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S. HRG. 112–680 

IMPLEMENTING DERIVATIVES REFORM: REDUCING 

SYSTEMIC RISK AND IMPROVING MARKET 

OVERSIGHT 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED TWELFTH CONGRESS 

SECOND SESSION 

ON 

EXAMINING THE IMPLEMENTATION OF THE NEW DERIVATIVES RULES 

AND RESPONSIBILITIES OF THE CFTC AND SEC AS MANDATED 

UNDER TITLE VII OF THE DODD-FRANK WALL STREET REFORM AND 

CONSUMER PROTECTION ACT 

MAY 22, 2012 

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

( 

Available at: http://www.fdsys.gov/ 
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

TIM JOHNSON, South Dakota, Chairman 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

HERB KOHL, Wisconsin 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

MICHAEL F. BENNET, Colorado 

KAY HAGAN, North Carolina 

RICHARD C. SHELBY, Alabama 

MIKE CRAPO, Idaho 

BOB CORKER, Tennessee 

JIM DEMINT, South Carolina 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

JERRY MORAN, Kansas 

ROGER F. WICKER, Mississippi 

DWIGHT FETTIG, Staff Director 

WILLIAM D. DUHNKE, Republican Staff Director 

CHARLES YI, Chief Counsel 

JEFFREY SIEGEL, Senior Counsel 

LAURA SWANSON, Policy Director 

WILLIAM FIELDS, Legislative Assistant 

JANA STEENHOLDT, Legislative Assistant 

ANDREW OLMEM, Republican Chief Counsel 

MIKE PIWOWAR, Republican Chief Economist 

BETH ZORC, Republican Counsel 

DAWN RATLIFF, Chief Clerk 

RIKER VERMILYE, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

(II)
C O N T E N T S 

TUESDAY, MAY 22, 2012 

Page 

Opening statement of Chairman Johnson ............................................................. 1 

Opening statements, comments, or prepared statements of: 

Senator Shelby .................................................................................................. 2 

WITNESSES 

Mary L. Schapiro, Chairman, Securities and Exchange Commission ................. 4 

Prepared statement .......................................................................................... 36 

Gary Gensler, Chairman, Commodity Futures Trading Commission ................. 5 

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

Response to written questions of: 

Senator Shelby ........................................................................................... 47 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Prepared statement of Bartlett Naylor, Financial Policy Advocates ................... 74 

(III)

(1) 

IMPLEMENTING DERIVATIVES REFORM: REDUCING SYSTEMIC RISK AND IMPROVING 

MARKET OVERSIGHT 

TUESDAY, MAY 22, 2012 

U.S. SENATE, 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, 

Washington, DC. 

The Committee met at 10:05 a.m. in room SD–538, Dirksen Senate Office Building, Hon. Tim Johnson, Chairman of the Committee, presiding. 

OPENING STATEMENT OF CHAIRMAN TIM JOHNSON 

Chairman JOHNSON. I will call this hearing to order. 

Today we will review the progress being made to reduce systemic 

risk and improve oversight of the derivatives market. But before 

we get to the main subject of this hearing, I want to make a few 

comments about recent news made by JPMorgan Chase. 

The company’s massive trading loss is a stark reminder of the financial crisis of 2008 and the necessity of Wall Street reform. Since 

the firm’s May 10 conference call, my staff and Ranking Member 

Shelby’s staff have jointly held briefings with regulators and a 

briefing with the company itself. Following these briefings I announced last week that I intend to call JPMorgan’s CEO Jamie 

Dimon to testify before the Committee. 

In calling for Mr. Dimon to testify, I expect him to inform the 

Committee of the details surrounding what has been reported to be 

a very complex trade. With today’s hearing, our June 6th bank supervision hearing with other key regulators and Treasury, and the 

hearing with Mr. Dimon, the Committee is on its way to having a 

more complete understanding of the facts about the JPMorgan 

matter that will help us better oversee the implementation of Wall 

Street reform. 

This trading loss has been a wakeup call for many opponents of 

Wall Street reform and the need to fully fund the agencies responsible for overseeing the swap trades that appear to be at the core 

of the firm’s hedging strategy. It is my hope that all of my colleagues who expressed such alarm about this matter will now join 

Democrats in advocating full funding for our regulatory ‘‘cops on 

the beat’’ to address the very issues that some now suddenly seem 

so concerned about. 

It is understandable that this high-profile trading loss has 

caused many to renew their interest in Wall Street reform, but as 
2 

Chairman, I have never taken my eye off the ball. That is why we 

are here today continuing our oversight responsibilities. 

Much of the reaction to recent events has focused on other provisions of Wall Street reform, but what has gotten far less attention 

is the impact derivatives reform will most certainly have on reducing the likelihood that banks would want to engage in certain highrisk, complex swap transactions in the first place. Higher margin 

and capital requirements for uncleared swaps, increased clearing 

obligations, real-time reporting requirements, and new anti-fraud 

and anti-manipulation authorities included in Wall Street reform 

will reduce market risk and improve the integrity of swap trading 

between large financial firms. 

Chairman Schapiro and Chairman Gensler, I commend you and 

your staffs for your tireless efforts implementing these new reforms, and I look forward to hearing from you today. As you continue your efforts, I urge your agencies to take a single, unified approach to regulating cross-border transactions and to integrate this 

approach into all your swap rules. Differences between your two 

sets of rules and implementation efforts should be minimized to improve compliance and limit costs. And efforts by the United States 

to promote harmonization abroad will be more challenging if we 

cannot harmonize efforts by our agencies here at home. 

Last, I would like to apologize in advance to my colleagues, but 

I will need to excuse myself for a 10:30 markup in the Appropriations Committee for my MilCon-VA bill. Senator Merkley has graciously agreed to chair this hearing in my absence. 

To reserve time for questions, opening statements will be limited 

to the Chair and Ranking Member. However, I would like to remind my colleagues that the record will be open for the next 7 days 

for additional statements and other materials. 

I now turn to Senator Shelby for his opening remarks. 

STATEMENT OF SENATOR RICHARD C. SHELBY 

Senator SHELBY. Thank you, Mr. Chairman. 

Since the passage of the Dodd-Frank Act, its proponents have repeatedly claimed that both consumers and our financial markets 

will benefit from the new law. We now know that both of those 

claims are false. 

Since last year, Chairman Gary Gensler oversaw the largest consumer protection failure in the history of the CFTC. Under Chairman Gensler’s watch, customers of MF Global had $1.6 billion of 

funds improperly taken from their accounts. 

The first and most basic responsibility, I believe, Mr. Chairman, 

of the CFTC is to ensure that customer funds are not misappropriated. Yet, despite all the new authorities conferred on the CFTC 

by Dodd-Frank, the CFTC was still unable to fulfill this primary 

responsibility to MF Global customers. 

The CFTC’s failure is especially troubling here because the funds 

went missing during a time when it was well known that the firm 

was under severe financial stress, and the risk of misappropriation 

there was very high. Even more embarrassing for the CFTC is the 

fact that there were numerous CFTC officials onsite at the firm 

when the funds went missing. 
3 

While I am pleased to see that the MF Global trustee is making 

progress in returning funds to MF Global customers, Chairman 

Gensler nonetheless owes the public, I believe, a full accounting of 

how they failed to protect those customer assets in the first place. 

Unfortunately, Chairman Gensler continues to recuse himself 

from all matters pertaining to MF Global, which effectively insulates him from congressional scrutiny. Mr. Chairman, I believe the 

public deserves more from their financial regulators. We need regulators who are willing to explain their actions rather than run for 

the hills. If there were regulatory failures, the responsible parties 

need to be held accountable for their actions, and they need to 

admit what happened. 

Chairman Gensler’s recusal has impeded Congress’ ability to examine every facet of the MF Global failure. I hope that today 

Chairman Gensler will be more forthcoming about his involvement 

with MF Global so that Congress can finally begin to understand 

what role he played and how Congress should respond. I also hope 

that Chairman Gensler will be more forthcoming about his management of the CFTC’s implement of Dodd-Frank. 

Chairman Gensler and SEC Chairman Mary Schapiro have jointly created widespread uncertainty about the regulation of derivatives. According to a recent report, regulators have met only onethird of their Dodd-Frank rulemaking deadlines. And while there 

is no question that the rulewriting process mandated by DoddFrank makes it very difficult to meet some of the deadlines, the 

regulators share culpability here. 

For example, although the CFTC and the SEC have proposed numerous new rules for derivatives, they have still not proposed rules 

that clarify the definition of a swap. 

Let me repeat that. Almost 2 years after the passage of DoddFrank, giving the CFTC and the SEC joint jurisdiction over the 

swap markets, they have still not agreed on the definition of a 

swap. Yet somehow they finalized rules based upon swap activities 

defining and governing swap dealers and major swap participants. 

If market participants do not know which of their activities will fall 

under the swap definition, how can they be expected to know 

whether these activities will be subject to the patchwork of registration, recordkeeping, clearing, and trading rules? And if market 

participants do not know if their activities will cause them to be 

classified as a swap dealer or a major swap participant, how can 

they be expected to know when to submit comments? 

This is just one example that I am bringing out here of how 

Dodd-Frank and its implementation have created unnecessary uncertainty in our markets. As the American economy continues to 

struggle with high unemployment, sluggish growth, and the fallout 

from the ongoing European crisis, the last thing I believe we need 

are self-inflicted wounds. This includes those inflicted by Congress, 

regulators, and most recently, poorly conceived trading and hedging activities in one of our largest banks. 

Today’s hearing presents here in the Banking Committee an opportunity to discuss all of these and how they can be avoided in 

the future, and I thank you for calling this hearing, Mr. Chairman. 

Chairman JOHNSON. Thank you, Senator Shelby. 
4 

Now I would like to briefly introduce our witnesses, neither of 

whom are strangers to this Committee. Chairman Mary Schapiro 

is the head of the U.S. Securities and Exchange Commission. 

Chairman Gary Gensler is the head of the Commodity Futures 

Trading Commission. We appreciate both of your taking time out 

of your schedules to be with us today. 

Chairman Schapiro, please begin your testimony. 

STATEMENT OF MARY L. SCHAPIRO, CHAIRMAN, SECURITIES 

AND EXCHANGE COMMISSION 

Ms. SCHAPIRO. Chairman Johnson, Ranking Member Shelby, and 

Members of the Committee, I appreciate the opportunity to testify 

regarding the Securities and Exchange Commission’s ongoing implementation of Title VII of the Dodd-Frank Act. 

As you know, Title VII creates an entirely new regulatory regime 

for over-the-counter derivatives and directs the Commission and 

the CFTC to write a number of rules necessary to implement it. Of 

course, Title VII is just one of the many areas ranging from credit 

rating agencies to private fund and municipal adviser registration, 

to specialized corporate disclosures where the SEC is charged with 

writing rules. 

The SEC already has proposed or adopted rules for over threefourths of the more than 90 provisions in the Dodd-Frank Act that 

mandate SEC rulemaking. Additionally, the SEC has finalized 14 

of the more than 20 studies and reports that the Dodd-Frank Act 

directs us to complete. And the Commission has proposed almost 

all of the rules required by Title VII. We are continuing to work 

diligently to implement all provisions of Title VII as well as the 

many other rules we are charged with drafting and to coordinate 

implement with the CFTC and other domestic and foreign regulators. 

Under the Dodd-Frank Act, regulatory authority over swaps is 

divided between the CFTC and the Commission. The law assigns 

the SEC the authority to regulate security-based swaps while the 

CFTC has primary regulatory authority over the bulk of the Title 

VII over-the-counter derivatives market called ‘‘swaps.’’ Our 

rulemakings are designed to improve transparency, to reduce information asymmetries, and facilitate the centralized clearing of security-based swaps to reduce counterparty risk. They are also designed to enhance investor protection by increasing disclosure regarding security-based swap transactions and mitigating conflicts 

of interest. By promoting transparency, efficiency, and stability, 

this framework is intended to foster a more stable and competitive 

market. 

In implementing Title VII, SEC staff is in regular contact with 

the staffs of the CFTC, the Federal Reserve Board, and other financial regulators. In particular, Commission staff has coordinated extensively with CFTC staff in the development of the definitional 

rules, including joint rules further defining key product terms, 

which we expect to finalize soon, and rules further defining categories of market participants, which we adopted last month. Although the timing and sequencing of the CFTC’s and the SEC’s 

rulemaking may vary, they are the subject of extensive interagency 
5 

discussions, and the objective of consistent and comparable requirements will continue to guide our efforts. 

The Dodd-Frank Act also specifically requires that the SEC, the 

CFTC, and the prudential regulators ‘‘consult and coordinate with 

foreign regulatory authorities on the establishment of consistent 

international standards.’’ Accordingly, the Commission is actively 

working with regulators abroad to address the regulation of OTC 

derivatives, encouraging foreign regulators to develop rules and 

standards complementary to our own. 

The Commission expects to complete the last of the core elements 

of our proposal phase in the near term, in particular, rules related 

to the financial responsibility of security-based swap dealers and 

major security-based swap participants. The Commission is finalizing a policy statement regarding how the substantive requirements under Title VII within our jurisdiction will be put into effect. 

This policy statement will establish an appropriate and workable 

sequence and timeline for the implementation of these rules. 

As a practical matter, certain rules will need to go into effect before others can be implemented, and market participants will need 

a reasonable, but not excessive, period of time in which to comply 

with the new rules. This statement will let market participants 

know the Commission’s expectations regarding the ordering of the 

compliance dates for various rules. Relevant international implementation issues will also be addressed in the single proposal. 

Finally, your invitation letter requested that I address recent 

trading losses reported by JPMorgan Chase. Our best information 

is that the trading activities in question took place in the bank in 

London and perhaps in other affiliates, but not in the broker-dealer 

that is directly supervised by the SEC. Although the Commission 

does not discuss investigations publicly, I can say that in circumstances of this nature where the activity does not appear to 

have occurred in one of our regulated entities, the SEC would be 

primarily interested in and focused on the appropriateness and 

completeness of the entity’s financial reporting and other public 

disclosures. 

In conclusion, as we continue to implement Title VII, we look forward to continuing to work closely with Congress, our fellow regulators both at home and abroad, and members of the public. Thank 

you for the opportunity to share our progress on the implementation of Title VII, and I will, of course, be happy to answer any questions. 

Chairman JOHNSON. Thank you. 

Chairman Gensler, please begin your testimony. 

STATEMENT OF GARY GENSLER, CHAIRMAN, COMMODITY 

FUTURES TRADING COMMISSION 

Mr. GENSLER. Good morning, Chairman Johnson, Ranking Member Shelby, and Members of this Committee. I am pleased to testify 

along with SEC Chairman Schapiro. Today I am going to speak to 

the three topics of your invitation letter: first, where is the CFTC 

on swaps market reform; second, the CFTC’s role in overseeing 

markets for credit derivative products such as those traded by 

JPMorgan Chase’s Chief Investment Office; and, third, international progress on swaps reform and related issues of cross-bor-
6 

der application. I also welcome Ranking Member Shelby’s questions 

and look forward to chatting about that in public, as I would in private with any of the Members. 

The CFTC is a small agency that is tasked with overseeing the 

futures markets and now, with passage of Dodd-Frank, a market 

nearly 8 times larger, the swaps market. Given these new responsibilities, we are significantly underfunded, but you have heard me 

say that before. 

Our market oversight critically relies on market participants 

foremost complying with the laws and related rules and then the 

self-regulatory organizations, like the CME and the National Futures Association, that provide the first line of oversight. But in addition to that, we do rely on promulgating and implementing rules, 

and in that context, the CFTC has completed 33 swaps market reforms to date. We have just under 20 to go. 

What do they do? They bring transparency to this marketplace; 

second, they lower risk through something called ‘‘central clearing 

of standardized swaps’’; and, third, lower risk by comprehensively 

regulating the dealers. 

We are on track to finish the reforms this year, but it is still very 

much standing up, and we are also giving the market time to phase 

in implementation to lower the costs and burdens on this very significant transition. 

To increase market transparency, we have completed eight key 

reforms, including real-time reporting to the public and to regulators that will begin later this summer. On clearing, we finalized 

risk management and will soon seek public comment on which contracts themselves would be under what was called ‘‘the clearing 

mandate.’’ 

To promote market integrity, we have completed strong antifraud and anti-manipulation rules as well as aggregation position 

limits, and we are looking soon to finalize the end-user exception. 

To lower risk of the swap dealers posed to the economy at large, 

we have completed rules requiring robust sales practices and risk 

management in a joint rule with the SEC on the further definition 

of the words ‘‘swap dealer’’ and ‘‘securities-based swap dealer.’’ All 

of this is still, though, pending because it has to relate to us finalizing the further definition of the terms ‘‘swap’’ and ‘‘securitiesbased swap.’’ 

It is essential that the two Commissions move forward expeditiously to finalize this rule, and I am glad to say that both Commissions now have a draft of this rule that has been worked out 

through staff, and hopefully we will be able to finalize this in the 

near term. 

We have made significant progress as well working with domestic and foreign regulators to bring a consistent approach to swaps 

market reform, and though not identical, Europe, Japan, and Canada now all have made real progress legislatively and now in 

rulewriting to bring similar reform. And, in particular, I want to 

say we are working on a consistent approach to global margin for 

uncleared swaps. It is important for a lot of reasons, but let me 

note one reason is that the CFTC proposed a rule that did not require financial end users to post margin, and we are advocating the 
7 

same globally. I just wanted to make sure people know that in the 

end-user community. 

The Commission is also working on a balanced approach to crossborder application of swaps reform. I think Congress was guided by 

the experience of AIG with its London affiliate—well, actually it 

was a London branch—Lehman Brothers, Citigroup, Bear Stearns, 

and even Long-Term Capital Management, when it applies reforms 

to transactions that might be booked offshore but nonetheless have 

a direct and significant effect on U.S. commerce and activities. 

That in essence is a stark reminder we got in the last 2 weeks 

when JPMorgan’s trading losses were overseas from trades that 

lost multi-billions of dollars and the credit default swaps and indices on credit default swaps. 

The CFTC’s Division of Enforcement has opened an investigation 

related to credit derivative products traded by JPMorgan Chase’s 

Chief Investment Office, and although I am unable to provide any 

specific information about a pending investigation, I will touch 

upon the Commission’s role in overseeing these markets. The 

CFTC has oversight and clear anti-fraud and anti-manipulation authority regarding the trade of credit default swaps indices. We also 

oversee the clearinghouses that already clear some of these products. Starting this summer, there will be real-time reporting to the 

public. And later this year, but not yet, we envision the dealers 

themselves to begin to register and that trading will commence on 

swap execution facilities. So we are in the midst of implementation 

that will take still some time. 

In conclusion, though we have made great progress in bringing 

common-sense reforms to the swaps market, promoting transparency and lowering risk, it is critical we complete these reforms 

for the protection of the public. 

Thank you. 

Chairman JOHNSON. I would like to thank both of our witnesses 

for their testimony. 

As we begin questions, I will ask the clerk to put 5 minutes on 

the clock for each Member. 

Chairman Gensler and Chairman Schapiro, what role did your 

agencies have in monitoring the swap trades at issue in the 

JPMorgan matter? And were any concerns raised about these 

trades at either of your agencies? What changes will the derivative 

reforms bring to the regulation of these types of trades? And what 

are the potential implications for the Volcker Rule? 

Chairman Gensler, please start. 

Mr. GENSLER. As I mentioned in more depth in my written remarks, we are in the midst of standing up a regime that will still 

take some time, but the credit default swap indices—these are 

parts of the products that reported in the press that JPMorgan 

Chase’s Chief Investment Office was trading—already come under 

our completed anti-fraud and anti-manipulation regime, and the 

clearinghouses—three of them, actually—already clear credit default swap indices voluntarily. Later this year, we anticipate seeking public comment on actually having a clearing mandate so that 

more of these trades will come into the clearinghouse. Currently it 

is just dealers to dealers. Later this year, we will have a regime 

that I actually think dealers will start to register, but this bank 
8 

was not yet registered as a swap dealer because we do not yet have 

complete rules to make that a true being. And later this year or 

maybe into 2013, you will start to see the commencement of trading transparent markets. We are not trying to do this against a 

clock. We are trying to get it balanced. I know that Congress gave 

us 1 year to get the job done, and we are pushing on 2 years. I do 

think we need to get the job done to better protect the American 

public, but at the same time take in the 30,000 comments we have 

received. 

You asked when did it come to our attention. With matters like 

this, I do not want to get into the specifics of an investigation, but 

as press reports have shown, these are credit default swap indices 

that are under our jurisdiction for anti-fraud and anti-manipulation and the clearinghouses we monitor on a very real-time daily 

basis for the completeness of the margin and the safety and soundness of the clearinghouses. 

Chairman JOHNSON. Chairman Schapiro? 

Ms. SCHAPIRO. Thank you, Mr. Chairman. To the best of our understanding, none of the transactions were held in or executed in 

the U.S. broker-dealer. The activity took place in the London 

branch of the OCC-regulated bank and in a London-based affiliate 

investment management unit. So the SEC did not have any direct 

oversight or knowledge of the transactions. 

I would reiterate what Chairman Gensler said. If the DoddFrank rules had been in place when the activity was going on, 

these positions likely would have all been cleared. Some substantial majority were—or some substantial number were, but not all 

were cleared. They would have likely been exchange traded. They 

would have been reported to a swaps data repository, and there 

would have been detailed transparency to regulators and transparency to the public, and I would say under the SEC’s proposed 

rules for reporting, we would have known the trading desk and the 

trader as well who put the positions on. The dealer would have 

been registered and subject to business conduct standards, and 

they would also operate under the new rules for enhanced prudential supervision for bank-holding companies with assets greater 

than $50 billion. 

So I think there are a number of pieces that would be in place 

once all the proposals to implement Dodd-Frank are completed. 

Chairman JOHNSON. Chairman Schapiro, can you commit to us 

that the SEC will issue the last of your proposed derivatives rules 

in the coming months and that you will prioritize within the SEC 

the importance of enacting the final rules in a timely manner? 

Ms. SCHAPIRO. Absolutely, Mr. Chairman. We have the last piece 

of proposing rules for us, the financial responsibility rules for swap 

dealers and major swap market participants. I hope that we will 

issue that in the next couple of months. 

There are also the two other key pieces from the SEC’s perspective. One is, as I spoke about in my testimony, the implementation 

plan that will lay out in a policy statement our views on how the 

rules should be sequenced and implemented, what the compliance 

timelines would look like, and we will see comment on that. And, 

finally, a cross-border release that will talk about the application 

of each of our rules potentially to cross-border activity or cross-bor-
9 

der operating entities, and we want to propose that cross-border release before we adopt final rules beyond the definitional rules. 

Chairman JOHNSON. Senator Shelby. 

Senator SHELBY. Thank you, Mr. Chairman. 

A lot of people have been basically saying, Chairman Gensler, 

that the CFTC and the SEC, Chairman Schapiro, were in the dark, 

that you did not know what was really going on at JPMorgan. We 

do not know that yet. But when did you first learn about these 

trades, Chairman Gensler? 

Mr. GENSLER. I would say that the trades that came to, I think, 

many of our attention, personal attention, with press reports—— 

Senator SHELBY. Press reports. 

Mr. GENSLER. But our staff was aware of trades that are in the 

clearinghouses because they monitor the clearinghouses daily in an 

aggregate basis for the clearinghouse risk and that the clearinghouse is fully collecting margin to protect the risk of the clearinghouses. 

Again, we do not regulate JPMorgan Chase as a swap dealer yet, 

but we do regulate the clearinghouses, and then have anti-fraud 

and anti-manipulation authority. 

Senator SHELBY. Did the CFTC really know what was going on 

there on such a large position that JPMorgan had taken here? 

Mr. GENSLER. Well, again, our—— 

Senator SHELBY. Were you in the dark, or did you know what 

was going on? You said you learned about—— 

Mr. GENSLER. I would say that it is in transition to speak about 

this. Our oversight of the clearinghouses gives us a lot of window 

into the clearinghouse, which I think has 27 members in it, and the 

risks that are in that clearinghouse and the margin that is collected there. That is not the full JPMorgan picture, of course, because they have a lot of swaps that are not cleared. That would 

have been our principal regulatory role—in terms of the bank, we 

do not have any specific oversight there. 

Senator SHELBY. So you really did not know what was going on 

or the problem with the trade until you read the press reports like 

all of us? 

Mr. GENSLER. Well, that is what I have said, yes. 

Senator SHELBY. Yes, sir. Chairman Schapiro, I will pose the 

same question to you. 

Ms. SCHAPIRO. Certainly. 

Senator SHELBY. Where was the SEC here? Did they know what 

was going on? And if not, why not? 

Ms. SCHAPIRO. The SEC became aware of the activity, again, also 

through press reports back in April when the London Whale trading was first reported on. Just to remind everyone, this activity did 

not take place in a broker-dealer, and we do not have oversight responsibility over the broad-based CDS index products that were the 

subject of much of the trading, although I think there is still much 

to learn here about the full—— 

Senator SHELBY. And what was your responsibility, as you see it, 

as Chairman of the SEC, looking at what happened or trying to 

find out what happened at JPMorgan Chase? What is your responsibility? 
10 

Ms. SCHAPIRO. Well, clearly, our focus right now is on whether 

the company’s public disclosure and financial reporting is accurate 

in light of what the press has teed up as what did they know and 

when did they know it. 

Senator SHELBY. Absolutely. 

Ms. SCHAPIRO. And so there were—— 

Senator SHELBY. And if they knew something, say, a month earlier that was going wrong, should they have disclosed that to the 

SEC, the CFTC? And is that what you are trying to find out now, 

or do you already know? 

Ms. SCHAPIRO. That is what we are investigating right now. 

Were their earnings release statements and their Q1 financial reports accurate and truthful? 

Senator SHELBY. But you are in the investigation of that now? 

Ms. SCHAPIRO. Yes, sir. 

Senator SHELBY. What did they know inside, when did they 

know it, and what should they have divulged; is that correct? 

Ms. SCHAPIRO. Exactly. 

Senator SHELBY. Is that correct, Chairman? 

Mr. GENSLER. Yes, and as Congress gave the CFTC similar authority to the SEC—we did not formally have as strong an antifraud and anti-manipulation authority, which included also deceptive practices. That is part of this new authority that we have. We 

currently have oversight of the clearinghouses. I do not want to go 

into the particulars of this ongoing investigation that because it is 

really just best not to compromise the investigation itself. But it is 

in that realm of—— 

Senator SHELBY. As Chairman of the CFTC, though, in a derivative position like this, are you basically telling us that you did not 

know there was a problem there until you read the press reports? 

Is that basically correct? 

Mr. GENSLER. I think that is accurate. We are also standing up 

a regime. We do not have any regulatory oversight of JPMorgan 

Chase National Association, the bank. We will, I think, at some 

point when they register as a swap dealer later this year, but they 

are not currently registered as a swap dealer. We have some oversight of their futures commission merchant, but that does not—— 

Senator SHELBY. Are you saying this is a no-man’s land, there is 

nothing—there are things that have not crystallized in a regulatory 

fashion yet over such a big bank? 

Mr. GENSLER. The bank is overseen by bank regulators, but 

under Dodd-Frank the market regulators, as market regulators, we 

will stand up and oversee swap dealing activity in a bank or an affiliate of a bank or securities-based swap dealing activity. But you 

are right, currently the American public is not protected in that 

way. 

Senator SHELBY. Chairman Gensler, were any of the trades conducted through JPMorgan’s futures commission merchant? 

Mr. GENSLER. Not that I am aware of. Maybe upon further review we will find, but today our knowledge is no. 

Senator SHELBY. OK. Thank you, Mr. Chairman. 

Senator MERKLEY. [Presiding.] Senator Menendez. 

Senator MENENDEZ. Thank you, Mr. Chairman. 
11 

At the last hearing the Committee had on MF Global, I asked 

the MF Global trustees—Mr. Freeh and Mr. Giddens who at the 

company was responsible for the wrongdoing there, and they informed me that their investigation was just beginning to determine 

that. I want to ask you both the same question. Can you shed any 

light at this point? 

Ms. SCHAPIRO. Not at this point, no, sir. 

Senator MENENDEZ. So you do not know at this point who is responsible for what took place at MF Global. 

Ms. SCHAPIRO. No. I think the agencies collectively, including the 

criminal authorities, are working very hard to untangle exactly 

what happened at that firm. 

Senator MENENDEZ. With reference to what happened at 

JPMorgan where the huge losses there take place, have you determine who was responsible at this point for that? 

Ms. SCHAPIRO. No. As I said, our focus is very much—because we 

did not regulate the London branch of JPMorgan Bank, that is an 

OCC-regulated entity. The Fed is the holding company regulator. 

Our focus is on the quality of their risk disclosure and their specific 

disclosures as a public company. When they talked about their potential—all the risks that they faced as a business, when they talk 

about potential losses under their VaR model, we are very focused 

on the accuracy and the timeliness of that disclosure. 

Senator MENENDEZ. In your—yes. 

Mr. GENSLER. I would just say that we are aware that it is primarily in the bank, that much of this emanated from the London 

branch of the bank. And as news reports have suggested, credit derivative products are at the center of it. 

Senator MENENDEZ. In reference to these investigations, are they 

criminal or civil? 

Ms. SCHAPIRO. The SEC’s authority is simply civil, not criminal. 

Senator MENENDEZ. Are you working with entities that are conducting criminal investigations? 

Ms. SCHAPIRO. I believe the FBI has announced publicly that 

they have opened a criminal investigation, and we will all work 

closely together even though we have different aspects—— 

Senator MENENDEZ. Into which of the two that I am referring to? 

Ms. SCHAPIRO. I am sorry? 

Senator MENENDEZ. MF Global? 

Ms. SCHAPIRO. I think actually with respect to both. 

Senator MENENDEZ. With respect to both, OK. So, in essence, it 

is the agencies that are conducting civil reviews, I assume, and to 

the extent that there are criminal reviews that are being conducted, they are being conducted by law enforcement entities. Is 

that correct? 

Ms. SCHAPIRO. That is right. 

Senator MENENDEZ. So it is not the Senate Banking Committee 

that is conducting those. 

Ms. SCHAPIRO. I would not deign to tell the Senate Banking 

Committee what to do or not to do. 

Senator MENENDEZ. But at this point, as far as I know, we are 

not. So let me ask you this: Do you interpret—do you hope to interpret the Volcker Rule in a way that what took place at JPMorgan 
12 

would not have been possible to have taken place, or would not 

have taken place without real consequences? 

Ms. SCHAPIRO. I think we have obviously been thinking a lot 

about this, and the Volcker Rule is foremost in everyone’s minds 

because of where we are in the process of reviewing comment letters, but also because of this activity. And it strikes me that the 

statute is pretty clear that in order to rely on the risk-mitigating 

hedging exemption to the Volcker Rule, there has to be some pretty 

strong criteria that needs to be met. Whether or not the JPMorgan 

trades out of their CIO meets those standards or not, I do not think 

we have a view yet. But they have to be correlated to the risk. 

They cannot give rise to significant new exposures. They have to 

be subject to continuous monitoring and management. They have 

to mitigate one or more specific risks on either individual positions 

or aggregated positions. 

The compensation of the persons doing the trading cannot contribute to their taking outsize risk or unnecessary risk. And they 

have to, importantly, I think, document the risk-mitigating purpose 

of the trades when the hedge is being done at a desk that is different than the position that is being hedged was done at. 

So I think there is strong language there, and what we need to 

do is take what happened at JPMorgan and view it through the 

lens of those criteria and see how that helps to inform the rulemaking going forward. 

Senator MENENDEZ. Well, I hope, as one of those who supported 

the Wall Street reform legislation, that the agencies are going to 

look at this broadly because if JPMorgan lost $2 billion, or some 

report it as just slightly more, through these trades, what is to stop 

them from losing $10 billion the next time or, even worse, to stop 

another less capitalized bank from taking losses so large that it 

could bring it down? I mean, that is the whole effort that we tried 

to move here in the Senate, which is to have the type of reform 

that does not create the systemic risk that then places everybody 

in America responsible for the decisions of large entities such as 

this. And I hope that that is how the regulators at the end of the 

day understand that that was the mission that all of us who supported Wall Street reform wanted to see. 

Thank you, Mr. Chairman. 

Senator MERKLEY. Senator Corker. 

Senator CORKER. Thank you, Mr. Chairman, and I thank both of 

you for your testimony. 

When an event like one that has just occurred happens in the 

middle of a rulemaking process, that affects things, does it not? 

Meaning that you have an example, a real-live example, and, you 

know, we have had this issue, we realize it is a blip on the radar 

as far as their earnings. But it does affect the way rules end up 

being promulgated. Would you both agree? 

Mr. GENSLER. I think it gives us real live experience, like AIG 

and Lehman Brothers and Citigroup did in a more disastrous way. 

This is not that, but it—— 

Senator CORKER. So I think, you know, as the American people 

are watching, they wonder why in the world we are having these 

hearings, and I think the point is that there is a lot happening at 
13 

the regulator level, and an event like this ends up affecting things, 

and it affects the rules that end up being created. 

I guess I have this fear, I think much of what we did was a punt 

to you guys. I mean, the fact that—and you did not do that. We 

did that. But the fact that it has taken you 2 years to define what 

a swap is is pretty incredible, and it is because we never defined 

it ourselves or did the work to understand what a swap is. But the 

thing I guess I fear is in a rush to make it look like the DoddFrank legislation addressed these kind of issues, what you may 

do—I mean, we never debated what these institutions should be. 

We just sort of layered a lot on top. We have these highly complex 

organizations where even the CEO itself realizes that he did not 

know what was happening in this London operation. And I fear 

that you are under pressure, that a lot of calls are being made, that 

the Administration is concerned that the American people are 

going to wake up and look at the last 3 years as a bad dream, you 

know, that maybe the health care bill become unconstitutional, this 

big Dodd-Frank bill really does not address real-time issues, and 

that what you are going to do is end up causing the Volcker Rule 

to be something that it was never intended to be. And I just would 

like for you to respond to that, and in the process possibly making 

these highly complex organizations even more risky than they already are. I would just like a couple of comments in that regard. 

Mr. GENSLER. I think our job that you delegated or asked us to 

do is to be—— 

Senator CORKER. ‘‘Punted’’ was the word I used. 

Mr. GENSLER. I was trying to be more respectful to Congress. 

Senator CORKER. You do not need to be. 

[Laughter.] 

Mr. GENSLER. And I appreciate that. I think it was to ensure 

that the American public gets the benefit of transparency and 

lower risk because firms will fail in the future, as they have in the 

past, and the critical thing is they have a freedom to fail, and the 

American public does not stand behind them. And it is like the one 

industry that we do this around the globe, and that is why I am 

so committed personally to getting this reform done. 

I think this circumstance is just a reminder in one area—I look 

at it more about cross-border application than the Volcker area, if 

I can say respectfully, because whether it was Lehman Brothers, 

AIG, Long-Term Capital—Long-Term Capital Management, you 

might recall, was this hedge fund in Connecticut, but it was set up 

in the Caymans. It is just a reminder to make sure that we get 

that part right. The London risk can come back and hurt the good 

folks of your State. 

Senator CORKER. Is there a pressure, though, to define what has 

occurred here in such a way that you may end up in the short term 

making a piece of legislation look good, but in the process cause a 

highly complex institution like this to be in a position where they 

are not appropriately hedging the activity so that you actually 

make it more risky? I mean, is that the kind of thing that you all 

do talk about from time to time? 

Mr. GENSLER. Well, we are most definitely public actors, as you 

are as a member of this great body, the Senate, and we are influenced by—we have had 30,000 comment letters, 1,600 meetings 
14 

with folks from the markets. So this will be part of the topic of the 

dialogue, absolutely, but I think we have to, just as we always do 

to get it balanced and get it right, not, if your concern is, tip too 

far one way or the other. But I think it is a good reminder that 

risks in London can come back here, and we cannot have the U.S. 

taxpayers stand behind them. 

Senator CORKER. So my time is going to run out, and I know by 

previous history I will be cutoff immediately. I do want to just ask 

that when you are making the rules that you are making, that we 

really do it here to the process of cost/benefit analysis. I am now 

moving to other types of regulations. I know that you know courts 

now are challenging some of the rules and regulations because regulators are not doing that. 

And, second, to ensure that we do not create another systemic 

risk by shifting off to these clearinghouses systemic risk that otherwise was held in other places. 

So, anyway, I thank you for what you do, and I look forward especially to the next hearing we have with the banking regulators 

that actually are supposed to oversee these activities. 

Thank you. 

Senator MERKLEY. Thank you, Senator Corker, and thank you all 

for your testimony. 

I wanted to start with returning to the basic premise of the 

Volcker Rule, which is to create a firewall between traditional 

banking, that is, deposit-taking/loan-making institutions, and 

hedge fund-style investing. 

In the effort to create that firewall, one of the issues was when 

banks were holding funds in between making loans, how would 

they be able to utilize those funds so that they had liquidity for 

making loans, but it was relatively safe, so it is clearly not in the 

world of proprietary trading or hedge fund investing, if you will? 

So the basic statute provided for a notion of investing in Government bonds as kind of the safe place to put your money, but allowed the regulators additional flexibility. 

The draft regulations have the liquidity management proposal, 

and it is not really clear in the end what would be allowed here. 

But if we look at JPMorgan, they have $381 billion in funds that 

were awaiting, if you will, lending out, so in between loans. Unlike 

other institutions that largely put it into Government bonds, they 

took half of that and they put it into corporate bonds. That started 

this sequence of events that led to this $2 to $3 billion or greater 

loss, and that they then said, well, we have these corporate bonds, 

we better protect against them dropping in value, and they bought 

some insurance. And then they said, well, we have got to pay for 

that insurance, so we will sell another form of insurance to create 

the revenues to pay for that. And pretty soon they were in the position of doing what AIG did, which was to sell lots of insurance very 

cheaply, and then when the bets went bad, they had to pay off. 

So it begins with this liquidity management issue, and that really has not been focused on much here. But what is the appropriate 

place to put your funds in between making loans so that you are 

clearly in the deposit-taking/loan-making business and not in the 

hedge fund business? 
15 

Ms. SCHAPIRO. Senator, I think that is a great question, and the 

rationale behind the liquidity management exclusion that was included in the rules was to make sure that banking entities would 

have sufficient readily marketable assets to meet their short-term 

liquidity needs, and I think we can all agree that is really critical 

to the safe and sound operation of a banking entity. And there are 

requirements around that that there has to be a documented liquidity management plan, and there are criteria that are set out 

in the rule. But I think the question you raise really requires us 

to go back and look at that and see if we carried that to its logical 

extreme, could we have anticipated to JPMorgan and maybe we 

need to tighten this up and just look at it much more closely and 

much more carefully. 

That is why I think really in response to Senator Corker’s question, this is very instructive. It would be wrong for us not to take 

this example that is a real-life, real-world example of what can 

happen, whether it is the application of the cross-border provisions 

or it is the Volcker Rule itself, to use this example and to see what 

the impact would be of all the things that we have proposed to do. 

Senator MERKLEY. So I would say if you take the situation that 

funds that are awaiting making new loans, if you will, can be invested in a huge variety of things, and essentially it is a gateway 

to be involved in proprietary trading, and it has two impacts. One 

is it diverts funds that were intended to be lent out the door, reducing liquidity or credit for businesses and families; and, second, it 

introduces a lot of risk and complexity. 

Chairman Gensler? 

Mr. GENSLER. Well, as a derivatives and swaps regulator, we are 

mostly going to be focused on the implementation of the Volcker 

Rule with regard to swap dealers and futures commission merchants. I do not have as many views as Chairman Schapiro on the 

liquidity management piece, but if I could pick up on a second, I 

think implied in there, was we received a letter from JPMorgan all 

of us received on our side of the regulators—in February specifically saying that they thought we had to loosen up or widen out 

the hedging exemption. We are entrusted by Congress to figure out 

how to prohibit proprietary trading so taxpayers do not stand behind these institutions, but permit market making, which is important to markets, and permit hedging, which helps lower risk of 

these institutions. So it is that challenge—it is not an easy challenge, by the way. But I think you were very clear. It has got to 

be tied specifically to individual or aggregate positions, and I think 

Congress was pretty clear on that, and it is instructive to me that 

it was actually February 13th that JPMorgan sent in like a 65- 

page letter, and within that they said you have to loosen up this 

portfolio hedging. And so I think this has to be looked at in the 

context of their February letter as well. 

Senator MERKLEY. Great. I am out of time, so we are going to 

return to Senator Johanns. Thank you. 

Senator JOHANNS. Thank you, Mr. Chairman. 

Thank you both for being here. Madam Chair, let me follow up 

on a statement you have made a couple of times during the hearing 

that I just want to understand better. You said that SEC did not 

regulate the London branch, that that actually was something over 
16 

on the OCC side. And I am trying to maybe take the next step here 

with my question. Could this risk management that was being 

done by JPMorgan have been done in such a way that it would be 

under your jurisdiction? Or are you just saying this does not fall 

within the purview of the powers given to me? 

Ms. SCHAPIRO. If the trades were done in an SEC-regulated entity, broker-dealer or ultimately when the rules are finalized a security-based swap dealer, then it would clearly be under the jurisdiction of the SEC. 

Senator JOHANNS. OK. Which, of course, raises another question. 

If I were running JPMorgan, couldn’t I just set this up in a way 

to avoid you? 

Ms. SCHAPIRO. Well, that is an important issue that we are all 

wrestling with in the context of the cross-border release and how 

will we apply our rules to activities that might not take place in 

the U.S. entity but might face a U.S. customer or might take place 

in an affiliate of a U.S. entity but overseas or in a branch of a U.S. 

entity overseas. And those are the issues that we will lay out in 

our cross-border release. 

I think generally a foreign entity with a foreign customer, we can 

feel reasonably comfortable that our Title VII rules would not 

apply. But the foreign affiliate of a U.S. entity—rather, a foreign 

entity that is registered with us doing business with a foreign customer would likely be subject to our rules. A U.S. entity, including 

a branch of a U.S. entity, operating in a different country or doing 

business with any U.S. person would have Title VII rules applying. 

So we want to lay this out in detail for commenters. 

Senator JOHANNS. One of the concerns about Dodd-Frank, and 

maybe even more specifically this area of Dodd-Frank, as you 

know, and it has been one of my concerns, is the more you crank 

it down, the more the regulations become more and more onerous, 

the greater the temptation is for smart people to hire smart lawyers and accountants and at the end of the day avoid you. 

Ms. SCHAPIRO. That is right, and that is why the international 

efforts we are engaged in really are critical here, and they are 

painstakingly time-consuming as we sit on a bilateral basis and a 

multilateral basis with regulators in the other major markets and 

go through issues like pre-trade transparency, post-trade transparency, margin, the clearing mandate, the exchange trading or 

SEF mandate, and work through each and every one of these 

issues to try to get the regulatory regimes as comparable as possible so that there is not an opportunity for people to engage in regulatory arbitrage and just do their business in the least regulated 

market. 

But if it faces U.S. customers and has the potential to impact the 

U.S. financial system, we have to very seriously consider making 

that part of our mandate. 

Senator JOHANNS. Mr. Chairman, I want your comments on this, 

but before you comment, when you say—and I have no doubt you 

are working hard in the international arena and you want everybody to be as harmonized as they can be. But I have worked in 

that international arena in a position much like yours, and, you 

know, we would work days, weeks, months, years with the WTO 

process, for example, with 150 countries trying to get people on the 
17 

same page for sanitary/phytosanitary issues in trade. And at the 

end of the day, they all had their own agenda, and they all had 

their own interest. And some saw an economic benefit in doing 

something very different than what we were proposing they do. 

And before I take all the time, go ahead, Mr. Chairman, because 

I could go on and on. I think this is a very serious problem. 

Mr. GENSLER. I think, Senator, you are right on both points, that 

we will ultimately have differences. We are working well together, 

but there are different cultures, different political systems, different agendas. There will be some differences. And, two, I think 

you are correct that modern finance, large complex financial institutions will rationally look to see whether they can find the lowest 

tax regime and accounting regime that favors them or regulatory 

regime that they can put customer money at risk or have less capital and so forth. 

So knowing those two things—that there will be differences and 

that rationally these large firms will do all this—I did it once when 

I was a co-finance officer of a large firm. I mean, you know, we set 

up four to six legal entities in every jurisdiction, and Long-Term 

Capital Management’s was in the Cayman Islands, and Citibank’s 

SIVs were originated in London but set up in the Caymans. And 

AIG financial products that we think were in Connecticut, they 

needed a bank license, so they went to France and they got a bank 

license, and they put a branch in London. Joseph Cafano, the gentleman who ran it, was running it out of London. All that risk 

came back here. 

So we have to be very careful, as Chairman Schapiro said, to say, 

yes, there are costs on financial institutions, yes, there will be differences overseas, but the bigger cost is if we let the American taxpayer be at risk. So we are trying to cast this appropriately where 

there is direct and significant effect on U.S. commerce or activities. 

Wall Street rationally is advocating something different. If I was 

on the other side of the table representing them, I would advocate 

something different than I am in this job right now. And so it is 

an interesting challenge, and we are not going to be as good as we 

hope to be. They will get something by us. In probably 3 to 6 years 

or 10 years somebody is going to say you missed something, they 

figured out something in the Mauritius islands or something. 

Senator JOHANNS. Mr. Chairman, thank you. 

Senator MERKLEY. Senator Reed. 

Senator REED. Well, thank you very much. Chairman Schapiro, 

you have already indicated that you do not have direct jurisdiction 

over the activities of the JPMorgan entity, but in this joint rulemaking, this collaborative rulemaking, you are trying to define 

hedges in a way that covers the legitimate operations of financial 

institutions minimizing their risk, without allowing speculation. 

There is this tension, it seems, the tension between risk management and profit making, and I know you have suggested sort of the 

criteria. Do you have anything else to add in terms of this dilemma 

of defining a hedge so that it is properly protecting clients and protecting investments of the bank but not opening it up to, you know, 

speculation? 

Ms. SCHAPIRO. Well, I think that is the hard challenge that Congress has given us, and I would say it is also true with the market- 
18 

making exemption as well. And we believe deeply that businesses 

have to be able to engage in both activities, market making to ensure our markets are operating as efficiently as possible and hedging to reduce businesses’ risk. And I think the criteria that are laid 

out are actually pretty good in terms of helping us keep the focus 

on hedging as truly hedging, you know, mitigating one or more specific risks of either individual positions or aggregated positions, the 

hedge itself not giving rise to significant exposures, at least at the 

inception, but also monitoring and adjusting hedges if, as we have 

seen in some of the newspaper articles about the JPMorgan transactions, they morph into something else over time, that there not 

be compensation programs, and as you know, we have been working hard in the disclosure area with respect to compensation, that 

really incentivize this outside risk taking in a way that threatens 

the franchise by encouraging people to take bigger risks than they 

should. 

So I think the criteria are there. I think it is really incumbent 

upon the regulators to figure out how to write a rule that allows 

legitimate hedging to go forward as it needs to, but it must be really, genuinely risk-mitigating hedging, and not anything people 

want to do called hedging. 

Senator REED. There is another variation on this that you have 

to deal with, and that is, we in Dodd-Frank have end-user exemptions. For a nonfinancial company, you could be doing hedging as 

an end user, but you could also be very aggressive in your hedging. 

We saw the example of Enron, which was not, you know, a financial company, but it collapsed because of very aggressive use of derivatives. 

Is there anything that you are contemplating in your rules or 

anything you are going to do to anticipate this type of problem, 

Chairman Gensler? 

Mr. GENSLER. Well, I think actually Congress anticipated it because they included another category called major swap participant. And I think Congress said that if you are nonfinancial, you 

get to choose whether you are involved in this clearing and trading, 

and we are suggesting through our margin rule that you get to 

choose on that, too. But if you are so big that you are a major swap 

participant and you could be systemic, then you would be brought 

into this. 

Could I answer your first question just a little bit? 

Senator REED. Yes, please. 

Mr. GENSLER. I think that Chairman Schapiro said it very well. 

One thing I would add is that this concept of portfolio hedging can 

mean different things to different people. I think what Congress 

said, it has to be tied to specific risk of individual or aggregate positions, and this experience reminds us maybe we have to go back 

and make sure. It really is tied to specific aggregate positions. It 

is not sort of like, well, we think revenues will go up or we like 

the European debt markets these days. And one thing from my experience is that these things sometimes morph or mutate into 

something else, particularly when they are set up as a separate 

business unit and they have a separate profit and loss statement 

and separate compensation, because hedges, to really be hedges, 

generally lose money just about as many days as they make money 
19 

because they are hedging something, the position is going up, the 

position makes money, the hedge loses money; and if the position 

goes down, vice versa. When you set it up as a really separate unit 

somewhere else, maybe in a different country, different leadership, 

you start to—it is prone to morph. 

Senator REED. Yes, I guess one of the—it is just an initial reaction, and maybe it is untooted, is that when your entity that is designed to be sort of the risk manager and chastise everybody in the 

institution for being too aggressive or not responsive to risk is really one of your major profit centers, and I think that might be a sign 

that the role is emerging in a sort of unpredictable and maybe unproductive way. 

Just a final point I want to make, not in response to a question, 

is that you pointed out, Chairman Gensler, the international interconnections here, which suggests very strongly that our regulations 

have to be not only strong and internationally applicable, but we 

have to have people on the ground looking at these institutions. If 

an American institution is going to locate their activities overseas, 

the comparable regulator, in this case OCC, should not only have 

been there, but been there in force with adequate personnel to look 

very closely at what was happening and be the first line of defense, 

if you will. 

Mr. GENSLER. Well, I cannot speak to them, but I think the system we have at the CFTC, unfortunately—or fortunately—does not 

contemplate that. We really have been kept reasonably small. We 

are just 10 percent larger than we were in the 1990s. And we rely 

foremost on the law and people complying with the law, on the 

rules, and then the self-regulatory organizations. We do examine 

the self-regulatory organizations, but we do not have people onsite 

at any futures commission merchant. We do not have people onsite 

at the clearinghouses. That is just the reality of our funding and 

the decisions that have been made over decades in a bipartisan 

way. 

Senator REED. But just a point, I mean, there have been questions consistently here today. When did you know? When were you 

aware of it? Could you have anticipated it? Recognizing it is OCC’s 

responsibility, if they do not have people on the ground sitting day 

to day at the desk, you will not know until some enterprising reporter breaks the news, and by then a lot of damage could be done. 

Mr. GENSLER. Agreed. 

Ms. SCHAPIRO. The other tremendous benefit we do get, though, 

will be when we have full reporting of these transactions and there 

is transparency to regulators I think will make a big difference. 

Senator REED. Thank you, Mr. Chairman. 

Senator MERKLEY. Senator Toomey. 

Senator TOOMEY. Thank you, Mr. Chairman, and thank you both 

for being here. I would like to follow up on the discussion that 

Chairman Gensler has been touching on but I am a little bit confused about, and that is, your views on the permissibility of hedging in the aggregate. I think you just used the expression just a 

moment ago about portfolio hedging that is tied to specific positions. So I am wondering if you could clarify that, because if you 

tie hedges to individual specific positions on a one-off basis, that 
20 

is obviously the opposite of hedging in an aggregate portfolio that 

has some kind of cumulative net risk. 

So my question is: Is it your view that it is and will continue to 

be permissible as well as cost-effective to manage interest rate and 

currency and credit risk in the aggregate in these portfolios rather 

than limiting it to a one-off individual basis? 

Mr. GENSLER. I think Congress actually addressed themselves to 

this and said that it had to be tied to the specific risk of either individual or aggregate positions, but tied to the specific risk of some 

aggregate positions, to answer—— 

Senator TOOMEY. OK. So—— 

Mr. GENSLER. But it has got to be tied to some—— 

Senator TOOMEY. So, for instance, it could be the aggregate interest rate risk of a bond portfolio—— 

Mr. GENSLER. That may have 170 bonds in it, and then they—— 

Senator TOOMEY. All across the maturity spectrum, so you could 

measure that and quantify that and then hedge that. And then 

would the rule prescribe the kinds of instruments that would be 

permissible to use to hedge that kind of portfolio? 

Mr. GENSLER. As written now, it speaks to—and this may change 

in a final rule, but as written now, it talks to instruments that are 

reasonably correlated with the risk. So it is all in that word ‘‘reasonably.’’ 

Senator TOOMEY. And who decides what is reasonably correlated 

to the risk? Ultimately the regulator do. 

Mr. GENSLER. Well, I think a first order, the institution does, the 

firm does, but then there is a compliance program, and the regulators would—— 

Senator TOOMEY. But the whole point of the rule is ultimately for 

you to set bans and say this is permitted and this is not. And that 

is the purpose of the rule. 

Mr. GENSLER. It is, though as written, I would consider it more 

a principles-based and compliance regime that the firm has to have 

policies and procedures to ensure that their hedges are reasonably 

correlated to the specific risk. 

Senator TOOMEY. But, again, I think the ultimate question in 

hedging is a question of who gets to decide, I think. There is an 

inherent risk in hedging. That is why it is called a ‘‘hedge,’’ right? 

It is not a complete offset. And so there is always some residual 

risk, and there is always a subjective judgment call since in large, 

sophisticated, complex, liquid markets like ours, there are a lot of 

choices available to someone who wants to hedge any given portfolio. And my concern, Mr. Chairman—and it goes to the heart of 

what Dodd-Frank is all about, and these folks are doing their job 

of trying to implement it, but I think they are given an impossible 

task, and the task is to micromanage the activities of these institutions. That is what Dodd-Frank attempts to do. It says we are 

going to limit systemic risk by controlling everything you can do in 

great minute detail. 

Let me give an example. Chairman Schapiro alluded earlier to 

the challenges of establishing the market-making exemption. My 

understanding is among the many specific rules that we are going 

to impose on financial institutions, we are going to establish 

metrics that will quantify, for instance, how much income can be 
21 

earned from the day one bid-offer spread versus what can be 

earned from subsequent market moves. We are going to have rules 

that will prescribe how much business a market maker must do 

with end users versus that which would be done with the interdealer community. We are going to have to decide and have rules 

that will dig down into whether we are going to quantify these 

things at the level of the individual trader—or will we aggregate 

several traders? Or will we aggregate the entire trading floor? How 

will we do this? 

We are going to have to have rules that will establish which 

kinds of asset classes are permitted to hedge which kinds of risks. 

So if you have got a corporate bond portfolio, that has credit risk. 

Can you short the S&P 500 against that as a proxy for credit risk? 

Or can you use credit default swaps? 

My point is this has a huge cost, not just the direct staggering 

cost of compliance, but it also has a cost of less liquidity because 

traders have fewer options. It is going to lead to less innovation because people are going to be prescribed very narrowly in what they 

can do. And it is going to have who knows what kind of unintended 

consequences, as Senator Johanns observed, when people decide, 

you know what, it is better to just avoid this incredible micromanagement and go somewhere else, which is why, I think, Mr. 

Chairman, we have gone down the wrong road here. The better solution is require more capital so that we can let people do what 

they want to do, let the people in the marketplace make the decisions they will make, and then let them live with the consequences 

without having the taxpayer at risk because we have required a 

sufficient buffer that a firm could lose 1 percent of their capital in 

a recent example and not have everybody sweating bullets about it. 

Frankly, firms ought to be able to make decisions and then live 

with the consequences, and taxpayers should not be at risk. I do 

not think you achieve that by trying to control every aspect of their 

business, which is what these folks, unfortunately, have to do. I 

think the alternative of a tougher capital regime achieves the goal 

of reducing systemic risk without putting us in the impossible position of trying to run these institutions. 

Senator MERKLEY. Senator Hagan. 

Senator HAGAN. Thank you, Mr. Chairman. And, Chairman 

Gensler and Chairman Schapiro, thanks for your comments today 

and your commitments. 

Chairman Schapiro, in Senator Reed’s discussion, you mentioned 

data collection. When will the SEC start collecting that data? And 

where does the implementation stand? 

Ms. SCHAPIRO. The security-based swap reporting data collection 

will begin when the rules are finalized, which they are not yet, for 

Regulation SBSR. It is hard for me to predict with a five-member 

Commission exactly when we will have final adopting rules, hopefully sometime later this year. We have one set of rules left to propose, and then we have done one final. We will do another final in 

the next month or so, hopefully, and then a steady stream after 

that. 

It is important, obviously—I am a big believer in transparency 

in the marketplace, and we have seen it work extremely well in 

other markets. We think it is critical for the public to have access 
22 

to this information and very critical for regulators to have access 

to this information. It is a discipline that ultimately translates to, 

I think, management as well to know that the regulators and the 

public can see the information. 

So when we do have the rules in place, we will have quit granular information right down to the trader and the trading desk from 

which a particular transaction emanated. 

Mr. GENSLER. And I would say, and maybe to Senator Toomey’s 

comments earlier, I think transparency is so critical, too, so I am 

hoping that I could maybe convince you that, in addition to capital, 

transparency, because as Senator Hagan said, in the credit default 

swap indices area and in interest rates and so forth, it will be later 

this summer, probably as soon as—possibly as soon as August. And 

then in the commodity—oil and gas and the others—3 months after 

that, because we have already completed the rules both for the 

public to see the trades, which I think is very big, and then for the 

regulators as well. 

Senator HAGAN. Chairman Gensler, speaking about transparency, you and I have talked at length about that, especially in 

the swaps market, and I think we all do agree that transparency 

obviously is critical to reducing the risk and creating the efficient 

markets. 

The Markit’s CDX North American Investment Grade you mentioned in your testimony. It certainly has received attention recently for the role it played in the losses at JPMorgan. And this 

index of credit default swaps contracts is a relatively transparent 

product that is tradable, that is standardized, and it is priced daily. 

I would like to hear your thoughts on the transparency of a product such as the CDX index and how that can reduce risk in the financial system. And then how could we see such large losses in 

this tradable product? And what lessons do you think our financial 

institutions will take from this incident? 

Mr. GENSLER. Well, I think you are correct that it is a rather 

standardized product. Right now the dealers are into a clearinghouse, but as we complete the rules, the nondealer, the hedge fund 

positions, will also come into the clearinghouse. Regulators will get 

more transparency seeing all of the trades not only in the clearinghouse but in the data repository. 

For the public, right now there is not mandatory post-trade 

transparency, and I think as that comes into being in the next several months, there will be a benefit in that the public would see 

the pricing. 

Now, we mask the sizes. If somebody did a very large size trade, 

it just gets a plus at the end. I apologize. I cannot remember where 

it gets a plus, whether it is at $100 million size or $200 million in 

credit default swaps. But I think the public will greatly benefit 

from such transparency in addition to the regulators. 

Senator HAGAN. Thanks. 

Chairman Schapiro, I wanted to ask about the value-at-risk, an 

industry standard reporting metric that I think most of the financial institutions include in their 10–K filings. Can you discuss the 

value-at-risk and how it is used by the financial institutions and 

what are the rules regarding its disclosure? 
23 

Ms. SCHAPIRO. Sure. The VaR estimates, or value-at-risk estimates, give you at a particular confidence level, 95 percent, 99 percent, the potential decline in the value of a position or a portfolio 

under normal market conditions. And I would say that raises one 

of the weaknesses of VaR, is that it does not measure for you the 

maximum possible losses in a portfolio that could occur, could be 

incurred, particularly during very stressed market conditions. So it 

has its limitations. 

Nonetheless, public companies are required to discuss their risk, 

and they are given an option really of three ways to go forward in 

their Item 305 Regulation S–K disclosure. When they have to give 

quantitative information about market risk, they can use a tabular 

presentation of information; they can do a sensitivity analysis; or 

they can do a VaR disclosure. And most financial institutions, in 

fact, choose to do that. 

They also have to disclose at the same time, though, any material limitations on the model, what it is not telling about risk exposures, and when there are changes to the VaR model as newspapers have reported was done at JPMorgan, they changed their 

VaR model those changes have to be disclosed, too. The changes to 

the model characteristics also have to be publicly disclosed. 

Senator HAGAN. And have you followed that at some of these 

other losses that have taken place in the recent past, how it impacted from the SEC evaluations? 

Ms. SCHAPIRO. Our staff would look at—well, particularly in the 

capital context, where VaR is also used to allow firms—certain 

firms, a very small number of firms, in fact—to use VaR to compute the market risk deduction from net capital. If they have large 

losses, we actually make them back-test and provide us with full 

information about why their estimates of losses were so far of. 

Senator HAGAN. Thank you. 

Senator MERKLEY. Senator Schumer. 

Senator SCHUMER. Thank you, Mr. Chairman. 

My first question relates a little bit to funding. We have heard 

a lot of people being critical, why didn’t you know more about this. 

And, obviously, that takes staff, and you have been given huge 

amounts of responsibilities but without, in my judgment, the concomitant resources to fulfill all those responsibilities. That is one 

of the reasons things are taking longer than they should. That is 

one of the reasons you are not everywhere. 

I think one of my greatest regrets in the Dodd-Frank bill is we 

had a proposal—it did not affect the CFTC, but it affected the 

SEC—that would have allowed all of the—a little levy on transactions that is supposed to fund the SEC to actually fund the SEC, 

and, unfortunately, we had an internecine fight here, and the Appropriations Committee insisted on not doing that. They have increased your funding, but not to the extent that it would have been 

under Dodd-Frank, the proposal I had in Dodd-Frank. 

So could you talk for a minute about the funding issue and how 

vital it is, especially in relationship to the oversight that you are 

being asked to do by everyone on both sides of the aisle? 

Ms. SCHAPIRO. Sure, I would be happy to start. As you point out, 

we have been asked to take on very significant new responsibilities, 

not just over-the-counter derivatives but hedge funds that are now 
24 

registered and overseen by the SEC, municipal advisers, which will 

add many new registrants, specialized corporate disclosure, a whistleblower program, quite a lot of new responsibilities. 

In fiscal year 2012, the current fiscal year, we asked for 116 new 

positions for Dodd-Frank implementation. We did get a very good 

budget for fiscal year 2012—again, not as good as had we been selffunded, but we were very grateful to get an increase at a time 

when many agencies did not. 

So the hiring is going on right now for those new positions, and 

I will say we have fortunately been able to attract tremendous talent to the SEC and very different skill sets than we have traditionally had. 

Senator SCHUMER. What about investment in technology, which 

is often more than a 1-year deal? 

Ms. SCHAPIRO. Yes, it is, and we have made technology investment a significant focus of our additional resources and have been 

able to make dramatic improvements, I think, in the agency’s core 

technology. 

That said, we are still way outgunned by the firms that we regulate in terms of technology, but we are making, I would say, steady 

progress in that regard. 

For fiscal year 2013, when many of these new rules will actually 

start to be in effect and we will have the clear responsibilities for 

oversight and monitoring of the security-based swaps market, we 

have asked for an additional 273 positions. 

Senator SCHUMER. So that is a lot. 

Ms. SCHAPIRO. It is a lot. 

Senator SCHUMER. What are the vibes on the Appropriations 

Committee? 

Ms. SCHAPIRO. They do not show their cards. 

Senator SCHUMER. Well, we hope they do soon. 

Chairman Gensler? 

Mr. GENSLER. Thank you. I applaud your efforts in the DoddFrank Act to get Mary’s agency self-funded. 

Senator SCHUMER. You were in the conference committee trying 

to do the same thing, but we failed in both cases. 

Mr. GENSLER. I think that this is a good investment for the 

American public. The CFTC is funded at about $205 million. But 

I liken it to football, if you are a football fan. Imagine if all of a 

sudden there was 8 times the number of teams but no more referees, and then instead of having seven refs on the field you had 

one on the field. What would happen? There would be mayhem on 

the field. There is sometimes mayhem in the financial markets 

anyway, but hopefully with seven refs, there is less of it. And the 

fans lose confidence, in this case market participants. And ultimately in these derivatives markets, you need the corporate end 

users to have confidence that when they enter the market, they can 

do it free of fraud and manipulation. They can enter the market 

with speculators on the other side. That is not a bad word. But 

that they feel that the market is a fair and accurate reflection of 

the pricing of risk. And so we are way underfunded at the CFTC. 

Senator SCHUMER. OK. I agree with your comment in reference 

to Senator Toomey that even if you think capital requirements are 

the major protection here to provide the cushion, maybe because 
25 

you cannot regulate every single little trade, that transparency— 

that does not gainsay the need for transparency, so I would like to 

follow up on my good colleague from North Carolina’s questions on 

that. 

We know from media reports that the JPMorgan losses involved 

large positions in broad-based indexes comprised of credit default 

swaps on over 100 companies. As I understand it, the vast majority 

of trades in this index are recorded in DTCC’s Trade Information 

Warehouse. So that would mean regulators have access to some information about overall activity in the markets, but may not have 

information about exactly who was buying and who was selling. Is 

that correct? 

Mr. GENSLER. That is correct, though I think as our rules go into 

effect over the course of the next several months, we will have that 

information more specifically, and we already do have it in the 

clearinghouses. A significant portion of these transactions dealer to 

dealer are in the clearinghouse. 

Senator SCHUMER. Right. And as I take it, the counterparty coding system is what you are talking about? Or will that add additional information? 

Mr. GENSLER. Well, that will add additional information 

through—it is an international arrangement on legal—— 

Senator SCHUMER. Right. What is the prognosis of that coming 

into effect? When? 

Mr. GENSLER. Well, on the index credit default swaps, we finalized rules last year which go into effect 2 months after we finish 

our joint product rule—another reason we need to finish the joint 

product rule—and the legal identifiers to which the Senator refers, 

we are actually, I think, going to announce in a week or 2 weeks 

that we put it out to a service. Four parties came in and it looks 

very close that we will pick somebody, and that will be up and running. 

Senator SCHUMER. Just one more quick question, which is a consequence of this. Would it be possible to set up an early warning 

system that would warn us if, say, a single company accumulates 

unusually large positions in any single product? Is there any warning system that regulators could develop that could help identify 

risky positions? 

Mr. GENSLER. I think on the first part, yes. The second, it is a 

little harder. Early warning, that is what we do now in the futures 

world, in corn and wheat, and even interest rate products. 

Senator SCHUMER. Right. 

Mr. GENSLER. We hope and plan to do that in the swaps products. 

Senator SCHUMER. It is harder to do, I guess, because they are 

more complicated? 

Mr. GENSLER. More complicated, but once we have the information and tie into it and have the funding, we meet every Friday in 

a closed-door surveillance meeting where we go over significant positions in the markets. 

Senator SCHUMER. So you think your surveillance is going to get 

better? 

Mr. GENSLER. It is going to get better, but underfunded, it is 

stretched and thin, and something is going to give. It could give in 
26 

the wheat market. It could give in the oil markets. But something 

will give. 

Senator SCHUMER. Do you have any comment on that, Chairman 

Schapiro? 

Ms. SCHAPIRO. No, I think the clearinghouses also obviously, to 

the extent these instruments are mandatorily cleared, will have 

clear insight into early warning levels, concentrations by particular 

firms, and be in a position to adjust the margin requirements to 

account for that. 

Mr. GENSLER. I might just add, the clearinghouses, the two main 

clearinghouses, one is called ICE Clear Credit here in the United 

States and ICE Clear Europe over in Europe, have a concentration 

where, when positions get large, they actually add additional margin on top, and without getting into the details, you can imagine 

what happened here. 

Senator SCHUMER. Yes, you can. 

Thank you, Mr. Chairman. 

Senator MERKLEY. So we are going to have additional 5-minute 

rounds. Senator Shelby. 

Senator SHELBY. Thank you. I would like to go back to MF Global, if I could, Mr. Chairman. Chairman Gensler I am referring to. 

Chairman Gensler, this Banking Committee’s due diligence has basically revealed to a lot of us that you played an active role in the 

oversight of MF Global during the week leading up to its failure. 

We would like to know how many conversations did you have with 

MF Global CEO Jon Corzine during MF Global’s final week. And 

during these conversations, were there any discussions about possible shortfalls in customer accounts? This is central to what we 

are looking at. 

Mr. GENSLER. I thank you for that question. I had no individual 

conversations with Jon Corzine. I did participate on that Sunday 

on a group call with Chairman Schapiro, our staff, her staff—I 

think New York Fed and the London regulators were on as well— 

with presentations coming over a conference call with 40, 60 people 

on it, which I believe once or twice Jon Corzine spoke up and gave 

some information. 

If I could answer your further question, I think, about what was 

my role that weekend, would that be helpful? During that 

week—— 

Senator SHELBY. You were the Chairman—and you still are—on 

that day. 

Mr. GENSLER. Yes, yes, yes. 

Senator SHELBY. Of the CFTC. Go ahead. What was your role as 

Chairman? 

Mr. GENSLER. My role as Chairman of the CFTC, as that week 

developed and the firm looked to be in a frail state, to ensure for 

the movement of customer money, over that weekend we were informed by other regulators—FINRA, actually, I think was the first 

one to inform us, and I compliment them for that—that there were 

negotiations going on to move the position. So we wanted to ensure 

that those customer monies and positions were moved. We were assured from the company and from the first-line regulators, Chicago 

Mercantile Exchange, that all the monies were there. It was only 

about 2:30 in the morning when I was woken on Monday, the 31st 
27 

of October, that I learned of the shortfall. But the Sunday was really about moving the customers, and the key focus—we did not care 

beans about Jon Corzine. We cared about the thousands of customers that needed those monies moved, and we were assured all 

the money was there and CME had been checking the books. 

Senator SHELBY. How many people did you roughly have onsite 

at MF Global? 

Mr. GENSLER. I am not aware of the number, whether it was— 

it was less than a handful, but I think starting Thursday, we sent 

some folks in on Thursday. Friday, the full Commission in our surveillance meeting got a briefing that Friday morning. And the 

briefing was that they were in what is called ‘‘segregation compliance.’’ But then over the weekend, we kept asking questions for 

more details because, you know, we wanted to see the details. It 

was not fully forthcoming, but by Sunday, we were on these joint 

calls together, the SEC and others, and hearing, no, it is all there. 

And then we actually asked to talk to the buyer late Sunday 

night—Interactive Brokers it was at the time—to see that they 

were guaranteeing that they would ensure all the monies as well. 

Senator SHELBY. So that was the steps you are relating that you 

took to protect the customers’ assets after learning that customer 

assets were missing? 

Mr. GENSLER. Well, no. All throughout the weekend, we were assured by the company and also the front-line regulators they were 

in compliance. The law is that 24 hours a day, every minute of 

every day, one is to be in compliance, and one must report if you 

are not. 

Senator SHELBY. You are either in compliance or you are not, 

right? 

Mr. GENSLER. Yes, it is just—it is really straightforward. 

Senator SHELBY. And you are supposed to protect your customers’ funds separately. Is that right? 

Mr. GENSLER. Absolutely. It is at the critical heart of the—— 

Senator SHELBY. So when we talk about segregated accounts, 

that is what you are talking about? 

Mr. GENSLER. That is what we are—and people here, I agree 

with you, sir, were hurt because that did not happen. I am not involved in the specific investigation, and I chose—even though the 

General Counsel and the Chief Ethics Officer said I could be, I said 

I thought that once it turned to an investigation that specifically 

was about Jon Corzine possibly, I thought that made sense to step 

aside. 

Senator SHELBY. Let me ask you this question, Mr. Chairman. 

On what date and at what time did the CFTC staff first learn that 

there was a possible shortfall in the customer segregated accounts? 

Mr. GENSLER. Well, I can only speak to what I remember, but 

what I remember was being woken up at 2:30 in the morning 

by—— 

Senator SHELBY. Was that on Sunday? 

Mr. GENSLER. No. Monday. 

Senator SHELBY. Monday morning. 

Mr. GENSLER. Well, technically the 31st of October. 

Senator SHELBY. OK. And after you learned there at 2:30 in the 

morning on Monday or Sunday night of the missing customer as-
28 

sets, what specific steps did you take to ensure that customer funds 

were not improperly transferred over the weekend before the firm 

failed? 

Mr. GENSLER. Well, this was already Monday. I put on my bathrobe and I went to a conference call and joined it with other regulators, and I think it was 4 to 6 hours later that it was put into 

a SIPC proceeding. 

Senator SHELBY. On October 30, 2011, a CFTC employee gave to 

CME, Chicago Mercantile Exchange, employees a disk containing 

documents to support MF Global’s October 26, 2011, segregated 

funds statement, which initially showed no shortfall. When did the 

CFTC, Mr. Chairman, receive this disk from MF Global? 

Mr. GENSLER. I am not familiar with the disk, Senator. 

Senator SHELBY. You are not familiar. OK. It is our understanding that the CFTC did receive the disk and that the CFTC 

began reviewing the documents of the disk, and we would like to 

know when, and I will ask you for the record. And what was the 

result of this review of these documents? And did it show any 

shortfall? I think we would like to know, and if you do not know, 

you can get this information—— 

Mr. GENSLER. So if the General Counsel could follow up and 

make sure that you get the information that you asked for. 

Senator SHELBY. For the record. 

Mr. GENSLER. For the record. 

Senator SHELBY. OK. 

Senator SHELBY. Chairman Gensler, in May, about a year ago, 

May 2011, FINRA determined that MF Global had a capital deficiency. MF Global CEO Jon Corzine personally appealed that decision to the SEC, chaired by Chairman Schapiro. The SEC upheld 

FINRA’s determination, and MF Global publicly reported the deficiency in August of 2011. 

When did the CFTC first learn that MF Global had a capital deficiency? 

Mr. GENSLER. Again, if I—— 

Senator SHELBY. Did you learn it then? Or did you never learn 

it. Go ahead. 

Mr. GENSLER. Again, if I could have the General Counsel follow 

up on the specifics, but as I recall, my own memory was over the 

course of that summer. But they could follow up as to specifics if 

there was a date that the staff learned it. 

Senator SHELBY. Well, that goes to the heart—and I would be interested in the answer—of the SEC and the CFTC’s coordination 

of the regulation. So if the SEC did something that they should 

have, upheld the FINRA determination, and if the CFTC did not 

know that, then there is a problem. But if you did know it and did 

not do anything about it, that is a problem. 

Mr. GENSLER. My memory is that there was coordination, but as 

to the specific dates and times, that I do not recall. 

Senator SHELBY. Thank you, Mr. Chairman. 

Senator MERKLEY. Senator Warner. 

Senator WARNER. Thank you, Mr. Chairman, and I apologize for 

being out for so long. Maybe I will—I do not have a specific question on MF Global, but there are two quick questions I would like 

to ask and get on the record. One is, I mean, some of the items 
29 

that Senator Shelby was mentioning was this issue of coordination 

between your two agencies on approach to rule implementation. 

One of the things that I have been concerned for some time on is 

that in Dodd-Frank, very active in Title I and Title II, and we created the Financial Stability Oversight Council to try to have this 

forum for what I thought at least or hoped would be resolution of 

areas where there might be this rubbing. I was particularly interested in one area. I think Senator Shelby did not agree with me 

on this one, but on the OFR, which would be, in effect, the independent repository of data and information so that the FSOC could 

have the ability to adjudicate, if need be, between different interpretations or conflicts on agency promulgation or on rule promulgation. 

We are very concerned that the Administration has been a little 

bit slow on getting the OFR nominee. They now have one together 

to get passed, but I would like you to weigh in on FSOC’s ability 

to—maybe not so much with the MF Global circumstance but be 

that adjudicating body where issues rise up, and has it been effective or not. Either one—and I have got one follow-up as well. 

Ms. SCHAPIRO. I am happy to start. I actually think FSOC has 

turned out to be a very good forum for the agencies to share concerns and ideas and differences as they arise and have a discussion 

and hear the views of other people from their unique perspectives 

regulating different types of institutions but all connected within 

the financial markets. So I think we are working on our next annual report that will try to lay out the systemic risk issues that we 

see facing the economy. Every agency contributes to that, and those 

particular issues become, you know, very lively discussions for how 

to approach particular problems. 

I think OFR hopefully is starting to get going in a more meaningful way, and I think it can be an important adjunct to the work 

of the individual agencies with respect to data collection and analysis in particular. But I think it is working pretty well, and I think 

one of the real side benefits of FSOC has been it has enabled us 

to develop much stronger bilateral relationships within FSOC as 

well, and Dodd-Frank has done that because of the necessity to 

write joint rules. 

Senator WARNER. Thank you. 

Chairman Gensler? 

Mr. GENSLER. I would say having witnessed what was its predecessor, the President’s Working Group, both in the 1990s—being 

honored to serve then—and in this Administration, I think it is a 

real enhancement. It is more formal, and so with formality sometimes there is not as much flexibility, but I think it is a big enhancement. It has not been tested in two ways yet. It really has 

not been tested in a real crisis again. So, I mean, that has yet to 

happen. But I think it will serve better than just the old President’s Working Group. And it has not truly been tested, as you say, 

when two agencies have a knock-down, drag-out disagreement. It 

has been helpful, though, to smooth through some smaller differences, and I think it has been positive in that way. 

Senator WARNER. Well, my hope would be that the OFR would 

be that kind of—at least the data analysis—because my concern is 

you are going to get data from different agencies coming in that 
30 

may be completely counter to each other. And somebody—you have 

got to have a trusted independent entity in there sorting through 

that. 

I know my time is about up. Let me ask one last question and, 

again, not directly related to the JPMorgan issue, but, you know, 

one of the challenges we have on the international implementation 

is when we have a large American entity that has got a foreign sub 

and you have got then a foreign counterparty to that American foreign-based subsidiary, and how we deal with the extraterritorial 

application of U.S. laws, how do we do that vis-a-vis foreign laws, 

you know, what is your state on—what is your sense on the whole 

international implementation question, and particularly in terms of 

counterparties, foreign counterparties? 

Mr. GENSLER. I think we have made real progress, but there will 

be differences between Europe, the United States, Canada, Japan, 

and other jurisdictions. So then you get to this question of crossborder transactions. We are a believer in substituted compliance 

where we rely on some compliance regime overseas, but we also are 

a believer in learning from experience. And in 2008, in the three 

or four biggest circumstances—AIG, Lehman Brothers, Citigroup, 

Bear Stearns—they all had offshore entities either in the Cayman 

Islands or in London or branches of French banks in London. And 

we have to learn from those experiences and not be, excuse me, 

naive that Wall Street will structure around these things. Some of 

these large institutions have thousands of legal entities. Long-Term 

Capital Management was the same. It was in the Cayman Islands, 

actually, even though it operated out of Connecticut. 

So we have to be thoughtful and cover a lot of those transactions 

and not just leave it to say, well, my guaranteed affiliate will meet 

your guaranteed affiliate in London, because that is the worst outcome. The risk will all flow back here, but the jobs will move overseas. And that seems like that is a bad place to be. 

The second thing, though, I think we can, even if it is our guaranteed affiliate meeting your guaranteed affiliate in London, that 

still might be that we rely on substituted compliance where we can. 

Ms. SCHAPIRO. I would just add that rather than deal with these 

issues rule by rule, we are going to lay out sort of a comprehensive 

approach to cross-border application, and we will propose that before we start to adopt final rules other than the definitional rules 

so that it can inform actually the reach of each and every rule as 

we go ahead and adopt them. And I think that will give everybody 

an opportunity to sort of see the entire picture of proposed rules 

and how we expect them to apply extraterritorially and comment 

to us on that. 

We know foreign regulators have a deep interest in this, and it 

is a very intense part of the discussion that Gary and I have with 

our foreign counterparts. 

Mr. GENSLER. And I would also add that if an overseas affiliate, 

not a branch, but if an overseas affiliate is dealing with some insurance company in Germany, we want to make sure that they 

have a competitive field, that they can compete just like, you know, 

a Barclays Bank or Deutsche Bank might do as well. So it is trying 

to get that balance as well. 

Senator WARNER. Thank you, Mr. Chairman. 
31 

Senator MERKLEY. Thank you, Senator Warner. 

Chairman Schapiro, you mentioned twice the list of factors that 

were essentially the ways to define risk mitigation that were in the 

Volcker Rule statute, and related issues in there were that you 

were addressing a specific risk, that it is correlated, and it does not 

give rise to significant exposure that you did not have to begin 

with. And often if you think about, for example, a company that 

has funds in between making loans under the liquidity rule and 

chooses to do some corporate bonds, assuming those will be allowed, then the first easiest thing, if you get worried about the 

quality of those bonds, which had been described as kind of extraordinarily high-quality bonds, but you get worried about it, you 

can reduce your exposure just by selling the bonds. So that is strategy one. 

Strategy two is you can take insurance directly against those 

bonds. That is certainly specifically insurance on a specific position 

you have. 

Then you start getting further and further afield. You can kind 

of imagine this spectrum of positions that are further afield where 

then you choose to do an index rather than insure the specific 

bonds that you have. And then you choose to do a particular 

tranche in the waterfall, and then you decide you need to raise income to pay for your insurance, so you sell some insurance against 

something else. 

At that point, it seems to me you have clearly crossed the line 

in which you have introduced by selling insurance to others. You 

are in a whole different world of risk introduction. 

So you have these two components being correlated to begin with 

and not introducing additional risk. Part of the challenge of the 

regulators is to kind of define this world. One of you cross the line 

from risk mitigation to simply having an excuse to do hedge fundstyle trading. 

Where do you see that line being drawn in that kind of progression of tightly correlated direct insurance to remotely correlated? 

Ms. SCHAPIRO. Well, I agree with you it is a continuum, and 

there are very plain vanilla ways to hedge, and those may even be 

more or less perfect hedges, and then there is a long continuum to 

something like portfolio hedging or maybe perhaps stepping off the 

hedging bandwagon entirely and being in the world of prop trading 

or speculating. And I think—we recognize that all hedges will not 

be perfect and that this is a continuum, and finding that point will 

be difficult. I think that is what the metrics are designed to help 

us do, and we proposed lots of metrics, and Senator Toomey mentioned some of them. I do not think there is an expectation that 

all of those will make it into the final rule. But the goal there is 

to help us see how behavior changes over time within a firm, how 

transactions change over time as a way to see whether things that 

are hedging are moving into a different realm. 

But that is clearly the difficult piece of this, is to find where 

something is no longer a hedge and how we can define that, and 

not in so specific a way that we have just opened the door to lots 

of other conduct. 

Senator MERKLEY. Would you say that it would be a red flag if— 

I will give you some examples. One, if the hedges only loosely cor-
32 

related when there was a tightly correlated instrument available, 

would it be a red flag if you are buying insurance to insure a larger 

quantity than you actually are holding? And would it be a red flag 

if you are suddenly in the business of selling insurance? 

Ms. SCHAPIRO. It might well be because then you have got a 

hedge transaction that is giving rise potentially to significant exposures that were not there at that inception because you have overhedged the position. 

You have to be able, it seems to me, to identify the positions that 

are being hedged and demonstrate that the hedge is, in fact, risk 

reducing. And to me, I keep going back to—and you and I have 

talked about this—the risk mitigation is an important piece of how 

we are describing the hedging here. But I think if you take all 

those factors together, you can build a pretty strong wall around 

this conduct. 

Senator MERKLEY. One of the things that Senator Levin and I 

had said on the floor in our colloquy was you really need—and you 

just said it so I want to re-emphasize it. You need to identify the 

specific assets, and you need to identify the specific risk that you 

are hedging, so that then at least gives the regulators a sense of, 

well, what was this trade all about. If you cannot identify the risk 

that you are hedging, then it is very hard to get your hands around 

it whether was appropriate or not. 

Ms. SCHAPIRO. Right, and I think to Senator Toomey’s point, that 

does not mean it has to be positioned—extraordinarily expensive to 

hedge and counterproductive, frankly, to hedge position by position. 

But there is something between position by position and complete 

speculation. 

Senator MERKLEY. Chairman Gensler? 

Mr. GENSLER. I said earlier I think this is one of the more challenging tasks that the regulators have been given, to ban, prohibit 

proprietary trading, permit market making, permit hedging 

To your question about hedging, I think hedging really does have 

to lower risk. That is what Congress wanted, I think, in this provision. And they come and they do overlap. I mean, it is not a perfect 

circumstance. So it is our challenge amongst the regulators to do 

as Congress said, to say if it is hedging a specific risk, individual 

or aggregate positions, but it should be—we put in the rule proposal ‘‘reasonably correlated.’’ Maybe that word ‘‘reasonably’’ needs 

more definition. I think that it can start to morph and mutate 

when you have a separate desk and they have a separate profit and 

loss and they are motivated at times to take on positions or even 

swing for the fences for a little bit of the extra potential for that 

desk to have profits. 

My own experience on Wall Street is long ago, but I will say that 

when I saw these desks, they sometimes worked for 18 to 24 or 36 

months, and then they usually took a big loss, and then they would 

be maybe shut down. Then several years later, they would sort of 

come up again. I might be old-fashioned. I liked it when you could 

tie the hedge somewhere reasonably to the positions. 

Senator MERKLEY. Well, indeed, that word ‘‘reasonably’’ is in the 

statute, and the reason it was put there is because the word ‘‘correlated’’ by itself would suggest that something could be barely coordinated and meet the—or correlated and meet the test. So it did 
33 

place the—you know, the challenge to the regulators is define ‘‘reasonably.’’ But it certainly was in all of the conversation meant to 

identify the specific risk and have something as directly related to 

insuring against that risk or hedging that risk as possible. 

Senator Warner, did you want to take an additional time period? 

We have each had our second period. 

Senator WARNER. I will just add one question I was—— 

Senator SHELBY. No, go ahead. Let him go. 

Senator WARNER. Are you sure? 

I was interested in the line that Senator Merkley was pursuing 

because I do think it is where the rubber hits the road. What is 

reasonable? What is that connectivity? In a certain sense, it may 

be—you know, if we were going to have an incident like this, it 

could be a blessing that it was happening with the strongest financial institution we have in the country, and thank goodness we already have in place higher capital requirements, so there is not a 

systemic risk or a risk to the institution, at least at this point. But 

I do want to get to the point of liquidation and how it relates to 

derivatives a little bit. 

One of the things—thank goodness, the case that Senator 

Merkley was talking about did not result in an institution going 

down, but one of the things I think we all worked very hard together—and actually, Senator Shelby, on Title I and II we got 85 

votes on your and Senator Dodd’s approach on that—was to make 

sure that any institution that goes into liquidation, while we maintain the systemic important parts, the institution is liquidated. And 

while neither one of your agencies is going to be—and we do not 

have taxpayer support, and that while neither one of your agencies 

is going to be directly involved in that liquidation process, clearly 

the question of how you clear and handle the derivatives that 

might be involved in that institution, the swaps, is an issue that 

is terribly important. I would just be curious, you know, how you 

are doing on thinking through that portion of the liquidation process. 

Mr. GENSLER. I think that central clearing does help that. In 

these credit default swap indices, there is central clearing currently 

just dealer to dealer. So the dealers facing a hedge fund are not 

yet in, and I think that will help a lot. 

We have spent a lot of time at the CFTC with the FDIC on Title 

II just to give them advice and thoughts on it. I think the most 

challenging piece is on the swaps that are not cleared because they 

still leave this tangled web of interconnectedness, and that is why 

it is so critical, we also think, to get the margin rules right, the 

dealer-to-dealer, particularly that there is margin being collected— 

not against the commercial end users—I always have to say that— 

but between the financial institutions and particularly between the 

dealers. 

Senator WARNER. And you think you are—are you dealing with 

both FDIC and the Fed on this? 

Mr. GENSLER. Yes, and we have had some even, I will call them 

colloquially, ‘‘tabletops’’ where we take hypothetical—not a real 

company, but we sort of think it through. 
34 

There is a challenge in one provision in Title II with the 

uncleared swaps, the stay provision, and if they are stayed for a 

day, you might remember—— 

Senator WARNER. I do remember that—— 

Mr. GENSLER.——worked on that. 

Senator WARNER. Very much. 

Mr. GENSLER. What uncertainty would be in the market. It 

seems that these weekends, everything is challenging to get it done 

before the Japan or Australia opens, which is Sunday around 5 

o’clock. But then there might be this 24-hour stay in the uncleared 

swaps, and that is an interesting set of challenges I hope I never 

face. 

Senator WARNER. Chairman Schapiro. 

Ms. SCHAPIRO. I really agree with what Chairman Gensler said. 

Senator WARNER. Thank you, Mr. Chairman. 

Senator MERKLEY. Senator Shelby. 

Senator SHELBY. Thank you, Mr. Chairman. 

Mr. Chairman, I have a few observations. Do both of you agree 

that you cannot take risk out of a marketplace? 

Mr. GENSLER. Absolutely. Risk is part of a marketplace and 

these large financial institutions help our society manage that risk. 

Senator SHELBY. Right, right. 

Do you agree with that? 

Ms. SCHAPIRO. You cannot take it out, and we should not try. 

Senator SHELBY. OK. So if you micromanage what entities are 

doing—for example, JPMorgan. JPMorgan is a huge bank. Obviously, it would be hard to micromanage them to begin with. But 

if they have got capital and if it is no risk to the taxpayer—I was 

thinking about what Senator Toomey was talking about, which I 

associate my remarks with—I do not know of any—I have said it 

here for years—bank or financial institution that has been well 

capitalized, first; second, well managed and well regulated that has 

gotten in trouble. I do not know of any. If you have got one, tell 

us about it. 

So capital I believe is number one, to make sure that the banks 

are adequately capitalized. And I guess it is up to you to determine 

the difference between speculation and investment. It might be 

hard at times. I probably could recognize it if I saw it, but maybe 

not, because somebody might be speculating and call it an investment. I do not know how you get around that. But I do believe that 

you cannot take risk out of the marketplace, and I hope you as regulators will not try to do that. 

Mr. GENSLER. I agree with that, but I would hope—if I can one 

more time say I think the transparency—the more transparent 

markets are, it is harder to misunderstand the risks that you have. 

The risk gets priced in a marketplace, and it might not be pleasant. 

I might be actually quite painful at times. But if you are well managed and you say, look, that risk is being priced differently than 

I thought, I am just going to have to eat my beans here and, you 

know, mark the position differently. Without that transparency, a 

lot of times things then start to get poorly understood, poorly managed, and so forth. 
35 

Senator SHELBY. Well, I agree. We should not let, you should not 

let institutions that you regulate operate in a dark hole somewhere. They cannot do it. 

Thank you, Mr. Chairman. 

Senator MERKLEY. Thank you. I think we are on the point of 

wrapping up. I will—— 

Senator WARNER. Mr. Chairman, could I just add—— 

Senator MERKLEY. Senator Warner. 

Senator WARNER. I love my friend Senator Shelby, and I agree 

you cannot take risk out, and I agree capital—but there is some 

point we can have such high capital standards we make our banks 

noncompetitive, too. So getting that balance right I do think the leverage ratios, having this view that looks beyond the single institution because, as I think was made mention, many of these institutions have literally thousands of subs. That is why the FSOC having that ability to raise up these issues to some higher level above 

the silos I think is important. But I could not agree with you more. 

You cannot take risk out of the marketplace. 

Senator MERKLEY. Well, and I would add to that. I would add 

that if you think about hedge fund-style investing, the aggregation 

of capital, and it is going to go wherever, the question is not whether it is risky. Yes, of course, it is risky. The question is: Is it going 

to be subsidized by taxpayer-insured deposits? And the second 

question is, when occasionally those investments or those bets go 

bad, whether it is simply going to, if you will, blow up or melt down 

the investments of the investors or whether it is going to reverberate in a way that affects a broader access to capital by businesses and families. And that is, of course, back to the whole theory of the firewall between traditional deposit-taking/loan-making 

banking and hedge funds. So I think it is compatible with that notion that you cannot take out the risk. 

I thank you all very much for your testimony and for the dialogue and for the Members. Oversight of the derivatives markets 

remains an important issue for this Committee, and the Committee 

Members look forward to working with both of you and your agencies to ensure that the implementation of derivatives reform improves protections for the American people and our financial system. 

Thank you. The hearing is adjourned. 

[Whereupon, at 11:58 a.m., the hearing was adjourned.] 

[Prepared statements, responses to written questions, and additional material supplied for the record follow:] 
36 

PREPARED STATEMENT OF MARY L. SCHAPIRO 

CHAIRMAN, SECURITIES AND EXCHANGE COMMISSION

MAY 22, 2012 

Chairman Johnson, Ranking Member Shelby, and Members of the Committee: 

I appreciate the opportunity to testify regarding the Securities and Exchange 

Commission’s ongoing implementation of Title VII of the Dodd-Frank Wall Street 

Reform and Consumer Protection Act (‘‘Dodd-Frank Act’’ or ‘‘Act’’). 

As you know, Title VII creates an entirely new regulatory regime for over-thecounter (‘‘OTC’’) derivatives. To that end, it directs the Commission and the Commodity Futures Trading Commission (‘‘CFTC’’) to write a number of rules necessary 

to implement the statutory regime. Since the Dodd-Frank Act was enacted in July 

2010, the Commission has proposed most of the rules required by Title VII. We are 

continuing to work diligently to implement all provisions of Title VII, and to coordinate implementation with the CFTC and our fellow regulators overseas. 

My testimony today will provide an overview of these efforts to implement Title 

VII, emphasizing the Commission’s activities since I last testified before this Committee on Dodd-Frank Act implementation in December. 

Background 

Title VII of the Dodd-Frank Act 

Title VII of the Dodd-Frank Act mandates the oversight of the OTC derivatives 

marketplace and requires that the Commission and the CFTC write rules that address, among other things, mandatory clearing, the operation of security-based swap 

and swap execution facilities and data repositories, capital and margin requirements 

and business conduct standards for security-based swap and swap dealers and 

major participants, and regulatory access to—and public transparency for—information regarding security-based swap and swap transactions. 

Under the Dodd-Frank Act, regulatory authority over swaps is divided between 

the Commission and the CFTC. The law assigns the Commission the authority to 

regulate ‘‘security-based swaps.’’ The CFTC, on the other hand, has primary regulatory authority over ‘‘swaps,’’ which represent the overwhelming majority of the 

overall market for over-the-counter derivatives subject to Title VII. 

With respect to the Commission’s efforts, this series of rulemakings is designed 

to improve transparency and facilitate the centralized clearing of security-based 

swaps, helping, among other things, to reduce counterparty risk. It also is designed 

to enhance investor protection by increasing disclosure regarding security-based 

swap transactions and helping to mitigate conflicts of interest involving securitybased swaps. By promoting transparency, efficiency, and stability, this framework 

is intended to foster a more nimble and competitive market. 

Ongoing Regulatory Coordination with the CFTC and Other Regulators 

In implementing Title VII, our staff is in regular contact with the staffs of the 

CFTC, Federal Reserve Board, and other financial regulators. In particular, Commission staff has consulted and coordinated extensively with CFTC staff in the development of the joint definitional rules arising under Title VII, including joint rules 

further defining key terms related to the products covered by Title VII, which we 

expect to finalize in the near term, and other joint rules further defining certain categories of market participants, which we adopted last month. Although the timing 

and sequencing of the CFTC’s and Commission’s proposal and adoption of rules may 

vary, they are the subject of extensive interagency discussions. As we continue with 

the implementation of the rules contemplated by Title VII, the objective of consistent and comparable requirements will continue to guide our efforts. 

The Dodd-Frank Act also specifically requires that the Commission, the CFTC, 

and the prudential regulators ‘‘consult and coordinate with foreign regulatory authorities on the establishment of consistent international standards’’ with respect to 

the regulation of OTC derivatives. 

Accordingly, the Commission is actively working on a bilateral and multilateral 

basis with our fellow regulators abroad to address the regulation of OTC derivatives. 

Through these discussions and our participation in various international task 

forces and working groups, we have gathered extensive information about foreign 

regulatory reform efforts, identified potential gaps, overlaps and conflicts between 

United States and foreign regulatory regimes, and encouraged foreign regulators to 

develop rules and standards complementary to our own under the Dodd-Frank Act. 

Such efforts include frequent communications and meetings with the European 

Union and other major foreign regulatory jurisdictions in Asia and North America. 
37 

Representatives from the Commission also participate in the Financial Stability 

Board’s Working Group on OTC Derivatives Regulation, of which a Commission representative serves as one of the co-chairs on behalf of the International Organization 

of Securities Commissions (‘‘IOSCO’’), and a Commission representative serves as 

one of the four co-chairs of the IOSCO Task Force on OTC Derivatives Regulation. 

In addition, representatives from the Commission, the CFTC, and a number of 

international regulators have met twice, most recently this month, to address crossborder issues related to the implementation of new legislation and rules to govern 

the OTC derivatives markets in their respective jurisdictions. 

As we continue with the adoption of the Title VII rules, we remain committed to 

consulting with other regulators at home and abroad in an effort to foster the development of common frameworks and to help ensure a level playing field for market 

participants. 

Next Steps for Implementation of Title VII 

In the near term, the Commission expects to complete the last of the core elements of our proposal phase, in particular, rules related to the financial responsibility of security-based swap dealers and major security-based swap participants. 

We also expect to complete our joint rulemaking on the product definitions with the 

CFTC in the very near term. Final product definitions will help inform derivatives 

market participants what products would be subject to the new swap and securitybased swap requirements, which we view as a crucial step in establishing the Title 

VII regulatory regime. Importantly, the adoption of final product definitions will not 

trigger compliance with any rules the Commission is adopting under Title VII, or 

related statutory requirements. Instead, the compliance dates applicable to specific 

rules adopted by the Commission under Title VII, and related statutory requirements, will be set forth in those final rules. 

The Commission also is continuing to develop a policy statement regarding how 

the substantive requirements under Title VII within its jurisdiction will be put into 

effect. This policy statement would be designed to establish an appropriate and 

workable sequence and timeline for the implementation of these rules. As a purely 

practical matter, certain of these rules will need to go into effect before others can 

be implemented, and market participants will need a reasonable, but not excessive, 

period of time in which to comply with the new rules applicable to security-based 

swaps. This statement should give market participants a degree of clarity as to how 

the Commission, in general, is thinking of ordering the compliance dates of the various sets of rules under Title VII. We intend to publish this policy statement for 

public comment in the very near term. 

Additionally, because the OTC derivatives market has grown to become a truly 

global market in the last three decades, we are continuing to evaluate carefully the 

international implications of Title VII. The development of our cross-border approach is being informed by our discussions with the CFTC and our fellow regulators in other jurisdictions. 

Rather than deal with the international implications of Title VII piecemeal, we 

intend to address the relevant issues holistically in a single proposal. The publication of such a proposal is intended in part to give investors, market participants, 

foreign regulators, and other interested parties an opportunity to consider as an integrated whole our proposed approach to the registration and regulation of foreign 

entities engaged in cross-border transactions involving U.S. parties. The Commission therefore anticipates that this release will be published prior to the finalization 

of the rules discussed therein so that the comments received can be taken into account in drafting the final rules. 

The application of Title VII to cross-border transactions raises a substantial number of complex issues. Among other things, it requires consideration and appreciation of foreign regulatory frameworks and of competition concerns. This is not an 

easy task. However, I believe that the publication of a fully developed, comprehensive SEC proposal to address these issues, and the opportunity for all interested 

parties to comment on this proposal, will significantly advance the level of understanding, and greatly facilitate public dialogue, on these issues. 

Title VII Implementation to Date 

Adoption of Entity Definitions Rulemaking 

Since I last testified before this Committee on Dodd-Frank Act implementation, 

the Commission has adopted final rules and interpretations jointly with the CFTC 

that further define the terms ‘‘swap dealer’’, ‘‘security-based swap dealer’’, ‘‘major 

swap participant’’, ‘‘major security-based swap participant’’, and ‘‘eligible contract 

participant’’. In developing these definitions, the Commission was informed by existing information regarding the single-name credit default swaps market, which will 
38 

constitute the vast majority of security-based swaps. The finalization of the entity 

definitions rulemaking is a foundational step toward the complete implementation 

of Title VII. 

The entity definitions rulemaking defines the term ‘‘security-based swap dealer’’ 

and adopts interpretations providing guidance as to how the dealer-trader distinction applies to activities involving security-based swaps. This guidance describes 

what constitutes dealing activity and distinguishing dealing from nondealing activities such as hedging. 

The rulemaking also implements the Dodd-Frank Act’s statutory de minimis exception to the security-based swap dealer definition in a way that is tailored to reflect the different types of security-based swaps. To do so, the rulemaking exempts 

those entities or individuals who engage in dealing activity in security-based swaps 

below a certain notional dollar amount over a 1-year period. The rule includes a 

phase-in of the exemption over time in a way that promotes the orderly implementation of Title VII. 

In establishing who is a security-based swap dealer, Title VII gave us the task 

of identifying those entities that engage in dealing activity in security-based swaps. 

Title VII does not require most market participants that engage in security-based 

swaps—such as mutual funds and pension funds—to be regulated as dealers. In addition, Title VII calls for only those dealers acting above a de minimis level to be 

regulated as dealers. We followed the statutory language to bring dealers acting 

above a de minimis level under the Commission’s direct oversight, and in so doing 

we have ensured that the vast majority of notional dealing activity in this market 

will be subjected to the SEC’s Title VII dealer regulatory regime. 

Additionally, the rulemaking implements the Dodd-Frank Act’s ‘‘major securitybased swap participant’’ definition through the use of three objective tests. 

The analysis of single-name credit default swap data conducted by the Commission’s Division of Risk, Strategy, and Financial Innovation was especially informative in the development of this rule. This analysis provided critically important information regarding potential dealing activity in the credit default swap market, 

which helped the Commission shape the final rules and evaluate the economic consequences of these rules. Nonetheless, the Commission has directed the staff to report to the Commission on whether changes are warranted to the rules based on 

an analysis of data after relevant provisions of Title VII are implemented. This report stems, in part, from the fact that the entity definition rules were developed 

based on our understanding of the existing market and currently available data. 

The report—together with the associated public comment—is intended to help the 

Commission thoroughly evaluate the practical implications and effects of the entity 

definition rules following the regulation of dealers and major participants pursuant 

to Title VII, using data reflective of the newly regulated market. 

Although the entity definition rules technically will be effective in the near term, 

security-based swap dealers and major security-based swap participants will not be 

required to register with the Commission until the dates provided in the Commission’s final rules for the registration of security-based swap dealers and major security-based swap participants, which are to be adopted at a later point in time. 

Additional Actions 

The Commission staff continues to work diligently to develop recommendations for 

the Commission to adopt final rules in each of the twelve areas required by Title 

VII where rules have been proposed: 

• Joint rules with the CFTC regarding further definitions of the terms ‘‘swap,’’ 

‘‘security-based swap,’’ and ‘‘security-based swap agreement;’’ the regulation of 

mixed swaps; and security-based swap agreement recordkeeping; 

• Rules prohibiting fraud and manipulation in connection with security-based 

swaps; 

• Rules regarding trade reporting, data elements, and real-time public dissemination of trade information for security-based swaps that would lay out who must 

report security-based swaps, what information must be reported, and where and 

when it must be reported; 

• Rules regarding the obligations of security-based swap data repositories that 

would require them to register with the Commission and specify the extensive 

confidentiality and other requirements with which they must comply; 

• Rules relating to mandatory clearing of security-based swaps that would establish a process for clearing agencies to provide information to the Commission 

about security-based swaps that the clearing agencies plan to accept for clearing; 
39 

• Rules regarding the exception to the mandatory clearing requirement for hedging by end users that would specify the steps that end users must follow, as 

required under the Dodd-Frank Act, to notify the Commission of how they generally meet their financial obligations when engaging in security-based swap 

transactions exempt from the mandatory clearing requirement; 

• Rules regarding the confirmation of security-based swap transactions that 

would govern the way in which certain of these transactions are acknowledged 

and verified by the parties who enter into them; 

• Rules defining and regulating security-based swap execution facilities, which 

specify their registration requirements, and establish the duties and implement 

the core principles for security-based swap execution facilities specified in the 

Dodd-Frank Act; 

• Rules regarding certain standards that clearing agencies would be required to 

maintain with respect to, among other things, their risk management and operations; 

• Rules regarding business conduct that would establish certain minimum standards of conduct for security-based swap dealers and major security-based swap 

participants, including in connection with their dealings with ‘‘special entities,’’ 

which include municipalities, pension plans, endowments and similar entities; 

• Rules regarding the registration process for security-based swap dealers and 

major security-based swap participants; and 

• Rules intended to address conflicts of interest at security-based swap clearing 

agencies, security-based swap execution facilities, and exchanges that trade security-based swaps. 

To facilitate clearing of security-based swaps, the Commission adopted final rules 

providing exemptions for security-based swaps transactions involving certain clearing agencies satisfying certain conditions. We also readopted certain of our beneficial ownership rules to preserve their application to persons who purchase or sell 

security-based swaps. 

Moreover, the Commission took a number of steps to provide legal certainty and 

avoid unnecessary market disruption that might otherwise have arisen as a result 

of final rules not having been enacted by the July 16, 2011, effective date of Title 

VII. Specifically, we have: 

• Provided guidance regarding which provisions in Title VII governing securitybased swaps became operable as of the effective date and provided temporary 

relief from several of these provisions; 

• Provided guidance regarding—and where appropriate, interim exemptions 

from—the various pre-Dodd-Frank provisions that would otherwise have applied to security-based swaps on July 16; and 

• Taken other actions to address the effective date, including extending certain 

existing temporary rules and relief to continue to facilitate the clearing of certain credit default swaps by clearing agencies functioning as central counterparties. 

Conclusion 

The Dodd-Frank Act provides the Commission with important tools to better meet 

the challenges of today’s financial marketplace and fulfill our mission to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. As we continue with implementation of Title VII, we look forward to continuing 

to work closely with Congress, our fellow regulators both home and abroad, and 

members of the public. Thank you for the opportunity to share our progress on the 

implementation of Title VII. I will be happy to answer any questions. 

PREPARED STATEMENT OF GARY GENSLER 

CHAIRMAN, COMMODITY FUTURES TRADING COMMISSION

MAY 22, 2012 

Good morning Chairman Johnson, Ranking Member Shelby and Members of the 

Committee. I thank you for inviting me to today’s hearing on implementation of the 

Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), 

international harmonization of swaps market reforms, and the Commodity Futures 

Trading Commission’s (CFTC) role in overseeing markets for credit derivative products, such as those traded by JPMorgan Chase’s Chief Investment Office. I also 

thank my fellow Commissioners and CFTC staff for their hard work and commit-
40 

ment on implementing the legislation. I’m pleased to testify along with Securities 

and Exchange Commission (SEC) Chairman Schapiro. 

Swaps, now comprising a $700 trillion notional global market, were developed to 

help manage and lower risk for commercial companies. But they also concentrated 

and heightened risk in international financial institutions. And when financial entities fail, as they have and surely will again, swaps can contribute to quickly spreading risk across borders. 

As the financial system failed in 2008, most of us learned that the insurance giant 

AIG had a subsidiary, AIG Financial Products, originally organized in the United 

States, but run out of London. The fast collapse of AIG, a mainstay of Wall Street, 

was again sobering evidence of the markets’ international interconnectedness. Sobering evidence, as well, of how transactions booked in London or anywhere around 

the globe can wreak havoc on the American public. 

Recently, we’ve had another stark reminder of how trades overseas can quickly 

reverberate with losses coming back into the United States. According to press reports, the largest U.S. bank, JPMorgan Chase, just suffered a multi-billion dollar 

trading loss from transactions in London. The press also is reporting that this trading involved credit default swaps and indices on credit default swaps. It appears 

that the bank here in the United States is absorbing these losses. And as a U.S. 

bank, it is an entity with direct access to the Federal Reserve’s discount window 

and Federal deposit insurance. 

I am authorized by the Commission to confirm that the CFTC’s Division of Enforcement has opened an investigation related to credit derivative products traded 

by JPMorgan Chase’s Chief Investment Office. Although I am unable to provide any 

specific information about a pending investigation, I will describe generally the 

Commission’s oversight of the swaps markets, the entities and products in our jurisdiction, and the Dodd-Frank reforms relevant to credit default swaps, and in particular index credit default swaps. 

The role the unregulated swaps market played in the 2008 crisis led to a new 

international consensus that the time had come for comprehensive regulation. 

Swaps, which were basically not regulated in Asia, Europe and the United States, 

should now be brought into the light of regulation. 

When President Obama gathered together the G–20 leaders in Pittsburgh in 2009, 

they agreed that the swaps market needed to be reformed and that such reform 

should be completed by December 2012. 

In 2010, Congress and the President came together and passed the historic DoddFrank Act. 

The goal of the law is to: 

• Bring public market transparency and the benefits of competition to the swaps 

marketplace; 

• Protect against Wall Street’s risks by bringing standardized swaps into centralized clearing; and 

• Ensure that swap dealers and major swap participants are specifically regulated for their swap activity. 

Despite different cultures, political systems and financial systems, we’ve made significant progress on a coordinated and harmonized international approach to reform. 

Japan passed reform legislation in 2010, and has made real progress on their clearing mandate. Further, they have a proposal before their Diet on the use of trading 

platforms, as well as post-trade transparency. The European parliament last month 

adopted the European Market Infrastructure Regulation (EMIR) that includes mandatory clearing, reporting and risk mitigation for derivatives. And the European 

Commission has published proposals providing for both pre-trade and post-trade 

transparency. Other major jurisdictions, including the largest provinces in Canada, 

have the legislative authority and have made progress on swaps reform. 

Implementation of Dodd-Frank Swaps Market Reforms 

The CFTC has made significant progress in completing the reforms that will bring 

transparency to the swaps market and lower its risk to the rest of the economy. 

During the rule-writing process, we have benefited from significant public input. 

CFTC Commissioners and staff have met over 1,600 times with the public and we 

have held 16 public roundtables on important issues related to Dodd-Frank reform. 

We are consulting closely with other regulators on Dodd-Frank implementation, 

including the SEC, the Federal Reserve, the Federal Deposit Insurance Corporation, 

the Office of the Comptroller of the Currency and other prudential regulators. This 

coordination includes sharing many of our memos, term sheets and draft work product. In addition, we are actively consulting with international regulators to har-
41 

monize our approach to swaps oversight, and share memos, term sheets and draft 

work product with our international counterparts as well. 

We substantially finished our proposal phase last spring, and then largely reopened the mosaic of rules for additional public comments. We have accepted further public comment after the formal comment periods closed. The agency received 

3,000 comment letters before we proposed rules and more than 28,000 comment letters in response to proposals. 

Last summer, we turned the corner and started finalizing rules. To date, we’ve 

completed 33 rules with less than 20 more to go. The Commission is turning shortly 

to the rule to further define the terms ‘‘swap’’ and ‘‘security-based swap,’’ the second 

of the two key joint further definition rules with the SEC. The staff recently has 

put forth to the Commission a final rule for our consideration. It is essential that 

the two Commissions move forward on the further product definition rulemaking expeditiously. 

Consistent with the provisions of the Dodd-Frank Act, the proposal states the 

CFTC regulates credit default swaps on broad-based security indices, while the SEC 

regulates them on narrow-based security indices (as well as credit default swaps on 

single name securities or loans). Under the proposal, most of the credit default swap 

indices compiled by the leading index provider, Markit, generally would be broadbased indices. These indices would generally include, but not be limited to, Markit’s 

CDX North American Investment Grade, as well as its CDX North American High 

Yield. While the credit default swaps based on these indices would be swaps under 

CFTC jurisdiction, the SEC would retain certain anti-fraud and anti-manipulation 

enforcement authorities over them as well, as it had prior to Dodd-Frank. 

Transparency 

The Dodd-Frank financial reform shines bright lights of transparency—to the public and to regulators—on the swaps market for the benefit of investors, consumers, 

retirees and businesses in America. Transparency is critical to both lowering the 

risk of the financial system, as well as reducing costs to end-users. The more transparent a marketplace is to the public, the more efficient it is, the more liquid it is, 

and the more competitive it is. 

The CFTC has completed key rules on transparency that, for the first time, provide a detailed and up-to-date view of the physical commodity swaps markets so regulators can police for fraud, manipulation and other abuses. We have begun to receive position information for large traders in the swaps markets for agricultural, 

energy and metal products. 

We also finished a rule establishing registration and regulatory requirements for 

swap data repositories, which will gather data on all swaps transactions. 

Starting this summer, real-time reporting to the public and to regulators will 

begin for interest rate and credit default swaps with similar reporting on other 

swaps later this year. Also later this year, market participants will benefit from the 

transparency of daily valuations over the life of their swaps. 

By contrast, in the fall of 2008, there was no required reporting about swaps trading. 

This month, we completed rules, guidance and acceptable practices for designated 

contract markets (DCMs). DCMs will be able to list and trade swaps, helping to 

bring the benefit of pre-trade transparency to the swaps marketplace. 

Looking forward, we have two important remaining transparency rules to complete related to block sizes and swap execution facilities (SEFs). The trading of credit default swap indices will benefit from the transparency provided on SEFs. 

The Japanese and European transparency proposals, as well as initiatives well 

underway in other jurisdictions, will further align international reform efforts and 

benefit the public. 

Central Clearing 

For over a century, through good times and bad, central clearing in the futures 

market has lowered risk to the broader public. Dodd-Frank financial reform brings 

this effective model to the swaps market. Standard swaps between financial firms 

will move into central clearing, which will significantly lower the risks of the highly 

interconnected financial system. 

The CFTC has made significant progress on central clearing for the swaps market. We have completed rules establishing new derivatives clearing organization 

risk management requirements. To further facilitate broad market access, we completed rules on client clearing documentation, risk management, and so-called 

‘‘straight-through processing,’’ or sending transactions immediately to the clearinghouse upon execution. 
42 

In addition, the Commission has adopted important customer protection enhancements. The completed amendments to rule 1.25 regarding the investment of funds 

bring customers back to protections they had prior to exemptions the Commission 

granted between 2000 and 2005. Importantly, this prevents use of customer funds 

for in-house lending through repurchase agreements. Clearinghouses also will have 

to collect margin on a gross basis and futures commission merchants will no longer 

be able to offset one customer’s collateral against another and then send only the 

net to the clearinghouse. And the so-called ‘‘LSOC rule’’ (legal segregation with 

operational commingling) for swaps ensures customer money is protected individually all the way to the clearinghouse. 

Furthermore, Commissioners and staff have gotten a lot of feedback from market 

participants on additional customer protection enhancements, including through a 

public roundtable. Staff is actively seeking further public input through our Web 

site and further meetings. Staff will use this outreach and review to put forward 

recommendations to the Commission for consideration. In addition, the National Futures Association and the CME Group have proposals for greater controls for segregation of customer funds. CFTC staff is working with these self-regulatory organizations on their proposals. 

CFTC staff now is preparing recommendations for the Commission and for public 

comment on clearing requirement determinations. The Commission’s first determinations will be put out for public comment this summer and hopefully completed 

this fall. They will begin with key interest rate products, as well as a number of 

CDX and iTraxx credit default swap indices. There is a great deal of consistency 

among the major jurisdictions on the clearing requirement, and the CFTC’s timeframe broadly aligns with both Japan and Europe. 

Currently, clearing exists for much of the standardized interest rate swaps, as 

well as for credit default swap indices, done between dealers. The major clearinghouses providing swaps clearing are registered with the CFTC. 

Moving forward, the Commission will consider a final rule on the implementation 

phasing of the clearing requirement and the end-user exception related to nonfinancial companies. 

Swap Dealers 

Regulating banks and other firms that deal in derivatives is central to financial 

reform. Prior to 2008, it was claimed that swap dealers did not need to be specifically regulated for their swaps activity, as they or their affiliates already were generally regulated as banks, investment banks, or insurance companies. The crisis revealed the inadequacy of relying on this claim. While banks were regulated for safety and soundness, including their lending activities, there was no comprehensive 

regulation of their swap dealing activity. Similarly, bank affiliates dealing in swaps, 

and subsidiaries of insurance and investment bank holding companies dealing in 

swaps, were not subject to specific regulation of their swap dealing activities. AIG, 

Lehman Brothers and other failures of 2008 demonstrate what happens with such 

limited oversight. 

The CFTC is well on the way to implementing reforms Congress mandated in 

Dodd-Frank to regulate dealers and help prevent another AIG. The Commission has 

finished sales practice rules requiring swap dealers to interact fairly with customers, provide balanced communications and disclose conflicts of interest before entering into a swap. In addition, this agency has finalized internal business conduct 

rules to require swap dealers to establish policies to manage risk, as well as put 

in place firewalls between a dealer’s trading, and clearing and research operations. 

We completed in April a joint rule with the SEC further defining the terms ‘‘swap 

dealer’’ and ‘‘securities-based swap dealer,’’ which is pivotal to lowering the risk they 

may pose to the rest of the economy. 

Based on completed registration rules, dealers will register after we finalize the 

second major definition rule with the SEC: the further definition of the terms 

‘‘swap’’ and ‘‘securities-based swap.’’ Swap dealers who make markets in credit default swap indices would be amongst those dealers who may have to register with 

the CFTC. 

Following Congress’ mandate, the CFTC also is working with our fellow financial 

regulators to complete the Volcker rule, which prohibits certain banking entities 

from engaging in proprietary trading. In adopting the Volcker rule, Congress prohibited banking entities from proprietary trading, an activity that may put taxpayers 

at risk. At the same time, Congress permitted banking entities to engage in certain 

activities, such as market making and risk mitigating hedging. One of the challenges in finalizing a rule is achieving these multiple objectives. 

The international community is closely coordinating on margin requirements for 

uncleared swaps, and is on track to seek public comment in June on a consistent 
43 

approach. This is critical to reducing the opportunity for regulatory arbitrage. The 

CFTC’s proposed margin rule excludes nonfinancial end-users from margin requirements for uncleared swaps. I’ve been advocating with global regulators that we all 

adopt a consistent approach. 

The Commission is working with fellow regulators here and abroad on an appropriate and balanced approach to the cross-border application of Dodd-Frank swaps 

market reforms. The CFTC will soon seek public comment on guidance regarding 

the cross-border application of Title VII rules. 

Market Integrity/Position Limits 

Financial reform also means investors, consumers, retirees and businesses in 

America will benefit from enhanced market integrity. Congress provided the Commission with new tools in Dodd-Frank to ensure the public has confidence in U.S. 

swaps markets. 

Rules the CFTC completed last summer close a significant gap in the agency’s enforcement authorities. The rules implement important Dodd-Frank provisions extending our enforcement authority to swaps and prohibited the reckless use of manipulative or deceptive schemes. Thus, for example, the CFTC has clear anti-fraud 

and anti-manipulation authority regarding the trading of credit default swaps indices. Also, the CFTC now can reward whistleblowers for their help in catching market 

misconduct. 

Congress also directed the CFTC to establish aggregate position limits for both 

futures and swaps in energy and other physical commodities. In October 2011, the 

Commission completed final rules to ensure no single speculator is able to obtain 

an overly concentrated aggregate position in the futures and swaps markets. The 

Commission’s final rules require compliance for all spot-month limits 60 days after 

the CFTC and SEC jointly adopt the rule to further define the term ‘‘swap’’ and ‘‘securities-based swap’’ and for certain other limits, following a collection of a year’s 

worth of large trader swap data. Two associations representing the financial industry, however, are challenging the agency’s final rule establishing those limits in 

court. The Commission is vigorously defending the Congressional mandate to implement position limits in court. 

Last week, the Commission approved a proposed rule that would modify the 

CFTC’s aggregation provisions for limits on speculative positions. The proposal 

would permit any person with a 10 to 50 percent ownership or equity interest in 

an entity to disaggregate the owned entity’s positions, provided there are protections 

and firewalls in place to ensure trading decisions are made independently of one another. The proposal was a response to a Working Group of Commercial Energy 

Firms (WGCEF) petition seeking relief from the aggregation provisions of the position limits rule. 

Position limits is another area where there has been close international coordination. The G–20 leaders endorsed an International Organization of Securities Commissions (IOSCO) report last November noting that market regulators should use 

position management regimes, including position limits, to prevent market abuses. 

The European Commission has proposed such a position management regime to the 

European Parliament. 

Cross-border Application of Dodd-Frank’s Swaps Reforms 

The Dodd-Frank Act states in Section 722(d) that swaps reforms shall apply to 

activities outside the United States if those activities have ‘‘a direct and significant 

connection with activities in, or effect on, commerce’’ of the United States. 

CFTC staff will soon be recommending to the Commission to publish for public 

comment a release on the cross-border application of swaps market reforms. It will 

consist of interpretive guidance on how these reforms apply to cross-border swap activities. It also will include an overview as to when overseas swaps market participants, including swap dealers, can comply with Dodd-Frank reforms through reliance on comparable and comprehensive foreign regulatory regimes, or what we call 

‘‘substituted compliance.’’ 

There is further work to be done on the CFTC cross-border release, but the key 

elements of the staff recommendations are likely to include: 

• First, when a foreign entity transacts in more than a de minimis level of U.S. 

facing swap dealing activity, the entity would register under the CFTC’s recently completed swap dealer registration rules. 

• Second, the release will address what it means to be a U.S. facing transaction. 

I believe this must include transactions not only with persons or entities operating in the United States, but also with their overseas branches. In the midst 

of a default or a crisis, there is no satisfactory way to really separate the risk 
44 

of a bank and its branches. Likewise, I believe this must include transactions 

with overseas affiliates that are guaranteed by a U.S. entity, as well as the 

overseas affiliates operating as conduits for a U.S. entity’s swap activity. 

• Third, based on input the Commission has received from market participants, 

the staff recommendations will include a tiered approach for requirements for 

overseas swap dealers. Some requirements would be considered entity-level, 

such as for capital, risk management and recordkeeping. Some requirements 

would be considered transaction-level, such as clearing, margin, real-time public 

reporting, trade execution and sales practices. 

• Fourth, such entity-level requirements would apply to all registered swap dealers, but in certain circumstances, overseas swap dealers could comply with 

these requirements through substituted compliance. 

• Fifth, such transaction-level requirements would apply to all U.S. facing transactions, but for certain transactions between an overseas swap dealer (including 

a foreign swap dealer that is an affiliate of a U.S. person) and counterparties 

not guaranteed by or operating as conduits for U.S. entities, Dodd-Frank may 

not apply. For example, this would be the case for a transaction between a foreign swap dealer and a foreign insurance company not guaranteed by a U.S. 

person. 

In putting together this release, we’ve already benefited from significant input from 

market participants. Throughout our nearly 60 rule proposals, we’ve consistently 

asked for input on the cross-border application of swaps reforms. 

Commenters generally say they support reform. But in what some of them call 

a ‘‘clarification,’’ we find familiar narratives of the past as to why many swaps 

transactions or swap dealers should not be regulated. Some commenters have expressed the view that if a transaction is done offshore, it should not come under 

Dodd-Frank. Others contend that as long as an offshore dealer is regulated in some 

capacity elsewhere, many of the Dodd-Frank regulations applicable to swap dealers 

should not apply. 

The law, the nature of modern finance, and the experiences leading up to the 

2008 crisis, as well as the reminder of the last 2 weeks, strongly suggest this would 

be a retreat from much-needed reform. 

When Congress and the Administration came together to draft the Dodd-Frank 

Act, they recognized the lessons of the past when they expressly set up a comprehensive regulatory approach specific to swap dealers. They were well aware of 

the nature of modern finance: financial institutions commonly set up hundreds if not 

thousands of ‘‘legal entities’’ around the globe with a multitude of affiliate relationships. When one affiliate of a large, international financial group has problems, it’s 

accepted in the markets that this will infect the rest of the group. 

This happened with AIG, Lehman Brothers, Citigroup, Bear Stearns and LongTerm Capital Management. 

Implementation Phasing 

As we move on from the rule-writing process, a critical part of our agenda is working with market participants on phased implementation of these reforms. We have 

reached out broadly on this topic to get public input. Last spring, we published a 

concepts document as a guide for commenters, held a 2-day, public roundtable with 

the SEC, and received nearly 300 comments. Last year, the Commission proposed 

two rules on implementation phasing relating to the swap clearing and trading 

mandates and the swap trading documentation and margin requirements for 

uncleared swaps. We have received very constructive public feedback and hope to 

finalize the proposed compliance schedules in the next few months. 

In addition to these proposals, the Commission has included phased compliance 

schedules in many of our rules. For example, both the data and real-time reporting 

rules, which were finalized this past December, include phased compliance. The first 

required reporting will be this summer for interest rate and currency swaps. Other 

commodities have until later this fall. Additional time delays for reporting were permitted depending upon asset class, contract participant and in the early phases of 

implementation. 

The CFTC will continue looking at appropriate timing for compliance, which balances the desire to protect the public while providing adequate time for industry to 

comply with reforms. 

Resources 

Confidence in the futures and swaps markets is dependent upon a well-funded 

regulator. The CFTC is a good investment of taxpayer dollars. This hardworking 

staff of 710 is just 10 percent more than what we had in the 1990s though the fu-
45 

tures market has grown fivefold. The CFTC also will soon be responsible for the 

swaps market—eight times bigger than the futures market. 

Picture the NFL expanding eightfold to play more than 100 football games in a 

weekend, leaving just one referee per game, and, in some cases, no referee. Imagine 

the mayhem on the field, the resulting injuries to players, and the loss of confidence 

fans would have in the integrity of the game. 

Market participants depend on the credibility and transparency of well-regulated 

U.S. futures and swaps markets. Without sufficient funding for the CFTC, the Nation cannot be assured that the agency can adequately oversee these markets. 

Conclusion 

Nearly 4 years after the financial crisis and 2 years since the passage of DoddFrank, it’s critical that we fully implement the historic reforms of the law. It’s critical that we do not retreat from reforms that will bring greater transparency and 

competition to the swaps market, lower costs for companies and their customers, 

and protect the public from the risks of these international markets. 

In 2008, the financial system and the financial regulatory system failed. The crisis 

plunged the United States into the worst recession since the Great Depression with 

eight million Americans losing their jobs, millions of families losing their homes and 

thousands of small businesses closing their doors. The financial storms continue to 

reverberate with the debt crisis in Europe affecting the economic prospects of people 

around the globe. 

The CFTC has made significant progress implementing reform having largely finished the rule proposals, and now having completed well over half of the final rules. 

We are on schedule to complete the remaining reforms this year, but until we do, 

the public is not fully protected. 

(47) 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY 

FROM GARY GENSLER 

Q.1. Chairman Gensler, during the week leading up to the bankruptcy of MF Global, how many times did you brief the other Commissioners on the CFTC’s management of the crisis? Please explain. 

A.1. During the week of October, 24, 2011, as MFG’s financial condition deteriorated, CFTC staff became involved in monitoring the 

firm’s financial condition. During that week, the other Commissioners and I were briefed by Commission staff about ongoing developments, including during the Commission’s senior staff briefing 

on Wednesday and its surveillance meeting on Friday. 

Q.2. Chairman Gensler, during the week leading up to the bankruptcy of MF Global, at any time did you indicate to the other 

Commissioners or CFTC staff that you were concerned about customer assets at MF Global? Please explain. 

A.2. Yes. During that week and increasingly over the last weekend 

of October, I was involved in discussions with other regulators regarding the developments. During some of the calls with regulators 

on October 29–30 and into the morning of October 31, MFG representatives and representatives of a firm considering facilitating 

the transfer of MFG customer positions also participated. As of October 28, my understanding from staff at the time was that MFG 

was not reporting a deficiency, under CFTC regulations, in the customer funds accounts. Given the firm’s deteriorating financial condition, however, we requested certain detailed back-up documentation regarding the segregated customer funds under section 4d of 

the Commodity Exchange Act and secured funds under Part 30 of 

the Commission’s regulations. We pressed for the information over 

the course of the weekend. Even though the firm had provided 

some summary information, the firm’s failure to provide the requested detailed supporting information was a source of concern to 

me. My involvement was in furtherance of the CFTC’s effort to ensure to the maximum extent possible the protection of customer 

property that had been entrusted to MFG. 

Q.3. Chairman Gensler, in an attempt to justify your MF Global 

recusal, you stated that you did not want your relationship with 

MF Global CEO Jon Corzine to ‘‘be a distraction.’’ 

• Why were you not concerned that your relationship with Mr. 

Corzine would be a distraction from any previous matter involving MF Global? 

• Prior to the MF Global bankruptcy, Mr. Corzine had met with 

you on matters related to Rule 1.25, which regulates the investment of customer segregated funds. Why did you not 

recuse yourself from those conversations? 
48 

A.3. In keeping with the consistent advice of our General Counsel 

and Alternate Designated Ethics Officer, I participate in all 

rulemakings, including Rule 1.25, as they are matters of general 

applicability. I was advised by the Commission’s General Counsel 

that I was not required to withdraw from participation. However, 

as it turned to a specific enforcement matter that could involve not 

just the company but specific individuals, including Jon Corzine, I 

informed the General Counsel of my decision on November 3 that 

I would not participate. My decision was in order to ensure that my 

participation did not serve as a distraction from the Commission’s 

important duties to locate customer funds and conduct an enforcement matter. Subsequently, I executed a ‘‘Statement of Non-Participation’’ to document my decision. 

Q.4. Chairman Gensler, you have stated that you ‘‘will not participate in any enforcement-related matters involving MF Global and 

any matter directly related thereto.’’ This language appears to prohibit you from participating in any of the CFTC’s efforts to develop 

recommendations based on lessons learned from the collapse of MF 

Global. In your absence, who is leading the CFTC’s efforts to develop recommendations based on lessons learned? 

A.4. I have tremendous confidence in the ability of my fellow Commissioners and the Commission’s dedicated staff to develop appropriate recommendations based on lessons learned. With respect to 

the matters in which I am not participating, Commissioner Jill 

Sommers is exercising the Commission’s executive and administrative functions that otherwise would be exercised by the Chairman 

in accordance with section 2(a)(6) of the Commodity Exchange Act. 

In keeping with the consistent advice of our General Counsel and 

Alternate Designated Ethics Officer, I participate in all 

rulemakings, as they are matters of general applicability. 

Q.5. Chairman Gensler, in Chairman Schapiro’s written testimony 

from the hearing on May 22, 2012, she said that the SEC will publish an implementation plan for their Dodd-Frank derivatives rules 

and allow the public to comment on it. Will you commit to publishing the CFTC’s implementation plan for the Dodd-Frank derivatives rules and allow the public to comment on it? 

A.5. The Commission has taken a number of actions to facilitate 

implementation of Dodd-Frank regulations. These include: 

March 16, 2011—Implementing the Dodd-Frank Act, FIA’s Annual 

International Futures Industry Conference, Boca Raton, Florida. 

Remarks of Chairman Gary Gensler (as posted on CFTC Web site 

and including listing of order in which rules might be considered). 

April 12, 2011—June 10, 2011—Comment period open (292 written 

comments filed); Concepts document published as a guide for commenters. 

May 2, 2011 and May 3, 2011—CFTC–SEC Staff-led Roundtable 

Discussion on Dodd-Frank Implementation. 

May 4, 2011—Notice published in Federal Register re-opening and 

extending comment periods (through June 30) in order to ‘‘provide 

interested parties with an additional opportunity to participate in’’ 

Dodd-Frank Rulemakings. Also requesting comment on the order 

in which the Commission should consider final rulemakings. 
49 

June 17, 2011—Commission seeks public comment on proposed 

order to grant exemptive relief from the application of Dodd-Frank 

Act effective dates. 

July 14, 2011—Commission publishes final order providing exemptive relief from effective dates of Dodd-Frank Act provisions in 

order to facilitate a smooth transition for market participants (expiring on December 30, 2011; extended on Dec. 23, 2011). 

September 8, 2011—Outline published of Dodd-Frank Title VII 

Rules the CFTC May Consider in 2011 and the First Quarter of 

2012. 

September 8, 2011—The Commission sought public comment on 

proposed rules specifically to establish schedules to phase in compliance with the swap clearing and trade execution requirement 

provisions of the Dodd-Frank Act. At that meeting, the Commission 

also approved a proposed rule to phase in compliance with previously proposed requirements, including the swap trading relationship documentation requirement and the margin requirements 

for uncleared swaps. 

December 23, 2011—Commission publishes amendment to July 14 

order extending effective date relief through July 16, 2012. 

January 11, 2012—Update of order of consideration of final rules 

posted on Commission Web site. 

July 3, 2012—Commission approves amendment to July 14 order 

extending effective date relief through December 31, 2012. 

July 30, 2012—Final rule published in Federal Register detailed 

phasing of compliance requirements for swaps subject to mandatory clearing 

Individual proposed rules specifically request public comment regarding implementation and sequencing. Examples of such rules 

include: Reporting, Recordkeeping and Trading Records requirements; Real-Time Public Reporting of Swap Transaction Data; Registration of Swap Dealers and Major Swap Participants; and Protection of Collateral of Counterparties to Uncleared Swaps Commission staff—along with staff from the SEC and other implementing agencies—have conducted a number of roundtables (transcripts available on CFTC.gov): 

August 20, 2010—Conflicts of interest in the clearing and listing of 

swaps 

September 14, 2010—Swap Data and Swap Data Repositories 

September 15, 2010—Swap Execution Facilities 

October 22, 2010—Credit Default Swaps 

October 22, 2010—Customer Collateral Protection 

December 2, 2010—Disruptive Trading Practices 

December 12, 2010—Capital and Margin 

June 3, 2011—Protection of Cleared Swaps Customer Collateral 

June 8, 2011—Swap Data Recordkeeping and Reporting 

June 16, 2011—Definition of Swap Dealer and Major Swap Participant 

July 6, 2011—Changes related to Commodity Pool Operators and 

Commodity Trading Advisors 
50 

August 1, 2011—International issues 

January 30, 2012—‘‘Available to Trade’’ Provision for SEFs and 

DCMs 

Feb 29 and March 1, 2012—Roundtables to discuss additional 

customer collateral protection 

May 31, 2012—The Volcker Rule 

June 5, 2012—Core Principle 9 for Designated Contract Markets 

August 9, 2012—Additional Customer Protections 

Q.6. Chairman Gensler, the Dodd-Frank Act includes indemnification provisions that make it difficult, if not impossible, for foreign 

regulators to obtain information on swap transactions. All five SEC 

Commissioners support repealing the indemnification requirements. Two CFTC Commissioners agree, saying that the CFTC’s 

recent interpretive guidance does not fix the problem. Do you agree 

with the seven SEC and CFTC Commissioners that the indemnification provisions should be repealed? 

A.6. The CFTC is working to ensure that both domestic and international regulators have access to swap data to support their regulatory mandates. The CFTC adopted proposed interpretative guidance stating the view that foreign regulators seeking access to 

swap data repositories will not be subject to the indemnification 

provisions if the trade repository is regulated by foreign law and 

the data is reported under foreign law. The CFTC requested public 

comment on all aspects of the interpretative guidance. 

Q.7. Chairman Gensler, the SEC’s swap entity definition rulemaking contains a lengthy discussion of how they determined that 

$8 billion is the appropriate de minimis level to be regulated as a 

dealer in the derivatives markets they oversee. 

• How did the CFTC determine that the same $8 billion figure 

is appropriate for the markets that you oversee? 

• What credit default swap data did the CFTC use in its analysis? 

• What interest rate swap data did the CFTC use in its analysis? 

• What commodity swap data did the CFTC use in its analysis? 

• What agricultural swap data did the CFTC use in its analysis? 

A.7. After reviewing comments received regarding the CFTC and 

SEC joint proposed rule to further define the terms ‘‘swap dealer’’ 

and ‘‘major swap participant,’’ the Commissions arrived at the determination that, generally, a $3 billion notional value in swaps activity over the prior 12 months represented an appropriate de minimis threshold. The amount was based on input from commenters 

and supported by several rationales, including the estimated size 

of the domestic swap market. Commenters who addressed the question proposed that the standard be set at a level between $200 million and $3.5 billion in notional amount entered into over a period 

of 12 months. Data and other market descriptions were provided 

through written comments as well as through input in roundtable 

discussions hosted by staffs of the two Commissions, as well as 

index CDS data provided by the SEC and data contained in the 

Quarterly Report on Bank Trading and Derivatives Activities 

issued by the Office of the Comptroller of the Currency. The Com-
51 

missions also determined it to be appropriate to establish a de 

minimis threshold phase-in period during which higher de minimis 

thresholds would apply. During this phase-in period, the joint final 

rule provides generally for a de minimis level of swap dealing activity over the prior 12 months of a gross notional value of $8 billion. 

The Commissions noted particularly that the implementation of 

swap data reporting under the Dodd-Frank Act may result in new 

data that would be useful in confirming the Commissions’ determination to establish the $3 billion threshold which applies after 

the phase-in period. 

Q.8. Chairman Gensler, the Depository Trust and Clearing Corporation (DTCC) has made a comprehensive global database of detailed credit default swap transaction and position data available 

to regulators for more than a year. It is my understanding that all 

of the financial regulators, except the CFTC, have made use of this 

data as of the date of the hearing. 

• When the press began to report that JP Morgan’s London office 

had taken extremely large positions in credit default swap indexes—which fall under the jurisdiction of the CFTC—why 

didn’t the CFTC immediately begin examining the DTCC data? 

• If the CFTC had made use of the DTCC data, would you have 

had a better line of sight into the JP Morgan trades that are 

the subject of so much scrutiny? 

A.8. The CFTC’s Division of Enforcement has opened an investigation related to credit derivative products traded by JPMorgan 

Chase’s CIO. I am unable to provide any specific information about 

a pending investigation. 

Q.9.–1. Chairman Gensler, according to Mr. Corzine’s Congressional testimony, he met with you on May 5, 2010 at the CFTC. 

• What issues were discussed at that meeting? Who else was 

present at that meeting? 

Q.9.–2. Chairman Gensler, on November 17, 2010, MF Global submitted a comment letter on a CFTC regulation. Five days later, you 

were a guest lecturer on Government regulation at Mr. Corzine’s 

class at Princeton University. 

• Were any of the issues related to MF Global’s comment letter 

discussed at any time while you were at Princeton, inside of 

class or outside of class? Please explain. 

Q.9.–3. Chairman Gensler, according to Mr. Corzine’s Congressional testimony, he met with you in December 2010 at the CFTC. 

• What issues were discussed at that meeting? Who else was 

present at that meeting? 

A.9.–1.–3. For the convenience of the Committee, I include a document that will address these questions. The included document is 

a Memorandum detailing my activities prior to my withdrawal 

from participation in the matter. The document includes details, to 

the best of my recollection, of contacts with Mr. Corzine. 

Insert 1 [Confidential Memorandum follows:] 
52 

U.S. COMMOOITY FUTURES TRAOING COMMISSION 

Three l.efsyette Cerrtre 

IIU 21$\SIIeeI. NW. Wnhingloo, DC 20581 

Telephone: (202) 418-511O 

Facsimile: (202) 418-552" 

CONFIDENTIAL MEMORANDUM 

TO: Chainnan Gensler 

FROM: DanM,Berlwvi ~ • • 

General Counsel~Agency Ethics Official 

JohnP.Dolartff 

Counsel andA!tematc Designated Agency Ethics Official 

DATE: D«embef 13,201 1 

SUBJECT: Participation inMauers Concerning MY Global, Inc. 

L hlroducti!lll I,d Summary 

Pumwtt to.5 C.F.R. § 2635.502, the Commodity Futures Tntding Commission (CFTCor 

Commission) designated agcocy ethics !lfficial (DAEO) has undertaken this review of the 

participation !If CFTC Chairman GIry Gensler in certain CFTC manclS regarding MF Global, 

Inc. (MFG!), a futures rommission merchant (FCM) rtgistmd with the CFTC. During the 1980s 

and 1990s ClWnnan G~l\Slcr .mel tIx f!llm" Pmidenl and ClUdExccutive Officer (CEO) of 

MFGI, Jon Corzine, worked together and were p!I'tlItrs at Goldman Sacbs (OS), an investment 

"""-' 

On November 3, 2011, the General COW\SeI and DAEO provided Chairman Oensla \lith an oral 

opini!lD that the Chairman was IIOt required to withdraw from participation in MFGI maners an 

result oftU., prior relationship with Mr. Corzine. On that same dalc Chairman Genslcr 

nonetheless eleeted 10 not participate in enforcement matters related to MFG!.: Following this 

I Mr. Cottillucsigned as PJeSidenl and CEO ofMFGI on Friday, November4, 2011. 

IOn November 8, 201 1, Chaimtan Gmsler executed B "Statement of Non-Participation. " This 

stlltement explained the Cbairman's decision: "Wilh respect to the ItlCCIII matters involving MF 

Global, the 5IIff at thc CFTC is working liard 10 recover customers' funds and to fUld om what 

happened 10 the missing customer mOllcy and bow it happened. The ern has a tremendously 

capable staffand I do nol want my participation 10 be in any way 8 di5lraetioll in this-important 

matter." 
53 

decision, the General Co~lllIld DAEO and ADAEO decided to undertake this review 10 

determine whether Chairman Gensler's participation in matters involving MFGI was appropriate. 

Based on the facts and circumstances detailed in this memorandum, and based upon the 

Slandards set forth in 5 C.F.R. § 2635.502, this review C()nclud~ thai Cbainnan Gensler was IlQI 

required 10 wit!idraw from matters involving MFGL From a legal and ethical perspective. 

Chairman Gensler's participation in Commission matters involving MFGI was nOI improper. 

II. Faclual Background 

A. MF Global, Inc. 

Subsidiary ofMF Global 

MG Global is a financial business comprising a holding ~wmy. MF Global Holdings Ltd., a 

Delaware coipOration headquartered in New York City, ana a variety of subsidiaries located in 

the United Slates and other countries.) One of the subsidiaries is MFGI, which is an FCM 

registered with the CFTC as well as a securities broker-deaJer registered with the SEC.~ 

According to the Annual Report (SEC Form 10·K) filed by Mf Global Holdings Lid. in May 

2011, MF Global is a broker in markets for commodities and listed derivatives and a broker· 

dealer in markets for commodities, fixed incomesocurities, equities, and foreigll exchange.' 

MFGl BankrvDtt;y 

On October 31, 2011, the Securities Inveslor Prote<:lion Corporation (SIPC) filed an application 

{or the miry of a protective order in the U.S. Bankruptcy Coun placing MFGI in liquidation 

under the Securities Investor Protection Aet (SIPA). On that same date, "the Commission's 

Division of Enforcement opened an investigation into whether the Commodity Exchange Act 

(CEA) or Commission regulations were violated in COMCetiOn with MFG!, and the Commission 

[l authorized the Division to issue subpoenas.'" 

in a lj.ling on November 2, the Commission infoaned the Banbuptcy Court thai it "intends to 

take all appropriate Dction, wilhin the. purview of the Bankruptcy Code and the [CEAl,lo en5\1le 

that customers maximize their recovery of funds and to discover the reason for the shortfall in 

lMF Global Holdings Ltd. Fonn 100K {or fiscal year ended Matcb 31. 201 1 al I, 

hnp:l/www.sec.gov/ArcbivtSledgar/datall40ll 06lO0O 1193125 11145663/d IOk.hlm (accessed 

November 6, 2011); see Disclaimer, MF Global Website. hltD://www,mfglobaI.CQmldisclaimer 

~accessed November 6. 2011). 

Disclaimer, MF Global Website, bnp:IJWW\N.m(g!obal,comldiS91aimer (accessed November 6, 

2011). 

j MF Global Holdings Ltd. Fonn IO-K {or fiscal year ended Marcil 31, 20J 1 at 5, 

httpJIwww.sec.gov/Archivesledgar/datalI401106l000119312511145663/dIOk.htm(accessed 

November 6, 2011). 

'CFTC Press Release, PR614(}-11, November 10. 2011 . 

2 
54 

segreption.,,7 

Ke)! officials 

Ion S. Corzine wu the Cha.imuIII and Chief Executive Officer of MF Global Holdings LAd. until 

bisrecent resignation.' ACCQrding to theMF Global website, Mr, Corzine also is an operating 

partner at J.C. Flowers & Co. LLC.' Acoording to the MF Global website, Mr. Corzine joined 

GS as a fixed income trader in 1975 and subse1:juently served as chief financial officer and as 

chairman and senior partner from 1994 through 1999.10 

BtadJey I. Abelow is the President IIlId Chief Operating Officer of MF Global Holdings Ltd. 11 

Acoording to the MF Global website, Mr. Abelow previously was a partner and mBMging 

director of OS, where he JlUllUlged the operations groUp.ll Earlier he was responsible for GS's 

operations, technology, risk. and finance functions in Asia.l l He joined OS in 1989.1~ 

Laurie R Ferber is the General Counsel ofMF Global HoJdings Ltd. U ACCQrdirl to the MF 

Global website, Ms. Ferberworl:ed for GS for over 20 yean beginning in 1997.1 She held a 

number of different positions inc1udiDj serving as co.genel1ll counsel orlbe Fixed Income, 

1 Statement of Commodity Futures Trading Commission in Suppol1 of the Trustee's Emergency 

-MoflOn for an Order Approving the Transfer of Certain Segregated Customer Commodity 

Accounts ofMF Global Inc. and Related Mlll"gin and Motion for Expedited Hearing, MFGl 

Bankruptoy Case. November 2, 2011. 

I Executive Officers Biognrpny, MF Global Website, 

hltp:llwww.mfglobaJinvestorrellltions.comlphoerriuhtml?c-194911&p-irol·govMfUlage 

~aocessed November 6, 20 11). 

Executive Officers Biography, MF Global Website, 

http://www.mfglobalinvestonelations.comfphoenix.zhtml?C'''19491 1 &p=irol. 

ll.ovBio&ro---I98970 (acwssm November 6, 2011). 

ro ld. 

I I Executive Officers Biography. MF Global Website, 

http://www.mfglobalinvestorrelatiolt'i.comfphocni:uhtml?C'''194911&p'''irol·govManage 

~acocssed November 6, 2011 ). 

l Executive Offi~rs Biography, MY Global Website, 

hnp:llwww.mfglobalinvestorrelatiollS.comiphoenix.zhtml?e=I94911&p=irol. 

~ovBio&LD-204097 (atcessed November 6, 20 II). 

Id. 

I~ ld. 

u Executive Offi~rs Biography. MF Global Website, 

hnp:llwww.mfglobalinvestorrelations.comiphoenix.zhtml?C-194911&p-irnl-govMfUlage faccessed November 6, 201 I). 

6 Executive Officers Biography, MF Global Website, 

http://www.mfg!oba!investorrelations.comlphoenbt.zhtm.i?c-l94911&p.-iroJ· 

govBio&.lD-I86545 (aeeessed. November 6, 201 1). 

, 
55 

Currency and Commodities Division and laWlching and running the economic dl:rivatives 

bWiiness. 17 

I. Christopher Flowers is the founder and executive chainnan of J.C. Flowers & Co. LLC, a 

private equity finn. I' Aecording 10 press reporu, I.C. Flowers & CO. Owtl!i preferred stock in 

MF Global that, if converted to common stock, would amount to 6% of the total.

19 Also 

aceording to press reports, Mr. Flowers worked with Mr_ Cottine at GS and later recommended 

that Mr. Corzine take over as MF Global's chairmtUl and chief executive officer in March 

2010,:0 

B, Relationship Between ChainnlD GtIl,ler l ad Mr. Corone

21 

Chairmalt GeltSlu 's Employment at as 

Chairman Gensler worked at as from September 1979 Wltil ~tember 1997, when he left to 

5C!Ve Ii$ Assistant Secretary of Treasury fOl" Financial Markets. In lale 1988, when Chairman 

Gensler became a partner in the flIttl, there were approximately 128 partners at GS, ineluding 

Chairman Gensler and Mr. Corzine.2J 

From hi5 arrival at GS in 1979 untillatc 1991 or eaJly 1992, Chairman ~n5ler \IIIOrked in the 

Mergers and Acquisitions (M&A) Department 24 In late 1991 or eaJly 1992, Chainnan Gensler 

end a few other junior partners at the firm were asked to transfer to other departments as part of 

their career development. The transfers were suggested by Mr. Roberl Rubin (the oo-Cbairman 

and Co-Stninr Partnero(GS at the time) and Mr. Corzine (the co-head of the fixed income 

department (FI) at the time). Mr. Gensler was asked to transfer to FI and agreed. 

Chairman Gensler's initial assignment in A was in the mortgage trading department. In this 

capaeity, he reported to Miehael Mortara, who reponed to Mr. Corzine and the olber oo-head of 

FI, Mr. Mark Winkelman. Chairman Gensler, Mr. Mortara, and Mr. Corzine all worked on the 

fixed income trading floor. 

11 Id. 

II 1.C. Flowers &. Co. LLC: Private Company lnfonnation - Business Week, (accessed 

November 6, 2011) hnp:/finvesring.buslnesswec1c.comlresearch 

Istockslprivatelsnapshot.asp7privcapld"\ 089961. 

19 JC Flowe~ Fund Said to Sec $41.8 Million Loss on MF G!obal-Businessweek (No\'("mbc:r2, 

2011), http://www.businessweek..comInews/2011-ll..o2ljc-flowers.fund-said-to-see-47-8-

million-Ioss-(ln-mf-global.html (accessed November 6. 2011). 

20 1d. 

21 The (acts ill this section are ba5ed primarily upon l1li interview with Chairman Gensler 

condueted on November 4, 201 1. 

2l Chainnan ~nsler served as Assistant Secretary (or Financial Markets from September 1991 

until April 1999, IIIId lIS Underse<:retary ofTreuury for Domestic Finance from April 1999 to 

Jamwy 2001. 

Il By 1997, when Chairman Gensler left GS, thm!. wert approximately 190-200 partners 8t GS. 

'4 Chainnan Geruler spent approxilDlltely 6.12 months during the 1983-1984 time period on the 

equity trading floor lIS pan ora "mobility program." 

4 
56 

In January 1993, Mr. Corzine requested, and Chainnan Gensler agreed. that Chainnan GensJer 

serve as co-head offlXed ineome trading in the GS office in Tokyo, Japan. Chainnan Gensler 

served in this position until late 1994. During this two-year period, Mr. Corrine and Mr. 

Winkelman were Chairman Gensler's direct supervisors. 

In the fnll of 1994, Chairman OeMler \W.S asked by Mr. Steve Friedman, who was then co-head 

orGS with Mr. Rubin, to transfer out ofF! to be the head oftbe Operations, Technology, and 

Finance Division (OTF) in Asia. Chairman Gensler reported \0 Mr. John Thain, head of 

worldwide OTF. Shortly thereafter, Mr. Corzine became the Senior Partner of OS and Cbairman 

of tile Management Committee.~ 

Chainnan Gcnsler Rltumed \0 New York in November 1995 to become co-head of Finance. In 

this position, Chairman Gensler continued to report to Mr. Thain, who continued to Rlport to Mr. 

Corzine and Mr. Paulson. As co-head of Finance, Chainnan Gensler served on various 

commiltees of the firm, including the Risk Committee. Mr. Corzine also was a member of the 

Risk Committee (which had approximalely 10-15 members), and sometimes he participated on 

other committees. 100. Chairman Gensler served as co-head of Finance until he left GSin 1997 

for !be Treasury Department. Prior 10 leaving OS, Chairman Gensler visited with Mr. Conine at 

the latter's apartment to provide departing observatioll5.26 

Mer Chairman Gensler loeB GS 

To the best of his recollection, Chairman Gensler believes he did not see Mr. Corzine for three 

yean af'terChairman Gensler left GS. 11 While Chaillllan Gensler served at TreasLlJ}'. the only 

time that he saw Mr. Corzine WIllI in late 2000 or early 2001. Then-Senalor-elect Corzine had 

come to the Treasury Departnu:nt to visit with Secretary ofTreasury Lawrence Swruners, and 

following the meeting with Secretary Summm, Mr. Corzine stopped by to say hello to then-· 

UndersecRlIary Gensler. 

In early 2002, Chairman Gensler volunteered to serve as an advisor to Senator Paul Sarbanes on 

legislation thai eventually was enacted II!i the Sarbanes-Oxley Act. Senator Sarbanes was 

Chairman of the Senate Committee on Banking, Housing IUld Urban Affairs and Senator Corzi~ 

was a member of the same Committee. In his role as advisor to Senator Sarbanes, Chairman 

Gensler occasionally spoke with Senator Corzine about the pending legislation. Chainnan 

Gensler also spoke with Senator Corzine while Chainnan Gcnsler. Senator Sarbaoes, and Senator 

Corzine were on the Senate floor during the consideration of the legislation for final Senate 

passage. 

11 Executive functions were shared between Mr. Conine and Mr. Henry Paulson, who served as 

Chief Operating Partner and Vice..Chainnan of the Management Committl:C. Mr. Thain reported 

to Mr. Corzine and Mr. Paulson. 

26 Mr. Corzine subsequenlly left GS in early 1999. 

17 Chairman Gensler believes that he may have spoken with Mr. Corzine once or twice by 

telephone: whilesetving at Treasury, but cannot specifically recall any such COl1versations. 

, 
57 

In 2003-2004, Chairman Gensler served as Treasurer oftbe Maryland State Democratic Pany. 

During the same time. SeMtor Conine became head of the Democratic Senatorial Campaign 

Committee. As fI. result of their fundraising responsibilities, Chairman Gensler saw Senator 

Conine f1.t several politic.! events attended by lfll'ge numbers of people. This included an event 

10 support the CiUllpaign of Senator KelI}' rorPresident in 2004, which was ilttended by 

approximately 400 others, including other members of Congress. 

In 2005, Chainnan Gensler was invited to a fundraiser in Washington, DC, for the New Jersey 

State Democratic Party. Approximl1C:ly 100 people attended, including both Senator Corzine 

and !heather Senator from New Jersey, Senator Frank Lautenberg. At the time, Senator Corzine 

was CiUllpaigning to be elected Governor orNew Jersey. As a participant in the fumlraiser, 

Chairman Gensler contributed $10,000 to the New Jersey State Democratic Party (as he similarly 

contributed to the State DemOC/'lltic Party ofseveril other States), which earned him the title of 

being II. "host" of the fundraiser.:!I Chairman Gensler did not see Governar Conine for another 

three ye.m. 

During the primary season for the 2008 Presidential camp!lign, Chairman Gensler first Served as 

an unpaid senior advisor 10 the campaign of then-Senator Hilary Clinton. Chairman Gensler 

recalls speaking .... ith Governor Conine 011 a couple of occasions to answer Governor Corzine's 

questions about Senator Clinton'5 positions on various policy issues. Chairman Genslec recalls 

seeing Governor Conine at a fundraising event in New Jersey in either August or September of 

2008 for then-Senator Obama. 

Chairman Gensler's Tenure allhe CF1C 

Chairman Gensler began serving as ChailIDan of the CFTC in May 2009. AI the time he joined 

the CITe. Chainnan Gensler detemlined DOt to participate in any CITCmalters involving GS. 

Shortly after joining MFGl in March 2010, Mr. Conine mn with Chainnan Gensler and the 

Chairman's staff al CfTC headquarters. Mr. Conine requested the meeting, which Chairman 

Gensler recalls as a ''meet and greet>' and thai Mr. Corzine did oot make any specific requests to 

Chairman Genslec. 

In November 2010, Mr. Corzine asked Chairman Gensler to speak at a semiDIIJ at Princeton 

University that Mr. Corzine was conducting on financial iostitutions and reguiation.19 Mr. 

Andrew Ross Sorkin also spoke at this seminar. and Mr. Conine introduced both or them. 

Following the seminar, Chairman Gensler joined Mr. Conine and approximately 15-20 students 

for dinner?O Chairman Gensler flfld Mr. Conine did not discuss any issues relating to MFGJ 

while Chairm411 Gensler was at Princeton. 

11 Cbainnan Gensler's conDibution was to the New Jersey State Democratic Party, not directly to 

Senator Comne's campaign for Governor. 

29 A copy ofCha.innan's Gensler's spee<:b can be found at: 

1\np:llwww,cfte,gpv/Pre5sRoom./SpeechesTestimooy!2010lindex,htm. (last visited Nov. 6, 2011). 

Mr. Sorkin was unable to stay for Ihe dinner. 

6 
58 

In December 2010, Mr. Conine and Ms. Ferber met with Chairman Gensler and other CFTC 

~taff. Chairman Gensler doe,o; not recall the subjcct of the meeting or the matters discussed. 

In J~ 2011 , Chainnan Gensler was the keynote speaker at lunch at a conference sponsored by 

Saodler O'Neill and Partners, an investment banking and broker/dealer firm?1 Mr. Conine WlLS 

seated at !he same table as Chainnan Gensler during the Iuru:h. The invitation did not come from 

Mr. Corzine, and Chairman Gensler and Mr, Corzine did not discuss any i~ues relating to MFGl 

while Chairman Gensler was al. ~ conference. 

In September 2011, ChaiIlllan Gensler and Mr. Corzine were both wedding guests ofmutuai 

acquaintances. Chairman Gensler and Mr. Corzine did not discuss any i~ues rdating to MFGI 

while attending the wedding. 

Chairman Gensler has been on two conference cells with Mr. Conine during his lerm as 

Cbaimmn oftheCfTC. The first, on July 20, 201 1, was a cooference call to discuss topics 

relating 10 a ruJemaldng regarding CITC Rules 1.25 and ]0.7.ll Second, Chainnan Gensler 

participated in a series of conference calls with other regulatory authorities and MFGI during the 

days leading up to the filing of the MFGI bankruptcy proceedings. Chairman Gensler is awan: 

that Mr. Corzine was on the line for at least part ofooe of these calls, regarding the European 

bond portfolio. J] Since becoming Chairman of the CITe. Chairman Gensler has nol had any 

private telephone conversations with Mr. Conin~.).1 

Sum!!u!a 

Chaimlan Gensler worKed. with Mr. Corzine during the last 6 years ofCbairman Gensler's tenure 

at GS. During two of those yws (199]-1994), Chairman Gensler reported directly to co-heads 

Messrs. Corzineand Winkelman; during the other four yeaB, Mr. Conine was hi!l second-level 

supervisor. Their relationship during this period was solely professional. Chaimtan Gensler and 

1! Tbefum regularly sponsors such oonfercnees. See, e.g., 

~lPs:ltruislCr,sandlcronei1l .comkortJc:rcocesl (last visited Nov. 6, 20 11). 

J A reoord of this call can be found at 

ht]p;//www.cfic.KOy/LawRegyilllionlDoddFrankAc!lExtemalMeetjngsldfmeeling OUOII 928 

(last visited Nov. 7,201 I). In response to media questiollll as to whether a <klay in oonsideration 

of this rulemaking showed favoritism to MFGI, Chairman Gensler has stated that he has "been 

consistent 00 \his rule, and I allowed more time for others 10 cootinue 10 look at it." Set Sma 

Brush, Bloomberg, "MF Global Didn't Get Preferential Treatment, CFTe's Gensler," Nov. 1. 

2011. 

llit is possible that Mr. Corzine was 00 the line during other portions of these oonfcrcnce calls. 

14 On November 8, 2011, BNA reported that Chainnan Gensler and Mr. Conine spoke shottly 

after Mr. Corzine resigned from his positions at MF Global. ~e Steven Joyce, BNA, "Geosler 

Says Reeusal Decision Made Days Before Conioe Resigoation, Grassley Letter," Nov. 8, 2011 . 

This report is nol accurate; the reported conversation between Chainnan Gensler and Mr. 

Corzine did not occur. 

7 
59 

Mr. Conine did not socialize or spend time IOgetber apart from their mutual professional 

activities.}l 

Since the time they worlttd together III GS over 14 yeaJ'li ago, Chairman Gensler's conlllCls with 

Mr. Corzine have been infrequent Generally, they have met when they both were present at a 

function organized by oth~. Similarly, Chairman Gensler has not socialized with Mr. Conine 

after his departure from GS, nor have their families socialized with eaeh other. Chairman 

Gensler and Mr. Conine do not correspond with each other, Chaimtan Gensler does not recall 

any emails or other electronic communications between himself and Mr. Corzine for at least as 

far baclc as ten years. Chainnan Gensler does not C8Il')' Mr. Corzine's personal phone number in 

his cell phone directory. 

Chairman Gensler-and Mr. Corzine have never attended any of each other! major nollprofessioDailife-events during the entire time they have known each other. Mr. Conine did nol 

attend Chairman Gensler's wedding (which occurred while Chairman Gensler was at GS), the 

bat·mitzvah! of Chairman Gensler's daughters, or the funertll ofCbairman Gensler's wife. 

Similarly, Chairman Gensler did DOt lItIend Governor Corzine's inaugural in 2005 or his wedding 

in 2010. 

Chairman Gell5ler did not ask Mr. Corzine for suppon ofrus nomination as CFTC Chairman. He 

has never contributed directly to any of Mr. Conine's electoral campaigns. He Iw raised money 

for several national Democratic figures, bUI has never soliciied a campaign contribution for Mr. 

Conine. Nor does he recall ever soliciting a campaign contribution from Mr. Corzine. 

C. Rellrionsbip Between Cb,irmaa Gensler . nd Other ForlJl.fr GS Offid.1s 

Working For or 00 8th,lrOr MFGI)6 

Certain other cunent MFGJ employees and officials previously worked at GS at the same time lIS 

Chairman Gensler. Chairman Gensler's relationship with these individuals fs as follows: 

.8taddbe/o1f 

Mr. Abelow became a parmer at GS at llfOuod the time that Chairman Genslerwas leaving GS. 

At some point, Mr. Abelow became hClld ofOTF in Asia, the position Chainnan Gensler had 

previouslyoc:eupicd. Chairman Gensler recalls that when he was in OTF he and Mr. Abelow 

had 8 '\veckly to bi.weekly working relationship." 

IS Chairman Gensler recalls one non.professional inleraCl.ion ihat indirectly involved Mr. Corzine 

during his tenure at GS. In 1991, Chairman Gensler learned that Mr. Corzine had registered to 

run in the New York City Marathon that year. Chairman Gensler recalls that he asked Mr. 

Corzine's secretary whether Mr. Corzine actually wu going to run the marathon. A few weeks 

later Mr. Corzine'.s secretary told Chairman Gensler that Mr. Corzine would not run in the race 

and would not use the number he had been provided. Mr. Conine's secretary gave Mr. 

Corzine's number to Mr. Gensler, who then used Mr. Corzine's bib number in the llICe. 

J6 The facts in this section arc based primarily upon an interview with Chairman Gensler 

conducted on November 4, 2011. 
60 

Aftcr leaving as, Chainnan Gensler did oot see Mr. Abelow until August or September 2008, al 

a fundraiser for the Presidential campaign of then-Senator Obama. As previously noted, 

Govemor Corzine also attended this evenL At the time, Mr_ Abelow was Governor Corzine's 

Chief ofSlBff. Chairman Gensler recalls speaking to Mr. Abelow for approximately five to ten 

minutes lit this evenL 

Chainnan Gensler believes it ili possible that he filly have spoken to Mr. Abelow on one or more 

occasions in his capacity as Governor Corzinc's Chief of Staff to facililBle the discussions with 

Governor Corzine previously noted during the Presidential PrUIIIU)' ~eason prior to the 2008 

eJection. After that, Chairman Gensler did not speak with Mr. Abelow again until one of the 

multi-party conference calls betwcen regulators and MFGI during the weelrend prior to the 

bankruptcy filing ofMFGI. 

Chainnan Gensler and Mr. Abelow did nOI have a social rellltioru;hip apart from their 

professional relationship at GS. 

ChrisWDher FIowm 

Chairman Gensler began working with Mr. Flowers in the M&A department at GS upon his 

anival at GS in 1979. They worked together in M&A for approximately 12 ycars--unlil 

Cbainnan Gensler was u-ansfem:d from M&A tn Fl. While Chairman Gensler was in the M&:A 

department, he and Mr. Flowers frequenUy discussed M&A imles and strategies, but Cbainnan 

Gensler and Mr. Flowers spedaliz.cd in different industries and, to the best of his recollection, 

did not work together on any specific deals. 

After Chairman Gensler left GS, Mr. Flowers visited him once at the Treasury Department 

Chainnan Gensler recalls that as part of this visit they may have had lunch together. 

Chairman Gensler docs not recall seeing Mr. Flowers in pl!lWD since that meeting at tbe 

Treasury Depamnmt. Mr. Flowen called Chairman Gensler twice at the CFTC. With respect to 

the first call, Chairman Gensler recalls tfw Mr. Flowers expressed condolences that his wife had 

passed away, and be provided Chairman Gensler with the name of an individual who was 

knowledgeable about fmancial market reguiatioo.

JJ Mr. Flowers.did not ask for lilly action by 

Cbainnan Gensler or the CfTC. 

In connection with the MFGI mBltCr, Mr. Flowers called Cliairman Gensler on October 31 , 201 1, 

before Chainnan (knsler arrived al the office. ChIIirman Gensler returned Mr. Flowers' call 

after heamved at the office. Several other CFTC employees were present in Cliairman 

Gensler's office forthe call and several individuals were present willi Mr. Flowers, including 

Mr. G1lldfield, Henri Sleenkamp (Chic'fFinanciaJ Officer) and another MFOI official. The 

MFGl officials on me call provided the call panicipants with information regarding MFGI's 

financial SIaM. 

)1 Cbainnan Gensler did not I»lItact that individual and does not recall his or her name. 

9 
61 

Chainnan Gensler and Mr. Flowers did not have a social relationship apart from their 

professional relationship at GS. 

Writ FerIHr 

At the time that Chairman Gensler was in Flat OS, Ms. Ferber was a senior compliance. 

officer/attorney at the firm. Chairman Gensler believes that he may have spoken with Ms. 

Ferber on one: or more compliance matters when he was in Fl, but hedoes not recall anything 

specific. 

After leaving GS, Chainnan GensJa- did not have any contact with Ms. Ferber until he met With 

the BoanI of Directors oflbe Futures Industry Associatioo (FlA) in September 2010. AI the 

time, Ms. Ferber represented MfGl on the FlA Board of Directors. Ms. Ferber also attended the 

meeting between Mr. Corzine and CFTC officials, including Chairman Gensler, in December 

2010. M3. Ferber also was on the July 20, 2011, conference call between MFGI officials 

(including Mr. Corzine) IIfld CFTC officials, including Chairman Gensler, concerning topics 

relating to a CITC rulemaking regarding Rules 1.25 and 30.7. Chainnao Gensler does nol 

believe that he met or spoke with Ms. Ferber after thaI, until she participated in one or more 

multi-party conference calls between MFGJ and regulators prior to the bankruptcy filing. 

Chairman Gensler and Ms. Ferber did not have a social relationship npar! from their professional 

relationship at GS. 

J~ob GQ(4fkld 

Chairman Gensler first met Mr. Goldfield in late 1991 orearEy 1992, after Chainnan Gensler 

began woricing in FI. Mr. Goldfield also I'IOrked in FI, ttading options on the government bond 

""'k. 

At the time that Chainnan Gensler was c:o-head affixed iucome trading in Tokyo, he also had 

c:o-supervisory responsibility for the trading ofVen currency 5WapS conducted in Asia. At the 

same time, Mr. Goldfield, who was located in New York, had 5lIpervisof)' responsibility for the 

worldwide GS swap bonk. Accordingly, Chairman Gensler and Mr. Goldfield had overlapping 

responsibilities widl.l'especl to the GS Yen swap book. Chairman GensJer recalls that he and Mr. 

Goldfield also Inter may have served together aD the Risk Committee. 

Mr. Goldfield visited Chairman Gensler all one occasion al the CFTC. During the coru;idel'lltion 

of the Dodd-Frank legislation, Mr. Goldfield met with Chairman Gensler and at leasl one-other 

member of the Chairman's staff. Mr. Goldfield told the Chaimtan that he was doing good workand ifbe ever needed anything, to give him n call. Chairman Gensler does nOI recall any other 

meetings with Mr. Goldfield since Chainnan Gensler left OS. 

On October 30, 20 11 , Mr. Goldfield e-mailed Cbainnan Genslerto infonn him that be was at 

MF Global "in case there are questions." Mr. Goldfield aJso infonned Mr. Gensler that he bad 

"no fUI8Dciai interest in the company and (WlIS] Dot looking at 'jt for investment."' Mr. Gensler 

asked Mr. Goldfield whether there were "any omelVations you wish to pass along?~ Mr. 

Goldfield replied. "Not as of now, I want only (0 send along novel insigbts that are useful ~ 

Cbainnan Qen5ler responded, "Nove.! and useful. Now those are limiting conditionS, though I 

10 
62 

would say that most everything you have shared over our long knowing eao::h other has been 

useful." Mr.Goldfield then stated, ~Also wll!ll 10 make sure thaI I am right befo~ I comment" 

Chairman Gensler does not recall any funber comments or infonnalion from Mr. Goldfield. 

Mr. Goldfield Was present at MFOI during one of the confe~nces call between MfGI and 

regu1ators on October 30, 2011. To the best of his recollection, Mr. Goldfield did not speak on 

the call. A participant from another regulatory agency who was present at MFGI headquarters in 

New York and who was on the call relayed to C!w.irmllJl Gensler during the clill that Mr. 

Goldfield walked by and requested that he say "hcllo to (xnskr." 

Mr. Goldfield also was present at MFGI during a conference call between MFot and regulators 

on Iile morning of October 31, 2011. 

Chairman Gensler and Mr. Goldfield did not have a social relationship apart from their 

professional relationship at GS. 

m. ' ,ua' StaJldard 

The slllDdard for determining whether an employee may participate in a matter affecting !he 

employee's fllllUlcial interests, Of involving penons wilil whom Iile employee has or has had 8 

professioll8l, business, economic, or persoll8l relationship, is set forth in 5 C.F.R. § 2635.502. 

Spccifiea1ly, § 2635.502(8) provides: 

(a) Consideration of appearances by the employee. Where an employee knows that II 

particular matter involving specific parties is likely to have II direct and predictable effect 

on the financial interest ofa member ofrus household, or knows thai a penon with whom 

he has a covered relationship is or represents a party to such matter. and where the 

employee detennines that the drcumstanoes would cause • reasonable penon with 

knowledge of the relevant facts to question his impartiality in the matter, the employee 

should not participate in the matter unless he has informed the agency designee of the 

appearance problem and received authorization from the ageoc)' designee in accordance 

with parayaph (d) of this section. 

(I) In considering whethCl' a rdationship would cause a reasonable penon to 

questioo his impartiality. an employee may 5Cdt: the !\$Sislance ofhb sUpervisot, 

an agency ethics official or the agency designee. 

(2) Arl employee Who is coneerned thai circumstances other than those 

specifically described in this 5eCtion would raise a question regarding his 

impartiality should use the process described In this section to detemiine whelher 

he should or should not participate in a particular maner. 

With respect to a "covered relationship," § 263S.502(b)(iv) provides that an employee bas a 

"covered relationship" with any person "for whom theemployee has, within (~Irut )'Car, served. 

11 
63 

as officer, director, trustee, general partner, agent, anomey, consultant, contractor oremploye.e," 

(Emphasis added.)ll 

When the circumstances identified in § 2635.502(a) are not prescnt- Le" there is no direct and 

predictable effect on the financial interest ofa member of his household, and tlJere is no covered 

relationship-§ 2635.502(a)(2) provides that the: procedures specified in § 2635.502 should still 

be foll~ if a question concerning the employee's impartiality may nevertheless remain.)9 

II Section 2635.502(b) provides in fun \hat an employee has a "covered relationship" with: 

(i) A person, other than a prospective employer described in § 2635.603(c). with wbom 

the employee has or seeks a business, contractual or olbe! flll8l\CiaI relationship that 

involves otbef than a routine consumer transaction; 

(ii) A person who IS a memwofthe. employee's household, or who is a relative wilh 

whom the employee has 8 close penonal relationship; 

(Hi) A pmon for whom the employee's spouse, pm:nt or dependent child is, 10 the 

employee's knowledge, serving or seeking to serve as an officer, director, ttustee, genem1 

partner, agent, anomey, consultant, contractor or employee; 

(iv) AIly person for whom the employee has, within the lasl YC31', served as officer. 

dire~tor, trustee. general partner, agent, lIttomey, consultant, contnlClor or employee; or 

(v) An organization, other than a political party described in 26 U.S.C. 527(e), in which 

the employee is an active participaot. Participation is active if, for example, it involves 

service as an official of the organization or in 8 capacity similar 10 IhIIt ofa commiUee or 

subcommittee chairperson or spokesperson, or participation in directing the activities of 

the organization. in other cases, significant time devoted to promoting specific programs 

of the organization, including coordination offundraising efforts, i! an indication of 

active participation. Paymenl of dues or the donation or solicitation offlllll.llcial suppon 

do~ not. in illlelf, constitute active participation. 

39 Under these circumstances-where no financial interest is affected and no covered relationship 

e:cists----the Office. ofGovemment Ethics (OGE) does not consider the failure to rollo", these. 

procedures to be "an ethica1lapse": 

OGE has consistently maintained that, although employees are encouraged to use. the 

process provided by section 2635.502(a)(2), 'Jl]he election not to use. that process cannot 

appropriately be considered to be an ethica1lapse.' OGE Informal Advisol)' Lencr, 94 x 

10(2); Ite "(£0 OGE 97 x H (,obligation' to (olklw process where covtted relationships 

involved, but employees 'encouraged' to use process in other ciI'<:UffiS\.ances); OGE 95 x 

5 ('not required by 5 C.F.R. 2635.502 to use tile process described in that section' where 

there is no coverW relationship with person who is a party or represents a party); DOE 94 

x 100IXcmp!oye.e may 'elect' to use process in secltion 2635.502(a)(2), but 'election not 

to use thaI ptOCeS5 should nut be characterized, however, as an 'ethical lapse'). 

" 
64 

"For CJUIJllple." the Office ofGovemment Ethics (ooE) explains, "iCan employee believes that a 

personal friendship, or a professional, social, political or other ass(l(.iation not specificaJlylTeated 

as a cove~ relationship, may raise an appearance question, then the employee should use the 

section 2635,502 process to resolve. the qllCstion.,,40 

In this event, Ullder the § 263S.S02 process, the threshold determination is to "consider whether 

the employee's impartiality would reasonably be questioned if the employee were to participate 

in a particularmaner involving specific parties where persons, with certain personal or business 

relationships with the employee are involved . .041 lrit is determined that the employee's 

participation would "raise a question in the mind ofa reasonable person about his impartiality," 

the agency's designated ethics official may nonetheless authorize the employee to participate in 

the tIlJItter "based 00 a determination, made in light orall relevant circunl5laru:es, that the interest 

of the Government in the employee's participation outweighs the concern that a reasonable 

person may question the integrity oC the agency's progrsrns and operations.oo4Z 

ooE 01 x 8, Impartiality and Rom!lOtic Relationships, August 23, 2001. OGE has further 

indicated that in such circlUlllilance:i, "even ifi! were now determined, in hindsight, that a 

reasonable person with knowledge of the circumstances would question the [persoo's] 

impartiality, we cannot say that she violated the impartiality ruJe.

H Id 

.co OGE, Memorandum dated April 26, 1999, from Stephen O. POItS, Director, 10 Designated 

Agency Ethics Officials, Regarding Recusai Obligations!lOd Screening Arrangements, 99 x 8. 

Under section 263S-S02(a)(2), an employ~e may determine not to participate in a matter due [0 

:p~ce concerns even iftllat employee's withdrawal is not required. /d. 

4 ld. S C.P.R. § 263S,S02(c). 

-u S C.F.R. § 263S.S02(d). This section provides the following factors that may be considered in 

making this detem\ination: 

(1) The nature of the relationship involved; 

(2) The effect that resolution of the matter would bave upon the fmancial interests oCtile. 

person involved in the relationship; 

(3) The nature and importance of the employee's role in the maner, including the extent 

to which tile employee ii called upon 10 exercise discretion in the matter; 

(4) The sensitivity oftbe mailer, 

(S) The difficulty of reassigning the matter 10 another employee; and 

(6) Adjusunl:l\ts that may be made in the employee's duties that would ~ucc or 

eliminate tbe likelihood that a reasonable person would question the employee'& 

impartiality. 

13 
65 

IV. AnaMIs 

Is there Q fimmdal inlewt or "corew nlaflonship "? 

Neither Chainnan G1:nsler nor any member ofms household his a finencial interest in MFGl, or 

in any commodity or Sti:urity interest held by MFGL More broadly, neither Chairman Gensl~r 

nor any member of his household has any other fmancial interest that would be predictably or 

directly affected by I CFTC investigation involving MFGI or associated CFTC actions, 

induding participation in the MFGl bankruptcy proceedings, and the recovery of customer 

funtb. Acoordingly, the resolution of tile MFGT matter would not havc a "direct and predictablc" 

effect upon the financial interests ofChairmM Gensler or My member ofms household. 

Chairman Gensler does not have a "covered relationship" with MFGI or any of its employees, 

officers, directors, or shareholders. Chairman Gensler's partnership with GS, Mr. Corzine, and 

other paItne~ at GS terminated in 1997, more than 14 ~ars ago. This is far beyond the one-year 

"cooling off period" provided in § 2615.502(bXiv) for 8 person who was a genernl ~ with 

another penon to be considered to have a "covered relationship" with sucb other person.~l 

Is Ihere a reasonable Ixyjs (Q glleslion Ihe emP/Q.ree ', ;moarllaUtv? 

The sole fact that Chairman Gensler at one time was a business partner with Mr. Corzine, 

without more, does not constitute a reasonable basis, within the meaning of § 2635.502, to 

question Chairman Gensler's impartiality with respect to mamrs relating to MFGI. 

Once the one-year cooling-off period has passed, the fact iha.l an employee previously was 

within a covered relationship with respect to another individual, without more., cannot by itself 

be the basis to reasonably question lUI employee's impartiality. To hold otherwise would, in 

effect, lrlmSfonn the one·year cnolillg off period into a lifetime prohibition, for in every such 

instance the CQvered relationship within the ooo-year period could be cited as the basis for 

disqualification beyond the one-year period .... 

The ethics regulations do not requi~ such a result. To the CQnirary, the procedures in § 2635.502 

clearly con~mplate that employees who at one time may have had a covered relationship with 

respect to another person or entity, but that no longer have such a covered relationship, may 

participate ill a mailer involving the person or entity that previously was within the covered 

relationship. 

To constitute a reasonable basis to question ChainnllJl Gensler's impartiality, therefore, there 

must be some additional indicia ofa relationship between Chainnan Gensler lIJld Mr. Corzine, 

GS, or il.!l partners, beyond the factors thaI would establish a covered relationship-i.e., fdets in 

OJ 5 C.F.R. § 2635.502{b)(iv). As previously noted, OGE has stared that if no financial interest is 

involved and a covered relationship is not present, a detennination not 10 follow the prncedll/"es 

in § 2635.502-and hence 10 participate in the maner-cannol be considered to be an "cthical 

laJm." Nonctheless. in acwroance with DOE recommendations, Chainnan Gensler has 

detmnined to follow the § 2635.502 process. 

«This conclusion is consistent with the OGE position that in ci.rcwnstances in which no 

financial interest is involved and a covered relationship is not present, a determilllltion not to 

follow the procedures in § 2635.502 cannOI be considered to be an "ethical lapse." 

" 
66 

addition to Chairman Gensler's partnership 8t GS some 14 years ago. H6W1:ver, the facts 

regarding Chainnan Gensler's relationship with Mr. Corzine and others at GS who are now 

associated with MFGI - both during the time that Chairman Gensler worked al OS and 

afterwards -- are insufficienl to provide such indicia. 

The record set forth above indicates chat 811111 times, both during their partnership and 

afterwards, the rc1ationmip between Chairman Gensler and Mr. Corzine was exclusively a 

professional relationship. Chairman Gensler and Mr. Corzine did not socialize or meet apan 

ftom their professioMl obligations and interests. The rewrd indicates that since Chairman 

Gensler and Mr. Conine left OS in the late 1990s, they have mel only infrequently and solely on 

matters of mutual professional interest. Indeed, most of their encowlters have a«urred when 

they both have been inviled to onend on event by others. Although both Chairman Gensler IISld 

Mr. Corzine have been involved in political fundmising and electoral campaigning. neither has 

done so on the other's behalfor at the other's request. They have nol socialized, and they have 

not been involved in caeh olber's personal lives. Their infrequent professional contacts, over a 

14-year period following their departure from their partnership at GS, do not constitute a oovered 

relationship or a simillll" type of relationship that would form a reasonable basis under section 

2635.502 to question Chairman Gensler'S impartialitY with respecl to MFG!. 4! 

Following his departUre from GS, Chairman Gensler's cootacts with Mr. Abelow, Mr. Flowers, 

Ms. Ferber, and Mr. Goldfield have been more attenuated than his contacts with Mr. Corzine. 

Based on the highly infrequeot na~ of Chairman Gensler's contacts with these individuals 

since he left the GS partnelShip in 1991, Chairman Gensler's relationships with these 

individuals, both individually and collectively, are insufficient to constitute a reasonahle basis 

under section 2635.502 to question Chairman Gensler's impartiality with respect to MFG!. 

In swn, this review determines, based on the facts IIOd circumstance; stated herein, that there is 

oot a reasonable basis under 5 C.F.R. § 2635.502 to qUCsriOD Chainn.an Gensler's impartiality 

with respect to the Commission's investigation ofMFGI and involvemeot in related matters, 

such lIS the MFGI bankruptcy proceedings. Accordingly, 5 C.F.R. § 2635.502 does not preclude 

Chairman Genslu's participation in these maners, and Chairman Gensler is 001 required to 

withdraw from participation. From a legal and ethical perspective, Chainnan Gensler's 

participation in Commission maners involving MFGl \¥Quid not be improper.

oIIi 

., ChaUrnan Gensler's contribution to the New Jersey Stale Democratic Party at the time Mr. 

Corzine was campaigning for GovernorofNew Jersey is not sufficient to warrant a different 

conclusion. During this lime period/ Chairman Gensler was an active fundraiser for and 

contributor to Democratic candidates for elected office in many statts. Chllirman Gensler's 

contribution to the New Jt1Sey Stale Democratic Party then:rore is not sufficient to establish a 

special relationship between Chairman Gensler and Mr. Corzine that \¥Quia warrant a different 

conclusion. 

oIIi This review solely addresses ma~rs before the Commission prior to and at the time of the 

Chairman's election not 10 participate and is based on the facts contained herein. 

" 
67 

Q.10. Chairman Gensler, according to a March 1, 2011 MF Global 

filing at the Securities and Exchange Commission (SEC), the compensation committee of MF Global’s board ‘‘believes that Mr. 

Corzine’s leadership improved posture with regulators.’’ 

How did MF Global’s posture improve with the CFTC under Mr. 

Corzine’s leadership? 

A.10. I have no information regarding the basis of the statement 

in the filing. 

Q.11.–1. Chairman Gensler, according to Mr. Corzine’s Congressional testimony, you gave a luncheon speech at a conference sponsored by the investment firm of Sandler & O’Neill on June 9, 2011. 

During the question and answer session, Mr. Corzine asked you 

about proposed changes to Rule 1.25. 

• What specific question did he ask? What was your answer? 

• Did you have any other discussions about Rule 1.25 with Mr. 

Corzine? 

Q.11.–2. According to a memo posted on the CFTC’s Web site, on 

July 20, 2011, Mr. Corzine called you regarding Rule 1.25. Discussion included ‘‘MMMFs, asset-backed and issuer-based concentration limits, counterparty concentration limits, in-house transactions 

and repurchase agreements with affiliates.’’ 

• Please provide more details about the discussion. 

• Who else participated on the call? 

A.11.–1.–2. For the convenience of the Committee, I include a document (Insert 1 previously referenced) that will address a number 

of questions. The included document is a Memorandum detailing 

my activities prior to my withdrawal from participation in the matter. The document includes details, to the best of my recollection, 

of contacts with Mr. Corzine. 

Q.12. Chairman Gensler, according to Mr. Corzine’s Congressional 

testimony, you and Mr. Corzine attended a wedding celebration of 

mutual friends on September 14, 2011. 

Please provide the details of any discussions you had with Mr. 

Corzine regarding MF Global or CFTC regulation while attending 

that wedding celebration. 

A.12. For the convenience of the Committee, I include a document 

(Insert 1 previously referenced) that will address a number of questions. The included document is a Memorandum detailing my activities prior to my withdrawal from participation in the matter. 

The document includes details, to the best of my recollection, of 

contacts with Mr. Corzine. 

Q.13.–1. Chairman Gensler, when did you first learn that Moody’s 

had downgraded MF Global on October 24, 2011? What specific actions did you take based upon the downgrade? 

Q.13.–2. Did you have direct conversation, or were you part of conversations, with any firms that were considering buying part or all 

of MF Global’s business over the weekend of October 29, 2011 and 

October 30, 2011? If so, what was the nature of those conversations, and who was involved? 
68 

Q.13.–3. Please provide details (including dates, times, and topics 

discussed) of the communications (e.g., phone calls, emails, text 

messages, etc.) you had with Jon Corzine, or any of his agents or 

representatives, or any senior members of MF Global, or any of 

their agents or representatives, from October 24, 2011 through November 1, 2011. 

A.13.–1.–3. During the week of October 24, 2011, as MFG’s financial condition deteriorated, CFTC staff became involved in monitoring the firm’s financial condition. During that week, the other 

Commissioners and I were briefed by Commission staff about ongoing developments, including that the firm had been downgraded by 

Moody’s. During that week and increasingly over the last weekend 

of October, I was involved in discussions with other regulators regarding the developments. During a call with regulators on the 

evening of October 30, representatives of a firm, Interactive Brokers, considering facilitating the transfer of MFG customer positions also participated. My involvement was in furtherance of the 

CFTC’s effort to ensure to the maximum extent possible the protection of customer property that had been entrusted to MFG. Though 

it was not always apparent which representatives from MFG were 

present on calls with regulators over the weekend of October 29– 

30 and into the morning of October 31, to the best of my knowledge 

and recollection, Mr. Corzine was on the line for at least part of 

one of these calls, and discussed matters regarding MFG’s European bond positions. 

Q.14. Chairman Gensler, over the weekend of October 29, 2011 and 

October 30, 2011, MF Global employees were trying to reconcile a 

$900 million under segregation figure. When did you first learn 

about it? 

A.14. I first learned in the early morning hours of October 31, 

2011, that the firm was reporting a shortfall in the segregated accounts under section 4d of the Commodity Exchange Act. 

Q.15. Chairman Schapiro and Chairman Gensler, under your management, the SEC and the CFTC have been in violation of the law 

for failing to meet 73 statutory deadlines for rulemaking set by 

Dodd-Frank. 

Can you assure this Committee that your agencies will be in 

compliance with all applicable Dodd-Frank deadlines that are due 

by the end of this year? If not, please explain why your agencies 

are missing so many statutory deadlines. 

A.15. The Dodd-Frank Act had a deadline of 360 days after enactment for completion of the bulk of our rulemakings—July 16, 2011. 

Both the Dodd-Frank Act and the Commodity Exchange Act (CEA) 

give the CFTC the flexibility and authority to address the issues 

relating to the effective dates of Title VII. This flexibility has allowed us to approach the rulemaking process thoughtfully—not 

against the clock. We have coordinated closely with the SEC on 

these issues. Last year, the CFTC granted temporary relief from 

certain provisions that would otherwise have applied to swaps or 

swap dealers on July 16, 2011. The Commission has extended that 

relief to accommodate its implementation schedule. 
69 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY 

FROM CFTC STAFF 

Q.1. As I mentioned at the hearing, according to the CME’s 

timeline, a CFTC employee gave two CME employees a disc containing documents to support the October 26, 2011 segregated 

funds statement on the evening of October 30. 

• When did the CFTC receive the disc from MF Global? 

• When did the CFTC begin reviewing the documents on the 

disc? 

• What was the result of the review of these documents? Did it 

show any shortfall? 

• What specific actions did the CFTC take after reviewing the 

documents? 

• Could you provide the Committee with copies of the documents 

on the disc? 

A.1. At some point after 5 p.m. CDT, and possibly at approximately 

5:30 p.m. CDT, on October 28, 2011, MF Global gave a CFTC employee three computer discs. Staff did not at that time undertake 

a comprehensive review of the discs. A subsequent review of a larger set of records including the information on the discs reflected a 

shortfall in the customer segregated funds as of Wednesday October 26, 2011. 

Q.2. The CFTC had staff onsite at MF Global’s Chicago offices the 

weekend before the firm’s bankruptcy filing. 

• What specific steps did your agency take to protect customer 

assets prior to learning that customer assets were missing? 

• What date and time did CFTC staff first learn that there was 

a possible shortfall in the customer segregated accounts? How 

did the CFTC staff learn about the possible shortfall? 

• What date and time did CFTC staff first learn that there was 

a definite shortfall in the customer segregated accounts? How 

did the CFTC staff learn about definite shortfall? 

• After you learned of the missing customer assets, what specific 

steps did your staff take to ensure that additional customer 

funds were not improperly transferred? 

A.2. Between 2 p.m. and 2:30 p.m. CDT, Sunday October 30, 2011, 

a CFTC employee and MF Global employee had a brief conversation from which the CFTC employee understood there was a deficiency or discrepancy in the segregated account. On October 31, the 

Securities Investors Protection Corporation with the support of the 

CFTC and the consent of MF Global initiated a liquidation proceeding under the Securities Investors Protection Act of 1970 

(SIPA) to protect the customers of MF Global. In FCM bankruptcies, commodity customers have, pursuant to section 766(h) of 

the Bankruptcy Code, priority in customer property. If customer 

property is insufficient to satisfy in full all the claims of customers, 

Part 190 of the Commission’s regulations allows other property of 

the debtor’s estate to be classified as customer property to make up 

any shortfall. 
70 

Q.3. Who is responsible for the protection of commodity customer 

funds at a futures commission merchant (FCM)? 

A.3. Under the Commodity Exchange Act, an FCM must treat all 

money, securities and property received from a customer as margin 

for the trades or contracts of that customer as belonging to that 

customer. Furthermore, all customer money, securities, and property must be separately accounted for and segregated from the 

FCM’s proprietary funds. The FCM cannot use funds deposited by 

one customer to margin or secure trades for another customer. 

Commission Regulation 1.20 requires that accounts holding segregated funds be titled specifically to identify the contents of the 

account as separate from the ownership of the FCM. In addition, 

FCMs must obtain letters from their depositories acknowledging 

that the funds deposited in those accounts are customer funds and 

must be treated as such under the CEA—i.e., such depositories are 

prohibited from treating them as belonging to the FCM or any person other than the customer. Commission Regulation 1.12 requires 

FCMs to notify the Commission immediately of any occurrence of 

under-segregation. 

Q.4. As I mentioned at the hearing, according to the CME’s 

timeline, a CFTC employee gave two CME employees a disc containing documents to support the October 26, 2011 segregated 

funds statement on the evening of October 30. 

• When did the CFTC receive the disc from MF Global? 

• When did the CFTC begin reviewing the documents on the 

disc? 

• What was the result of the review of these documents? Did it 

show any shortfall? 

• What specific actions did the CFTC take after reviewing the 

documents? 

• Could you provide the Committee with copies of the documents 

on the disc? 

A.4. At some point after 5 p.m. CDT, and possibly at approximately 

5:30 p.m. CDT, on October 28, 2011, MF Global gave a CFTC employee three computer discs. Staff did not at that time undertake 

a comprehensive review of the discs. A subsequent review of a larger set of records including the information on the discs reflected a 

shortfall in the customer segregated funds as of Wednesday October 26, 2011. 

Q.5. What authorities does the CFTC have to protect customer segregated accounts at a futures commission merchant (FCM) during 

an emergency situation? 

A.5. An FCM is required to hold sufficient funds in segregated accounts to meet the aggregate total account balances of each of the 

FCM’s customers trading on designated contract markets. When 

the firm does not hold sufficient funds in segregation to meet the 

account balances of each of its customers, the Commission can initiate an enforcement action to freeze the customer segregated accounts at the FCM to prevent the FCM from removing funds without appropriate court approvals. If the FCM also is undercapitalized, Commission Regulation 1.17 provides that the FCM must 
71 

transfer customer accounts to another FCM, and cease operating as 

an FCM. If the FCM can immediately demonstrate to the satisfaction of the Commission that it has the ability to come back into 

compliance with the minimum capital requirements, the Commission may grant the FCM up to a maximum of 10 business days to 

achieve compliance without having to transfer customer accounts. 

It is often preferred in an emergency situation to transfer customer 

accounts and margin funds from the failing FCM to a financially 

sound FCM. The transfer of the customer accounts and margin 

funds may pose less of a disruption to customers than a court order 

freezing customer accounts. 

Q.6. In May 2011, FINRA determined that MF Global had a capital 

deficiency. MF Global CEO Jon Corzine personally appealed that 

decision to the SEC. The SEC upheld FINRA’s determination and 

MF Global publicly reported the deficiency in August 2011. 

• When did the CFTC first learn that MF Global had a capital 

deficiency? How did the CFTC learn about it? 

• In your view, how effective was the SEC’s and CFTC’s coordination of the regulation of MF Global? 

A.6. The CFTC learned that MF Global had a capital deficiency in 

or about late August 2011. In particular, MF Global submitted a 

letter to the Commission dated August 25, 2011 stating that on August 24, 2011 FINRA had advised the firm that its capital treatment of certain repo to maturity transactions should be modified 

resulting in increased capital requirements under SEC Rule 15c3– 

1. The letter further stated that the firm had increased its capital 

prior to being advised of the increased capital requirement by 

FINRA, and that its excess net capital on August 24, 2011 was approximately $113 million after giving effect to the additional capital requirements for the repo to maturity transactions. By letter 

dated August 30, 2011, and received by the Commission on August 

31, 2011, MF Global stated that on August 29, 2011, FINRA had 

directed the firm to restate its July 2011 FOCUS Report with the 

revised capital treatment for the repo to maturity transaction. The 

restated FOCUS Report was filed with the Commission on August 

31, 2011 and showed MF Global to be undercapitalized at the end 

of July 2011. 

Q.7. In December 2009, MF Global settled an enforcement action 

with the CFTC arising from multiple risk supervision failures. 

• Following that enforcement action, what specific steps did you 

take to ensure that MF Global customer assets were not at 

risk of being misappropriated? 

A.7. The Commission’s order imposed a $10 million civil monetary 

penalty and required MF Global to comply with several undertakings, including enacting policies and procedures to enhance risk 

monitoring procedures, training, compliance procedures and compliance audit procedures. MF Global was also required to undertake 

an independent review and assessment. The assessment, among 

other things, was to review the effectiveness of existing and future 

risk management, supervisory and compliance policies and procedure at MF Global. 
72 

Q.8. MF Global filed its 10–K for the fiscal year ended March 31, 

2011, disclosing detailed information about its exposure to European sovereign debt in its repo-to-maturity portfolio. What specific 

actions did the CFTC take based upon the information contained 

in MF Global’s 10–K? 

A.8. MF Global was placed on heightened financial surveillance in 

March 2008 by its designated self-regulatory organization, the 

CME. The heightened financial surveillance required MF Global to 

provide the CME, on a daily basis, with a net capital computation 

and computations demonstrating its compliance with its obligation 

to segregate customer funds under Section 4d of the Commodity 

Exchange Act and to set-aside customer funds for trading on nonU.S. contract markets under CFTC Regulation 30.7. MF Global 

also filed copies of its daily capital and customer funds calculations 

with the CFTC. Staff of the CME and CFTC reviewed the daily 

submissions to assess MF Global’s compliance with the CFTC’s capital and customer funds protection requirements. 

Q.9. On August 31, 2011, MF Global amended its FOCUS report for July to report a capital deficiency of $150 million as of July 31, 

2011. What specific actions did the CFTC take based upon the 

amended FOCUS report? 

A.9. The CFTC learned that MF Global had a capital deficiency in 

or about late August 2011. In particular, MF Global submitted a 

letter to the Commission dated August 25, 2011 stating that on August 24, 2011 FINRA had advised the firm that its capital treatment of certain repo to maturity transactions should be modified 

resulting in increased capital requirements under SEC Rule 15c3– 

1. The letter further stated that the firm had increased its capital 

prior to being advised of the increased capital requirement by 

FINRA, and that its excess net capital on August 24, 2011 was approximately $113 million after giving effect to the additional capital requirements for the repo to maturity transactions. By letter 

dated August 30, 2011, and received by the Commission on August 

31, 2011, MF Global stated that on August 29, 2011, FINRA had 

directed the firm to restate its July 2011 FOCUS Report with the 

revised capital treatment for the repo to maturity transaction. The 

restated FOCUS Report was filed with the Commission on August 

31, 2011 and showed MF Global to be undercapitalized at the end 

of July 2011. 

Q.10. Please provide the details regarding any discussions of MF 

Global at any of the Intermarket Financial Surveillance Group’s 

(IFSG’s) meetings or calls in 2011, including IFSG’s annual meeting on October 19, 2011. 

A.10. The IFSG is comprised of securities and futures self-regulatory organizations. Though the CFTC is not a member, CFTC 

staff did attend the meeting on October 19, 2011. The SEC and 

FINRA led the discussion of the topic of European sovereign debt 

and the potential impact on broker-dealers. FINRA discussed how 

it had reviewed the largest broker-dealers and did not identify any 

material exposures to European sovereign debt with the exception 

of MF Global. The SEC also had reviewed the broker-dealers for 

exposure to foreign sovereign debt, and noted no major concerns 

(other than MF Global). FINRA also discussed how FINRA and the 
73 

SEC had required MF Global to take additional capital charges on 

its European sovereign debt positions. The capital charges were 

retroactive to the end of July 2011. MF Global increased its capital 

in August, when informed of the capital charges. The retroactive 

application of the charges to the end of July 2011, however, caused 

MF Global to be undercapitalized as of the end of July 2011. 

FINRA discussed how it was going to continue to monitor brokerdealer exposure to foreign sovereign debt on an ongoing basis. 

Q.11. When did you first learn that MF Global had retained 

Evercore to explore selling its FCM business? When did you first 

learn that MF Global had instructed Evercore to explore selling the 

entire firm? 

A.11. CFTC staff do not recall any direct interaction with Evercore 

partners. However, often in the case of a failing FCM, a preferred 

option is to accomplish the transfer of customer accounts and margin funds from the failing firm to a financially sound FCM. Such 

a transfer would normally pose less of a disruption to customers. 

Q.12. Over the weekend of October 29, 2011 and October 30, 2011, 

MF Global employees were trying to reconcile a $900 million under 

segregation figure. When did CFTC staff first learn about this reconciliation? 

A.12. Between 2 p.m. and 2:30 p.m. CDT, Sunday October 30, 

2011, a CFTC employee and MF Global employee had a brief conversation from which the CFTC employee understood there was a 

deficiency or discrepancy in the segregated account. 

Q.13. What CFTC staff members were onsite at MF Global on each 

of the following days? 

• Monday, October 24, 2011 

• Tuesday, October 25, 2011 

• Wednesday, October 26, 2011 

• Thursday, October 27, 2011 

• Friday, October 28, 2011 

• Saturday, October 29, 2011 

• Sunday, October 30, 2011 

• Monday, October 31, 2011 

A.13. Roughly, up to seven CFTC staff members were present at 

various times at MF Global’s offices in Chicago and New York from 

October 27 to October 30, 2011. 
74 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Written Testimony of Public Citizen 

Bartlett Naylor, Financial Policy Advocate 

Implementing Derivatives Reform: Reducing Systemic Risk and Improving 

Market Oversight 

May 22,2012 

Before the: 

The Committee on 

Banking, Housing and Urban Affairs 

U.s. Senate 

The Honorable Tim Johnson. Chair 
75 

Chairman Johnson, Ranking Member Shelby, Committee Members and distinguished 

panelists. 

My name is Bartlett Naylor and I am the Financial Policy Advocate for Public Citizen's 

Congress Watch Division. Public Citizen is a national non-profit and we work to take 

on powerful interests on behalf of the American public, working to win concrete results 

for our health and well-being. 

I submit the following report: "Forgotten Lessons of Deregulation: Rolling Back DoddFrank's Derivatives Rules would Repeat a Mistake that led to the Financial Crisis," by 

Taylor Lincoln, Research Director of Congress Watch. 

As Mr. Lincoln's report explains, there is little dispute that inadequate regulation of 

derivatives was a major contributor to the financial crisis of 2008. Congress approved 

important measures in the Dodd-Frank Wall Street Reform Act. But a number of bills 

proposals threaten to create large oversight-free zones that could allow risky behaviors 

to flourish. 

We've stumbled down this path of deregulation before. We ask the committee members 

to consider this history as a cautionary tale. 
76 
77 

Acknowledgments 

This report was written by Taylor Lincoln, Research Director of Public Citizen's Congress 

Watch division. Congress Watch Financial Policy Advocate Bartlett Naylor provided expert 

advice. Congress Watch Director David Arkush edited the report. 

About Public Citizen 

Public Citizen is a national non-profit organization with more than 250,000 members and 

supporters. We represent consumer interests through lobbying, litigation, administrative 

advocacy, research, and public education on a broad range of issues including consumer 

rights in the marketplace, product safety, financial regulation, safe and affordable health 

care, campaign finance reform and government ethics, fair trade, climate change, and 

corporate and government accountability. 

PUBLICCITIIEN 

Public Citizen's Congress Watch 

215 Pennsylvania Ave. S.E. 

Washington, D.C. 20003 

P: 202-546-4996 

F: 202-547-7392 

http://www.citizen.org 

© 2012 Public Citizen. All rights reserved. 
78 

Public Citizen Forgotten Lessons of Deregulation: Derivatives 

"The sophisticated counterparties that use [over-thecounter] derivatives simply do not require the same 

protections under the [Commodities Exchange Act] as 

those required by retail investors." 

-President's Working Group on Financial Markets (1999), 

consisting of Federal Reserve Chairman Alan Greenspan, SEC 

Chairman Arthur Levitt, Treasury Secretary Lawrence Summers, 

and CFTC Chairman William 1. Rainer 

Although debate continues over some of the root causes of the 2008 financial crisis, 

there is little dispute that inadequate regulation of derivatives was a major 

contributor. In admissions of the sort not often heard in Washington, many of the policy 

makers who supported derivatives deregulation in the late 1990s now acknowledge that 

they were wrong. They include former President Bill Clinton, former Federal Reserve 

Chairman Alan Greenspan, and, with more nuance, two former Treasury secretaries. 

In the first decade of the 2000s, derivatives issuers used their regulatory exemption to take 

enormous risks. Derivatives buyers, in turn, drew a false sense of security from the 

promises laid out in the contracts they purchased. This illusion of security spurred a 

lending binge that caused housing prices to soar. After the housing bubble burst, the 

inability of derivatives issuer American International Group (AIG) to make good on its 

obligations threatened to cause cataclysmic failures among financial institutions. This was 

largely responsible for prompting the federal government to authorize hundreds of billions 

of dollars in bailouts. The combination of the financial crisis and a devastated housing 

market caused a recession from which the nation has yet to recover. 

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 addressed many 

of the shortcomings in derivatives oversight. But, now, at least nine bills are pending in 

Congress that would erode the derivatives' reforms in Dodd-Frank. Some of these bills seek 

to exempt large classes of derivatives trades from the law's requirements that such trades 

be transparent, guaranteed by centralized clearing organizations, and accompanied by 

adequate collateral. Other bills would impose additional burdens on agencies' ability to 

promulgate financial services regulations, including those regarding derivatives. Each of 

the seven derivatives bills introduced in the House of Representatives has at least been 

approved by a committee and three have passed the full House. [See Appendix] The push to 

roll back the reforms in Dodd-Frank comes amid news that IPMorganChase, the nation's 

May 2012 3 
79 

Public Citizen Forgotten Lessons of Deregulation: Derivatives 

largest bank, lost at least $2.3 billion-and may eventually lose more than $4 billion-from 

recent derivatives trades gone awry.l 

The effort to exclude certain derivatives trades from public oversight is reminiscent of the 

campaign to deregulate derivatives in the late 1990s. Americans should reject such appeals 

this time around. 

A. History: At the End of the Clinton Administration, the Federal Government Deregulated 

Financial Derivatives. 

Financial derivatives are instruments "that gain or lose value as some underlying rate, 

price, or other economic variable changes," according to a definition offered by the 

Congressional Research Service. 2 Although they are commonly tied to commodities, 

securities, interest rates, or currency values, derivatives can be based on almost anything, 

including stock prices, energy prices, or even the weather.3 Derivatives have traditionally 

been used to manage risk. 

A type of derivative called a swap was developed in the 1980s. Participants in swaps 

agreed to pay one or the other depending on the fluctuation of an underlying variable.4 

Swaps often performed the same economic function as traditional futures, in which a party 

agreed to buy a commodity or financial instrument on a specified date.s But in contrast to 

futures, which were traded on regulated exchanges and backed by centralized 

clearinghouses, swaps began as privately negotiated deals between counterparties and 

were traded on an unregulated "over the counter," or OTC, basis.6 Unlike traders using 

regulated exchanges, the participants in over-the-counter trades relied on each another to 

make good on their deals. 

1 Dan Fitzpatrick and Gregory Zuckerman, Three to ExitJ.P. Morgan Drew, Others to Departin Wake of Loss, 

Which Could Total More Than $4 Billion, THE WALL STREET JOURNAL (May 14, 2012), http://on.wsj.comfl19m82. 

2 MARK JICKLlNG, CONGRESSIONAL RESEARCH SERVICE, THE COMMODITY FUTURES MODERNIZATION ACT (2003), 

lillp--il!li.tJyJlliYB c K. 3 See, e.g., Bank for International Settlements (BIS), Semiannual OTC Derivatives Statistics at End-June 2011 

(Nov. 2011), http://bit.ly/3iisbfl. 

4 The Commodity Future Trading Commission defined swaps as "an agreement between two parties to 

exchange a series of cash flows measured by different interest rates, exchanges rates, or prices with payment 

calculated by reference to a principal base (notional amount)." 

5 For discussion of the similarities of swaps and futures, see MARK fICKLING, CONGRESSIONAL RESEARCH SERVICE, 

THE COMMODITY FUTURES MODERNIZATION ACT (2003) (Swaps "serve the same economic purposes and are often 

interchangeable" with futures) and Michael Greenberger, Derivatives in the Crisis and Financial Reform in THE 

POLITICAL ECONOMY OF FINANCIAL CRISES 4 (Gerald Epstein & Martin Wolfson eds., Oxford University Handbook, 

forthcoming) ht1P-~.YYxUxX ("Swaps contained all the features of a futures contract"). 

6 See, e.g., GENERAL ACCOUNTING OFFICE, THE COMMODITY EXCHANGE ACT, LEGAL AND REGULATORY ISSUES REMAIN 1 

(April 1997), httl':111 usa.~oYlIb09tp. 

May 2012 4 
80 

Public Citizen Forgotten lessons of Deregulation: Derivatives 

The absence of transparency in over-the-counter trading allowed swaps dealers to 

command more favorable prices. Trading over the counter also enabled dealers to dodge 

the licensing and margin requirements imposed by regulated exchanges. But because 

swaps were similar to futures, they were potentially in violation of the CEA's exchangetrading requirement. This left open the possibility that a court would refuse to enforce a 

swap if a counterparty questioned its legality.7 Consequently, swaps dealers sought an 

exemption to the exchange-trading requirement that would give them legal certainty.s 

The Commodity Futures Trading Commission (CFTC) in 1989 provided an exemption to the 

exchange-trading requirement for swaps that were individually negotiated and not 

marketed to the public. But doubt existed over the CFTC's permission under the CEA to 

offer this assurance. Congress subsequently granted the CFTC such authority. In 1993, the 

CFTC stipulated that non-standardized swaps negotiated between two parties would be 

exempt from the exchange-trading requirement.9 

Still, questions remained over the legality of many over-the-counter swaps. By the mid1990s, swaps were becoming increasingly standardized, largely due to master agreements 

provided by the International Swaps Dealers Association (now the International Swaps and 

Derivatives Association).10 "OTC derivatives were now so ... standardized that they could 

be traded electronically on a multilateral basis, thereby exhibiting all of the trading 

characteristics of traditional exchange traded standardized futures contracts," University of 

Maryland law professor Michael Greenberger testified to the congressionally appointed 

Financial Crisis Inquiry Commission (FCIC) in 2010.11 Greenberger served as director of the 

CFTC's Division of Trading and Markets in the late 1990s, when questions over regulation 

of derivatives hung in the balance. 

Such standardization raised the prospect that many contracts trading over-the-counter did 

not meet the terms of the CFTC-issued exemption from the exchange-trading requirement 

and, thus, could be disallowed.12 Meanwhile, over-the-counter trading of swaps and other 

derivatives was soaring. The notional value of over-the-counter derivatives contracts 

tripled from 1994 to 1997, to more than $28.7 trillion.13 

7 Michael Greenberger. Derivatives in the Crisis and Financial Reform in THE POLITICAL ECONOMY OF FINANCIAL 

CRISES 4 (Gerald Epstein & Martin Wolfson eds., Oxford University Handbook, forthcoming) 

http://hit.lyiYY.,,-UliX [Hereinafter DERIVATIVES IN THE CRISIS] 

sId. 

'ld. 

10 ld. 

11 Testimony of Michael Greenberger to the Financial Crisis Inquiry Commission (June 30, 2010), 

12 DERIVATIVES IN THE CRISIS, at 5-6. 

13 Commodity Futures Trading Commission, Concept Release CFR Parts 34 and 35, Over-the-Counter Derivatives, 

63 Fed. Reg. 26114, 26115 (issued May 6, 1998) [Hereinafter CONCEPT RELEASE]' Notional value refers to the 

target price underlying asset to which a derivative is pegged. For instance a barrel of oil may have a notional 

May 2012 5 
81 

Public Citizen Forgotten Lessons of Deregulation: Derivatives 

"I have 13 bankers in my office and they say if you go 

forward with this, you will cause the worst financial 

crisis since World War 11." 

-Assistant Secretary of Treasury Lawrence Summers to CFTC 

Chairman Braoksley Barn on Born's plan ta cansider increasing 

regulation of derivatives (1998) 

Instances of investors experiencing wholly unexpected losses in over-the-counter 

derivatives trades also were increasing. Many such losses were suffered by ostensibly 

sophisticated investors who did not grasp derivatives' complexity.14 Most prominently, 

Orange County, Calif., lost $1.5 billion in derivative investments in 1994 and was forced to 

file for bankruptcy. Merrill Lynch, which sold the derivatives to the county, eventually paid 

$400 million to settle claims that it provided deceptive information.1s Several other large 

institutions suffered significant losses in derivatives during the 1990s. In many cases, they 

were able to recoup part of their losses in litigation against the firms that guided them in 

their investments,16 

The rising volume of over-the-counter derivatives trades coupled with lingering doubts 

over their legality created political tension. CFTC Chairman Brooksley Born favored 

increaSing regulation. Industry instead sought a guarantee that derivatives traded over the 

counter would be excluded from regulation. 

Early in 1998, Born contemplated issuing a request for comments on whether the 

regulatory system for financial derivatives should be altered. She received a telephone call 

from Lawrence Summers, who was then an assistant secretary of Treasury. "[ have 13 

bankers in my office and they say if you go forward with thiS, you will cause the worst 

financial crisis since World War II," Summers reportedly said,l7 

value of$100. The potential payments forthose trading a derivative pegged to the price of a barrel of oil 

would be the fluctuation between $100 and its actual price. 

141d. 

15 E. Scott Reckard and Michael Wagner, Merrill Lynch to Pay $400 Million to Orange County, THE LOS ANGELES 

TIMES (June 03, 1998). 

16 CONCEPT RELEASE, at 26115. In footnote 6 of the Concept Release, the CFTC cited a study listing 22 examples 

of significant losses in financial derivatives transactions and made reference to a 1997 GAO study that 

identified 360 substantial losses suffered by end-users. 

17 Manuel Roig-Franzia, Credit Crisis Cassandra: Brooksley Born's Unheeded Warning [5 a Rueful Echo 10 Years 

On, WASHINGTON POST (May 26, 2009), htt;l'/Iwapo st/QIK9f. 

May 2012 6 
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Public Citizen Forgotten Lessons of Deregulation: Derivatives 

"Diversity within the financial sector provides insurance 

against a financial problem turning into economy-wide 

distress." 

-Federal Reserve Chairman Alan Greenspan (1999) 

Born proceeded nonetheless. In May 1998, the CFTC issued a "concept release" seeking 

comment on whether to alter its largely hands-off approach to financial derivatives trading. 

The release noted that the over-the-counter derivatives market had experienced "explosive 

growth" in recent years, with increasing reports of losses, many by investors who did not 

understand the risks that they were taking.1S 

"Accordingly," the release stated, "the Commission believes it is appropriate at this time to 

consider whether any modifications ... are needed to enhance the fairness, financial 

integrity, and efficiency ofthis market."19 

Born's release was the opening volley in a highly public debate that she would lose in the 

halls of Washington, D.C., but ultimately win in the eyes of history. On the same day that the 

CFTC published its concept release, Greenspan, Treasury Secretary Robert Rubin, and 

Securities and Exchange Commission Chairman Arthur Levitt Ir. issued a joint statement 

expressing "grave concerns about this action and its possible consequences."20 

"We seriously question the scope of the CFTC's jurisdiction in this area and we are very 

concerned about reports that the CFTC's action may increase the legal uncertainties 

concerning certain types of OTC derivatives," the three wrote. 21 Greenspan, Rubin and 

Levitt began pushing for legislation that would impose a moratorium on the CFTC's 

permission merely to consider changing regulation of derivatives. 22 

The collapse of Long-Term Capital Management in September of that year strengthened 

Born's case. Long-Term was a hedge fund that had used just $2.2 billion of underlying 

capital to make $1.25 trillion of investments in derivatives. 23 Turmoil in Russia had roiled 

the market in ways that Long-Term could not survive. The potential cascading effects of 

Long-Term's impending losses prompted the New York Federal Reserve to broker a deal 

18 CONCEPT RELEASE. at 26119. 

19Id. 

W Timothy L. O'Brien, A Federal Turf War Over Derivatives Control, THE NEW YORK TIMES (May 8, 1998). 

21Id. 

22 Senate Temporarily Blocks New Rules on Derivative Securities, THE NEW YORK TIMES (Oct. 7, 1998). 

23 Joseph Kahn and Peter Truell, Troubled Investment Fund's Bets Now Estimated at $1.25 Trillion 

THE NEW YORK TIMES (Sept. 26, 1998). 

May 2012 7 
83 

Public Citizen Forgotten Lessons of Deregulation: Derivatives 

whereby a consortium of banks bailed out the fund. 24 The banks infused $3.6 billion in 

capital in exchange for 90 percent of Long-Terms' stock to avert disaster.25 

Born said in House testimony that the episode "should serve as a wake-up call about the 

unknown risks in the over-the-counter derivatives market."26 But lawmakers did not heed 

the alarm. Instead, they imposed a six-month moratorium on the CFTC's permission to 

work on derivatives regulationP 

Some even took reassurance from the Long-Term episode. Greenspan, for instance, said it 

confirmed his "spare tire" theory that "diversity within the financial sector provides 

insurance against a financial problem turning into economy-wide distress."28 

Greenspan continued to champion deregulation of derivatives unabashedly. "By far the 

most significant event in finance during the past decade has been the extraordinary 

development and expansion of financial derivatives," Greenspan said in a March 1999 

speech. "The fact that the [over-the-counter] markets function quite effectively without the 

benefits of [CFTC regulation] provides a strong argument for development of a less 

burdensome regime for exchange-traded financial derivatives."29 

Born announced her plan to resign in January 1999 and left office in April.30 In November 

of that year, the President's Working Group on Financial Markets-consisting of William J. 

Rainer (Born's replacement as chairman of the CFTC), Summers (who had become 

secretary of the Treasury), Greenspan and Levitt-issued a report calling for deregulation 

of the over-the-counter derivatives market to provide "legal certainty" that various 

activities were exempt from regulation under the CHA. "The sophisticated counterparties 

24 Gretchen Morgenson, Seeing a Fund as Too Big to Fail, New York Fed Assists Its Bailout, THE NEW YORK TIMES 

(SEPT. 24, 1998) and Joseph Kahn and Peter Truel!, Troubled Investment Fund's Bets Now Estimated at $1.25 

Trillion, THE NEW YORK TIMES (Sept. 26, 1998). The General Accounting Office would conclude two years later 

that the actions by the New York Federal Reserve set a dangerous precedent: "Although no federal money 

was committed to the recapitalization, FRBNY's intervention raised concerns among some market observers 

that it could create moral hazard by encouraging other large institutions to assume greater risks, in the belief 

that the Federal Reserve would intervene to avoid potential future market disruptions." GENERAL ACCOUNTING 

OFFICE, RESPONSES TO QUESTIONS CONCERNING LoNG-TERM CAPITAL MANAGEMENT AND RELATED EVENTS 2 (Feb. 23, 

2000), http·!/1.usa.goy/r9dWOD. 

Z5 FCIC REPORT, at 57. 

26 Manuel Roig-Franzia, Credit Crisis Cassandra: Brooksley Born's Unheeded Warning Is a Rueful Echo 10 Years 

On, WASHINGTON POST (May 26, 2009), http://wapo.st/OIK9f. 

27 Senate Temporarily Blocks New Rules on Derivative Securities, THE NEW YORK TIMES (Oct. 7, 1998). 

2. FCIC REPORT, at 58. 

29 Id., at 48. 

30 Press Release, Commodity Futures Trading Commission, Chairperson Brooksley Born Announces Her 

Intention Not to Seek Reappointment to a Second Term (Jan. 19, 1999), h~.:i.<U:QY/JV3bllcr and Manuel 

Roig-Franzia, Credit Crisis Cassandra: Brooksley Born's Unheeded Warning Is a Rueful Echo 10 Years On, 

WASHINGTON POST (May 26,2009), http://wapo.st/QfK9f. 

May 2012 8 
84 

Public Citizen Forgotten Lessons of Deregulation: Derivatives 

that use OTC derivatives simply do not require the same protections under the CEA as 

those required by retail investors," the report said.31 

In December 2000, at the end of the Clinton administration, Congress passed the 

Commodity Futures Modernization Act (CFMA), which almost fully deregulated OTC 

derivatives trades. The law exempted contract participants with at least $10 million in 

assets (signifying that they were sophisticated investors) from exchange trading 

requirements. The law also preempted state laws that might have otherwise prohibited 

trades that amounted to gambling.32 President Clinton signed the bill. 

Thus, the "multi-trillion dollar OTC derivatives market was removed from almost all 

pertinent federal and state enforcement to which trading markets had been subject since 

the New Deal," Greenberger wrote in 2011. "In effect, almost no law applied to this market" 

after passage of the CFMA."33 

B. In the Absence of Regulation, the Derivatives Market Pushed the Financial System to the 

Brink of Collapse. 

Over-the-counter derivatives trading grew dramatically in the years following passage of 

the CFMA. The notional value of such trades, according to the FCIC, increased from $95.2 

trillion in 2000 to $672.2 trillion in 2008-a more than seven-fold increase.34 By contrast, 

the entire world's assets in 2008 added up to only $178 trillion, according to the McKinsey 

Global Institute.3s 

It was possible for the value of derivatives trades to dwarf the entire world's wealth in part 

because multiple derivative positions could to be taken on the same underlying assetincluding by people who didn't even own or agree to buy the asset. This would prove 

particularly disastrous in the case of credit default swaps, a type of derivative that J.P. 

Morgan & Co. pioneered in the early 1990s and which insurance company American 

International Group Inc. (AIG) began selling in about 1998.36 Credit default swaps "insured" 

securities, such as collateralized debt obligations (COOs), which consisted of bundled 

securities, often including bundled subprime mortgages. 

31 PRESIDENT'S WORKING GROUP ON FINANCIAL MARKETS, REPORT OF THE PRESIDENT'S WORKING GROUP ON FINANCIAL 

MARKETS 16 (NOVEMBER 1999). 

32 DERIVATIVES IN THE CRISIS, at 52. 

"ld., at 10. 

34 FClC REPORT, at 48. 

3S McKINSEY GLOBAL lNSTlTlITE, GLOBAL CAPITAL MARKETS: ENTERING A NEW ERA (SEPTEMBER 2009), 

h ttl': I Ibitiy/yRPffiZ. 

36 John Lanchester, Outsmarted: High Finance vs. Human Nature, THE NEW YORKER (June 1, 2009), 

http://nYLkr/KpGeWM and Carrick Mollenkamp, Serena Ng, Liam Pleven and Randall Smith, Behind AIG's 

Fal/, Risk Models Failed to Pass Real·World Test, THE WALL STREET JOURNAL (Oct.31, 2008). 

May 2012 
85 

Public Citizen Forgotten Lessons of Deregulation: Derivatives 

Between 2003 and 2007, Wall Street created $700 billion in COOs that included mortgagebacked securities as collateral.37 Wall Street managers were hungry for mortgages to 

fashion new COOs, for which they profited handsomely. This appetite effectively enabled 

mortgage lenders to lower their underwriting standards because they believed they could 

easily unload newly issued mortgages to COO underwriters. "In effect, the COO became the 

engine that powered the mortgage supply chain," the FCIC wrote.38 

But COOs and credit default swaps were intertwined, as evidenced by the FCJC's finding 

that credit default swaps also "fueled the mortgage securitization pipeline."39 Investors in 

COOs gleaned a sense of security by purchasing credit default swaps, which, they believed, 

would protect them in case their COOs failed. "Investors became unmoored from the 

essential risk underlying loans to non-credit worthy individuals" because credit default 

swaps provided a "seeming safety net to these risky investments," Greenberger wrote.40 

The worldwide credit default swaps market, according to the FCJC, increased from $6.4 

trillion at the end of 2004 to $58.2 trillion by the end of 2007.41 As Greenberger has noted, 

that nearly equaled the gross domestic product for the entire world, which in 2007 was 

about $60 trillion.42 

The danger posed by credit default swaps was compounded because-unlike most 

derivatives-they paid off their entire notional value if the underlying asset failed, rather 

than simply paying according to a fluctuation of an underlying asset value.43 In a rough 

analogy, a traditional derivative would have paid the difference between a mortgage and 

the amount a bank could recoup in a foreclosure sale. But a CDS would pay the entire 

mortgage value. In practice, the stakes were astronomically greater due to the aggregated 

nature of the COOs that credit default swaps insured. 

37 FCIC REPORT, at 129. 

38 [d., at 128. 

J9 [d., at xxiv. 

40 DERIVATIVES IN THE CRISIS, at 12. 

41 FCIC REPORT, at 50. 

H World Bank, lillu;LLlJ.i.tJJJl"616pl. 

43 The Role of Derivatives in the Financial Crisis Testimony, Financial Crisis Inquiry Commission (June 30, 2010), 

testimony of Prof. Michael Greenberger, http://bit.ly/yiYNrt. 

May 2012 10 
86 

Public Citizen Forgotten Lessons of Deregulation: Derivatives 

"By 2008 our regulatory framework with respect to 

derivatives was manifestly inadequate." 

-Former Treasury Secretary Lawrence Summers (2010) 

This danger was further exacerbated because multiple credit default swaps could be 

purchased on the same underlying asset. Besides using credit default swaps to insure 

assets they owned, investors could purchase them on assets owned by others. Such 

arrangements were called "naked credit default swaps" and were the equivalent of buying 

insurance on a neighbor's house in the hopes that it burns down.44 

Naked credit default swaps marked an evolution in the purpose of derivatives from their 

traditional risk-management function to sheer gambling. When the financial crisis struck in 

2008, three-to-four times as many naked credit default swaps were in circulation as credit 

default swaps held by investors who owned the underlying asset.4S This amounted to many 

investors buying fire insurance on the same house. If one such house burned down, it 

would be a very bad day for the company insuring it. Naked credit default swaps left open 

the possibility that thousands or millions of houses that were insured many times over 

could, metaphorically, catch fire at once. Such a wildfire would constitute catastrophic day 

for the insurance company. 

But issuers of credit default swaps-particularly AIG-saw no such risk. They viewed the 

fees they received from credit default swaps as virtually free money because they did not 

think they would ever have to pay. AIG's models showed only a 0.15 percent chance-1 in 

667-that it would ever have to make a single payment on a credit default swap because of 

the supposed diversity of assets within CDOS.46 

Because of this misplaced confidence and the absence of regulations to prevent firms from 

taking undue risks, credit default swap issuers did not maintain adequate reserves in case 

of disaster. AIG, for instance, took on $500 billion in credit default swap risks without being 

required to post any collateral, according to the FCIC,47 

4. See, e.g., MICAH HAUPTMAN, PUBLIC CITIZEN, BANKING ON FAILURE: SPECULATORS' USE OF CREDIT DEFAULT SWAPS TO 

BET ON OTHERS' MISFORTUNE Is UNSEEMLY, DANGEROUS (November 2011), http:Uhit.ly/xlru:.lillJ1. 

45 DERIVATIVES IN THE CRISIS, at 14 . 

• 6 Brady Dennis and Robert O'Harrow Jr., A Crack in The System, WASHINGTON POST (Dec. 30, 2008), 

http://wapo.stl2qmzdG. 

47 FCIC REPORT, at 50. 

May 2012 11 
87 

Public Citizen Forgotten Lessons of Deregulation: Derivatives 

"Very strongly held views in the financial services 

industry in opposition to regulation were 

insurmountable." 

-Former Treasury Secretary Robert Rubin, claiming in 2010 that 

he had favored greater regulation of derivatives in the 1990s 

Issuers of credit default swaps were permitted to take such risks in part because credit 

default swaps were not regarded as insurance, even though that is essentially what they 

were.48 If credit default swaps were defined as insurance, they would have been regulated 

by the states. This means they would have been subject to capital reserve requirements and 

naked credit default swaps would have been illegal.49 

"Under state insurance law, [naked credit default swaps] would be considered insuring 

someone else's risk, which is flatly banned," Greenberger wrote. To preserve their noninsurance status, credit default swap dealers advised bond issuers who purchased their 

products to refer to them as "swaps," not insurance.so 

The fact that credit default swaps were traded off of regulated exchanges heightened the 

risk they posed. On regulated exchanges, a clearing facility guaranteed each counterparty 

against the others. Consequently, the clearing facility required the parties to post adequate 

collateral. No such protections applied to over-the-counter trades.Sl 

Eventually, the housing bubble burst, causing widespread mortgage defaults and 

corresponding defaults of COOs. Holders of credit default swaps that insured those COOs 

demanded billions of dollars in collateral. But AIG, the largest CDS provider, had nowhere 

near the capital to satisfy these demands. AIG's inability to make good on its obligations 

threatened to trigger a chain reaction of failures throughout the financial system that 

woul<;l cripple the economy. S2 

48 MICAH HAUPTMAN, PUBLIC CiTIZEN, BANKING ON FAILURE: SPECULATORS' USE OF CREDIT DEFAULT SWAPS TO BET ON 

OTHERS' MISFORTUNE Is UNSEEMLY, DANGEROUS (November 2011), http://bitiyixml'KHd, 

49 DERIVATIVES INTHE CRISIS, at 12, 

50 Id" at 13, 

SlId. 

52 See, e,g., Mary Williams Walsh, A.LG, Secures $150 Billion Assistance Package, THE NEW YORK TIMES (Nov. 10, 

2008), http://nytLmsIl!GNes. 

May 2012 12 
88 

Public Citizen Forgotten Lessons of Deregulation: Derivatives 

"Those of us who have looked to the self-interest of 

lending institutions to protect shareholder's equity 

(myself especially) are in a state of shocked disbelief.." 

-Former Federal Reserve Chairman Alan Greenspan (2008) 

This threat prompted Congress to authorize hundreds of billions of dollars in bailouts to 

prevent a full economic meltdown. AIG has since received at least $140 billion from the 

government through various programs. 53 To put this figure in perspective, it would fund 

the SEC for about 105 years and the CFTC for about 683 years. 54 

C. The Policy Makers Who Pushed for Derivatives Deregulation Now Admit They Were Wrong. 

Today, there is widespread consensus, even among those who pressed for a laissez faire 

approach in the 1990s, that creating a regulation-free haven for derivatives was a big 

mistake. 

In 1998, Lawrence Summers warned Brooksley Born that any step toward regulating 

derivatives would cause the greatest economic disaster since World War II. He also cosigned the report claiming that parties in derivatives trades did not need oversight because 

they were "sophisticated." 

He no longer holds these views. While stating that he could not have foreseen the changes 

in the derivatives market when he pressed for deregulation, he told the FCIC that "by 2008 

our regulatory framework with respect to derivatives was manifestly inadequate."ss 

Robert Rubin, Summers' predecessor as Treasury secretary, co-signed the 1998 statement 

expressing "grave concerns" about Born's solicitation of opinions on whether to alter 

derivatives' regulation. He nOw sees this episode differently. He had agreed with Born's 

views at the time, he told the FCIC in 2010, but "very strongly held views in the financial 

services industry in opposition to regulation were insurmountable."s6 

53 Id. and Where Is the Money: Eye on the Bailout, PROPUBLlCA, httl':!Ibit.ly /Zle071. 

~ 

54 U.S. SECURITIES AND EXCHANGE COMMISSION IN BRIEF FY 2013 CONGRESSIONAL JUSTIFICATION (February 2012). 

and Christopher Doering, Obama Seeks $308 Million Budget/or CFTC, REUTERS (FEB. 

10,2012), http://J'cut.rs/xYcMe7. 

55 FCIC REPORT, at 49 .. 

56Id. 

May 2012 13 
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Public Citizen Forgotten lessons of Deregulation: Derivatives 

"Even if less than 1 percent of the total investment 

community is involved in derivative exchanges, so much 

money was involved that if they went bad, they could 

affect 100 percent of the investments. And indeed 100 

percent of the citizens ... and I was wrong about that." 

-Former President Bill Clinton (2010) 

In Rubin's defense, he warned about the risks of unregulated derivatives in his 2003 

memoirs.57 But when critical decisions were being made in the late 1990s, Rubin used his 

substantial influence to help block regulation, not to insist on it.58 

Former Federal Reserve Chairman Greenspan, who was perhaps the most ardent advocate 

for deregulating derivatives, admitted at the onset of the financial crisis in 2008 that he had 

been "partially" wrong in his view that derivatives did not require more oversight. "Credit 

default swaps, I think, have serious problems associated with them," he testified. More 

fundamentally, in repudiation of his longstanding faith in markets' ability to regulate 

themselves, Greenspan testified, "those of us who have looked to the self-interest of lending 

institutions to protect shareholder's equity (myself especially) are in a state of shocked 

disbelief."59 

Greenspan continued: "The evidence strongly suggests that without the excess demand 

from securitizers, subprime mortgage originations, undeniably the original source of the 

crisis, would have been far smaller and defaults, accordingly, far fewer"6o 

Former President Clinton expressed a mea culpa for allowing himself to be convinced that 

the regulation of derivatives was unnecessary because only sophisticated investors traded 

them. "Even if less than 1 percent of the total investment community is involved in 

derivative exchanges, so much money was involved that if they went bad, they could affect 

100 percent of the investments, and indeed 100 percent of the citizens ... and I was wrong 

about that."61 

57 Dan Froomkin, Rubin: I ActuallY Supported Regulating Derivatives, HUFFINGTON POST (June 20, 2010), 

http://huff.to/aMXilN. 

sa ld. 

s. Testimonyofformer Federal Reserve Chairman Alan Greenspan before the House of Representatives 

Committee on Government Reform (110th Cong" Oct. 23, 2008), httll:Ubit.lylIcqflPL. 

6°ld, 

61 Dan Froomkin, Rubin: I ActuallY Supported Regulating Derivatives, HUFFINGTON POST (June 20, 2010) 

http://huffto!aMXjlN. 

May 2012 14 
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Public Citizen Forgotten Lessons of Deregulation: Derivatives 

D. Dodd-Frank Enacted Significant Reforms but Members of Congress Are Seeking to Reduce 

These Protections. 

The Dodd-Frank law instituted measures to make derivatives trading transparent and less 

risky for the financial system. The law generally called for swaps to be traded on 

designated exchanges, to be cleared by designated organizations, and to be subject to 

capital and margin requirements. 

Trading on exchanges provides for transparency, permitting buyers to shop for competitive 

prices. Clearing ensures that centralized organizations accept responsibility to make good 

on contract obligations. This would prevent reprisals of the AIG episode, in which no 

backstop was in place-save for the taxpayers. The capital and margin requirements plug 

the gaping regulatory hole that allowed the likes of AlG to take on risks that exceeded its 

resources. The act allowed swaps that are highly customized be traded off of exchanges. 

But even in these cases, it imposed capital and margin requirements and insisted on public 

reporting. 62 

Since the passage of Dodd-Frank, industry has engaged in a concerted effort to weaken it. 

At least nine bills are pending in Congress that would water down its derivatives reforms. 

Three additional bills would saddle federal agencies with additional burdens to fulfill 

requirements to issue concerning financial services, induding those involving derivatives. 

[See Appendix] 

Among other things, these bills would eliminate a requirement for federally insured banks 

to spin off their derivatives operations;63 reduce disclosure requirements for certain 

derivatives trades;64 provide a broad exemption from Dodd-Frank's provisions for swaps 

involving foreign affiliates of U.S. companies;6s and exempt purportedly small players, even 

those with up to $200 billion in the notional value of their derivatives exposure.66 

These proposals threaten to create large oversight-free zones that could allow risky 

behaviors to flourish. We have seen the damage caused by the errors in judgment in the 

late 1990s. Congress and federal agencies need to ensure that there is no sequel. 

62 Dodd-Frank Wan Street Reform and Consumer Protection Act § 701-814 and DERIVATIVES IN THE CRISIS, at 

17-26. 

63 H.R. 1838, 112th Congo (2011). 

64 H.R. 2586, 112th Congo (2011). 

65 H.R. 3283, 112th Congo (2011). 

66 H.R. 3336, 112th Congo (2012) and Letter from Americans for Financial Reform to members of Congress 

(April 11, 2012). 

May 2012 15 
91 

Public Citizen Forgotten Lessons of Deregulation: Derivatives 

Appendix 

Bills Seeking to Weaken Derivatives Regulation 

lliIINumb", .;" "" """ 

•• $rief ~"mlnary t ". : .. 

H.K 1838, Swaps Bailout Amends Section 716 of Dodd-Frank (known as the Passed House Committee 

Prevention Act, Rep. Nan lincoln amendment), which bans federally insured on Financial Services by 

Hayworth (R-N.Y.) financial institutions from engaging in swaps trading. voice vote, Feb 16, 2012. 

Amended in committee to exempt foreign swap 

activity by subsidiaries of U.S" banks. 

H.R. 2586, 5wap Executive Bans regulators from requiring swaps exchanges Passed House Committee 

Facility Clarification Act, (SEFs) to make bids or offers available to participants. on Financial Services by 

Rep. Scott Garrett (R-N.l.) voice vote, Nov. 30, 2011; 

Passed House Committee 

on Agriculture by voice 

vote, Jan. 2S, 2012. 

H.R. 2682, Business Risk Prohibits regulators from requiring derivatives end Passed House 370-24 on 

Mitigation and Price users qualifying for clearing exemption (such as March 26, 2012. 

Stabilization Act, Rep. airlines) to post margin. (Corresponds with Senate 

Michael Grimm (R-N.Y.) Bill 5.1650) 

H.R. 2779, (no title), Provides broad exemption from regulation of swaps Passed House 357-36, 

Rep. Steve Stivers (R-Ohio) between affiliates. March 26, 2012. 

H.R. 3283, Swap Provides broad regulatory exemption for U.s, swap Passed House Committee 

Jurisdiction Certainty Act, dealers when dealing with foreign entities, including on Financial Services 41-

Rep. Jim Himes (D-Conn.) foreign affiliates of U.S. companies; replaces U.S. 18, March 27, 2012; 

capital regulation and oversight for foreign affiliates of referred to House 

US. companies with oversight by the non-U.S. Committee on Agriculture. 

jurisdiction. 

H.R. 3336, Small Business Exempts any bank, thrift, credit union or farm credit Passed House 312-111, 

Credit Availability Act, Rep. institution from being considered a "financial entity" if April 25, 2012. 

Vicky Hartzler (R-Mo.) it has less than $1 billion in "outward exposuretl or 

swaps connected to hedges. 

H.R. 3527, Protecting Main Exempts transactions for hedging or mitigating Passed House Committee 

Street End-Users from commercial risk from the calculation of whether one on Agriculture by voke 

Excessive Regulation, meets the threshold to be designated as a swap vote, Jan" 25, 2012. 

Rep.Randy Hultgren (R-Ill.) dealer; creates exemption from margin and dearing 

requirements for swap dealers trading up to $3 bi!l1on 

in notional value annually. 

5.947, (no title), Sen. Mike Exempts various trades from specified margin Referred to Senate 

Johanns (R-Neb.) requirements, including swaps in which one of the Committee on Banking, 

counterparties is neither a swap dealer nor a major Housing, and Urban 

swap participant, Affairs. 

S. 16S0, Dodd-Frank Establishes SEC Office of Derivatives to coordinate Referred to Senate 

Improvement Act, Sen. oversight and administer derivatives-related rules. Committee on Banking, 

Mike Crapo, (R-ldaho) Housing, and Urban 

Affairs. 

May 2012 16 
92 

Public Citizen Forgotten Lessons of Deregulation: Derivatives 

Bills Imposing Addition Burdens for Agencies to Promulgate Financial Regulations 

Bill!lluml>",. """u" .... 

., '. , 

'. 

H.R. 1840, no title, Rep. Requires detailed cost-benefit analysis of all CFTC Passed by House 

Michael Conaway (R- regulations. Committee on 

Texas) Agriculture by voice 

vote, Jan. 25, 2012. 

H.R. 2308, SEC Regulatory Requires detailed cost-benefit analysis of all SEC Approved by House 

Accountability Act, Rep. regulations. Financial Services 

Scott Garrett (R-N.J.) Committee 30-26, Feb. 

16,2012. 

S. 1615, Financial Prohibits issuance of regulations if quantified costs are Referred to Senate 

Regulatory Responsibility greater than the quantified benefits; authorizes Committee on Banking, 

Act of 2011, Sen. Richard judicial review for a person adversely affected or Housing, and Urban 

Shelby (R-Ala.) aggrieved by a regulation; establishes the Chief Affairs. 

Economists Council to report to certain congressional 

committees on activities of the financial regulatory 

agencies. 

May 2012 17