order? 

A.22. An activity is permissible under section 4(k)(1)(B) of the BHC 

Act only if the activity, in the Board’s determination, is ‘‘complementary to a financial activity and does not pose a substantial 

risk to the safety and soundness of depository institutions or the 

financial system generally.’’ As noted in its advance notice of proposed rulemaking released January 14, 2014, the Board is considering whether the physical commodities activities continue to meet 

the requirements of section 4(k)(1)(B). Also as noted, the Board is 

evaluating the potential costs and other burdens (to financial holding companies and the public generally) associated with narrowing 

or eliminating the authority to engage in such activities. 

Q.23. Can a 4(k) order be reversed if the terms of the order itself, 

as established by the FRB, are violated? 

A.23. The Board noted in its orders approving certain financial 

holding companies to engage in specified physical commodities activities under section 4(k)(1)(B) of the BHC Act that the Board’s decisions are specifically conditioned on compliance with all the comVerDate Nov 24 2008 10:22 Oct 30, 2014 Jkt 046629 PO 00000 Frm 00063 Fmt 6602 Sfmt 6602 L:\HEARINGS 2014\01-15 REGULATING FINANCIAL HOLDING COMPANIES AND PHYSIC
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mitments made in connection with each company’s notice to the 

Board. Moreover, the commitments and conditions relied on in 

reaching such decisions are enforceable in proceedings under applicable law. 

Q.24. Section 4(j) requires a determination that a complementary 

activity ‘‘can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in 

efficiency, that outweigh possible adverse effects, such as undue 

concentration of resources, decreased or unfair competition, conflicts of interests, unsound banking practices, or risk to the stability of the United States banking or financial system.’’ Can a 4(k) 

order be revoked if the conditions laid out in section 4(j) no longer 

apply? 

A.24. Section 4(j) of the Bank Holding Company Act requires, in 

connection with a notice under the subsection, the Board to consider whether the performance of the proposed activity by the bank 

holding company can reasonably be expected to produce benefits to 

the public that outweigh possible adverse effects. In its ANPR regarding physical commodities activities, the Board also has requested comment on this matter. 

Q.25. In light of public discussions on this issue, is the FRB considering rescinding its prior grants of ‘‘complementary’’ powers to engage in physical commodity activities to individual FHCs? If not, 

please explain public policy reasons for not ordering individual 

FHCs to cease some or all of their ‘‘complementary’’ commodity activities. 

A.25. As noted in its ANPR regarding physical commodities activities, the Board is evaluating the potential costs and burdens on financial holding companies and the public associated with narrowing or eliminating the authority to engage in Complementary 

Commodities Activities. The ANPR specifically poses the question 

about the ways in which financial holding companies would be disadvantaged if they did not have authority to engage in Complementary Commodities Activities, and how the elimination of the authority might affect financial holding company customers and the 

relevant markets. 

Q.26. The following are questions related to the FRB’s legal interpretation and use of the Section 4(k)’s merchant banking provision 

under the BHCA: 

Please describe how the FRB monitors and supervises FHCs’ 

physical commodity activities and investments made under the 

merchant banking authority. 

A.26. The Federal Reserve’s examinations of the merchant banking 

activity of financial holding companies focus on a firm’s merchant 

banking risk management policies and procedures, compliance and 

audit, and portfolio risk ratings. Federal Reserve staff meets regularly with the largest financial holding companies to assess their 

merchant banking activities. 

These meetings focus on the performance of merchant banking 

investments and on changes in business strategy that might warrant a closer examination. Federal Reserve staff also reminds the 

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9See 12 CFR part 225, Appendix A, section II.B.5.; 12 CFR 217.152. 

10 12 U.S.C. §1847. 11 Id. Fines of more than $100,000 per violation per day only may be assessed for knowing 

violations made with the intent to deceive, defraud, or profit significantly. Id. 12 Id. Imprisonment for a term of more than 1 year per violation only may be assessed for 

knowing violations made with the intent to deceive, defraud, or profit significantly. Id. 

agement of portfolio companies held under merchant banking authority. 

The Federal Reserve’s capital rules for bank holding companies 

also impose significant risk based capital requirements on merchant banking investments. 9

In addition, the ANPR regarding physical commodities activities 

seeks comment on whether the Federal Reserve should revise its 

implementing regulation for merchant banking authority or otherwise change its supervisory or regulatory approach to merchant 

banking activities of financial holding companies. The Board is interested in public comment on ways to better constrain the risks 

of merchant banking activities and ways to better ensure that holding companies avoid engagement in the day-to-day operations of 

portfolio companies. 

Q.27. How does the FRB supervisory staff verify that such policies 

and procedures are effectively in compliance with the spirit and intent of the law that prohibits the use of merchant banking authority as a way for FHCs to get into impermissible commercial businesses? 

A.27. Please see response for Question 26. 

Q.28. Does the FRB collect and analyze specific data on individual 

FHCs’ merchant banking portfolios, other than the information on 

their market value? 

A.28. The Federal Reserve collects the Annual Report of Merchant 

Banking Investments Held for an Extended Period (schedule FR Y12A). This report collects data on merchant banking investments 

that are approaching the end of the holding period permissible 

under Regulation Y. Data collected include the name and location 

of company held, primary activity of company held, type of interest 

held by the financial holding company (e.g., common stock, preferred stock, general partner, limited partner), percent of ownership, acquisition cost, carrying value, and plan and schedule for 

disposition of the covered investment. A financial holding company 

generally has to submit an FR Y-12A if it holds shares, assets, or 

other ownership interests of companies engaged in nonfinancial activities for longer than 8 years (or 13 years in the case of an investment held through a qualifying private equity fund). 

Q.29. What are the penalties for violating the relevant provisions 

of section 4 of the Bank Holding Company Act? 

A.29. Section 8 of the BHC Act provides civil and criminal penalties for companies and individuals that violate provisions of the 

act or regulations or orders issued thereunder. 10 Civil and criminal 

monetary penalties in amounts of up to $25,000 and $1,000,000, respectively, may be assessed for each day during which the violation 

continues. 11 Violations of section 8 of the BHC Act also may result 

in up to 5 years of imprisonment for criminal violations. 12 A comVerDate Nov 24 2008 10:22 Oct 30, 2014 Jkt 046629 PO 00000 Frm 00065 Fmt 6602 Sfmt 6602 L:\HEARINGS 2014\01-15 REGULATING FINANCIAL HOLDING COMPANIES AND PHYSIC
62 

13 Id. Section 8 of the BHC Act provides a tiered penalty structure for such actions generally 

based on the seriousness of the violation. Id. 

pany that fails to make, submit, or publish reports or information 

required under the BHC Act or the Board’s regulations issued 

thereunder or that submits or publishes any false or misleading report or information is subject to fines ranging from $2,000 to 

$1,000,000 (or 1 percent of the total assets of the company, if such 

amount is less than $1,000,000). 13

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