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HEARING TO REVIEW REAUTHORIZATION OF 

THE COMMODITY FUTURES TRADING 

COMMISSION

HEARING

BEFORE THE

SUBCOMMITTEE ON 

GENERAL FARM COMMODITIES 

AND RISK MANAGEMENT

OF THE

COMMITTEE ON AGRICULTURE 

HOUSE OF REPRESENTATIVES

ONE HUNDRED TENTH CONGRESS

FIRST SESSION

OCTOBER 24, 2007

Serial No. 110–32

(

Printed for the use of the Committee on Agriculture 

agriculture.house.gov 

COMMITTEE ON AGRICULTURE 

COLLIN C. PETERSON, Minnesota, Chairman 

TIM HOLDEN, Pennsylvania, 

Vice Chairman 

MIKE MCINTYRE, North Carolina 

BOB ETHERIDGE, North Carolina 

LEONARD L. BOSWELL, Iowa 

JOE BACA, California 

DENNIS A. CARDOZA, California 

DAVID SCOTT, Georgia 

JIM MARSHALL, Georgia 

STEPHANIE HERSETH SANDLIN, South 

Dakota 

HENRY CUELLAR, Texas 

JIM COSTA, California 

JOHN T. SALAZAR, Colorado 

BRAD ELLSWORTH, Indiana 

NANCY E. BOYDA, Kansas 

ZACHARY T. SPACE, Ohio 

TIMOTHY J. WALZ, Minnesota 

KIRSTEN E. GILLIBRAND, New York 

STEVE KAGEN, Wisconsin 

EARL POMEROY, North Dakota 

LINCOLN DAVIS, Tennessee 

JOHN BARROW, Georgia 

NICK LAMPSON, Texas 

JOE DONNELLY, Indiana 

TIM MAHONEY, Florida 

BOB GOODLATTE, Virginia, Ranking 

Minority Member 

TERRY EVERETT, Alabama 

FRANK D. LUCAS, Oklahoma 

JERRY MORAN, Kansas 

ROBIN HAYES, North Carolina 

TIMOTHY V. JOHNSON, Illinois 

SAM GRAVES, Missouri 

JO BONNER, Alabama 

MIKE ROGERS, Alabama 

STEVE KING, Iowa 

MARILYN N. MUSGRAVE, Colorado 

RANDY NEUGEBAUER, Texas 

CHARLES W. BOUSTANY, JR., Louisiana 

JOHN R. ‘‘RANDY’’ KUHL, JR., New York 

VIRGINIA FOXX, North Carolina 

K. MICHAEL CONAWAY, Texas 

JEFF FORTENBERRY, Nebraska 

JEAN SCHMIDT, Ohio 

ADRIAN SMITH, Nebraska 

TIM WALBERG, Michigan 

PROFESSIONAL STAFF

ROBERT L. LAREW, Chief of Staff 

ANDREW W. BAKER, Chief Counsel 

APRIL SLAYTON, Communications Director 

WILLIAM E. O’CONNER, JR., Minority Staff Director 

SUBCOMMITTEE ON GENERAL FARM COMMODITIES AND RISK MANAGEMENT

BOB ETHERIDGE, North Carolina, Chairman 

DAVID SCOTT, Georgia 

JIM MARSHALL, Georgia 

JOHN T. SALAZAR, Colorado 

NANCY E. BOYDA, Kansas 

STEPHANIE HERSETH SANDLIN, South 

Dakota 

BRAD ELLSWORTH, Indiana 

ZACHARY T. SPACE, Ohio 

TIMOTHY J. WALZ, Minnesota 

EARL POMEROY, North Dakota 

JERRY MORAN, Kansas, Ranking Minority 

Member 

TIMOTHY V. JOHNSON, Illinois 

SAM GRAVES, Missouri 

CHARLES W. BOUSTANY, JR., Louisiana 

K. MICHAEL CONAWAY, Texas 

FRANK D. LUCAS, Oklahoma 

RANDY NEUGEBAUER, Texas 

CLARK OGILVIE, Subcommittee Staff Director

(II) 

(III)

C O N T E N T S 

Page 

Etheridge, Hon. Bob, a Representative in Congress from North Carolina, 

opening statement ................................................................................................ 1

Goodlatte, Hon. Bob, a Representative in Congress from Virginia, opening 

statement .............................................................................................................. 4

Prepared statement .......................................................................................... 5

Graves, Hon. Sam, a Representative in Congress from Missouri, prepared 

statement .............................................................................................................. 6

Moran, Hon. Jerry, a Representative in Congress from Kansas, opening statement ...................................................................................................................... 2

Prepared statement .......................................................................................... 2

Peterson, Hon. Collin C., a Representative in Congress from Minnesota, opening statement ........................................................................................................ 3

Prepared statement .......................................................................................... 4

Walz, Hon. Timothy J., a Representative in Congress from Minnesota, prepared statement ................................................................................................... 6

WITNESSES

Lukken, Hon. Walter, Acting Chairman, Commodity Futures Trading Commission, Washington, D.C. .................................................................................. 7

Prepared statement .......................................................................................... 9

Williams, Orice M., Director, Financial Markets and Community Investment, 

U.S. Government Accountability Office, Washington, D.C. .............................. 38 

Prepared statement .......................................................................................... 39

SUBMITTED QUESTIONS

Responses from Hon. Walter Lukken, Acting Chairman, Commodity Futures 

Trading Commission, Washington, D.C. ............................................................ 65

Responses from Orice M. Williams, Director, Financial Markets and Community Investment, U.S. Government Accountability Office, Washington, D.C. . 75

(1)

HEARING TO REVIEW REAUTHORIZATION OF 

THE COMMODITY FUTURES TRADING 

COMMISSION 

WEDNESDAY, OCTOBER 24, 2007

HOUSE OF REPRESENTATIVES, 

SUBCOMMITTEE ON GENERAL FARM COMMODITIES AND

RISK MANAGEMENT, 

COMMITTEE ON AGRICULTURE, 

Washington, D.C. 

The Subcommittee met, pursuant to call, at 1:30 p.m., in Room 

1300 of the Longworth House Office Building, Hon. Bob Etheridge 

[Chairman of the Subcommittee] presiding. 

Members present: Representatives Etheridge, Scott, Marshall, 

Boyda, Herseth Sandlin, Ellsworth, Space, Walz, Pomeroy, Peterson (ex officio), Barrow, Moran, Graves, Conaway, Neugebauer, and 

Goodlatte (ex officio). 

Staff present: Alejandra Gonzalez-Arias, Tyler Jameson, Scott 

Kuschmider, Clark Ogilvie, John Riley, Kristin Sosanie, Bryan 

Dierlam, and Jamie Weyer. 

OPENING STATEMENT OF HON. BOB ETHERIDGE, A 

REPRESENTATIVE IN CONGRESS FROM NORTH CAROLINA 

The CHAIRMAN. This hearing of the Subcommittee on General 

Farm Commodities and Risk Management to review reauthorization of the Commodity Futures Trading Commission will come to 

order. First, I would like to welcome our witnesses here today and 

say we are looking forward to your testimony. Also, I want to welcome the other members of the Commodity Futures Trading Commission who are with us today, Commissioner Mike Dunn, Commissioner Jill Sommers and Commissioner Bart Chilton. Your attendance here today is appreciated, showing solidarity with the 

Acting Chairman, and I know he appreciates it as well. 

Today this Subcommittee takes another important step on the 

road to reauthorization. Last month we heard from a host of industry participants on a wide range of issues affecting the futures 

markets. Last July we heard from a number of witnesses including 

the two who will testify today about energy trading and the developments that have been occurring in these specific markets. Today 

it all comes together. The recent report from GAO, of which Ms. 

Williams will testify, provides us with a clearer picture of what is 

happening in the energy markets. While the report does not include specific legislative recommendations, it does suggest that 

Congress may want to examine the regulatory structure for some 

2

of these markets. Something I am confident we would be doing 

even in the absence of the report. 

From the CFTC we will be hearing their recommendations on a 

number of issues. Most importantly we will be receiving results of 

their own examination of energy markets. I look forward to exploring further the Commission’s recommendations during the question 

and answer period. 

In last month’s hearing several witnesses expressed a great deal 

of anxiety regarding recent FERC action, as it may be encroaching 

upon the CFTC’s exclusive jurisdiction over the futures markets. 

While not exactly a topic usually considered under reauthorization, 

I suspect some Members will use the opportunity of this hearing 

to hear directly from the CFTC regarding this matter. As I stated 

at that hearing, it was Congress’ intent that the CFTC should have 

exclusive jurisdiction over futures markets to provide certainty in 

the markets on the rules that apply to those markets. For the 

CFTC to fail to assert its exclusive jurisdiction when appropriate 

would not only jeopardize the success that we have seen in the futures markets since passage of the CFMA, but also equal a failure 

to uphold the will of the United States Congress. 

Again, I want to thank the witnesses for their participation and 

now I turn to the gentleman from Kansas, Mr. Moran, for his opening statement. 

OPENING STATEMENT OF HON. JERRY MORAN, A 

REPRESENTATIVE IN CONGRESS FROM KANSAS 

Mr. MORAN. Mr. Chairman, thank you very much. 

This is an important and useful hearing and I will leave my remarks to be very brief. It is axiomatic that no elected official is 

ever short of words but we have had reauthorization hearing after 

reauthorization hearing, and opening statement after opening 

statement by the two of us, and I think both of us are very anxious 

to reach a consensus and reach a conclusion and move forward as 

quickly as possible on reauthorization legislation both here in the 

House, and ultimately in the Senate, and signed by the President. 

I appreciate again this hearing. 

Mr. Lukken, I appreciate your testimony. I thought it was very 

precise and I appreciate the exact instructions. Sometimes we get 

witnesses who in some ways hedge their recommendations to us 

and you did not do that and I am grateful for that. I, also, would 

like to take the opportunity to point out that we have a long history in Kansas for providing personnel to be Commissioners at the 

CFTC and I welcome Jill Sommers, our latest Kansas addition to 

your Commission. I look forward to working with her, the other 

Commissioners, and you, Mr. Chairman. I look forward to hearing 

what Ms. Williams has to say and I am anxiously awaiting the testimony of both of you. Thank you very much. 

[The prepared statement of Mr. Moran follows:]

PREPARED STATEMENT OF HON. JERRY MORAN, A REPRESENTATIVE IN CONGRESS

FROM KANSAS

Thank you Mr. Chairman. It is a pleasure to be here as we continue toward reauthorization of the Commodity Exchange Act. Today we have two expert witnesses 

to report on possible ways to improve the Act during reauthorization. I look forward 

3

to hearing the suggestions of both Acting Chairman Lukken and Ms. Williams from 

the Government Accountability Office. 

The CFTC has continued to operate far too long without proper reauthorization 

and sufficient funding. In recent years markets have evolved and trading volume 

increased exponentially. It is essential the Committee listen carefully to the suggestions of today’s witnesses and those of industry participants from the September 26, 

2007, hearing held by this Subcommittee, and move toward reauthorization as soon 

as possible so the CFTC has the tools necessary to properly oversee markets. 

Thank you, Acting Chairman Lukken and Ms. Williams, for your testimony today.

The CHAIRMAN. I thank the gentleman. He yields back. 

Now I would turn to the Chairman of the full Committee, Mr. 

Peterson, for his opening statement. 

OPENING STATEMENT OF HON. COLLIN C. PETERSON, A 

REPRESENTATIVE IN CONGRESS FROM MINNESOTA 

Mr. PETERSON. Thank you, Mr. Chairman, and thank you for 

calling this hearing today and for the work you have been doing 

to keep the Committee on track regarding the Commodity Exchange Act reauthorization. As everybody knows, we have been 

busy all year trying to get the farm bill done but reauthorization 

of this Act is another major responsibility for this Committee. I 

commend you and Mr. Moran and others for the work that you 

have done with the series of reauthorization hearings. We need to 

get this reauthorization done and signed into law. 

I would like to welcome today as witnesses, Mr. Lukken and Ms. 

Williams. I appreciate you being with us. Mr. Lukken chaired a 

hearing at CFTC on September 18 regarding many of the issues 

this Committee will consider during the reauthorization. I look forward to his input as we continue this process. 

Our Committee considers reauthorization at a time when the futures markets are changing with increased volume and tradable 

products. In the 7 years since the passage of the Commodity Futures Modernization Act we have seen growth in trading volume, 

number of participants and new trading products having grown beyond the price hedging of physical commodities to include a wide 

selection of highly complex financial products and indicators. I am 

sure from CFTC’s perspective gathering data on these newer but 

still heavily traded products is not always easy and the that effective oversight is a real challenge. 

Last month the CFTC held a meeting about the oversight of exempt commercial markets and their effect on traditional futures exchanges. I notice in Mr. Lukken’s testimony that the CFTC proposes increased oversight over the ECMs when certain conditions 

are met. I am grateful to the Commission for providing specific recommendations in this area and can assure that the Committee will 

give serious consideration to the points that you have raised. 

Ms. Williams will present the GAO’s findings about energy derivative transactions and some of those exempt trading platforms and 

the CFTC’s limited oversight in that venue. Given some of the 

more publicized events that we have seen with energy trading it 

would appear to the layperson that there are separate markets out 

there that appear to be similar but are playing under different 

rules. I hope Mr. Lukken can shed some light from CFTC’s perspective on what exempt commercial markets can offer the marketplace 

in terms of price discoveries and innovations. 

4

So it is my hope that today’s hearing will giving us a good understanding of what needs to be done in this reauthorization in order 

to continue to ensure the integrity of our futures markets. I would, 

again, welcome today’s witnesses and appreciate the time. 

[The prepared statement of Mr. Peterson follows:]

PREPARED STATEMENT OF HON. COLLIN C. PETERSON, A REPRESENTATIVE IN

CONGRESS FROM MINNESOTA

Thank you, Chairman Etheridge, for calling this hearing today and for the work 

you have done keeping this Committee on track regarding Commodity Exchange Act 

reauthorization. We have been busy all year trying to get the farm bill done, but 

reauthorization of this Act is another major responsibility for this Committee and 

I commend you for the work you have done with this series of reauthorization hearings. We need to get this reauthorization done and signed into law. 

I would like to welcome today’s witnesses: Acting CFTC Chairman Walter Lukken 

and Ms. Orice Williams with the Government Accountability Office. 

Mr. Lukken chaired a hearing at CFTC on September 18, regarding many of the 

issues this Committee will consider during CFTC reauthorization and I look forward 

to his input as we continue that process. 

Our Committee considers CEA reauthorization at a time when futures markets 

are changing with increased volume and tradable products. In the 7 years since the 

passage of the Commodity Futures Modernization Act, we have seen growth in trading volume, numbers of participants, and new trading products, having grown beyond the price hedging of physical commodities to include a wide selection of highly 

complex financial products and indicators. I’m sure from the CFTC’s perspective, 

gathering data on these newer, but still heavily-traded products is not always easy, 

and that effective oversight is a real challenge. 

Last month, the CFTC held a meeting about the oversight of exempt commercial 

markets, or ECMs, and their effect on traditional futures exchanges. I notice in 

Chairman Lukken’s testimony that the CFTC proposes increased oversight for 

ECMs when certain conditions are met. I am grateful to the Commission for providing specific recommendations in this area and can assure it that the Committee 

will give serious consideration to the points you have raised. 

Ms. Williams will present the GAO’s findings about energy derivatives transactions in some of those exempt trading platforms and CFTC’s limited oversight in 

that venue. Given some of the more publicized events we have seen with energy 

trading, it would appear to the layperson that there are separate markets out there 

that appear to be similar, but are playing under different rules. I hope Chairman 

Lukken can shed some light, from the CFTC’s perspective, on what exempt commercial markets can offer the marketplace in terms of price discovery and innovation. 

It is my hope that today’s hearing will give us a good understanding of what 

needs to be done in this reauthorization in order to continue to ensure the integrity 

of the futures markets. 

I would again like to welcome today’s witnesses and I yield back my time.

The CHAIRMAN. I thank the gentleman. 

Ranking Member of the full Committee, Mr. Goodlatte. 

OPENING STATEMENT OF HON. BOB GOODLATTE, A 

REPRESENTATIVE IN CONGRESS FROM VIRGINIA 

Mr. GOODLATTE. Mr. Chairman, thank you. I want to commend 

you for holding this hearing and the work that you and Mr. Moran 

and the Chairman and others have done on the Commodity Futures Trading Commission through authorization. I want to welcome our witnesses. 

The last reauthorization began in May of 1999 and resulted in 

three committees working for more than a year to report legislation 

to amend the Commodity Exchange Act and Federal securities law. 

Hopefully, this reauthorization will be significantly less complicated and controversial. Granted some areas of controversy still 

exist in the areas of energy derivatives, sales of off-exchange forex 

instruments, single stock futures regulation and the continuing 

5

globalization of electronic trading. I am hopeful, however, that we 

can sort these matters out by carefully considering the testimony 

submitted to this Committee. I am also confident in the CFTC’s 

ability to police the derivatives markets. I believe the Commodity 

Futures Modernization Act set a course for the wise use of an array 

of risk management instruments by large and small businesses 

alike. While forming the basis of sound business practices in different venues these instruments also remain cost-effective. Additionally, I am heartened by the steady rise in the trading volumes 

on our Nation’s futures exchanges. The increased trade volumes 

provide evidence that our exchanges still offer a unique product 

that may be used efficiently and with reasonable safety. I also assume that rising volume numbers mean that financial services 

firms offering tailored over-the-counter products to their customers 

are laying some of their risk off on the organized exchanges. 

This morning, the CFTC released, Report on the Oversight of 

Trading on Regulated Futures Exchanges and Exempt Commercial 

Markets. This report is the result of CFTC’s hearing on this topic, 

economic analysis by the Office of Chief Economist, and the CFTC’s 

internal deliberations and expertise on futures trading. I commend 

the CFTC for investing the resources needed to develop the recommendations and I look forward to Chairman Lukken expanding 

on them in his testimony. 

I, again, thank you for the opportunity to offer some of my 

thoughts on this important undertaking and look forward the testimony of the witnesses. Thank you, Mr. Chairman. 

[The prepared statement of Mr. Goodlatte follows:]

PREPARED STATEMENT OF HON. BOB GOODLATTE, A REPRESENTATIVE IN CONGRESS

FROM VIRGINIA

Mr. Chairman, I want to commend you for holding this hearing today, and continuing the Committee’s work on the Commodity Futures Trading Commission’s reauthorization. 

The last reauthorization, which began in May of 1999, resulted in three committees working for more than a year to report legislation to amend the Commodity 

Exchange Act and Federal securities law. Hopefully, this reauthorization will be significantly less complicated and controversial. 

Granted, some areas of controversy still exist in the areas of energy derivatives, 

sales of off-exchange forex instruments, single stock futures regulation, and the continuing globalization of electronic trading. I am hopeful, however, that we can sort 

these matters out by carefully considering the testimony submitted to this Committee. 

I am also confident in the CFTC’s ability to police the derivatives markets. I believe the Commodity Futures Modernization Act set a course for the wise use of an 

array of risk management instruments by large and small businesses alike. While 

forming the basis of sound business practices in different venues, these instruments 

also remain cost-effective. 

Additionally, I am heartened by the steady rise in the trading volumes on our nation’s futures exchanges. The increased trade volumes provide evidence that our exchanges still offer a unique product that may be used efficiently and with reasonable safety. I also assume these rising volume numbers mean that financial services 

firms, offering tailored over-the-counter products to their customers, are laying some 

of their risk off on the organized exchanges. 

This morning, the CFTC released, Report on the Oversight of Trading on Regulated Futures Exchanges and Exempt Commercial Markets. This report is the result 

of CFTC’s hearing on this topic, economic analysis by the Office of Chief Economist 

and the CFTC’s internal deliberations and expertise on futures trading. I commend 

the CFTC for investing the resources needed to develop the recommendations and 

I look forward to Chairman Lukken expanding on them in his testimony. 

6

Thank you for the opportunity to offer some of my thoughts on this important legislative undertaking and I thank the witnesses for testifying here today.

The CHAIRMAN. Thank you, sir. 

The Chair would request that other Members submit their opening statements for the record so that the witnesses may begin their 

testimony and ensure that we have ample time for questions. 

[The prepared statements of Mr. Walz and Mr. Graves follow:]

PREPARED STATEMENT OF HON. TIMOTHY J. WALZ, A REPRESENTATIVE IN CONGRESS

FROM MINNESOTA

Mr. Chairman, thank you for holding this hearing today on the reauthorization 

of the Commodity Futures Trading Commission. 

Since 1974, when the CFTC began to oversee trading in derivatives, it has been 

necessary for the CFTC to strike an appropriate balance to find the ‘‘sweet spot’’ 

of regulation that would protect investors but not stifle the industry. 

I am particularly interested to hear testimony today from Acting Chairman 

Lukken about foreign currency exchanges. Three years ago, the Zelener case limited 

the CFTC’s ability to address foreign currency fraud and the question of what type 

of authority the CFTC should possess in this area is an important issue for many 

in the forex market. 

I have met with some of the stakeholders who are involved in the forex market 

and I believe I can speak to the perspective of many of them. They do not fear government regulation, they welcome it. 

Forex traders realize that there is a role for the government to play in creating 

a level playing field and making sure everyone plays by the rules. But what they 

do not want is heavy-handed regulation that will squelch a new market that is 

widely used by many investors overseas, but is just getting its footing in the United 

States. 

I think it is very important that Congress get this question right. It should not 

be our goal to treat every commodity the same when it comes to regulation. It 

should not be our goal to interfere with a market that is operating fairly and efficiently. 

Mr. Chairman, I look forward to the opportunity to hear the testimony of our witnesses today and the chance to ask them questions about how they believe forex 

regulation should be addressed. 

PREPARED STATEMENT OF HON. SAM GRAVES, A REPRESENTATIVE IN CONGRESS FROM

MISSOURI

I want to thank the Chairman and Ranking Member for having this hearing 

today. I appreciate the opportunity to submit remarks to the record. 

Last month we heard from industry folks on reauthorization of the Commodity 

Exchange Act and they provided some useful insight on how we should proceed. 

Today, I look forward to hearing the recommendations of the Commodity Futures 

Trading Commission (CFTC) and working with them as we begin the reauthorization effort. 

I have reviewed Chairman Lukken’s testimony and I am very pleased with some 

of the changes he is recommending, particularly in exempt commercial markets and 

in over-the-counter markets. I agree with his conclusion that more transparency is 

better for all parties involved. Additionally, I am pleased with the new position reporting recommendations he is suggesting and look forward to working with him 

and his staff along with the industry folks as we begin consideration of this important legislation. 

Last, I ask the CFTC to please comment on H.R. 3009, the Market Transparency 

Reporting of United States Transactions Act of 2007 that I introduced. 

I look forward to listening to the panelists today and moving forward with this 

reauthorization.

The CHAIRMAN. We would like to welcome now to the panel, to 

the table our panelists, the Honorable Walter Lukken, Acting 

Chairman of the Commodity Futures Trading Commission and Ms. 

Orice Williams, Director of Financial Markets and Community Investment for the U.S. GAO. That’s the United States Government 

7

Accountability Office. Mr. Lukken, please begin when you are 

ready and I would request if you would, please, try to summarize 

your full statement and each of your full statements will be entered 

into the record. 

STATEMENT OF THE HON. WALTER LUKKEN, ACTING

CHAIRMAN, COMMODITY FUTURES TRADING COMMISSION, 

WASHINGTON, D.C. 

Mr. LUKKEN. Thank you, Mr. Chairman. Good afternoon, Chairman Etheridge, Ranking Member Moran and Members of the Subcommittee. I am pleased to appear on behalf of the Commodity Futures Trading Commission to discuss important issues surrounding 

our reauthorization. 

Seven years have passed since the passage of the Commodity Futures Modernization Act. During that expanse of time, significant 

changes occurred within the futures industry. Since 2000, annual 

growth volume on U.S. futures exchanges have increased 442 percent. New exchanges are being created and new products are being 

invented on a daily basis. But perhaps the greatest shift in the futures industry is the undeniable fact that our markets are global. 

For firms and exchanges this is welcome news—more growth opportunities than ever before. But for regulators, this global repositioning means we must rethink how we do our jobs and adapt appropriately. 

Thankfully, with the passage of CFMA, Congress had the foresight to provide this agency with the tools needed to oversee this 

rapidly changing marketplace. Much has been made of the flexibility provided by the CFMA, but the adoption of a core principles 

approach equally enhanced the Commission’s ability to get in front 

of the developing regulatory problems. At a time of scarce resources, this has allowed the CFTC to target our efforts effectively 

to areas where the risks to the public are the greatest. And I am 

pleased to report that, by and large, the legal framework of the 

CFMA is working extraordinarily well. 

That said, regulators and lawmakers cannot anticipate every evolution of these markets. With this recognition, I come before you 

today to discuss two broad areas for consideration. First, based on 

recommendations from the Commission presented today, Congress 

may wish to evaluate whether enhancements are necessary for the 

legal framework provided for exempt commercial markets. Second, 

Congress may want to review whether the CFTC has adequate authority to police retail fraud, particularly in the foreign currency 

area, and whether the penalty scheme for market manipulation reflects the severity of this economically disruptive behavior. 

The CFMA created a tiered regulatory structure for the futures 

industry which tailored requirements to the specific risks of the 

marketplace. Within this tiered design Congress created a lighttouch regulatory category called exempt commercial markets or 

ECMs on which certain commodities such as energy products could 

be traded by institutional participants. Due primarily to the nonretail nature of these markets and the types of transactions executed policymakers believe the risks associated with the wholesale 

exchanges to be low. 

8

However, the energy markets have changed dramatically in the 

past 7 years and the Commission’s regulation of these markets 

should evolve in kind. Although these exempt markets have increased competition, certain energy contracts offered on ECMs now 

function as virtual substitutes for contracts listed on regulated exchanges. 

Last month, the Commission convened a hearing to examine the 

oversight of trading on designated contract markets and ECMs. 

Commission staff, exchanges, ECMs, and industry and consumer 

groups testified before the Commission in a productive debate. 

Based on this hearing, the Commission presents to this Committee 

a report today detailing the Commission’s findings and recommendations regarding these energy markets. 

As the Committee knows, under the CEA price discovery is the 

key determinate to Commission regulation, as others outside the 

marketplace begin to use prices to conduct business, such as farmers, utilities and others. Similarly, price discovery was the primary 

focus when the Commission began its review of ECMs. 

Testimony from the Commission’s hearing and staff analysis on 

this subject has led us to conclude that certain natural gas products on the InterContinental Exchange and NYMEX function as 

virtual substitutes. Not only are the products substantially identical in terms and pricing, but the market participants are also the 

same, with all of the top 25 natural gas traders on NYMEX also 

trading significantly on ICE. Moreover, our economic analysis by 

staff show that trading activity in these products on ICE serves a 

significant price discovery function on 20 percent of the trading 

days measured. 

Many witnesses from the hearing testified that ECMs provide a 

valuable platform for markets seeking a low-cost, effective ‘‘onramp’’ to launch new ideas for contract design and trading. However, the reality that some ECM contracts are serving a significant 

price discovery function leads the Commission to conclude that 

changes to the CEA may be necessary. 

To that end, the Commission recommends that the CEA be 

amended so that when an ECM futures contract is determined to 

serve a significant price discovery function the Commission would 

have the authority to: one, require large trader position reporting 

for that contract; two, require an ECM to adopt position limits or 

accountability levels for that contract; three, an ECM to exercise 

self-regulatory responsibilities over that contract in preventing manipulation; and four, exercise emergency authorities regarding such 

transactions. 

These recommendations have the support of the entire Commission and will allow the agency to properly oversee price discovery 

contracts while keeping in place the tiered regulatory structure 

that has fostered innovation and competition in these global markets. As a member of the President’s Working Group on Financial 

Markets, I have fully consulted with my colleagues on the Working 

Group regarding these recommendations and they are comfortable 

with our leadership on this issue. 

I now want to turn to another reauthorization matter, the issue 

of retail fraud in foreign currency trading. In 2004, the 7th Circuit 

curtailed the Commission’s ability to combat retail off-exchange forVerDate 0ct 09 2002 10:06 Jun 05, 2009 Jkt 041481 PO 00000 Frm 00012 Fmt 6633 Sfmt 6601 I:\DOCS\110-32\50071.TXT SOLEM PsN: REBEKA
9

eign currency fraud. In the Zelener case, the court held that contracts at issue were not futures contracts, but rather a rolling spot 

contract that could not be the basis for CFTC fraud action. This 

has provided a potential road map to scam artists for evading the 

CFTC’s fraud authority. 

In the last 7 years, The CFTC has brought 98 enforcement ac- tions involving forex fraud and has been awarded more than $1 billion in penalties involving more than 26,000 victims. Recently, 

however, because of the Zelener decision, the Commission has lost 

some key forex cases and now finds it more difficult to prosecute 

forex actions. Unless Congress clarifies the Commission’s jurisdiction in this area, a large sector of retail fraud will remain effectively outside of the prosecutorial authority of the CFTC. The Commission believes that the consensus PWG language included in this 

Committee’s last reauthorization would substantially address this 

problem. 

The Commission also asks Congress to clarify that the CFTC has 

fraud authority regarding off-exchange ‘‘principal-to-principal’’ futures transactions. This is necessary to clarify our fraud authority 

regarding non-intermediated trades in light of a court decision that 

clouded our authority in this area. The House reauthorization bill 

of 2005 included language addressed this problem. 

In addition, the Commission asks Congress to enhance its penalty scheme for market manipulation to reflect the economic severity of such activity by increasing the maximum fine to $1 million 

per violation and the maximum prison sentence to 10 years. 

As the futures markets have grown in size and complexity, the 

Commission continues to evolve in kind using the regulatory tools 

provided by the CFMA and this Committee. However, the Commission’s funding has remained static over the last few years while 

staffing levels have been decreasing to historic lows. The Commission has always done more with less but is currently stretched to 

the limit. In reauthorization, I am hopeful that Congress will support sufficient funding for the CFTC at a level that matches its regulatory expectations for this agency and the growth of these markets. 

I greatly appreciate the opportunity to testify before you today 

and look forward to any questions the Committee may have. 

[The prepared statement of Mr. Lukken follows:]

PREPARED STATEMENT OF HON. WALTER LUKKEN, ACTING CHAIRMAN, COMMODITY

FUTURES TRADING COMMISSION, WASHINGTON, D.C. 

Good morning Chairman Etheridge, Ranking Member Moran and Members of the 

Subcommittee. I am pleased to appear on behalf of the Commodity Futures Trading 

Commission (Commission or CFTC) to discuss the important issues surrounding the 

reauthorization of the Commodity Exchange Act (CEA), the Commission’s governing 

statute. 

Seven years have passed since the passage of the Commodity Futures Modernization Act (CFMA). During that expanse of time, significant change has occurred within the futures industry. In the past 7 years, the annual volume on U.S. futures exchanges increased 442 percent. This industry has witnessed accelerated migration 

from open outcry trading to electronic platforms, with screen-based trading now accounting for a significant majority of all futures volume. New exchanges are created 

and new products are invented on a daily basis. But perhaps the greatest shift in 

the futures industry is the undeniable fact that our markets are global. Advances 

in technology have expanded the playing field to include every place in which there 

are people who wish to participate. For firms and exchanges, this is welcome news—

10

more growth opportunities than ever before. For the marketplace, it means increased liquidity and information coming into the price-discovery process. But for 

regulators, this global repositioning means we must rethink how we do our jobs and 

adapt appropriately. 

Thankfully, with the passage of the CFMA, Congress had the foresight to provide 

this agency with the flexible tools needed to oversee this rapidly changing marketplace. Before the principles-based regime implemented by the CFMA, some of the 

prescriptive rules written by the CFTC were virtually outdated on the day they 

were published. This was not the fault of the agency, but the reality of the marketplace. The nature of these markets is to innovate, compete and arbitrage opportunities with lightning speed. In crafting the CFMA, policymakers recognized that, instead of struggling against this dynamic, a regulatory structure should leverage 

these market characteristics to the advantage of the public interest and allow the 

agency to better anticipate change. 

Much has been made of the flexibility provided businesses by the CFMA, but the 

adoption of a core principles approach equally enhanced the Commission’s ability to 

get in front of developing regulatory problems. At a time of scarce resources, this 

has allowed the CFTC to target our efforts effectively to areas where the risks to 

the public are greatest. Although global growth has made the agency busier now 

than at any time in its history, the principles-based approach adopted in the CFMA 

has been remarkably dynamic. I am pleased to report that, by and large, the legal 

framework of the Act is working extraordinarily well and no major revisions of the 

Act are needed. 

That said, regulators and lawmakers cannot anticipate every evolution of these 

markets. With this recognition, I come before you today to discuss two broad areas 

on which Congress may wish to focus during the reauthorization process. First, 

based on recommendations from the Commission presented today, Congress may 

wish to evaluate whether enhancements are necessary for the legal framework provided for exempt commercial markets. Second, Congress may want to review whether the CFTC has clear and adequate authority to police fraud, particularly in the 

foreign currency area, and whether the penalty scheme for market manipulations 

reflects the severity of this economically disruptive behavior. 

Exempt Commercial Markets 

The CFMA created a tiered regulatory structure for the futures industry, which 

tailored regulatory requirements to the specific risks of the marketplace. This calibrated structure has provided the CFTC with flexibility and focus as we strive to 

keep pace with this industry’s global growth. 

Within this tiered design, Congress created a light-touch regulatory category 

called Exempt Commercial Markets or ECMs, on which certain commodities, such 

as energy products, could be traded by institutional participants. Due primarily to 

the non-retail nature of these markets and the types of transactions executed, policymakers believed the risks associated with these institutional exchanges were low. 

However, the energy markets have changed dramatically in these 7 years and the 

Commission’s regulation of these markets should evolve in kind. Although these exempt markets have increased competition and lowered costs for derivatives trading, 

certain energy contracts offered on ECMs now function as virtual substitutes for 

contracts listed on regulated exchanges, with tight correlation and linking of prices 

and participants. 

With this as a backdrop, last month the Commission convened a hearing to examine the oversight of trading on designated contract markets (DCMs) and ECMs. 

Commission staff, exchanges, ECMs, and industry and consumer groups testified before the Commission in a productive debate of the relevant issues. Based on this 

hearing, the Commission presents to this Committee a report detailing the Commission’s findings and recommendations regarding these energy markets. 

Today, I want to highlight some aspects of the Commission’s hearing and the resulting findings and recommendations. As the Committee knows, Section 3 of the 

Commodity Exchange Act provides that the public interest is served through the 

proper regulation of markets that serve a price discovery function in interstate commerce. Price discovery is the key determinant to Commission regulation and oversight, as others outside the marketplace begin to use prices to conduct business, 

such as farmers, utilities and others. Similarly, price discovery was the primary 

focus of this agency when the Commission began its review of the regulatory structure of ECMs. 

Although ECMs have been evolving over time, the relatively recent linkage of 

ECM contract settlement prices to DCM futures contract settlement prices raises 

the question of whether the CFTC has the necessary authority to police these markets for manipulation and abuse. Linkage of contract settlement prices was not conVerDate 0ct 09 2002 10:06 Jun 05, 2009 Jkt 041481 PO 00000 Frm 00014 Fmt 6633 Sfmt 6621 I:\DOCS\110-32\50071.TXT SOLEM PsN: REBEKA
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templated at the time of the CFMA nor at the time of the Commission’s 2004 rulemaking regarding ECMs that perform a significant price discovery function. The 

CFTC staff is concerned that ECM cash-settled ‘‘look-alike’’ contracts could provide 

an incentive to manipulate the settlement price of the underlying DCM futures contract to benefit positions in the ‘‘look-alike’’ ECM contract. 

Testimony from the Commission’s hearing and staff analysis on this subject has 

led us to conclude that one ECM, the InterContinental Exchange (ICE), is serving 

a significant price discovery role and that ICE and the New York Mercantile Exchange (NYMEX) function as virtual substitutes for each other in certain key products. Not only are the products substantially identical in terms and pricing, but the 

market participants are also the same, with all of the top 25 natural gas traders 

on NYMEX also trading significantly on ICE. Moreover, economic analysis by our 

staff indicates that the trading activity in these products on ICE serves a significant 

price discovery function on 20 percent of the trading days measured. 

Many witnesses from the hearing testified that ECMs provide a valuable platform 

for markets seeking a low-cost, effective ‘‘on-ramp’’ to launch new ideas for contract 

design and trading methodologies. ECMs serve as incubators for new concepts and 

provide robust competition with DCMs. This competition has spurred established 

DCMs to respond to ECM initiatives with innovations of their own, whether it is 

developing new products or accelerating the pace of automation. 

However, the reality that some ECM contracts are serving a significant price discovery function leads the Commission to conclude that changes to the CEA are necessary in order for the Commission to detect and prevent manipulation in these 

markets. 

It is critical that any legislative changes should not result in stifling the innovation and other benefits brought about by ECMs, that changes should not overcomplicate all already complicated statutory regime set out in the CEA, and that 

changes should be cost-effective for the Commission and industry to implement. 

To that end, the Commission recommends that the CEA be amended such that, 

upon a determination that an ECM futures contract serves a significant price discovery function, the Commission would have four new authorities: (1) Require large 

trader position reporting for that contract; (2) Require an ECM to adopt position 

limits or accountability levels for that contract; (3) Require an ECM to exercise selfregulatory responsibility over that contract in preventing manipulation; and (4) Provide the ECM and the Commission with emergency authority over that contract. 

These recommendations have the support of the entire Commission and will allow 

the agency to oversee price discovery contracts while keeping in place the tiered regulatory structure that has fostered the innovation necessary for U.S. markets to 

compete effectively in the highly competitive global marketplace. As a member of 

the President’s Working Group on Financial Markets (PWG), I have fully consulted 

with my colleagues on the PWG regarding these recommendations. 

In its report, the Commission recommends two other steps to keep abreast of the 

developing energy markets. First, the Commission recommends the agency establish 

an Energy Markets Advisory Committee to conduct periodic public meetings on 

issues affecting energy producers, distributors, market users and consumers in attempt to facilitate discussion and policy decisions as these markets evolve. 

Second, the Commission proposes that the CFTC and the Federal Energy Regulatory Commission (FERC) work together to develop best practices for utilities and 

others who use NYMEX settlement prices as benchmarks in pricing their energy 

products. Our agencies should also help develop best practices for these end-users 

of energy on how to utilize the futures and other derivatives markets in managing 

price risk and volatility. 

Today, the Commission also announced it has finalized its amendment to Regulation 18.05 clarifying its ability to obtain information from large traders in regulated 

markets regarding the full scope of their related positions, including over-thecounter transactions. This transparency serves as an important complement to the 

recommendations advanced today. 

I am confident that the Commission proposal strikes the right balance of ensuring 

that these markets remain free of manipulative conduct while allowing the markets 

to grow and innovate on U.S. soil. 

The Zelener Decision/Foreign Currency Fraud 

In our commitment to protecting market participants and market integrity, I 

want to turn to the issue of retail fraud in foreign currency trading. In 2004, the 

Seventh Circuit Court of Appeals curtailed the Commission’s ability to combat retail 

off-exchange foreign currency (forex) fraud. In the Zelener case, the court held that 

the contracts at issue were not futures contracts, but rather a type of spot contract 

that could not be the basis for a CFTC fraud action. This has provided a potential 

12

road map to scam artists as to how to deceive innocent retail customers while evading enforcement by the CFTC. 

The CFTC believes that the Zelener case and others that have followed it were 

incorrectly decided and that the contracts at issue are futures contracts. Rather 

than continue to expend scarce Commission resources litigating this issue, however, 

we present to Congress the opportunity to restore legal certainty by clarifying the 

CFTC’s jurisdiction in this area. 

In the last 7 years, the CFTC has brought 98 enforcement actions involving forex 

fraud against unsuspecting retail customers. In these 98 cases, there were approximately 26,000 victims who invested approximately $461 million. Courts have awarded more than $1 billion ($1,000,917,086) in customer restitution and civil penalties 

in these cases. However, because of the Zelener decision and its progeny, the Commission has lost some key forex cases and now finds it is more difficult to prosecute 

forex actions. Unless Congress clarifies the Commission’s jurisdiction over off-exchange forex transactions, a large sector of retail fraud will remain effectively outside of the prosecutorial authority of the CFTC. 

In November 2005, the PWG submitted to Congress a narrowly tailored proposal 

to allow the Commission to prosecute forex fraud cases. The proposal would require 

those who participate in the solicitation of retail forex transactions to register with 

the CFTC. It would also close a loophole that allowed firms to notice register as securities broker-dealers and serve as counterparties to off-exchange forex transactions. Last, the proposal would bolster the CFTC’s anti-fraud authority over retail 

off-exchange forex transactions like those in dispute in the Zelener case. This narrow fix is endorsed by the PWG and was included in the reauthorization bill that 

this Committee and the House of Representatives passed in 2005. 

Principal-to-Principal Antifraud Authority 

The Commission also submits to this Committee that it may wish to address an 

important issue relating to the CFTC’s antifraud authority for futures contracts. 

Congress should clarify that CEA Section 4b, the CFTC’s main antifraud provision, 

gives the CFTC the authority to bring fraud actions in off-exchange ‘‘principal-toprincipal’’ futures transactions. This clarification is necessary to eliminate a potential obstacle to the use of the CFTC’s antifraud authority in today’s non-intermediated markets. 

In late November 2000, the Seventh Circuit Court of Appeals suggested that the 

CFTC may be able to use Section 4b only in ‘‘intermediated’’ transactions—i.e., those 

involving a broker-customer relationship. In other words, the court indicated that 

the CFTC may not be able to use its Section 4b antifraud authority in principalto-principal transactions. Meanwhile, at about the same time, the CFMA was enacted to permit off-exchange futures transactions entered into on a principal-to-principal basis, such as energy transactions pursuant to CEA Sections 2(h)(1) and 

2(h)(3). Congress specifically reserved the CFTC’s Section 4b antifraud authority in 

Section 2(h) of the CEA so that the CFTC could prosecute fraud involving transactions conducted under that Section. Since all Section 2(h) transactions must be 

done on a principal-to-principal basis to qualify for the exemption, it is important 

to clarify that the CFTC’s Section 4b antifraud authority applies to these non-intermediated transactions. Without this clarification, the work of Congress in 2000 to 

protect energy markets from fraud could be rendered meaningless. 

Accordingly, the House reauthorization bill of 2005 would have amended subsection 4b(a)(2) by adding the words ‘‘or with’’ in order to address off-exchange principal-to-principal transactions. This new language would make it clear that the 

CFTC has the authority to bring antifraud actions in off-exchange, principal-to-principal futures transactions, including exempt commodity transactions in energy 

under Section 2(h). This amendment to Section 4b would implement Congressional 

intent to reserve the CFTC’s antifraud authority with regard to these transactions. 

I note that the Section 4b language was supported by the Futures Industry Association, the National Futures Association, the Chicago Mercantile Exchange, the 

Chicago Board of Trade, the NYMEX, USFE, and others during the last attempt at 

reauthorization. 

In addition, the Commission asks Congress to enhance its penalty scheme for 

market manipulation to reflect the economic severity of such activity as well as the 

importance of protecting these markets. The Commission recommends amending the 

CEA to increase the civil and criminal penalties available for certain violations of 

the CEA such as manipulation, false reporting, and conversion. The maximum fines 

under Section 9 should be increased to $1 million, and the maximum prison sentence should be increased from 5 to 10 years. The Commission also recommends certain conforming amendments to the enforcement provisions in Sections 6(c), 6b, and 

6c of the CEA to effectuate this increase in civil monetary penalties. Increasing the 

13

civil penalties that may be imposed for manipulation to $1 million would conform 

the CEA to the penalty provisions that Congress enacted in the Energy Policy Act 

of 2005 for manipulation cases brought by the FERC with respect to the physical 

energy markets. 

Conclusion 

The CFTC has been able to work within the current structure of the CEA to oversee futures markets, to ensure the integrity of the price discovery mechanism, to 

maintain the financial integrity of the markets, and to protect customers. The CFTC 

stands ready to offer its assistance as Congress moves through the reauthorization 

process and considers these various options. 

As the futures markets have grown in size and complexity, the Commission continues to evolve in the administration of its duties. However, the Commission’s 

funding has remained static over the past few years, while staff levels have decreased to historically low levels. The Commission has always done more with less, 

but it is currently stretched to the limit. In reauthorization, Congress should be 

mindful of the resources that are needed to fulfill the Commission’s mandate. I am 

hopeful that Congress will support sufficient funding of the CFTC at a level that 

matches its regulatory expectations for this agency and the growth of these markets. 

My fellow Commissioners and I welcome this opportunity to work with you on the 

reauthorization of the CFTC. I greatly appreciate the opportunity to testify before 

you today on this important matter and would be pleased to answer any questions 

that the Committee may have.

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The CHAIRMAN. Thank you, sir. 

Before we move on I would ask unanimous consent of the Members that Mr. Barrow may sit with this Committee today. Without 

objection. 

Ms. Williams. 

STATEMENT OF ORICE M. WILLIAMS, DIRECTOR, FINANCIAL 

MARKETS AND COMMUNITY INVESTMENT, U.S.

GOVERNMENT ACCOUNTABILITY OFFICE, WASHINGTON, D.C. 

Ms. WILLIAMS. Mr. Chairman, Ranking Member and Members of 

the Subcommittee, I am pleased to be here today to discuss our recently issued report on the trading of derivatives for energy commodities, and the scope of CFTC’s authority and oversight. 

As you well know, recent increases in energy prices have raised 

questions about the reasons for the increase and the scope of 

CFTC’s authority over certain markets. Our work revealed that 

both derivatives energy markets and physical commodities markets 

have undergone substantial change and growth. For example, trading volume both on and off-exchange has grown tremendously as 

new traders have been attracted to these markets in search of 

higher returns. However, this growth in off-exchange trading has 

also resulted in questions about the scope of CFTC’s authority over 

these markets, particularly certain exempt commercial markets 

which are subject to less regulation and oversight than regulated 

exchanges. 

Our report addresses certain questions about trends and changes 

in the market and the scope of CFTC’s authority in enforcement activities in energy markets. Briefly, I would like to highlight a few 

of our findings and recommendations. 

Energy products are traded on futures exchanges, exempt commercial markets and over-the-counter or OTC markets. By design, 

each market is subject to varying levels of CFTC oversight with 

some markets largely unregulated. As you know, under the Commodity Exchange Act CFTC regulatory oversight is focused on surveillance of futures exchanges to protect the public and ensure the 

integrity of the market. Conversely, both the exempt commercial 

market and the OTC market are exempt from general CFTC oversight. However, both markets are subject to CFTC’s enforcement of 

the CEA’s anti-manipulation, and where applicable, antifraud provisions. 

This tiered structure results in CFTC having varied access to 

trading information depending on the market. That is, for regulated exchanges CFTC receives daily trading information. For exempt commercial markets, CFTC has authority to request information as needed, and for bilateral contracts, CFTC routinely receives 

no information. Changes in some markets, notably the natural gas 

market, have raised questions about whether the oversight of certain markets is sufficient. 

While the report recommends that Congress continue to consider 

the scope of CFTC’s authority as part of the reauthorization process, we also made a number of recommendations to CFTC to help 

improve its operations, including improving the transparency of 

certain trader reporting information, better documenting its surveillance activities, and developing more meaningful performanceVerDate 0ct 09 2002 10:06 Jun 05, 2009 Jkt 041481 PO 00000 Frm 00042 Fmt 6633 Sfmt 6601 I:\DOCS\110-32\50071.TXT SOLEM PsN: REBEKA
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based measures for its enforcement program. And we commend 

CFTC for taking steps to address these recommendations. 

However, the larger policy issues are much more complicated to 

solve and require ongoing debate and study. Therefore, as this Subcommittee and others in Congress continue to explore and debate 

policy alternatives for the scope of CFTC’s authority, additional information is needed to understand what may need to be done to 

best protect investors from fraudulent, manipulative and abusive 

practices. 

Such questions include: How different or more similar are the 

characteristics and uses of exchange and off-exchange products 

being traded, and are the differences still justified? To what extent 

does trading off-exchange effect price discovery and what are the 

regulatory implications? How much of an impact are non-traditional market participants, such as commodity index funds having 

on these markets? And finally, are energy markets unique or are 

these issues also relevant to other commodities markets, and if so 

how do you ensure equitable treatment? By answering these questions, information would be available to assess which, if any, 

changes should be made to CFTC’s tiered oversight structure. 

Mr. Chairman, this concludes my prepared statement. I would be 

happy to respond to any questions that you or other Members of 

the Subcommittee may have. Thank you. 

[The prepared statement of Ms. Williams follows:]

PREPARED STATEMENT OF ORICE M. WILLIAMS, DIRECTOR, FINANCIAL MARKETS AND

COMMUNITY INVESTMENT, U.S. GOVERNMENT ACCOUNTABILITY OFFICE, WASHINGTON, D.C. 

Commodity Futures Trading Commission 

Trends in Energy Derivatives Markets Raise Questions About CFTC’s Oversight 

Why GAO Did This Study 

Energy prices for crude oil, heating oil, unleaded gasoline, and natural gas have 

risen substantially since 2002, generating questions about the role derivatives markets have played and the scope of the Commodity Futures Trading Commission’s 

(CFTC) authority. This testimony focuses on (1) trends and patterns in the futures 

and physical energy markets and their effects on energy prices, (2) the scope of 

CFTC’s regulatory authority, and (3) the effectiveness of CFTC’s monitoring and detection of abuses in energy markets. The testimony is based on the GAO report, 

Commodity Futures Trading Commission: Trends in Energy Derivatives Markets 

Raise Questions about CFTC’s Oversight (GAO–08–25, October 19, 2007). For this 

work, GAO analyzed futures and large trader data and interviewed market participants, experts, and officials at six Federal agencies. 

What GAO Recommends 

As part of CFTC’s reauthorization process, GAO recommended that Congress consider exploring the scope of the agency’s authority over energy derivatives trading, 

in particular for trading in exempt commercial markets. In addition, GAO recommends that CFTC improve the usefulness of the information provided to the public, better document its monitoring activities, and develop more outcome-oriented 

performance measures for its enforcement program. CFTC generally agreed with 

GAO’s recommendations. 

To view the full product, including the scope and methodology, click on GAO–08–

174T. For more information, contact Orice Williams at (202) 512–8678 or 

williamso@gao.gov.

What GAO Found 

Various trends in both the physical and futures markets have affected energy 

prices. Specifically, tight supply and rising demand in the physical markets contributed to higher prices as global demand for oil has risen rapidly while spare producVerDate 0ct 09 2002 10:06 Jun 05, 2009 Jkt 041481 PO 00000 Frm 00043 Fmt 6633 Sfmt 6621 I:\DOCS\110-32\50071.TXT SOLEM PsN: REBEKA
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1GAO, Commodity Futures Trading Commission: Trends in Energy Derivatives Markets Raise 

Questions about CFTC’s Oversight, GAO–08–25 (Washington, D.C.: Oct. 19, 2007). 2Our analysis of energy prices and energy financial markets is generally limited to the time 

period from January 2002 through December 2006. 

tion capacity has fallen since 2002. Moreover, increased political instability in some 

of the major oil-producing countries has threatened the supply of oil. During this 

period, increasing numbers of noncommercial participants became active in the futures markets (including hedge funds) and the volume of energy futures contracts 

traded also increased. Simultaneously, the volume of energy derivatives traded outside of traditional futures exchanges increased significantly. Because these developments took place concurrently, the effect of any individual trend or factor on energy 

prices is unclear. 

Under the authority granted by the Commodity Exchange Act (CEA), CFTC focuses its oversight primarily on the operations of traditional futures exchanges, such 

as the New York Mercantile Exchange, Inc. (NYMEX), where energy futures are 

traded. Increasing amounts of energy derivatives trading also occur on markets that 

are largely exempt from CFTC oversight. For example, exempt commercial markets 

conduct trading on electronic facilities between large, sophisticated participants. In 

addition, considerable trading occurs in over-the-counter (OTC) markets in which eligible parties enter into contracts directly, without using an exchange. While CFTC 

can act to enforce the CEA’s antimanipulation and antifraud provisions for activities 

that occur in exempt commercial and OTC markets, some market observers question 

whether CFTC needs broader authority to more routinely oversee these markets. 

CFTC is currently examining the effects of trading in the regulated and exempt energy markets on price discovery and the scope of its authority over these markets—

an issue that will warrant further examination as part of the CFTC reauthorization 

process. 

CFTC conducts daily surveillance of trading on NYMEX that is designed to detect 

and deter fraudulent or abusive trading practices involving energy futures contracts. 

To detect abusive practices, such as potential manipulation, CFTC uses various information sources and relies heavily on trading activity data for large market participants. Using this information, CFTC staff may pursue alleged abuse or manipulation. However, because the agency does not maintain complete records of all such 

allegations, determining the usefulness and extent of these activities is difficult. In 

addition, CFTC’s performance measures for its enforcement program do not fully reflect the program’s goals and purposes, which could be addressed by developing additional outcome-based performance measures that more fully reflect progress in 

meeting the program’s overall goals. Because of changes and innovations in the 

market, the reports that CFTC receives on market activities may no longer be accurate because they use categories that do not adequately separate trading being done 

for different reasons by various market participants.

Mr. Chairman and Members of the Subcommittee:

I am pleased to be here today to discuss our recent report on the trading of derivatives for energy commodities, including crude oil and natural gas, and the Commodity Futures Trading Commission’s (CFTC) oversight of these markets.1 The expansion of derivatives trading in energy markets, particularly by participants such 

as hedge funds, and rapid growth in trading off regulated exchanges have raised 

questions about the quality and quantity of reporting on and oversight of these trading activities.2

Specifically, I will discuss (1) trends in the physical and energy derivatives markets and their effect on energy prices, (2) the scope of CFTC’s authority for protecting market users in the trading of energy derivatives, and (3) CFTC’s monitoring 

and detection of market abuses in energy futures markets. I should point out that 

our review was intended to identify trends in both the physical and derivatives energy markets and to provide information on the current regulatory structure for energy derivatives trading, including analyzing the various perspectives of market participants on these issues. While our report frames issues that need to be addressed, 

we do not offer specific policy solutions. 

During the course of our review, we obtained and analyzed energy futures prices 

and trading volumes from the New York Mercantile Exchange, Inc. (NYMEX). Specifically, we collected data for crude oil, heating oil, natural gas, and unleaded gas 

from January 2002 through December 2006. We also analyzed data obtained from 

CFTC on market participants and the outstanding trading positions of different categories of traders. We reviewed publicly available information, including academic 

studies and reports and market data. Finally, we interviewed a broad range of market participants and observers, representatives of energy trading markets, and govVerDate 0ct 09 2002 10:06 Jun 05, 2009 Jkt 041481 PO 00000 Frm 00044 Fmt 6633 Sfmt 6621 I:\DOCS\110-32\50071.TXT SOLEM PsN: REBEKA
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3 Energy swap transactions also may be conducted off-exchange if they satisfy the requirements for excluded swap transactions contained in section 2(g) of the Commodity Exchange Act. 

ernment regulators and agencies involved with the energy markets. This work was 

done in accordance with generally accepted government auditing standards. 

Summary 

Physical and derivatives markets for crude oil, unleaded gasoline, heating oil, and 

natural gas have experienced substantial changes in recent years. Within the physical market, tight supply and rising global demand, ongoing political instability in 

oil-producing regions, limited refining capacity, and other supply disruptions all contributed to higher prices. While these changes were occurring in the physical markets, in the derivatives markets volatility of energy prices generally remained above 

historic averages for most of the period but declined during 2006 to levels at or near 

the historical average. Moreover, trading volumes for futures increased, at least in 

part because a growing number of managed-money traders (including hedge funds) 

began to see energy futures as attractive investment alternatives. Another change 

occurring during this time was the increased trading of energy derivatives outside 

the organized exchanges. Trading in these markets—specifically electronic commercial markets and over-the-counter (OTC) markets—is much less transparent than 

trading on futures exchanges, and comprehensive data are not available because 

these energy markets are not regulated. Given that the developments in the physical and derivatives markets were occurring simultaneously, determining their effect 

on energy prices is difficult. Continued monitoring of the various factors that affect 

market prices, and how those factors are changing, will be important in protecting 

the public and ensuring market integrity. 

Energy derivatives are traded on futures exchanges and off-exchange in exempt 

commercial and OTC markets.3 Exempt commercial markets are electronic trading 

facilities that trade exempt commodities, including energy commodities, on a principal-to-principal basis solely between commercial entities meeting certain eligibility 

requirements. In the OTC markets, parties meeting certain requirements can enter 

into bilateral energy derivatives transactions. Unlike the futures exchanges, which 

are subject to comprehensive oversight by CFTC, exempt commercial markets and 

OTC markets are not subject to general CFTC oversight, although CFTC can enforce the CEA’s antimanipulation provisions and, where applicable, the antifraud 

provisions. To provide transparency about trading on the futures exchanges, CFTC 

routinely publicly reports aggregate information on trading by large commercial 

(such as oil companies, refineries, and other hedge traders) and noncommercial 

(such as hedge funds) participants that occurs on the exchanges. However, in the 

way the data are currently categorized, no distinction is made between commercial 

traders who use the exchanges to hedge their positions in the physical markets and 

those commercial traders, such as investment banks, who trade futures to hedge 

their trading in off-exchange derivatives. Given the developments and growth in the 

energy trading markets, questions have been raised over whether CFTC needs 

broader authority over the off-exchange derivative markets, particularly those involving exempt commodities and exempt commercial markets. 

At an operational level, we also reported that while CFTC conducts reporting, surveillance, and enforcement activities in the energy markets to help provide transparency to the public, detect fraudulent or manipulative trading practices, and deter 

abuses, the effectiveness of these efforts is unclear. For example:

• Although CFTC monitors exchange trading activity through its surveillance program and gathers additional information from NYMEX officials, traders, or 

other sources to determine if further action is warranted, staff did not routinely 

document the results of these inquiries. Instead, they kept formal records of 

their findings only in cases in which improper trading was identified. As a result, CFTC may be limiting its opportunities to identify trends and its ability 

to measure the extent and usefulness of its monitoring activities.

• We also found that CFTC has successfully pursued energy-related cases, but we 

were not able to determine how effectively CFTC’s enforcement activities were 

in identifying violations and deterring misconduct because the agency lacked 

meaningful outcome-based measures.

Our report includes a matter for Congressional consideration and three recommendations to CFTC. In light of recent developments and the uncertainty over 

the adequacy of CFTC’s oversight, we recommend that Congress, as part of the 

CFTC reauthorization process, further explore whether the current regulatory structure for energy derivatives, in particular for those traded in exempt commercial 

markets, adequately provides for fair trading and accurate pricing of energy comVerDate 0ct 09 2002 10:06 Jun 05, 2009 Jkt 041481 PO 00000 Frm 00045 Fmt 6633 Sfmt 6621 I:\DOCS\110-32\50071.TXT SOLEM PsN: REBEKA
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modities. To improve the transparency of market activities and the functioning of 

CFTC’s oversight, we recommend that CFTC reconsider how information it publishes in trading reports for energy products could be improved and CFTC has 

agreed to reexamine the classifications used in these reports. CFTC also agreed with 

our recommendations aimed at better documenting its surveillance activities and developing more outcome-based performance measures and has taken steps to implement them. 

Background 

Energy commodities are bought and sold on both the physical and financial markets. The physical market includes the spot market where products such as crude 

oil or gasoline are bought and sold for immediate or near-term delivery by producers, wholesalers, and retailers. Spot transactions take place between commercial 

participants for a particular energy product for immediate delivery at a specific location. For example, the U.S. spot market for West Texas Intermediate crude oil is 

the pipeline hub near Cushing, Oklahoma, while a major spot market for natural 

gas operates at the Henry Hub near Erath, Louisiana. The prices set in the specific 

spot markets provide a reference point that buyers and sellers use to set the price 

for other types of the commodity traded at other locations. 

In addition to the spot markets, derivatives based on energy commodities are 

traded in financial markets. The value of the derivative contract depends on the performance of the underlying asset—for example, crude oil or natural gas. Derivatives 

include futures, options, and swaps. Energy futures include standardized exchangetraded contracts for future delivery of a specific crude oil, heating oil, natural gas, 

or gasoline product at a particular spot market location. An exchange designated by 

CFTC as a contract market standardizes the contracts. The owner of an energy futures contract is obligated to buy or sell the commodity at a specified price and future date. However, the contractual obligation may be removed at any time before 

the contract expiration date if the owner sells or purchases other contracts with 

terms that offset the original contract. In practice, most futures contracts on 

NYMEX are liquidated via offset, so that physical delivery of the underlying commodity is relatively rare. 

Market participants use futures markets to offset the risk caused by changes in 

prices, to discover commodity prices, and to speculate on price changes. Some buyers 

and sellers of energy commodities in the physical markets trade in futures contracts 

to offset or ‘‘hedge’’ the risks they face from price changes in the physical market. 

Exempt commercial markets and OTC derivatives are also used to hedge this risk. 

The ability to reduce their price risk is an important concern for buyers and sellers 

of energy commodities, because wide fluctuations in cash market prices introduce 

uncertainty for producers, distributors, and consumers of commodities and make investment planning, budgeting, and forecasting more difficult. To manage price risk, 

market participants may shift it to others more willing to assume the risk or to 

those having different risk situations. For example, if a petroleum refiner wants to 

lower its risk of losing money because of price volatility, it could lock in a price by 

selling futures contracts to deliver the gasoline in 6 months at a guaranteed price. 

Without futures contracts to manage risk, producers, refiners, and others would 

likely face greater uncertainty. 

By establishing prices for future delivery, the futures market also helps buyers 

and sellers determine or ‘‘discover’’ the price of commodities in the physical markets, 

thus linking the two markets together. Markets are best able to perform price discovery when (1) participants have current information about the fundamental market forces of supply and demand, (2) large numbers of participants are active in the 

market, and (3) the market is transparent. Market participants monitor and analyze 

a myriad of information on the factors that currently affect and that they expect 

to affect the supply of and demand for energy commodities. With that information, 

participants buy or sell an energy commodity contract at the price they believe the 

commodity will sell for on the delivery date. The futures market, in effect, distills 

the diverse views of market participants into a single price. In turn, buyers and sellers of physical commodities may consider those predictions about future prices, 

among other factors, when setting prices on the spot and retail markets. 

Other participants, such as investment banks and hedge funds, which do not have 

a commercial interest in the underlying commodities, generally use the futures market for profit. These speculators provide liquidity to the market but also take on 

risks that other participants, such as hedgers, seek to avoid. In addition, 

arbitrageurs attempt to make a profit by simultaneously entering into several transactions in multiple markets in an effort to benefit from price discrepancies across 

these markets. 

43

Several Factors Have Caused Changes in the Energy Markets, Potentially 

Affecting Energy Prices 

The physical markets for energy commodities underwent change and turmoil from 

2002 through 2006, which affected prices in the spot and futures markets. We reported that numerous changes in both the physical and futures markets may have 

affected energy prices. However, because these changes occurred simultaneously, 

identifying the specific effect of any one of these changes on energy prices is difficult. 

Various Changes in the Physical Market Contributed to Rising Prices 

The physical energy markets have undergone substantial change and turmoil during this period, which can affect spot and futures markets. Like many others, we 

found that a number of fundamental supply and demand conditions can affect 

prices. According to the Energy Information Administration (EIA), world oil demand 

has grown since 1983 from a low of about 59 million barrels per day in 1983 to more 

than 85 million barrels per day in 2006 (fig. 1). While the United States accounts 

for about a quarter of this demand, rapid economic growth in Asia also has stimulated a strong demand for energy commodities. For example, EIA data show that 

during this time frame, China’s average daily demand for crude oil increased almost 

fourfold.

Source: GAO analysis of EIA data. 

Note: The world oil demand data for 2006 represent a preliminary estimate.

The growth in demand does not, by itself, lead to higher prices for crude oil or 

any other energy commodity. For example, if the growth in demand were exceeded 

by a growth in supply, prices would fall, other things remaining constant. However, 

according to EIA, the growth in demand outpaced the growth in supply, even with 

spare production capacity included in supply. Spare production capacity is surplus 

oil that can be produced and brought to the market relatively quickly to re-balance 

the market if there is a supply disruption anywhere in the world oil market. As 

shown in figure 2, EIA estimates that global spare production capacity in 2006 was 

about 1.3 million barrels per day, compared with spare capability of about 10 million barrels per day in the mid-1980s and about 5.6 million barrels a day as recently 

as 2002.


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4GAO, Motor Fuels: Understanding the Factors That Influence the Retail Price of Gasoline, 

GAO–05–525SP (Washington, D.C.: May 2005). 5GAO–05–525SP. 

Source: GAO analysis of EIA data.

Major weather and political events also can lead to supply disruptions and higher 

prices. In its analysis, EIA has cited the following examples:

• Hurricanes Katrina and Rita removed about 450,000 barrels per day from the 

world oil market from June 2005 to June 2006.

• Instability in major oil-producing countries of the Organization of Petroleum 

Exporting Countries (OPEC), such as Iran, Iraq, and Nigeria, have lowered production in some cases and increased the risk of future production shortfalls in 

others.

• Oil production in Russia, a major driver of non-OPEC supply growth during the 

early 2000s, was adversely affected by a worsened investment climate as the 

government raised export and extraction taxes.

The supply of crude oil affects the supply of gasoline and heating oil, and just as 

production capacity affects the supply of crude oil, refining capacity affects the supply of those products distilled from crude oil. As we have reported, refining capacity 

in the United States has not expanded at the same pace as the demand for gasoline.4 Inventory, another factor affecting supplies and therefore prices, is particularly crucial to the supply and demand balance, because it can provide a cushion 

against price spikes if, for example, production is temporarily disrupted by a refinery outage or other event. Trends toward lower levels of inventory may reduce the 

costs of producing gasoline, but such trends also may cause prices to be more volatile. That is, when a supply disruption occurs or there is an increase in demand, 

there are fewer stocks of readily available gasoline to draw on, putting upward pressure on prices. 

Another consideration is that the value of the U.S. dollar on open currency markets could affect crude oil prices. For example, because crude oil is typically denominated in U.S. dollars, the payments that oil-producing countries receive for their oil 

also are denominated in U.S. dollars. As a result, a weak U.S. dollar decreases the 

value of the oil sold at a given price, and oil-producing countries may wish to increase prices for their crude oil in order to maintain the purchasing power in the 

face of a weakening U.S. dollar to the extent they can. 

The Effect on Prices of Relatively High but Falling Volatility and a Growing Volume 

of Trading in Derivatives Is Unclear 

As you can see, conditions in the physical markets have undergone changes that 

can help explain at least some of the increases in both physical and derivatives commodity prices. As we have previously reported, futures prices typically reflect the 

effects of world events on the price of the underlying commodity such as crude oil.5

For example, political instability and terrorist acts in countries that supply oil create uncertainties about future supplies, which are reflected in futures prices. Conversely, news about a new oil discovery that would increase world oil supply could 


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6 CFTC collects data on traders holding positions at or above specific reporting levels set by 

the Commission. This information is collected as part of CFTC’s large trader reporting system.

result in lower futures prices. In other words, changes in the physical markets influence futures prices. 

At the same time that physical markets were undergoing changes, we found that 

financial markets also were amidst change and evolution. For example, the annual 

historical volatilities between 2000 and 2006—measured using the relative change 

in daily prices of energy futures—generally were above or near their long-term averages, although crude oil and heating oil declined below the average and gasoline declined slightly at the end of that period. We also found that the annual volatility 

of natural gas fluctuated more widely than that of the other three commodities and 

increased in 2006 even though prices largely declined from the levels reached in 

2005. Although higher volatility is often equated with higher prices, this pattern illustrates that an increase in volatility does not necessarily mean that price levels 

will increase. In other words, price volatility measures the variability of prices rather than the direction of the price changes. 

Elsewhere in the futures market, we found an increase in the number of noncommercial traders such as managed money traders.6 Attracted in part by the 

trends in prices and volatility, a growing number of traders sought opportunities to 

hedge against those changes or profit from them. Using CFTC’s large trader data, 

we found that from July 2003 to December 2006, crude oil futures and options contracts experienced the most dramatic increase, with the average number of noncommercial traders more than doubling from about 125 to about 286. As shown in 

figure 3, while the growth was less dramatic in the other commodities, the average 

number of noncommercial traders also showed an upward trend for unleaded gasoline, heating oil, and natural gas. 

Source: GAO analysis of CFTC data.

Not surprisingly, our work also revealed that as the number of traders increased, 

so did the trading volume on NYMEX for all energy futures contracts, particularly 

crude oil and natural gas. Average daily contract volume for crude oil increased by 

90 percent from 2001 through 2006, and natural gas increased by just over 90 perVerDate 0ct 09 2002 10:06 Jun 05, 2009 Jkt 041481 PO 00000 Frm 00049 Fmt 6633 Sfmt 6621 I:\DOCS\110-32\50071.TXT SOLEM PsN: REBEKA

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7The Bank for International Settlements is an international organization that fosters international monetary and financial cooperation and serves as a bank for central banks. 

cent. Unleaded gasoline and heating oil experienced less dramatic growth in their 

trading volumes over this period. 

While much harder to quantify, another notable trend was the significant increase 

in the amount of energy derivatives traded outside exchanges. Trading in these 

markets is much less transparent, and comprehensive data are not available because these energy markets are not regulated. However, using the Bank for International Settlements data as a rough proxy for trends in the trading volume of OTC 

energy derivatives, the face value or notional amounts outstanding of OTC commodity derivatives excluding precious metals, such as gold, grew from December 

2001 to December 2005 by more than 850 percent to over $3.2 trillion.7

Further, while some market observers believe that managed money traders were 

exerting upward pressure on prices by predominantly buying futures contracts, 

CFTC data we analyzed revealed that from the middle of 2003 through the end of 

2006, the trading activity of managed money participants became increasingly balanced between buying (those that expect prices to go up) and selling (those that expect prices to go down). Using CFTC large trader reporting data, we found that from 

July 2003 through December 2006, managed money traders’ ratio of buying (long) 

to selling (short) open interest positions was 2.5:1 indicating that on the whole, this 

category of participants was 2.5 times as likely to expect prices to rise as opposed 

to fall throughout that period, which they did. However, as figure 4 illustrates, by 

2006, this ratio fell to 1.2:1, suggesting that managed money traders as a whole 

were more evenly divided in their expectations about future prices. As you can see, 

managed money trading in unleaded gasoline, heating oil, and natural gas showed 

similar trends.

47

Source: GAO analysis of CFTC data. 

Note: Data for 2003 were for July through December. The percentages indicate what portion of long and short open interest was held by managed 

money traders. For example, in 2004, managed money traders held 14.5 

percent of the total long open interest for crude oil and 7.1 percent of the 

total short open interest. Because data are not included for all categories 

of traders, the percentages for these three categories within a particular period do not total 100. These data should be viewed as a general overview 

of managed money traders’ positions. They do not provide insights into how 

traders’ individual positions changed over time. Our data for 2006 include 


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8These reports include the number of traders, changes since the last report, and open positions. 9 71 Fed. Reg. 35627, 35630–31 (June 21, 2006). 

contract trading data for NYMEX reformulated gasoline blendstock (RB) 

and for the NYMEX gasoline contract (HU) that began to replace RB.

Overall, we found that views were mixed about whether these trends put any upward pressure on prices. Some market participants and observers have concluded 

that large purchases of oil futures contracts by speculators could have created an 

additional demand for oil that could lead to higher prices. Conversely, some Federal 

agencies and other market observers took the position that speculative trading activity did not have a significant impact on prices. For example, an April 2005 CFTC 

study of the markets concluded that increased trading by speculative traders, including hedge funds, did not lead to higher energy prices or volatility. This study 

also argued that hedge funds provided increased liquidity to the market and dampened volatility. Still others told us that while speculative trading in the futures market could contribute to short-term price movements in the physical markets, they 

did not believe it was possible to sustain a speculative ‘‘bubble’’ over time, because 

the two markets were linked and both responded to information about changes in 

supply and demand caused by such factors as the weather or geographical events. 

In the view of these observers and market participants, speculation could not lead 

to artificially high or low prices over a long period. 

CFTC Oversees Exchanges and Has Limited Authority Over Other Derivatives Markets 

Under CEA, CFTC’s authority for protecting market users from fraudulent, manipulative, and abusive practices in energy derivatives trading is primarily focused 

on the operations of traditional futures exchanges, such as NYMEX, where energy 

futures are traded. Off exchange markets, which are available only to eligible traders of certain commodities under specified conditions, are not regulated, although 

CFTC may enforce antimanipulation and antifraud provisions of the CEA with respect to trading in those markets. The growth in trading off-exchange has raised 

questions about the sufficiency of CFTC’s limited authority over these markets. 

These changes and innovations also have brought into question the methods CFTC 

uses to categorize published data about futures trading by participants in the offexchange markets and whether information about their activities in off-exchange 

markets would be useful to the public. CFTC is taking steps to better understand 

these issues. Most importantly, it is currently examining the relationship between 

trading in the regulated and exempt energy markets and the role this trading plays 

in the price discovery process. It is also examining the sufficiency of the scope of 

its authority over these markets—an issue that will warrant further examination 

as part of the CFTC reauthorization process. 

CFTC Has General Oversight Authority Over Futures Exchanges, but Information on 

These Exchanges Reported to the Public Has Not Kept Pace With Changing Market Conditions 

To help provide transparency in the markets, CFTC provides the public information on open interest in exchange-traded futures and options by commercial and 

noncommercial traders for various commodities in its weekly Commitment of Traders (COT) reports.8 As we reported, CFTC observed that the exchange-traded derivatives markets, as well as trading patterns and practices, have evolved. In 2006, 

CFTC initiated a comprehensive review of the COT reporting program out of concern that the reports in their present form might not accurately reflect the commercial or noncommercial nature of positions held by nontraditional hedgers, such as 

swaps dealers.9 A disconnect between the classifications and evolving trading activity could distort the accuracy and relevance of reported information to users and the 

public, thereby limiting its usefulness for both. 

In December 2006, CFTC announced a 2 year pilot program for publishing a supplemental COT report that includes positions of commodity index traders in a separate category. However, the pilot does not include any energy commodities. Although 

commodity index traders are active in energy markets, according to CFTC officials, 

currently available data would not permit an accurate breakout of index trading in 

these markets. For example, some traders, such as commodity index pools, use the 

futures markets to hedge commodity index positions they hold in the OTC market. 

However, these traders also may have positions in the physical markets, which 

means the reports that CTFC receives on market activities, which do not include 

such off-exchange transactions, may not present an accurate picture of all positions 

in the market place for the commodity. In response to our recommendation to reexVerDate 0ct 09 2002 10:06 Jun 05, 2009 Jkt 041481 PO 00000 Frm 00052 Fmt 6633 Sfmt 6621 I:\DOCS\110-32\50071.TXT SOLEM PsN: REBEKA
49

10President’s Working Group on Financial Markets, Over-the-Counter Derivatives Markets and 

the Commodity Exchange Act (Nov. 9, 1999). Members of group are the Chairman of CFTC, the 

Secretary of the Treasury, the Chairman of the Board of Governors of the Federal Reserve, and 

the Chairman of the Securities and Exchange Commission. 11 As stated by CFTC, the purpose of the proposed regulation is to make it explicit that persons holding or controlling reportable positions on a reporting market must retain books and 

records and make available to the Commission upon request any pertinent information with respect to all other positions and transactions in the commodity in which the trader has a reportable position, including positions held or controlled or transactions executed over-the-counter or 

pursuant to sections 2(d), 2(g) or 2(h)(1)–(2) of the CEA or part 35 of the Commission’s regulations, on exempt commercial markets operating pursuant to sections 2(h)(3)–(5) of the CEA, on 

exempt boards of trade operating pursuant to Section 5d of the CEA, and on foreign boards of 

trade (hereinafter referred to collectively as non-reporting transactions); and to make the regulation clearer and more complete with respect to hedging activity. The purpose of the amendments 

is to clarify CFTC’s regulatory reporting requirements for such traders. 72 Fed. Reg. 34413. 12Section 4b of the CEA is CFTC’s main antifraud authority. In a November 2000 decision, 

the 7th Circuit Court of Appeals ruled that CFTC only could use section 4b in intermediated 

transactions—those involving a broker. Commodity Trend Service, Inc. v. CFTC, 233 F.3d 981, 

991–992 (7th Cir. 2000). As amended by the Commodity Futures Modernization Act of 2000, the 

CEA permits off-exchange futures and options transactions that are done on a principal-to-principal basis, such as energy transactions pursuant to CEA sections 2(h)(1) and 2(h)(3). According 

to CFTC, House and Senate CFTC reauthorization bills introduced during the 109th Congress 

(H.R. 4473 and S. 1566) would have amended section 4b to clarify that Congress intends for 

Continued

amine the COT classifications for energy markets, CFTC agreed to explore whether 

the classifications should be refined to improve their accuracy and relevance. 

CFTC Authority Over Exempt Commercial Markets and OTC Markets Is Limited, 

and Views Vary About the Sufficiency of Its Regulatory Authority With Respect 

to Off-Exchange Energy Derivatives 

Now let me address some of the larger policy issues associated with CFTC’s oversight of these markets. Under CEA, CFTC’s authority for protecting market users 

from fraudulent, manipulative, and abusive practices in energy derivatives trading 

is primarily focused on the operations of traditional futures exchanges, such as 

NYMEX, where energy futures are traded. Currently, CFTC receives limited information on derivatives trading on exempt commercial markets—for example, records 

of allegations or complaints of suspected fraud or manipulation, and price, quantity, 

and other data on contracts that average five or more trades a day. The agency may 

receive limited information, such as trading records, from OTC participants to help 

CFTC enforce the CEA’s antifraud or antimanipulation provisions. The scope of 

CFTC’s oversight authority has raised concerns among some Members of Congress 

and others that activities on these markets are largely unregulated, and that additional CFTC oversight is needed. 

While some observers have called for more oversight of OTC derivatives, most notably for CFTC to be given greater oversight authority of this market, others oppose 

any such action. Supporters of more CFTC oversight authority believe that regulation of OTC derivatives markets is necessary to protect the regulated markets and 

consumers from potential abuse and possible manipulation. One of their concerns 

is that, due to the lack of complete information on the size of this market or the 

terms of the contracts, CFTC may not be assured that trading on the OTC market 

is not adversely affecting the regulated markets and, ultimately, consumers. However others, including the President’s Working Group, have concluded that OTC derivatives generally are not subject to manipulation because contracts are settled in 

cash on the basis of a rate or price determined in a separate, highly liquid market 

that does not serve a significant price discovery function.10 The Working Group also 

noted that if electronic markets were to develop and serve a price discovery function, then consideration should be given to enacting a limited regulatory regime 

aimed at enhancing market transparency and efficiency through CFTC, as the regulator of exchange-traded derivatives. 

However, the lack of reported data about this market makes addressing concerns 

about its function and effect on regulated markets and entities challenging. In a 

June 2007 Federal Register release clarifying its large trader reporting authority, 

CFTC noted that having data about the off-exchange positions of traders with large 

positions on regulated futures exchanges could enhance the Commission’s ability to 

deter and prevent price manipulation or other disruptions to the integrity of the regulated futures markets.11 According to CFTC officials, the Commission has proposed 

amendments to clarify its authority under the CEA to collect information and bring 

fraud actions in principal-to-principal transactions in these markets, enhancing 

CFTC’s ability to enforce antifraud provisions of the CEA.12

50

CFTC to enforce section 4b in connection with off-exchange principal-to-principal futures transactions, including exempt commodity transactions in energy under section 2(h) as well as all 

transactions conducted on derivatives transaction execution facilities. 

Also, in September 2007, CFTC conducted a hearing to begin examining trading 

on regulated exchanges and exempt commercial markets more closely. The hearing 

focused on a number of issues, including:

• the current tiered regulatory approach established by the Commodity Futures 

Modernization Act, which amended the CEA, and whether this model is beneficial;

• the similarities and differences between exempt commercial markets and regulated exchanges, and the associated regulatory risks of each market; and

• the types of regulatory or legislative changes that might be appropriate to address any identified risks.

Given ongoing questions about the similarity of products traded on the markets 

and how and whether exempt markets play a role in the price discovery process and 

whether existing reporting requirements are sufficient, we recommend that Congress take up this issue during the CFTC reauthorization process to begin to answer 

some of these questions and the implications for the current regulatory structure 

in light of the changes that have occurred in this market. 

CFTC Engages in Large Trader Reporting, Surveillance, and Enforcement 

Activities, but the Effectiveness of the Activities Is Largely Uncertain 

CFTC provides oversight for commodity futures markets by analyzing large trader 

reporting data, conducting routine surveillance, and investigating and taking enforcement actions against market participants and others. The Commission uses information gathered from surveillance activities to identify unusual trading activity 

and possible market abuse. In particular, CFTC’s large trader reporting system 

(LTRS) provides essential information on the majority of all trading activity on futures exchanges. CFTC staff said they routinely investigate traders with large open 

positions, but do not routinely maintain information about such inquiries, thereby 

making it difficult to determine the usefulness and extent of these activities. According to recent data provided by CFTC, about 10 percent of the enforcement actions 

involved energy-related commodities. However, as with programs operating in regulatory environments where performance is not easily measurable, evaluating the effectiveness of CFTC’s enforcement activities is challenging because it lacks effective 

outcome-based performance measures. 

CFTC Oversight Includes Surveillance of Energy Futures Trading, but the Full Extent of Follow-Up Activities Is Uncertain 

CFTC conducts regular market surveillance and oversight of energy trading on 

NYMEX and other futures exchanges, focusing on detecting and preventing disruptive practices before they occur and keeping the CFTC Commissioners informed of 

possible manipulation or abuse. According to CFTC staff, when a potential market 

problem has been identified, surveillance staff generally contact the exchange or 

traders for more information. To confirm positions and determine intent, staff may 

question exchange employees, brokers, or traders. According to the staff, CFTC’s Division of Market Oversight may issue a warning letter or make a referral to the Division of Enforcement to conduct a nonpublic investigation into the trading activity. 

Markets where surveillance problems have not been resolved may be included in reports presented to the Commission at weekly surveillance meetings. 

According to CFTC staff, they routinely make inquiries about traders with large 

open positions approaching expiration, but formal records of their findings are only 

kept in cases with evidence of improper trading. If LTRS data revealed that a trader 

had a large open market position that could disrupt markets if it were not closed 

before expiration, CFTC staff would contact the trader to determine why the trader 

had the position and what plans the trader had to close the position before expiration or ensure that the trader was able to take delivery. If the trader provided a 

reasonable explanation for the position and a reasonable delivery or liquidation 

strategy, staff said no further action would be required. CFTC staff said they would 

document such contacts on the basis of their importance in either informal notes, 

e-mails to supervisors, or informal memorandums. According to one CFTC official, 

no formal record would be made unless some signal indicated improper trading activity. However, without such data, CFTC’s measures of the effectiveness of its actions to combat fraud and manipulation in the markets would not reflect all surveillance activity, and CFTC management might miss opportunities to identify trends 

in activities or markets and better target its limited resources. In response to our 

51

13Section 9(a)(2) of the CEA prohibits ‘‘(a)ny person to manipulate or attempt to manipulate 

the price of any commodity in interstate commerce, or for future delivery on or subject to the 

rules of any registered entity, or to corner or attempt to corner any such commodity or knowingly to deliver or cause to be delivered for transmission through the mails or interstate commerce by telegraph, telephone, wireless, or other means of communication false or misleading 

or knowingly inaccurate reports concerning crop or market information or conditions that affect 

or tend to affect the price of any commodity interstate commerce . . .’’ 14The assessment includes a series of questions meant to serve as a diagnostic performance 

tool, drawing on available program performance and evaluation information to form conclusions 

about program benefits and recommend adjustments that may improve results. 15GAO, Results Oriented Government: GPRA Has Established a Solid Foundation for Achieving Greater Results, GAO–04–594T (Washington, D.C.: Mar. 31, 2004). 16GAO, Program Evaluation: OMB’s PART Reviews Increased Agencies’ Attention to Improving 

Evidence of Program Results, GAO–06–67 (Washington, D.C.: Oct. 28, 2005). 

recommendation, CFTC agreed to improve its documentation of its surveillance activities. 

CFTC Energy-Related Enforcement Actions Generally Involved Allegations of False 

Reporting and Attempted Manipulation, but Its Program Received a Mixed Rating and Lacks Effective Outcome-Based Performance Measures 

CFTC’s Division of Enforcement is charged with enforcing the antimanipulation 

sections of the CEA.13 The enforcement actions CFTC has taken in its energy-related cases generally have involved false public reporting as a method of attempting 

to manipulate prices on both the NYMEX futures market and the off-exchange markets. CFTC officials said that from October 2000 to September 2005, the agency initiated 287 enforcement cases and more than 30 of these cases involved energy trading. In the past several months, CFTC has taken a series of actions involving energy 

commodities, including allegations of false reporting, attempted manipulation of 

NYMEX natural gas futures prices, and attempted manipulation of physical natural 

gas prices. 

Although CFTC has undertaken enforcement actions and levied fines, measuring 

the effectiveness of these activities is an ongoing challenge. For example, the Office 

of Management and Budget’s most recent 2004 Program Assessment Rating Tool 

(PART) assessment of the CFTC enforcement program identified a number of limitations of CFTC’s performance measures.14 As is the case with most enforcement programs, identifying outcome-oriented performance measures can be particularly challenging.15 However, as we point out in the report, there are a number of other ways 

to evaluate program effectiveness, such as using expert panel reviews, customer 

service surveys, and process and outcome evaluations. We have found with other 

programs that the form of the evaluations reflects differences in program structure 

and anticipated outcomes, and that the evaluations are designed around the programs and what they aim to achieve.16 Without utilizing these or other methods to 

evaluate program effectiveness, CFTC is unable to demonstrate whether its enforcement program is meeting its overall objectives. CFTC has agreed that this is a matter that should be examined and has included development of measures to evaluate 

its effectiveness in its strategic plan and has requested funding to study the feasibility of developing more meaningful measures. 

In closing, I would like to reemphasize the difficulty in attributing increased energy prices to any one of the numerous changes in the physical or derivatives markets. As I have mentioned, our research shows that the physical and derivatives 

markets have both undergone substantial change and evolution, and market participant and regulatory views were mixed about the extent to which these developments exerted upward pressure on prices. Because of the importance of understanding the potential effects of such developments in these markets, ongoing review and analysis are warranted. As the scope of CFTC’s authority is debated, additional information is needed to understand what may need to be done to best protect 

investors from fraudulent, manipulative, and abusive practices. Such information includes:

• how different or similar are the characteristics and uses of exchange and offexchange products being traded and do these continue to justify different regulatory treatment;

• to what extent does trading in off-exchange financial derivatives affect price discovery and what are the regulatory and policy implications;

• how large of an effect are nontraditional market participants, such as commodity index funds, having in these markets; and

• are the changes in the energy markets unique or are such concerns also worth 

reviewing for other commodity markets.

52

By answering questions such as these, CFTC and the Congress will be better positioned to determine what changes, if any, may be needed to oversee these markets. 

Mr. Chairman, this concludes my prepared statement. I would be happy to respond to any questions that you or other Members of the Subcommittee might have. 

GAO Contacts 

For further information about this testimony, please contact Orice M. Williams on 

(202) 512–8678 or at williamso@gao.gov.

Staff Acknowledgments 

Contact points for our Offices of Congressional Relations and Public Affairs may 

be found on the last page of this statement. Individuals making key contributions 

include Cody Goebel (Assistant Director), John Forrester, Barbara Roesmann, and 

Paul Thompson.

The CHAIRMAN. Thank you and let me thank both of you for your 

testimony. 

And I would now recognize myself for 5 minutes. 

Mr. Lukken, in the hearings and, well, first of all, let me say 

thank you for being here and if I understood you correctly you indicated that the entire Working Group supports this proposal. And 

I assume the President’s total Working Group unanimously is on 

board, is that correct? 

Mr. LUKKEN. Well this has not come before the Working Group 

as a proposal. This was the leadership of the CFTC to put forward 

a Commission document. However, having said that the PWG during this whole development was kept apprised of what we were 

doing, why we were doing it and, certainly, being briefed on these 

issues. I could say, certainly, they don’t oppose the proposal but 

this has not come before the President’s Working Group in itself as 

an official document. 

The CHAIRMAN. Well, let me follow-up, do you plan to share with 

them and get their——

Mr. LUKKEN. We sought their input. We talked to them during 

this whole development and they are fully apprised of us coming 

forward here today, and comfortable with our leadership. 

The CHAIRMAN. Okay. Thank you. 

In our hearing in late September, Mr. Roth, who is President of 

National Futures Association described in detail the situation occurring in off-exchange retail trading of foreign contracts or forex. 

His testimony stated that forex dealers and members at the NFA 

constitute less than one percent of its membership but account for 

more than 20 percent of the current customer complaints, and 50 

percent of NFA’s enforcement docket, and 50 percent of emergency 

actions the NFA has taken this year. To address this problem, he 

recommended imposing that higher capitalization requirement of 

$20 million on forex dealers and requiring futures commission merchants who want to engage in retail forex transactions to also be 

actively engaged in exchange trading at a regulated exchange. Tell 

us about the Commission’s experience in overseeing retail off-exchange forex trading, and your thoughts on whether the recommendations of Mr. Roth would weed out some of the problem 

cases that appear to be in this sector of futures trading. 

Mr. LUKKEN. Well as I mentioned in my testimony, we certainly 

are very active in the forex area having brought 98 cases over the 

last several years in forex. NFA is also on the frontline of this 

fraud epidemic in the forex area. We have worked with them over 

the last several years to raise capital requirements to put rules 

53

into place to ensure that legitimate business can continue to occur 

in the foreign currency trading. Those that are trying to scam others are being shut down—that they are, indeed, businesses with 

appropriate resources and financial controls in place. So, I would 

say that NFA has, or is very close to this and, certainly, we would 

be supportive of adequate capital requirements put on to these 

types of firms. 

The CHAIRMAN. Thank you. On another subject, the President’s 

Working Group recommended language to address the Zelener case 

that was narrowly tailored to foreign exchange trading. Some in 

the industry have suggested that such a narrow fix will not prevent 

the purveyors of these Zelener-type contracts from simply crossing 

off foreign exchanges and substituting another commodity. Assuming the PWG language were to become law, can you specifically cite 

for the Subcommittee what parts of the Commodity Exchange Act 

would prevent someone from using the same contract but for, let’s 

say, natural gas, corn, wheat or another commodity so we don’t 

have to worry about these problems reoccurring. 

Mr. LUKKEN. Well, I think the reason that the President’s Working Group focused on foreign currency was the nature of the product itself. In some ways it is unique compared to other commodities 

because the definition of what is or is not a futures contract often 

revolves around whether something is—somebody is able to make 

or take delivery. With foreign currency that is pretty easy. It is a 

bank account. It is not too difficult to make and take delivery for 

foreign currency transactions. When you get into grains, oil, a shipment of oil, these other products, it is much more difficult to show 

that you are able to make and take delivery. Over the 3 years since 

the Zelener case, we have not seen a migration to other commodities. It has remained in the forex area. I am not saying that it may 

not someday migrate in some area that we can’t think about, but 

I think the narrow fix would take care of a substantial or vast 

amount of the problems that we are seeing now in the foreign currency fraud area. 

The CHAIRMAN. All right. Let me follow-up because it has been 

now about 2 years since the President’s Working Group made that 

recommendation and a lot has changed. As a matter of fact, the 

Commission has changed. 

Mr. LUKKEN. Yes. 

The CHAIRMAN. So am I taking that to be your recommendation 

that you have reviewed this, you feel like it would be adequate and 

that we shouldn’t take another look at it before we move forward? 

Mr. LUKKEN. Absolutely, I think that the fix that has been proposed would take care of a substantial amount of the problems that 

we face. You know, others may want to go further, but if we are 

looking for something that has consensus, that has already passed 

this Committee and the House already, this is going to take care 

of a vast majority of the problem. 

The CHAIRMAN. Would you say that all the Commissioners have 

that same, are in agreement with that? 

Mr. LUKKEN. They certainly have signed on to my testimony advancing this but some, obviously, you will have to talk to the other 

Commissioners and whether they would prefer a broader approach 

54

or not. But I think I could safely say that at a minimum, this needs 

to be done this——

The CHAIRMAN. Well, let me just say, it would be helpful for this 

Committee to know that if you would submit that to us——

Mr. LUKKEN. Sure. 

The CHAIRMAN.—later in writing, please. Thank you. And I have 

gone over my time and I apologize to Mr. Moran. 

Mr. MORAN. Mr. Chairman, thank you very much. Chairman 

Lukken, thank you. You testified or the Commission, I guess, testified that changes to our last CFTC reauthorization bill in the 

109th, there were specific proposals in regard to energy futures and 

transparency and, I believe, your testimony then was that those 

changes for price transparency were unnecessary. Does your position, the Commission’s position, remain the same? 

Mr. LUKKEN. Which provision? This was in regards to what type 

of transaction? 

Mr. MORAN. This is the Title II Amendments that were proposed 

by several Members of our Committee. 

Mr. LUKKEN. Well, I think either the focus of our recommendations today are dealing with exempt commercial markets, that once 

price discovery occurs in these types of transactions, that certain 

authorities would then be required upon those ECMs. It is part of 

that report that in regards to bilateral transactions that are occurring in this energy area that there is not consensus that more regulation needs to happen in regards to the bilateral markets. But as 

far as the ECMs that serve a price discovery function that has been 

our focus of this report. 

Mr. MORAN. I think I understand your answer. Let me take what 

you just said a bit further with a slightly different line of questioning. As I understand the recommendation is that you would 

like four new regulatory authorities over the ECMs, and that regulatory authority would come into play when, as I think you say, an 

ECM futures contract serves a significant price discovery function. 

Mr. LUKKEN. Correct. 

Mr. MORAN. What criteria would be used to determine when that 

ECM future serves that function? 

Mr. LUKKEN. We look at two broad criteria in making that determination. The first is volume, that there has to be a material 

amount of volume in the contract in order to warrant the public’s 

attention in this area. Second, that it needs to either be linked to 

a regulated market contractually, such that we are seeing with the 

ICE contract, or be a material price reference, meaning that a price 

discovery mechanism can be referenced by the public outside of a 

futures exchange. So, if something might develop on ICE it is not 

linked to a NYMEX product, but that people are referencing an 

interstate commerce outside of those transactions. So if there is either that linkage, material price referencing and some type of material trading, that is going to form our basis for determining 

whether something is a significant price discovery product. 

Mr. MORAN. And, finally, are there areas of disagreement with 

the GAO in regard to their report, their recommendations and suggestions. Would you respond to anything that is in that report that 

you have disagreement with? 

55

Mr. LUKKEN. No, we fully support the recommendations made by 

GAO and will work to try to resolve those. One of the issues dealing with, I think, the commitment of trader data that is currently 

being published for agricultural products for commodity index traders, we are holding an Agricultural Advisory Committee meeting on 

December 8, or I am sorry, December 6 at the Commission. Commissioner Dunn heads up that committee for the CFTC and one of 

the issues in looking at the commitment of traders, index trader 

program, and whether that is working well for agricultural products but also should it be extended to other products? And so that 

is going to be a time for us to explore whether this can go to other 

types of products including energy, and other types of commodities. 

When we first looked at this, however, I will note that it was easier 

to designate index traders for agricultural products because most 

of the index traders were just doing that. They were involved in 

index trading on those markets but when you look to products beyond agriculture, such as energy and others, oftentimes the index 

traders wear several hats. They are not only doing their index trading but they are also doing swap dealing and off-setting those 

transactions and also proprietary trading. Sometimes it is difficult 

to pull out of that data something that is meaningful that would 

be meaningful for the market participants. But nevertheless, we 

plan to look at this, review it and then see if it is something that 

the public would benefit from. 

Mr. MORAN. Mr. Chairman, briefly, we are now operating under 

a continuing resolution, have there been consequences to the CFTC 

authorization, I am sorry, operations as a result of this particular 

circumstance we once again find ourselves in? 

Mr. LUKKEN. Well, we have to put halts on hiring people that we 

had planned to hire to oversee these markets and that is difficult 

to defer that, technology upgrades have had to have been put on 

hold and there are a variety of things, like travel only for certain 

essential business purposes for a lot of the Commission employees. 

It is difficult to give depositions in other parts of the country if you 

are not able to travel there. So this is difficult, we are able to do 

our job but we are stretched thin. 

Mr. MORAN. Mr. Chairman, thank you very much. 

The CHAIRMAN. I thank the gentleman. 

The gentleman from Georgia, Mr. Scott. 

Mr. SCOTT. Thank you, Mr. Chairman. I have a couple of questions for you, Chairman Lukken and Ms. Williams. First of all, Mr. 

Chairman, let me commend you for what I think is a very excellent 

job you are doing and especially in your approach to take a balanced approach to any regulatory efforts within the system. As you 

clearly know, one size does not fit all in this. It is my understanding that there are discussions within the Commission about 

trying to determine whether ethanol falls under the agricultural 

commodity category and all the limitations that applies, or whether 

it qualifies as an exempt commodity that could be traded under an 

exempt commercial market that currently receives a higher level of 

regulation. Where does that discussion stand now and how soon 

would this determination be made concerning ethanol? 

Mr. LUKKEN. Again, to highlight my colleague, Mike Dunn, who 

is holding this Agricultural Advisory Committee in early December, 

56

this is on the agenda to talk to producers, different stakeholders 

in this area to find out, as you properly note agriculture must be 

agricultural products, have additional protections, must be traded 

on the full designated contract markets, where as energy products 

may be able to trade on these lighter-touch exempt commercial 

markets. Where ethanol falls, whether it is agriculture or energy 

we have really not been faced with having to make that determination but it is something we are going to have to resolve. So the first 

step is to have a hearing on this to talk to the stakeholders, and 

then internally debate where we need to go and, hopefully, in short 

order come up with an answer. 

Mr. SCOTT. How soon do you think that will be? 

Mr. LUKKEN. Well, the hearing is in December so we can, certainly, by first of next—first quarter come up with an answer in 

this area. 

Mr. SCOTT. Okay. My other question, as you know that legislation has been introduced in the House to give the CFTC authority 

and a directive to collect trading information on energy-based derivatives from the entire OTC market on a regular basis. Assuming 

that that were to take place, how much information would be coming to the CFTC? Does your agency now have adequate staff levels 

to sort through this data? And how helpful would this information 

be in the agency’s efforts to detect manipulation given the nature 

of derivatives traded on the over-the-counter market? 

Mr. LUKKEN. Congressman, the bilateral energy markets are 

enormous. You know, as we thought about this issue during our 

study last month, a lot of these transactions are individually negotiated, non-standardized contracts so for us to receive this type of 

information from a very large market and a non-standardized 

forum, it is very difficult for us to extrapolate information that is 

meaningful from a regulatory point of view. Having said that and, 

certainly, as you mentioned it would take an enormous amount of 

staff time and resources to do that, currently which we don’t have, 

having said that, that doesn’t mean that the bilateral markets 

aren’t in some ways useful on an ad hoc basis to get information 

from. And, in fact, today we came out with regulation 1805, which 

was finalized, which allows us when we see problems in the regulated marketplace to be able to go after information in the bilateral 

markets that may help us explain the entire picture of what may 

be going on in regards to certain traders. To use that is the most 

effective approach. It is regulating the designated contract markets 

and ECMs when they are serving a significant price discovery role, 

and then also complementing that with being able to go after certain information in the bilateral markets on a need-to-know basis. 

Mr. SCOTT. All right. Ms. Williams, right quick, time is running 

out, but the CFTC put out a report stating its contention that natural gas prices changes from August 2003 through August 2004 

were not significantly affected by the trading activity of managedmoney traders. As part of your review, you examined that report. 

Did you find any flaws in that report and what would you characterize in its findings as accurate? 

Ms. WILLIAMS. I think in terms of specifically what CFTC looked 

at we didn’t necessarily find significant issues with the report and 

what we tried to do in our report was kind of broaden the scope 

57

of research on this particular issue. So it was a narrowly focused 

report and I think for that purpose we didn’t find any significant 

issues. 

Mr. SCOTT. Thank you, Mr. Chairman. 

The CHAIRMAN. I thank the gentleman. 

The gentleman from Texas, Mr. Conaway. 

Mr. CONAWAY. Thank you, Mr. Chairman. 

Mr. Lukken, following along with Jerry Moran’s questions on the 

significant price discovery process, the volume issue that the number of contracts or dollar values have, what would that be in terms 

of your threshold? 

Mr. LUKKEN. That has not been fleshed-out but, initially you 

would have to be in some relationship to the market that we are 

looking at, some percentage of the market we are looking at so it 

could be either in dollars or volume of trades. 

Mr. CONAWAY. Okay. And on the, help me understand, you said 

there was some link between that price discovery and other commercial activities that is going on whether that price is referenced. 

How would you gain that information or what do you mean by 

that? 

Mr. LUKKEN. Well, this would be something we would have to 

work with this Committee and the industry to develop. It could involve and some, certainly, some of these products are so large that 

we just know about them from surveilling the regulated market. 

But this may involve us having to go out and talk to people in the 

industry to determine how people are referencing these products. 

You know, in starting to develop a standard, we have to make sure 

that it is concise, that it is predictable, that it is cost-effective for 

us and the industry to implement. 

Mr. CONAWAY. Yes. Would you develop these standards based on 

some sort of a rules process where you would put out the proposed 

way you would do this and have the industry respond? 

Mr. LUKKEN. That would be one way to do it if this Committee 

directed us to do that, yes. 

Mr. CONAWAY. All right. With respect to foreign exchange fraud, 

can you give me a sense of what the estimated dollar fraud is in 

any 1 year of losses? 

Mr. LUKKEN. Let me turn to my enforcement sheet here. Yes, the 

best we can do is there is about a billion dollars of penalties that 

we have recovered over the last 5 years in this forex. 

Mr. CONAWAY. And the penalties are related to the losses is that 

what it is? 

Mr. LUKKEN. Well, some of it is restitution, which is customer 

loss, some of it is civil monetary penalties. 

Mr. CONAWAY. Okay. 

Mr. LUKKEN. So we can get you figures on restitution if that 

might narrow your——

Mr. CONAWAY. Well, I am just trying to figure out, because if 

that is what you have caught——

Mr. LUKKEN. Right. 

Mr. CONAWAY.—and you have had complaints on then that is not 

100 percent of the exposure. 

Mr. LUKKEN. Probably not, no. 

58

Mr. CONAWAY. Okay. Ms. Williams, you posed a series of really 

interesting questions at the end of your comments, and I am wondering should your study have answered those questions or should 

those be posed to the Commission and us ask them to answer? Who 

should be the best group or whatever to answer those really good 

questions? 

Ms. WILLIAMS. I think some of them would need to be posed to 

the Commission, and I think some of them would need to be posed 

to a broader audience, and answered and addressed collectively. 

And I think our position in terms of posing the questions are these 

are some of the fundamental questions that need to be answered 

before you can come to policy decisions. 

Mr. CONAWAY. Are these rhetorical? Did you all answer them for 

yourself? Do you already know the answers? 

Ms. WILLIAMS. We don’t. 

Mr. CONAWAY. Oh, okay. 

Ms. WILLIAMS. We don’t. 

Mr. LUKKEN. Can you share them with me? 

Mr. CONAWAY. All right. Thank you, Mr. Chairman, I yield back. 

The CHAIRMAN. I thank the gentleman. 

The gentleman from Georgia, Mr. Marshall. 

Mr. MARSHALL. Thank you, Mr. Chairman. I appreciate your testimony and appreciate the good work your staff does. It is a pretty 

impressive group of people and I know that you struggle with resources to keep up. Has there been any discussion at the staff level 

or among the Commissioners concerning sources of funding and 

whether or not fees should be, industry fees should be used in 

order to fund the CFTC? 

Mr. LUKKEN. The Commission has not taken a position on fees. 

Obviously, the Administration has proposed in the past over the 

last 20 years putting a fee on this industry, a transaction tax. We 

are one of the only financial agencies that currently does not have 

a fee. I always feel more comfortable talking not about how the 

money is collected but how you do spend it and, certainly, the need 

is there to spend it, and whether it is appropriated or a fee we, certainly, as an agency need appropriate funding to meet this Committee’s mandate. 

Mr. MARSHALL. The Committee heard testimony earlier this year 

about assertions from different individuals that energy prices 

were—speculation in energy prices caused them to lose quite a bit 

of money as they placed, you know, they tied in their future needs 

with contracts. Specifically in Georgia, Municipal Gas Authority of 

Georgia locked in prices in October and believes very, very fervently that amorous speculation was largely the reason why it 

wound up losing millions and million of dollars. In the suggestions 

that you have made for amending the CEA in reauthorization, 

would the problems that they have identified or at least they believe exist be addressed or is your proposed amendment to the CEA 

sort of silent on that question? 

Mr. LUKKEN. I think it directly addresses their concerns. First 

off, I think the contract that they were referencing was this ICE–

NYMEX look-a-like contract that interacts together. 

Mr. MARSHALL. So your suggestion is that the look-a-like portion 

of this where ICE would be required to manage the contract as 

59

NYMEX would with position limits et cetera, would solve the problem somehow? 

Mr. LUKKEN. Well, as you mentioned, the ICE would now be required to put in speculative limits on these contracts as they expire 

similar to how NYMEX currently does it. We would, also, have a 

view of the entire market now, where as before we only saw the 

NYMEX portion, we would now see ICE’s traders as well as 

NYMEX’s traders. I think another important point that came out—

oh, I am sorry, go ahead. 

Mr. MARSHALL. Let us assume that there is a position limit. 

Would an Amaranth-type character that is convinced there is a lot 

of money to be made here, then move into the bilateral market and 

largely have the same effect on the market overall despite the position limit? 

Mr. LUKKEN. Well, the bilateral market does not serve significant 

price discovery function so in your case where your constituent was 

pricing off of ICE or pricing off of NYMEX, they would not be pricing off the bilateral transaction. 

Mr. MARSHALL. But doesn’t the bilateral market, huge as it is, 

large trading on the bilateral market inevitably is going to have an 

impact on the kind of trading that occurs on-exchange. 

Mr. LUKKEN. Correct, but it all has to come on-exchange at some 

point and that is when we see it. That is when we will see it on 

ICE, and we will see it on NYMEX. 

Mr. MARSHALL. And so what do you do when you see it? 

So you know that there is a big move being made by somebody, 

how do you—and how do you determine that that somebody is 

making a mistake, and that that somebody needs to be reined in, 

or an awful lot of people who are just sort of caught in this tempest 

are going to be hurt. 

Mr. LUKKEN. Well, oftentimes, I mean this is what our surveillance economists do. They have been doing this for 30 years. They 

call up these types of traders that they see with positions that concern them. They ask them what their economic justification might 

be for doing this. 

Mr. MARSHALL. Would you be in a position to simply tell Amaranth to stop? 

Mr. LUKKEN. To stop? 

Mr. MARSHALL. Buying, pushing price up. 

Mr. LUKKEN. Certainly, at certain levels, yes, our emergency authorities allow us to halt trading, liquidate trading, spec-limits will 

prevent them from getting into a position that could——

Mr. MARSHALL. Even if you—don’t you—isn’t that because you 

have authority to control manipulation, and their response would 

be, ‘‘No, we really do think this is what we need to do because that 

is what is going to happen to market.’’

Mr. LUKKEN. Well, their speculator position limits are hard limits, so they would have to get out whether we think it is manipulation or not. It is a rule violation so that is not something subject 

to interpretation. 

Mr. MARSHALL. Mr. Chairman, I see my time is up. I think we 

need to do a little bit more work on this to fully understand whether or not the changes that have been proposed will have the effect 

60

of calming the oscillations that we have seen as the result in part 

of major speculation in energy markets. Thank you, Mr. Chairman. 

The CHAIRMAN. I thank the gentleman, and I would say to him 

I am not sure we ever knew what speculation was, we got people. 

The gentleman, Mr. Walz. 

Mr. WALZ. Thank you, Mr. Chairman. And thank you, Mr. 

Lukken, just one quick question here and it may be more of an observation on this. This forex question continues to come up, come 

up and come up. We hear a lot of concerns and questions from this. 

I guess, my question on this, is this a relatively new product to the 

American consumers, and these products have been in other parts 

of the world, I am thinking Asia in particular, has been relatively 

popular. I think the number I hear is 40 percent of Japanese citizens own this as part of their portfolio. It is pretty well-established, 

pretty well-regulated in the UK and in Hong Kong, and my question is as this being a product that consumers obviously want and 

the numbers are going up there, are we working to figure out a 

way to get the correct amount of regulation on this? Or, are we just 

continuing to see this as a nuisance product that is embedded with 

fraud when I don’t think a lot of the other markets see that? I 

would be interested to hear your opinion. 

Mr. LUKKEN. I think you make very good points. We have to 

make sure that we strike the right balance of giving proper regulation to this product. If there is a legitimate demand by consumers 

in the United States for it that it is properly overseen, that the 

capital requirements on the firms offering it are adequate enough 

to ensure that fraud is not going to occur. So we are trying to 

strike that balance of making sure there is enough regulation, but 

also not too much regulation that you put legitimate firms out of 

business. 

Mr. WALZ. And is CFTC the right place for that to happen, in 

your opinion, or is that the only place for it to happen? 

Mr. LUKKEN. Well, traditionally we have, because these are futures transactions, we have expertise in this area. We have lots of 

experience enforcing forex problems so I think we have the right 

expertise to police the markets. 

Mr. WALZ. Thank you. I yield back, Mr. Chairman. 

The CHAIRMAN. I thank the gentleman. 

The gentleman from the Dakotas, Mr. Pomeroy. 

Mr. POMEROY. Thank you, Mr. Chairman. 

First of all, I want to note that attending the hearing today is 

Commissioner Chilton. He has previously served on the staff of 

House Agriculture Committee Members Jill Long and yours truly 

before going to the Senate where he worked for among others Leader Daschle. So I think it is very—we have a welcome addition to 

the Commission ranks to have someone that really so fully understands agriculture policy as seen by legislators, and I was very delighted with that particular appointment. Also, pleased to have a 

Commissioner sitting in on the whole hearing to get a sense for 

what we are wondering about. 

A question I would have is and I am in the middle of a Ways 

and Means markup and forgive me if it has been asked already. 

But I am interested in how CFTC has involved itself in the review 

61

of financial regulatory structures the Treasury has been conducting? 

Mr. LUKKEN. As a member of the President’s Working Group 

we——

Mr. POMEROY. I meant conducting through the President’s Working Group. 

Mr. LUKKEN. Yes, this is not an issue before the President’s 

Working Group formally. This is under the leadership of Secretary 

Paulson who has asked as series of 30 questions about the regulatory structure in the United States. I would note, and that he is 

trying to figure out what is the best system for U.S. competitiveness going forward. I would suggest that you should look at the 

competitive advantage of the U.S. futures industry. The fact that 

we are leaps ahead of others in gaining market share around the 

world. So we are engaged on this issue. One of the questions deals 

on principles-based regulation and whether the entire financial 

services sector should go under a principles-based system. I am 

here to say yes, that it has worked very well for this agency and 

for this market in general and allowed us to be flexible in a global 

marketplace. 

Mr. POMEROY. Help us understand that. What is that really? 

What is a real-life context in terms of a principles-based structure? 

Mr. LUKKEN. Well, oftentimes we will, through different acceptable practices, lay out what we expect of market participants. However, they may come up with a new way of doing something, a new 

way of trading or a new way of trying to conduct business. They 

could come to us and say, ‘‘Look, it doesn’t meet the specific rules 

that you have laid out for us, but we think in general it meets the 

principles that you have set out in principle 5. So allow us to do 

this knowing that.’’ So on the margins you allow for innovation. 

Those that want the safe harbor of the acceptable practice and 

knowing for certain that they are in compliance can stay within the 

four corners. But if those that want to innovate can help step outside of that and develop new best practices that others in the industry may abide by as well. So it has proven very effective for us 

and is really made the relationship between industry and the regulator something that is informal that they come to us early in the 

process if they have ideas and changes so that we are able to know 

what is coming down the pike versus doing something that is sort 

of ‘‘gotcha’’ form of regulation. 

Mr. POMEROY. I have been puzzling a lot with this whole 

subprime business about innovation versus transparency. We have 

had things that are so newfangled no one knows what the hell they 

are buying or investing in. How do you parse that one? 

Mr. LUKKEN. Well this is a bit out of the CFTC’s lane but these 

are very complex instruments and part of the problem is we didn’t 

know the amount of exposure of a lot of these types of instruments 

out there. I would say from a futures specific perspective, the markets have been very helpful. A lot of the re-pricing has been done 

in the futures markets themselves. From this August to last August trading volume is up 90 percent. So that is a sign that people 

are utilizing the futures markets in order to re-price this risk 

where there is liquidity and that is helping us to get through this 

transition. 

62

Mr. POMEROY. I don’t have enough time to pursue that. I might 

call you for further information. 

Mr. LUKKEN. Yes, sir. 

Mr. POMEROY. Thank you very much, Mr. Chairman. 

The CHAIRMAN. I thank the gentleman. 

I just have two quick questions to get on the record before we 

close and the Ranking Member has one and then we will try to 

close before we go vote so we can finish this. As you know, Senator 

Levin has introduced legislation to amend the CEA with regard to 

regulation of exempt commercial markets that trade energy-based 

derivatives. I would like to hear a comparison between that bill 

and your recommendation how the triggers for regulations differ, 

and how does the scope of regulation and regulatory requirements 

that could be imposed upon, to see if the instruments compare. Can 

you give us a quick answer to that? 

Mr. LUKKEN. Well, Senator Levin has provided, obviously, valuable leadership in this area and it was before his Committee that 

we committed to take a closer look a few months back at this issue. 

As far as the trigger I think Senator Levin’s bill also looks at significant price discovery as a trigger. They do have a few things differently. They look at the entire marketplace versus a product by 

product determination for us, and there are many other different 

things that may differ but, certainly, the general intent of looking 

at these markets and ensuring that they are properly policed, we 

are the same with Senator Levin and with our proposal. We would 

be happy though to provide a side-by-side. 

The CHAIRMAN. Would you, please, do that for the Committee? 

Mr. LUKKEN. Yes. 

The CHAIRMAN. I appreciate that. 

Mr. LUKKEN. We will have our——

The CHAIRMAN. If you would get it to us in writing. 

Mr. LUKKEN. Sure. 

The CHAIRMAN. Thank you. 

Ms. Williams, I have in my hand a new colleague from one of our 

House colleagues in support of H.R. 594, Prevent Unfair Manipulation of Prices Act. It says that GAO is essentially calling to implement the policy recommendation proposed by this Act. First question in conducting this review, did your group examine the policy 

recommendations of H.R. 594? Can you describe for us the provisions of H.R. 594 or should anyone reading this report, take it as 

an endorsement of H.R. 594? 

Ms. WILLIAMS. I would be more than happy to provide an official 

response for the record. 

The CHAIRMAN. Would you, please? 

Ms. WILLIAMS. But in terms of our report we didn’t take a position on any particular pending legislation or policy positions, but 

I will provide a response. 

The CHAIRMAN. Would, you please? Thank you, ma’am. 

Ms. WILLIAMS. Absolutely. 

The CHAIRMAN. I yield to the Ranking Member. 

Mr. MORAN. Mr. Chairman, thank you. 

Mr. Lukken, in—you talk about the intermediated transactions 

and the 7th Circuit Court of Appeals decision, have other venues 

63

cited the 7th Circuit Opinion? Are you encountering enforcement 

problems as a result of that, and the CFTC’s response? 

Mr. LUKKEN. Absolutely, other circuits are starting to reference 

the Zelener decision and starting to adopt its findings. And so that 

is the recent court cases that I referenced in my testimony that we 

are having problems as a result of that. So that is why it is imperative that this Committee, hopefully, take a close look at this and 

pass something soon. 

Mr. MORAN. So has Zelener become the law? 

Mr. LUKKEN. It is not the law in all circuits but others are beginning and it seems to be picking up momentum that other courts 

are beginning to reference it and adopt those findings. 

Mr. MORAN. I can’t remember from our earlier testimony and 

hearings on this topic, has any court of equal standing rejected 

Zelener? 

Mr. LUKKEN. It seems to me that there was a Second Circuit, oh 

there was a finding in the 6th Circuit but it is currently pending 

on appeal. 

Mr. MORAN. Okay. Thank you very much. 

Ranking Member Goodlatte has additional questions he would 

like to submit to our witnesses in writing. 

The CHAIRMAN. Without objection. 

Mr. MORAN. Thank you. 

The CHAIRMAN. Just before we close, Mr. Marshall would like to 

finish up on one of the pieces before we close out. I would recognize 

the gentleman from Georgia. 

Mr. MARSHALL. Thank you, Mr. Chairman. 

Chairman Lukken, we were talking about an Amaranth-type situation where people are convinced that as a result of the speculation of a very large trader the markets been moved inappropriately 

to the detriment of an awful lot of people who necessarily have to 

rely upon that market to cover their future positions and let us just 

assume that that can happen and let us assume that we would like 

to do something about it. You are suggesting that the proposed 

changes would have that effect because where there are like contracts and in this—in the Amaranth situation there were, ICE 

would now be acting pretty much as NYMEX where position limits 

are concerned. The question is you have this large trader that is 

convinced that it is in their financial interest to take these positions, now it can’t take as much of a position on ICE as it did in 

the past, doesn’t it move to the bilateral market or move overseas 

or something like that and effectively have the same impact upon 

the market and I understood you to say, ‘‘Well, no, because we are 

in a position to stop that.’’ I would like to know how you go about 

doing that. It would be comforting to a number of people that are 

quite concerned about the problem. 

Mr. LUKKEN. Let me clarify. I think for us when we looked at 

this problem, again the Commodity Exchange Act the key determinate for regulation is price discovery and that is when people are 

able outside the markets to reference these prices. In the bilateral 

markets, no one is referencing off of private transactions that may 

be individually negotiated. Certainly, as you correctly point out 

these may influence the regulated marketplace but I think as we 

are looking to find consensus on this. There was not consensus that 

64

due to cost considerations of collecting data and trying to fit these 

individually in negotiated transactions into a regulated system, the 

marginal benefits that might develop. 

Mr. MARSHALL. So I misunderstood you, I thought you suggested 

that if you discovered this was going on by an Amaranth-type, hypothetical character, you could tell them to stop. 

Mr. LUKKEN. If we saw something on a regulated exchange we 

could through our regulation 1805 authority ask them to stop their 

activity on the regulated exchanges, ask for additional information 

of what they are doing in the bilateral markets as well, so that you 

could see the entire picture. 

Mr. MARSHALL. But you could not stop them? 

Mr. LUKKEN. Not in the bilateral markets. 

Mr. MARSHALL. Thank you, Mr. Chairman. 

The CHAIRMAN. I thank the gentleman. 

Ranking Member, do you have additional? 

Mr. MORAN. No, sir. 

The CHAIRMAN. Let me thank our witnesses for being with us 

today. You have been very helpful and I appreciate it. Under the 

rules of the Committee, the record of today’s hearing will remain 

open for 10 days to receive additional materials and supplemental 

written responses from witnesses to any questions posed by Members of the panel. This hearing on the Subcommittee on General 

Farm Commodities and Risk Management is adjourned. 

[Whereupon, at 2:35 p.m., the Subcommittee was adjourned.] 

[Material submitted for inclusion in the record follows:]

65

SUBMITTED QUESTIONS

Responses from Hon. Walter Lukken, Acting Chairman, Commodity Futures 

Trading Commission, Washington, D.C.

Questions from Hon. Bob Etheridge, a Representative in Congress from North Carolina 

Question 1. Regarding the President’s Working Group (PWG) suggested language 

to correct the ruling in the Zelener case, has the current Commission taken another 

look at the language to determine its adequacy. If not, do each of the current Commissioners believe the proposal is adequate or does any of them believe it should 

be modified in some way; and, if so, how? 

Answer. The Commission believes it is necessary to resolve the Zelener issue. The 

current Commission has not revisited this issue since 2005, when the House approved the PWG proposed Zelener language. The Commission as a whole has never 

opined on the proposed PWG language. As I testified at the September hearing, I 

believe it is critical to resolve the Zelener issue and that the PWG language is an 

appropriate solution. At least two Commissioners now believe that a broader fix 

would be appropriate.

Question 2. As you know, Senator Levin has introduced legislation to amend the 

CEA with regard to regulation of exempt commercial markets (ECMs) that trade energy-based derivatives. I want to hear a comparison between that bill and your recommendations. Please provide a detailed side-by-side comparison. 

Answer. Senator Levin’s bill (S. 2058) and the Commission’s recommendations are 

directed to the same goal, though there are several differences in approach. For example, the triggers in Senator Levin’s bill and the Commission’s recommendations 

are generally similar—each looks to whether a significant price discovery function 

is being performed. But the Commission’s approach keeps the CEA Section 2(h) 

framework for ECMs in place, with targeted add-on provisions for significant price 

discovery contracts in exempt commodities. Senator Levin’s bill, by contrast, would 

establish a new category of registered trading platform for facilities trading pricediscovery energy commodity contracts, which would be separate and apart from the 

ECM trading platform for other exempt commodities. 

The consequences that result from a finding of a significant price discovery function also differ. Under Senator Levin’s bill, trading facilities that meet the price discovery test would be subject to 17 Core Principles. By contrast, the Commission’s 

recommendations focus on four key authorities: (1) large trader position reporting; 

(2) position limits and/or accountability levels; (3) self-regulatory oversight; and (4) 

emergency authority. This measured approach will preserve the role of ECMs as incubators for start-up markets and concepts, which several witnesses at our recent 

hearing said spurs competition and innovation. 

Finally, Senator Levin’s bill calls for record keeping and reporting obligations with 

respect to U.S. screen-based trading in energy contracts listed on foreign boards of 

trade. The Commission has not made any similar recommendations, which are problematic in today’s global marketplace. They also are unnecessary given the effectiveness of the Commission’s recently-adopted Policy Statement regarding screen-based 

trading in contracts listed on foreign boards of trade. 

Although these differences in approach make a precise side-by-side analysis difficult, a chart comparing Senator Levin’s bill and the Commission’s recommendations in general terms is attached.

Question 3. Under CFTC Rule 36.3, exempt commercial markets must provide 

price, quantity, and other data on contracts that average five or more trades a day 

over the most recent quarter for which they are relying on the Commodity Exchange 

Act’s exemption for these markets. The GAO report cites CFTC officials who say the 

agency does not actively check to determine whether that five or more trades a day 

threshold is being met on those exchanges that are relying on the CEA exemption 

but not providing information to the CFTC. Why isn’t the CFTC conducting more 

checking to see if contracts on those markets are meeting the five a day threshold? 

Does an ECM have a responsibility in this area? What are the consequences, if any, 

to an ECM that fails to notify the CFTC that a contract has crossed the threshold? 

Answer. GAO is correct. The Commission does not have a regular rule enforcement review program in place to check ECMs for compliance with the five-trade per 

day reporting requirement. However, there are safeguards in place to ensure ECM 

compliance with this provision. First, Regulation 36.3(b)(1)(ii) itself places an affirmative obligation on ECMs to notify the Commission when they have a contract that 

exceeds the threshold. Second, Regulation 36.3(c)(4) requires each ECM to file an 

annual certification with the Commission that it is continuing to operate within the 

conditions of its exemption from having to register as a designated contract market 

66

(DCM). The terms of the Commission’s ECM annual certification form make clear 

that these conditions include apprising the Commission of those contracts that meet 

the five-trade per day threshold. 

Finally, the consequences of failing to properly notify the Commission of a triggering of the reporting requirement are extreme—there is a strong incentive for 

ECMs to honor this provision. ECMs that fail to apprise the Commission that they 

have triggered the reporting requirement run the risk of losing their exemption 

from DCM registration and expose themselves to a Commission enforcement action 

for operating an unregistered exchange pursuant to Section 4(a) of the CEA, for failing to comply with the reporting requirement of Regulation 36.3(b)(1)(ii), and, likely, 

for making a false statement in a filing required under the Commission’s regulations pursuant to CEA Section 9(a)(3).

Question 4. Assuming the PWG Zelener language became law, what specific sections of the Commodity Exchange Act—if any—would prevent someone from using 

the same Zelener-type contract but for natural gas, corn, wheat, or another commodity besides forex? 

Answer. The Commodity Futures Modernization Act of 2000 (CFMA) authorized 

off-exchange trading by retail customers only in foreign currency futures and options. It did not change the law for commodities other than foreign currencies. Thus, 

off-exchange futures trading activity involving retail customers in any other commodity (such as natural gas, metals, corn, or wheat) remains illegal under CEA Section 4(a), which prohibits off-exchange trading in futures. 

Thus far, we have not seen the Zelener contract form, which the 7th Circuit held 

to be a spot contract, utilized for commodities beyond foreign currency. Further, the 

best means to address the Zelener issue—striking the necessary balance between 

cracking down on fraudsters while not interfering with legitimate businesses—may 

vary depending on the commodity involved. Accordingly, I believe that it is best to 

address the problem that is presently before us and that has been before us for the 

past several years—foreign currency.

Question 5. The CFTC Reauthorization bill from last Congress would have required introducing brokers to register with the National Futures Association (NFA). 

In his testimony last month, Mr. Roth, President of the NFA proposed to expand 

this to include commodity trading advisors (CTAs) and commodity pool operators 

(CPOs). Can you talk about whether CTAs and CPOs current are registered with 

any regulatory body and whether the Commission thinks we need to require their 

registration with the NFA? 

Answer. The CFMA specified certain categories of entities that may act as 

counterparties to customers for off-exchange retail forex transactions. However, the 

CFMA was silent with respect to intermediaries for such transactions and provided 

that most of the CEA does not apply to such transactions. Thus, entities that act 

in a manner similar to that of introducing brokers, CPOs or CTAs with respect to 

these forex transactions are not required to register, as would be the case if they 

were intermediating exchange-traded transactions. The registration requirement in 

the proposed forex amendments submitted by the PWG and included in the Reauthorization bill passed by the House of Representatives in December 2005 was not 

limited to introducing brokers. It would require registration of any person who participates in the solicitation or recommendation of off-exchange retail forex transactions.

Question 6. Please provide the Subcommittee with a record of total dollar amount 

of fines levied by the Commission for each year starting with 2000. Please do likewise for the total dollar amount of fines actually collected. 

Answer.

Civil Monetary Penalties FY 2000–2008

Fiscal Year Penalties Imposed Penalties Collected 

2000 $179,811,562 $3,299,362

2001 $16,876,335 $3,170,252

2002 1 $9,942,382 $5,922,387

2003 $110,264,932 $87,699,077

2004 $302,049,939 $122,468,925

2005 2 $76,672,758 $34,237,409

2006 $192,921,794 $12,321,530

2007 $327,378,507 $11,897,033

2008 3 $126,045,682 $4,835

1 Includes $30,005 for civil monetary penalties imposed in prior years. 

67

2 Includes $617,409 for civil monetary penalties imposed in prior years. 

3Through October 2007. Pending $125,000,000 BP Settlement Collection. 

The discrepancy between the amount of civil penalties imposed and the amount 

collected is accounted for by the following factors: (1) when courts order the defendants to pay both restitution to victims and a civil monetary penalty to the Commission, established Commission policy directs available funds to satisfy customer restitution obligations first; (2) in fraud actions, it is not uncommon that the proceeds 

of the fraud have been dissipated and/or that the penalty far exceeds the defendants’ represented financial ability to pay; (3) penalties assessed in default proceedings against respondents who are no longer in business and who cannot be located or are incarcerated; (4) penalties imposed in 1 year may not become due and 

payable until the next year; (5) a penalty may be stayed by appeal; (6) some penalties call for installment payments that may span more than 1 year; (7) penalties 

have been referred to the Attorney General for collection; and (8) collection still in 

process internally.

Question 7. If the Commission were allowed to keep 10% of the fines its actually 

collects to fund IT upgrades, modernization, and improvements, would that make 

a significant difference in improving the CFTC’s IT infrastructure—assuming there 

are no corresponding reductions on the appropriations side? 

Answer. Assuming there were no corresponding reductions on the appropriations 

side, any funds from penalties collected would improve our fiscal situation. In Fiscal 

Year 2006, we collected over $12 million in penalties, which (assuming the Commission retained 10%) would translate roughly into $1.2 million. This amount would 

not fully fund our IT requirements, but would provide much needed fiscal relief. 

Questions from Hon. Bob Goodlatte, a Representative in Congress from Virginia 

Question 1. The CFTC report recommends that if an Exempt Commercial Market 

(ECM) has a significant price discovery function it should have position limits imposed on it. Would the policy on position limits on ECMs be similar to the policy 

on Designated Contract Markets (DCM) with limits on speculative trades, reduced 

limits near expiration and review or exemptions of positions held in excess of the 

limits for legitimate hedges? Would the imposition of position limits on ECMs stifle 

in any way the creativity offered by ECMs? 

Answer. We anticipate that ECMs would be subject to the same type of accountability-level/position-limit regime that is currently required of DCMs under DCM 

Core Principle 5, including the availability of hedge exemptions and spot-month position limits where appropriate. Accordingly, ECM contracts that became subject to 

such an accountability-level/position-limit regime would be treated in a similar manner to comparable DCM contracts under DCM Core Principle 5. 

As with any regulatory restriction, there is a possibility that position limits may 

impact ECM operations. However, the Commission’s recommendation that an accountability-level/position-limit regime be imposed on ECM contracts that perform 

a significant price discovery function is a very discrete measure. This high standard 

has been carefully chosen to ensure that there are minimum safeguards in place to 

prevent the manipulation of contracts that could have a very real impact on the 

prices of commodities in interstate commerce—a goal that underpins the CEA and 

the statutory mandate of the CFTC.

Question 2. If a contract trading on an ECM is deemed to provide a significant 

price discovery function, by what mechanism would the authority you are requesting 

be effectuated? 

Answer. We would anticipate that any amendments to the CEA that require additional obligations of ECMs when they list contracts that become significant sources 

of price discovery would themselves include rulemaking authority for the Commission to establish standards and procedures for making such determinations and for 

effectuating the authorities that result from such a determination. These rules also 

would set forth the specific procedures and guidelines that the Commission would 

follow in making such determinations. The Commission in establishing such standards and procedures would attempt to ensure that they had a high degree of objectivity, thus minimizing any legal uncertainty for ECM operations.

Question 3. Additionally, who would make the determination that a contract trading on an ECM is serving a significant price discovery function? Over what time 

frame would you see the determination being made that a contract trading on an 

ECM is serving a significant price discovery function and that the additional authority needs to be implemented on this contract? 

Answer. We would anticipate that the Commission would be given the authority 

to make determinations as to whether ECM contracts are serving a price discovery 

function. We also anticipate that any price-discovery determination would be based 

68

upon a contract’s behavior over some reasonable length of time, as the Commission 

would want to avoid a situation where contracts are moving in and out of price-discovery status.

Question 4. Last year the Commission testified that the changes proposed in Title 

II of H.R. 4473 (the CFTC reauthorization bill in the 109th) specific to natural gas 

price transparency were not necessary. Has the Commission changed its position? 

Answer. We appreciated the bipartisan efforts of this Committee during the 109th 

Congress to address consumer concerns over volatility in the natural gas markets. 

The measures recommended in the Commission’s ECM Report strike an appropriate 

balance in the regulatory approach to these issues. As indicated in the Report, we 

do not see a need to impose added regulatory requirements on over-the-counter 

(OTC) bilateral energy contracts. A targeted approach to ECM significant price discovery contracts will best address the regulatory concerns that have been raised 

while still allowing ECMs to serve as a venue for start-ups where innovative trading 

ideas can incubate and be tested.

Question 5. What type of self-regulatory structure does ICE currently have? 

Answer. Currently, ICE, as an ECM, is not required by the CEA to have any oversight structures commonly associated with a self-regulatory organization such as a 

DCM.

Question 6. If an ECM and the CFTC were provided with emergency authority 

over a contract what could either do if fraud or manipulation were suspected or detected? 

Answer. Historically, the futures exchanges and the Commission have possessed 

broad authority under the CEA to address market emergencies. Under Section 8a(9) 

of the CEA, in an emergency, the Commission can require an exchange ‘‘to take 

such action as in the Commission’s judgment is necessary to maintain or restore orderly trading’’ in a contract. This broad authority would permit the Commission to 

impose trading limits, or even require liquidation, to restore orderly trading conditions in the marketplace. Similarly, Core Principle 6 of the CEA requires that DCMs 

adopt rules to provide for the exercise of emergency authority, in consultation or cooperation with the Commission, including the authority to liquidate positions and 

suspend trading where necessary and appropriate. Having these emergency authorities available often enables Commission and exchange staff to work with market 

participants to prevent emergency situations from arising in the first instance. We 

would anticipate that these same authorities would apply to significant price discovery contracts traded on ECMs.

Question 7. I, too, think the penalties under § 9 should be increased to reflect the 

severity of the crime. Instead of limiting penalties to $1 million, why not make the 

sanction a factor of the illegally obtained profit? Perhaps we should allow for treble 

damages (Three times the amount of damage a judge/jury found the defendant to 

cause) like antitrust law calls for. 

Answer. In addition to CEA Section 9, Sections 6(c) and 6c of the CEA currently 

provide for penalty authority of ‘‘not more than the higher of $100,000 [adjusted to 

$130,000 to account for inflation] or triple the monetary gain,’’ whichever is higher. 

Accordingly, the CEA already contemplates the possibility of penalties based on illegally obtained profits, including treble damages.

Question 8. You have testified, stated in press accounts, and told me in conversation that CFTC staffing levels have hit an all time low. In the 2000 modernization 

effort we authorized pay parity for the CFTC. How has this affected your staffing 

levels? 

Answer. Exempting the CFTC from Title V and authorizing pay parity with the 

FIRREA agencies has been crucial to recruiting and retaining professionals needed 

to oversee the complex futures markets. The Commission has implemented pay parity with funds appropriated by Congress. Since authorization, the Commission has, 

when necessary, sought funds to ensure that our pay structure and pay ranges are 

in line with the FIRREA agencies—and we are satisfied that they are. 

However, presently at the Commission, staffing levels are at an all-time historic 

low, and employee turnover has returned to the double-digit levels we had experienced prior to exemption from Title V. In the last 2 years, the Commission has lost 

over 100 employees, most of which were retirements of senior professionals. We 

need to improve in our ability to recruit, promote, retain, and reward good performers within the existing pay structure—and additional funds have been requested in FY 2009 for this effort.

Question 9. If the Commission does not receive an increase in its appropriation, 

can the Commission augment its budget by imposing/increasing registration fees or 

assessments on trades? 

69

Answer. The Commission has the authority to collect a number of fees related to 

our regulatory functions, such as contract market rule enforcement reviews and contract market designations. We have not interpreted this authority to extend to assessments on trades. The fees that we currently are authorized to collect are deposited in the General Fund of the U.S. Treasury.

Question 10. What happens to the money collected through the Commission’s enforcement activity? 

Answer. Funds collected from civil monetary penalties in CFTC enforcement actions are deposited in the General Fund of the U.S. Treasury. Funds collected from 

orders of restitution and disgorgement are distributed to injured victims.

Question 11. Last month this Subcommittee received testimony that securities 

and futures should be regulated in a consistent manner. Do you care to comment? 

Answer. We support the notion of regulating securities and futures in a consistent 

manner wherever possible, and over the past several years the Commission has 

taken several steps to align our requirements with those of the SEC where that 

makes sense. 

But it must be remembered that these are different markets—the SEC regulates 

markets whose primary function is capital formation, whereas the CFTC regulates 

markets whose primary functions are price discovery and risk management. Sometimes, the different functions of the markets, and the correspondingly different statutory mandates of the SEC and CFTC under the securities laws and the CEA, require different approaches by the two agencies. 

For example, in the securities world, there are extensive disclosures required by 

the issuers of securities, i.e., public companies. In the futures markets, there are 

no ‘‘issuers.’’ The mandated disclosures to retail futures customers thus focus upon 

the risks common to all futures trading.

Question 12. GAO testified that the Commission should more accurately report 

trading data for commercial versus non-commercial trades. The GAO highlights instances where commercial entities may actually place speculative trades but these 

trades are reported as commercial because the entity is a routine commercial trader. 

As a practical matter, can this be done given that entities are organized in any 

number of business units, they place trades in a variety of ways, and often establish 

proprietary methods for managing their company’s risk? This would make standardizing the reporting in the manner recommended by GAO very difficult. What kind 

of problems can this detailed reporting create? What would happen if you reported 

with this type of specificity? 

Answer. Using current reporting methodology, this detailed breakout of speculative positions held by commercials is not possible. To accomplish this, it would probably be necessary to either (1) have every commercial firm set up a separate reporting account for speculative trading; or (2) report its positions directly to the CFTC 

(as opposed to the current large trader reporting system, where futures commission 

merchants report customer positions to the CFTC). Either of these changes would 

entail additional costs to traders. Yet, it is not clear that such a change would substantially improve the commitments of traders (COT) data, as we are not aware that 

there is a substantial amount of speculative trading by commercials. 

The main issue that the CFTC has faced with COT reporting is that commercial 

swap dealers hedge OTC activity (including OTC commodity-index related activity) 

in futures markets. While this trading is hedging (i.e., it is to offset price risk), it 

is different than traditional hedging of underlying physical business.

Question 13. Given the global growth of risk management and the futures industry, what is the CFTC doing with international regulatory bodies to coordinate efforts to prevent fraud and manipulation across the globe? 

Answer. The CFTC has a robust and long-standing international presence. We are 

an active member of the International Organization of Securities Commissions 

(IOSCO), which is a standard-setting body for securities and futures regulators. 

IOSCO coordinates regulators around the world to promote high standards of regulation, including surveillance and enforcement standards. Additionally, the CFTC 

has numerous enforcement arrangements to share information with our overseas 

counterparts and coordinate our enforcement actions as much as possible. In addition to the CFTC’s 24 bilateral enforcement information sharing arrangements with 

foreign regulatory authorities, the CFTC also is a signatory to the IOSCO Multilateral Memorandum of Understanding that provides for the sharing of bank, brokerage, and client identification records among the international regulators. Most recently, the CFTC signed an MOU with the UK Financial Services Authority (FSA) 

in 2006 to share information on an on-going basis to help detect potential market 

abuses where contracts are linked by settlement provisions. Finally, this past October, the CFTC Division of Enforcement convened an international enforcement 

70

meeting with commodity regulators including participants from Europe, Asia, and 

South America. The meeting was focused on detecting and enforcing against antimanipulative conduct, with the goal of enhancing the ability of the CFTC and its 

fellow regulators to detect and deter misconduct affecting commodity prices.

Question 14. GAO has recommended the CFTC develop ‘‘meaningful outcomebased measures’’ to determine the agency’s effectiveness. What type of improved 

measures have you explored? Has GAO provided you detailed suggestions on what 

‘‘meaningful outcome-based measures’’ would be appropriate for an agency like the 

CFTC? 

Answer. GAO’s conclusions were derived primarily from the OMB PART review, 

which recognized that the effectiveness of an enforcement program is not easily 

measured. GAO suggested that ‘‘there are a number of . . . ways to evaluate program effectiveness, such as using expert panel reviews, customer service surveys, 

and process and outcome evaluations.’’ The Commission has requested funding in 

the OMB FY09 budget in order to explore alternate means to evaluate the effectiveness of the program. 

Question from Hon. Nancy E. Boyda, a Representative in Congress from Kansas 

Question. In our hearing in late September, Mr. Damgard, President of the Futures Industry Association, in his written testimony asked this Subcommittee and 

the CFTC to study the state of competition among centralized trading platforms and 

clearing entities for derivatives products with an eye toward making sure the existing futures market structure is the best for serving our customers. Does the Commission have any plans to look into this matter? 

Answer. Section 5b(c)(2)(N) of the CEA requires each derivatives clearing organization (DCO), unless appropriate to achieve the purposes of the CEA, to avoid (1) 

adopting any rule or taking any action that results in an unreasonable restraint of 

trade, or (2) imposing any material anti-competitive burden on trading. On an ongoing basis, the Commission reviews DCO rules and other actions for compliance with 

this provision. The Commission notes that this provision directs that competitive 

concerns be weighed in light of the other purposes of the CEA, such as maintaining 

the financial integrity of the markets. To date, the Commission has not identified 

an instance where a DCO has violated this provision. The Commission will continue 

to monitor DCO activity in this area.

71

Attachment 

Senator Levin’s ‘‘Close the Enron Loophole Act’’ S. 2058 CFTC Proposal significant price discovery contracts on ECMs 

I. Energy Trading Facilities Analogous Provisions in CFTC Proposal Applicable to Significant Price Discovery Contracts on ECMs.

Section 2(a) of S. 2058 amends Section 1a of the CEA Section 1 of the CFTC proposal amends Section 1a of the CEA. 

A. Adds definition of ‘‘energy commodity’’ as commodity 

1. used as source of energy such as crude oil, gasoline, natural gas, and 

electricity, and 

A. Adds definition of ‘‘significant price discovery contract’’ as agreement, contract, or transaction subject to proposed CEA Section 2(h)(7). 

2. results from burning of fossil fuel 

B. Adds definition of ‘‘energy trading facility’’ Not applicable to CFTC proposal. 

1. not a designated contract market (‘‘DCM’’) 2. facilitates the execution or trading of agreements, contracts, or transactions in an energy commodity AND 

a. facilitates the clearance and settlement of agreements, contracts, or 

transactions in an energy commodity; or 

Not applicable to CFTC proposal. 

b. the Commission determines performs a significant price discovery 

function for energy commodities listed on a trading facility or in the cash market. Factors for the CFTC to consider: 

CFTC to determine whether contract performs a significant price discovery 

function. Proposed CEA Section 2(h)(7)(A)–(B). 

(1) extent to which price of an agreement, contract, or transaction is 

derived from or linked to the price of a futures contract traded on a DCM 

Similar provision in CFTC proposal. Proposed CEA Section 2(h)(7)(B)(i)(I). 

(2) extent to which cash market transactions are directly based on the 

prices in the same energy commodity traded on the energy trading facility 

Similar provision in CFTC proposal. Proposed CEA Section 2(h)(7)(B)(ii). 

(3) the volume of contracts traded on the trading facility Similar provision in CFTC proposal. Proposed Section 2(h)(7)(B)(iii). (4) extent to which data is published after completion of transactions Similar provision in CFTC proposal. Proposed CEA Section 2(h)(7)(B)(ii). (5) extent to which arbitrage market exists between the trading facility and the DCM Similar provision in CFTC proposal. Proposed CEA Section 2(h)(7)(B)(i)(II). (6) other factors Commission deems appropriate Similar provision in CFTC proposal. Proposed CEA Section 2(h)(7)(B)(iv).

II. Section 2(b). Oversight of Energy Trading Facilities Analogous Provisions in CFTC Proposal.

A. Section 2(b)(1) of S. 2058 amends CEA Section 2(h)(3) to exclude Not applicable to CFTC proposal. 

‘‘energy trading facility’’ from qualifying as an exempt commercial market in 

order to make clear that those facilities must comply with new CEA Section 2(j) 

B. Section 2(b)(2) of S. 2058 adds a new Section 2(h)(7) to the CEA. This Not applicable to CFTC proposal. 

72

Attachment—Continued

Senator Levin’s ‘‘Close the Enron Loophole Act’’ S. 2058 CFTC Proposal significant price discovery contracts on ECMs 

new section provides that notwithstanding any other provision of CEA, an 

energy trading facility and persons trading on an energy trading facility are subject to the new CEA Section 2(j)

III. Section 2(c). Criteria for Trading Facility Registration Analogous Standards for Significant Price Discovery Contracts.

1. New Section 2(j)(4)(A) requires a trading facility to have the capacity to 

prevent price manipulation, excessive speculation, price distortion, and disruption of the delivery or cash-settlement process 

Adds proposed CEA Section 2(h)(7)(C)(ii) Core Principle applicable to significant 

price discovery contracts—ECM must have market surveillance, compliance, and disciplinary practices and procedures. 

2. New Section 2(j)(4)(B) requires a trading facility to monitor trading to 

prevent price manipulation, excessive speculation, price distortion, and disruption of delivery or cash-settlement prices 

Adds proposed CEA Section 2(h)(7)(C)(ii) Core Principle applicable to significant 

price discovery contracts—monitoring of trading to prevent market manipulation, price distortion, and disruptions of the delivery or cash-settlement process. 

3. New Section 2(j)(4)(C) requires a trading facility to list contracts not 

susceptible to manipulation 

Adds proposed CEA Section 2(h)(7)(C)(i) Core Principle applicable to significant 

price discovery contracts—not readily susceptible to manipulation. 

4. New Section 2(j)(4)(D) requires a trading facility that facilitates clearance and settlement by a derivatives clearing organization (‘‘DCO’’) must 

establish and enforce rules requiring financial integrity of contracts 

Not applicable to CFTC proposal. 

5. New Section 2(j)(4)(E) requires a trading facility to establish and enforce rules for obtaining information Adds proposed CEA Section 2(h)(7)(C)(iii) Core Principle—ability to obtain infor- mation. 6. New Section 2(j)(4)(F) requires a trading facility to adopt position limits 

or accountability levels to reduce threat of price manipulation, excessive speculation, price distortion or delivery or cash-settlement process 

Adds proposed CEA Section 2(h)(7)(C)(iv) Core Principle—position limitations or 

accountability. 

7. New Section 2(j)(4)(G) requires a trading facility to adopt rules for 

emergency authority including to (i) liquidate open positions; (ii) suspend or curtail trading; and (iii) require market participants to meet special margin requirements 

Adds proposed CEA Section 2(h)(7)(C)(v) Core Principle—emergency authority, 

including authority to (i) liquidate open positions, and (ii) suspend or curtail trading in contract. 

8. New Section 2(j)(4)(H) requires a trading facility to arrange for daily 

publication of trading information 

Adds proposed CEA Section 2(h)(7)(C)(vi) Core Principle—daily publication of 

trading information. 

9. New Section 2(j)(4)(I) requires a trading facility to establish and enforce 

rules to deter abuse 

Adds proposed CEA Section 2(H)(7)(C)(vii) Core Principle—compliance with 

rules. 

10. New Section 2(j)(4)(J) requires a trading facility to establish rules for 

recording and safe storage of trading information 

Not applicable to CFTC proposal. 

11. New Section 2(j)(4)(K) requires a trading facility to establish rules 

about trading procedures for entering and executing orders 

Not applicable to CFTC proposal. 

12. New Section 2(j)(4)(L) requires a trading facility to insure compliance 

with the rules 

Adds proposed CEA Section 2(h)(7)(C)(vii) Core Principle—compliance with 

rules. 

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13. New Section 2(j)(4)(M) requires a trading facility to disclose to the public and the Commission information about contract terms, trading conventions, financial integrity protections, etc. Not applicable to CFTC proposal. 14. New Section 2(j)(4)(N) requires a trading facility to establish fitness 

standards for directors and members of disciplinary committees 

Not applicable to CFTC proposal. 

15. New Section 2(j)(4)(O) requires a trading facility to establish rules governing conflicts of interest in the decision making process Not applicable to CFTC proposal. 16. New Section 2(j)(4)(P) requires a trading facility to maintain all business records for 5 years Not applicable to CFTC proposal. 17. New Section 2(j)(4)(Q) requires a trading facility to avoid adopting 

rules that create an unreasonable restraint of trade or impose anti-competitive burdens on trading on the facility 

Not applicable to CFTC proposal. 

B. Criteria for Energy Trading Facilities—new section 2(j)(5) provides that an 

energy trading facility must continue to comply with all of the criteria in section 2(j)(4) to continue operation, and that violation of any criteria shall constitute a violation of the CEA. 

Core Principles apply to ECMs trading significant price discovery contracts on 

an ongoing basis. Violations of the provisions of proposed CEA Section 2(h)(7) constitute violations of the CEA. 

C. Position Limits and Accountability—new section 2(j)(6) directs the Commission 

1. to ensure that the position limits and accountability levels that are established for energy trading facilities are on a parity with the position 

limits and accountability levels established for similar contracts traded on a DCM and applied in a functionally equivalent manner, 

Adds proposed CEA Section 2(h)(7)(C)(iv) Core Principle—position limitations or 

accountability. Also, amends CEA Sections 4g and 4i regarding recordkeeping and large trader reporting, and Section 8a regarding emergency authority, for significant price discovery contracts. 

2. to take action as necessary to reduce potential threat of price manipulation, excessive speculation, price distortion or disruption of delivery or 

cash-settlement process, and 

3. to obtain information from a trader regarding the trader’s exchange and 

off-exchange positions. 

D. Criteria for Commission Determination—new section 2(j)(6)(D) specifies criteria the Commission or exchange may consider when determining whether 

to require a trader to limit, reduce, or liquidate a position including: 

Not applicable to CFTC proposal. 

1. person’s open interest relative to the total open interest 2. daily volume of contract 3. person’s overall position in related contracts, including options, and the 

overall open interest or liquidity in the related contracts and options 

4. potential for positions to cause or allow price manipulation, excessive 

speculation, price distortion, or disruption of delivery or cash-settlement process 

5. person’s compliance record 6. any justification provided by person for such position, and 7. other factors as deemed appropriate by Commission 

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Attachment—Continued

Senator Levin’s ‘‘Close the Enron Loophole Act’’ S. 2058 CFTC Proposal significant price discovery contracts on ECMs 

E. Information for Price Discovery Determination—Section 2(d) amends other 

provisions of the CEA to enable the Commission to obtain information from an electronic trading facility or a derivatives transaction execution facility to evaluate whether the energy trading facility performs a price discovery function 

Conforming amendment (d) amends Section 2(h)(5) to extend CFTC’s special 

call authority for ECMs to obtaining information to make a significant price discovery determination. Also, significant price discovery determination process subject to CFTC rulemaking authority under proposed CEA Section 2(h)(7)(A).

IV. Section 3. Reporting of Energy Trades Analogous Provisions in CFTC Proposal.

A. Section 3 of S. 2058 adds a new CEA section 2(K) which requires U.S. persons who trade certain energy contracts on a foreign board of trade (‘‘FBOT’’) 

to keep records and to report large trades. 

Not applicable CFTC proposal.

V. Antifraud Authority Analogous Provisions in CFTC Proposal. 

A. Section 4 of S. 2058 amends Section 4b of the CEA to clarify the CFTC’s authority to bring fraud actions in off-exchange principal-to-principal futures 

transactions. 

Outside scope of proposal regarding significant price discovery contracts trading 

on ECMs; CFTC supports including this provision as part of CFTC reauthorization.

VI. Commission Rulemaking Analogous Provisions in CFTC Proposal.

A. Section 5 of S. 2058 requires the CFTC to issue proposed rules within 180 

days regarding requirements for an application for registration for an energy trading facility. CFTC must finalize rule within 270 days. 

Adds proposed CEA Section 2(h)(7)(A) requiring CFTC rulemaking to implement 

the provisions of this legislation.

VII. Conforming Amendments Analogous Provisions in CFTC Proposal.

A. Section 2 of S. 2058 includes various CEA conforming amendments to provide a comparable degree of CFTC authority over operations of registered 

energy trading facilities as exists with respect to DCMs. 

Adds conforming amendments to : 

CEA Sections (2)(a)(1)(A)—exclusive jurisdiction over significant price discovery contracts on ECMs; CEA Section 2(h)(4)(D)—remove existing significant price discovery function provision applicable to ECMs in light of new Core Principle in CEA Section 2(h)(7)(C)(vi) requiring daily publication of certain trading information; CEA Section 5c—issuance of CFTC interpretations regarding compliance with Core Principles, delegation of functions under Core Principles, violations of Core Principles; CEA Section 8a—authority to alter or supplement rules of the trading facility and to share information with the trading facility. 

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1See p. 54 of our report; and 1181175, p. 9, 4.1. 

2P. 56 of our report.

Responses from Orice M. Williams, Director, Financial Markets and Community Investment, U.S. Government Accountability Office, Washington, D.C. 

Question from By Hon. Bob Etheridge, a Representative in Congress from North 

Carolina

Question. We have heard many complaints that natural gas futures contracts 

have increased in volatility due to the increased participation of speculators—or 

noncommerical traders—in these markets. However, according to GAO’s report, the 

market that has seen the greatest increase in noncommerical traders in the past 

3 years has been the crude oil market; and—interestingly enough—your report 

states that this market has experienced declining volatility during the same period. 

Can you account for this discrepancy, or—if not—does this not cast doubt on the 

argument that increase participation by speculators inevitably causes increased volatility? 

Answer. As you point out, our analysis of the price volatility of futures contracts 

showed that crude oil volatility decreased, on an annual basis, from 2003 through 

2006. At the same time, CFTC large trader data reveal that the average daily number of noncommercial traders in crude oil futures and options contracts grew from 

about 125 to about 286 from July 2003 to December 2006. 

We agree that these trends are not consistent with assertions that increased speculation necessarily results in increased price volatility. However, it is important to 

note that while there may be a correlation between the two, causation is more difficult to prove empirically. Even if the number of noncommercial, or speculative, 

participants increased during a period of rapidly rising price volatility, there may 

be a number of factors contributing to such a trend. For example, speculative traders may be attracted to a market with high or increasing volatility because it increases the opportunity to profit from changing prices. Furthermore, natural gas 

historically has been more volatile than other energy commodities, and other commodities in general, due to difficulties in storage and transportation and sensitivity 

to changing weather. 

Questions from By Hon. Bob Goodlatte, a Representative in Congress from Virginia

Question 1. What is a ‘‘meaningful outcome based measure’’ and how can it help 

the Commission identify violations or deter misconduct? What specific ‘‘outcome 

based measures’’ have you recommended to the CFTC? What are examples of ‘‘outcome based measures’’ that are used by other Federal agencies that would be applicable to the CFTC? 

Answer. The Office of Management and Budget’s (OMB) Program Assessment 

Rating Tool (PART) review of CFTC’s enforcement program—which is the basis for 

much of our discussion—interprets a meaningful outcome based measure to be one 

that ‘‘fully reflect[s] progress on meeting the program’s overall goals.’’ 1 The purpose 

of outcome-based performance measures is to help the CFTC better assess and improve its performance in meeting program goals, including the identification of violations and deterrence of misconduct. As we note in our report, PART is meant to 

serve as a diagnostic performance tool, drawing on available program performance 

and evaluation information to form conclusions about program benefits and recommend adjustments that may improve results. 

Our report did not recommend that CFTC consider any specific outcome-based 

measures. Rather, we note that enforcement agencies, such as CFTC, face challenges in developing meaningful measures. Therefore, we identified a number of 

other ways to evaluate the effectiveness of its enforcement program including the 

use of expert panel reviews, customer service surveys, and process and outcome 

evaluations.2

Question 2. What type of classification would you like to see in the reports issued 

by the Commission to eliminate the ‘‘disconnect’’ you noted in your testimony? 

Answer. In December 2006, CFTC announced a pilot program to more accurately 

reflect the nature of positions held by nontraditional hedgers, such as swap dealers, 

in the COT report by including positions of commodity index traders in a separate 

category. We recommended that CFTC consider expanding this pilot (e.g., separate 

reporting category for commodity index funds) to include energy commodities. As 

currently structured, the Commitment of Traders (COT) reports for energy commodities make no distinction between commercial traders who use futures exchanges to 

hedge their positions in the physical markets and those commercial traders, such 

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as investment banks, who trade futures to hedge their trading in off-exchange derivatives.

Question 3. Did you evaluate how the market oversight division and the enforcement division of the CFTC interact? If so, do you find there to be adequate interaction between the two divisions? 

Answer. While we did not evaluate the extent of interaction, our report does describe how the market oversight division and enforcement divisions interact. For example, beginning on p. 44 of our report (GAO–08–25), we describe how CFTC can 

use information gathered from surveillance activities, especially on large traders, to 

identify unusual trading activity and possible market abuse. On page 48, we discuss 

how market oversight staff may refer instances of questionable trading activity to 

the enforcement division to conduct nonpublic investigations.

Question 4. In last month’s hearing and again today we received testimony on the 

increasingly global scale of the futures market. Did you consider the likelihood that 

any of your recommendations—greater regulation, reporting requirement or enforcement activity—would potentially force this business overseas, beyond the regulatory 

reach of the CFTC? 

Answer. Some industry observers we spoke with shared concerns that greater 

oversight could result in certain activities moving offshore. However, our matter for 

Congressional consideration (that Congress consider further exploring the adequacy 

of the current regulatory structure for energy derivatives) suggests that Congress 

further explore the currently regulatory structure. Any such consideration should include considering the global nature of the market and the impact regulatory 

changes may have on off-exchange markets. Similarly, our recommendations to 

CFTC should not directly affect market participants. For example, we recommend 

that CFTC reexamine the way it classifies the data it already receives from market 

participants in the COT reports versus new reporting requirements on market participants. Likewise, our recommendations on improving its monitoring documentation and evaluating its enforcement activities are both aimed at improving the operational effectiveness of CFTC’s existing activities and requirements.

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