Commodity Futures Trading Commission 

Office of External Affairs

Three Lafayette Centre 

 1155 21st Street, NW

Washington, DC 20581 

 202.418.5080

Speech 

Walk Softly and Carry a Big Stick

Acting CFTC Chairman Walt Lukken

ISDA Energy, Commodities and Developing Products Conference 

November 29, 2007 

(As Prepared for Delivery) 

I’d like to thank Bob Pickel and ISDA for inviting me to speak today addressing the important 

topics of energy and developing products. ISDA has been an innovative leader on these issues 

and I appreciate their work over the years to keep the derivatives market an engine of growth for 

the economy. 

There have been several important changes at the CFTC of late. We have two new 

commissioners – ISDA’s very own Jill Sommers and Bart Chilton. I know I speak for 

Commissioner Dunn in saying they have been welcome additions to the Commission for their 

unique experiences and insights. 

To say the least, it has been a busy time since taking over as Acting Chairman in July. In those 

five short months, I testified three times before Congress, the Commission held two public 

hearings and provided an extensive report to Congress on the regulation of exempt commercial 

markets, Congress is actively debating the CFTC’s reauthorization, the markets have 

experienced a major credit crunch resulting from the sub-prime crisis, including the implosion of 

a large FCM, the CFTC and FERC filed their respective cases against Amaranth, and the CFTC 
and Department of Justice reached a record settlement with BP for manipulating the propane 

market. Although my wife wishes otherwise, I do not see the pace of things slowing down any 

time in the near future. 

Much of the job of regulating is reacting to such situations as they arise. This is inevitable given 

the nature of the financial markets and its broad array of participants. But regulators should not 

be content to just play defense—we must be ready to anticipate trends as our industry and 

markets evolve. 

Without a doubt, the largest structural change affecting the oversight of our markets in the last 

decade is global competition brought on by the cyber-revolution. Without leaving their desks, 

traders now have a variety of choices on where to trade financial products, regardless of physical 

borders. This competition has significantly lowered costs and spurred innovation. In addition, the 

abundance of affordable technology and bandwidth has made trading location almost irrelevant 

from a latency point of view. Traders can now plug in and trade from virtually anywhere in the 

world. 

Technology allows a world marketplace to exist but for the rigid laws and regulations that 

hamstring its development. Unfortunately, regulation often lags behind these global market 

trends and regulators frequently find themselves playing catch-up as problems unfold. Regulators 

may attempt to meet these challenges by adopting detailed rules, but the breakneck pace of 

innovation inevitably changes the landscape, making the rules outdated almost upon enactment. 

Given the speed of our markets, we are left asking: how do regulators keep pace? To be honest, 

keeping pace is optimistic—realistically, regulators as a whole are fortunate to keep the 

industry’s taillights in view. Globalization, and its impact on product innovation, is rampant and 

while the private sector views globalization as an opportunity, regulators are grudgingly adapting 

to the modern economy. In a recent survey by IBM, 95 percent of the financial industry 

interviewed thought globalization to be a growth opportunity rather than a threat. Of the five 

percent who felt threatened, nearly all were regulators. Why is this? Because regulators 

understand that globalization shakes the foundation of their regulatory models. 

PAGE 2 OF 7 
Regulators no longer live in a “bright-line” jurisdictional world. Determining where an 

exchange or firm is located is difficult, if not impossible, with subsidiaries, boards of directors, 

customers, clearinghouses and self-regulators scattered around the globe. To say the least, it is 

difficult—but I think the key for regulators is not only to work harder, but work smarter. 

It was the adoption of “principles-based” regulation with the passage of the Commodity Futures 

Modernization Act (CFMA) in 2000 that has allowed the CFTC to work smarter. There has been

much debate recently on the relative benefits of outcome-based principles versus rules. There is 

a developing consensus in the U.S. that principles-based regulation is a model worthy of study, 

noting that the UK markets are flourishing under such an approach. But rather than fly to 

London, Washington policymakers need only visit New York or Chicago where the U.S. futures 

industry has been thriving under principles since the passage of the Commodity Futures 

Modernization Act (CFMA) in 2000. 

A principles-based system requires markets to meet certain public outcomes in conducting their

business operations. For example, U.S. futures exchanges must continuously meet 18 core 

principles—ranging from maintaining adequate financial safeguards to conducting market 

surveillance—in order to uphold their good standing as a regulated contract market. Such an 

approach has the advantage of being flexible for both regulator and regulated. As technology 

and market conditions change, exchanges may discover more effective ways to meet a mandated 

principle. 

But today I want to focus today on what is sure to be an important issue in the minds of 

policymakers debating the benefits of a principles-based regulatory approach—enforcement. 

Can enforcement be meaningful in a principles-based regime? Can enforcement programs fulfill 

their missions without the certainty of rules-based compliance? The answer to these questions is 

a resounding yes and we need to look no further than the CFTC’s own enforcement program to 

see a principles-based regulator making an astounding impact in stamping out fraud and 

manipulation. 

It is true that using a principles-based approach to regulation encourages a more collaborative 

relationship with the regulated entity but when improper activity occurs, this collaboration on the 

front-end must be complemented with strong enforcement on the backside. This “bookends 

PAGE 3 OF 7 
philosophy” is a powerful approach in preventing and deterring wrongful activity in the industry. 

It is also important to recognize that principles do not affect how wrongful activity is defined. 

Fraud, manipulation, false reporting and trade practice abuse are well-defined legal concepts in 

statute and case law that are not affected by the transition to principles. Most principles focus on 

ensuring that the controls and processes are in place to prevent such wrongful activity. However, 

the definitions of such activity are unaffected by the new approach. So, even within our 

principles-based regulatory approach at the Commission, a strong enforcement program is a 

necessary component to market regulation and given the recent results of our program, I am

confident that our markets are being well policed. 

It is this complement of flexible principles-based oversight with real-time enforcement that 

makes the “smart” regulation idea effective. I call it prudential regulation with a bite or as Teddy 

Roosevelt made famous, we walk softly and carry a big stick. 

Indeed the numbers are impressive. During the past five years, the Commission has filed a total 

of 295 enforcement actions and obtained more than $1.8 billion in total monetary sanctions 

including restitution, disgorgement, and civil monetary penalties. As hedge funds have become

the investment vehicle of choice for many large investors, the Commission has ferreted out those 

operations that use fraud and deceit. In the last seven years, the Commission filed a total of 61 

enforcement actions alleging misconduct in connection with commodity pools and hedge funds 

and has obtained a total of more than $231 million in penalties through these actions. 

The energy markets are a particular area in which the Commission’s enforcement program has 

effectively wielded a big stick. Protecting these markets is vital to our national interest because

of the direct impact of energy price manipulation on consumers and the economy. From 

December of 2002 through October of 2007, the Commission filed 39 enforcement actions, 

charging 64 companies and individuals with attempted manipulation, manipulation and/or false 

reporting. To date these actions have resulted in civil monetary penalties of more than $434 

million. And these defendants are some of the biggest players in the industry, including BP and 

Enron. We may be a relatively small federal agency, but we maintain a zero tolerance policy 

toward anyone who attempts to manipulate or disrupt the pricing in these important markets. 

PAGE 4 OF 7 
In this vein, I want to highlight the recent enforcement case against BP, which resulted in the 

largest manipulation settlement in our Commission’s history. The investigation, jointly brought 

by the CFTC and Department of Justice, revealed that BP manipulated the segment of the 

propane market used for residential and commercial heating in the Northeastern United States in 

February 2004 and attempted to manipulate that market in April of 2003. The investigation 

revealed that BP employees claimed to “control the market at will,” allowing BP to dictate prices 

to other market participants in order to obtain a significant trading profit. 

In settling the Commission’s charges, BP agreed to pay $125 million in civil monetary penalties 

and $53 million into a restitution fund intended to return money back to victims. The settlement 

was one of this agency’s most comprehensive and was designed to not only punish past behavior 

at BP, but to ensure that market misconduct does not happen again. As part of the agreement, 

BP agreed to establish a significant compliance and ethics program and to install an independent 

monitor to oversee BP’s trading activities. There were also criminal aspects to the case, which 

BP settled with the DOJ by paying $100 million in criminal fines and $25 million into consumer 

fraud fund. The total monetary sanction to BP as a result of its massive fraud was $303 million. 

Now that is what I mean about a big stick. 

I have focused a lot on the success of our enforcement program. But uncovering unlawful 

conduct after the fact is not enough; we must also strive to prevent manipulation before it occurs 

on our markets. Thankfully, with the passage of the CFMA, Congress had the foresight to 

provide this agency with the tools needed to oversee this rapidly changing marketplace. Much 

has been made of the flexibility provided businesses by the CFMA, but the adoption of a core 

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

regulatory problems. 

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

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

requirements to the specific risks of the marketplace. Within the tiered design, Congress created 

a light-touch regulatory category called Exempt Commercial Markets or ECMs, on which certain 

commodities, such as energy products, could be traded by institutional participants. Due 

primarily to the non-retail nature of these markets and the types of transactions executed, 

policymakers believed the risks associated with these wholesale exchanges were low. 

PAGE 5 OF 7 
However, the energy markets have changed dramatically in the past seven years and the 

Commission’s regulation of these markets should evolve in kind. Although these exempt 

markets have increased competition, certain energy contracts offered on ECMs now function as

virtual substitutes for contracts listed on regulated exchanges. 

 

In September, the Commission convened a hearing to examine the oversight of trading on ECMs. 

Commission staff, exchanges, ECMs, and industry and consumer groups, including ISDA, 

testified before the Commission in a productive debate. Testimony from the Commission’s 

hearing led us to conclude that certain natural gas products on the InterContinental Exchange 

(ICE) and New York Mercantile Exchange (NYMEX) function as virtual substitutes. Not only 

are the products substantially identical in terms and pricing, but the market participants are also 

the same with all of the top 25 natural gas traders on NYMEX also trading significantly on ICE. 

Moreover, economic analysis by our staff indicates that the trading activity in these products on 

ICE serves a significant price discovery function on 20 percent of the trading days measured. 

Nevertheless, many witnesses from the hearing testified that ECMs provide a valuable platform

for markets seeking a low-cost, effective “on-ramp” to launch new ideas for contract design and 

trading. However, the reality that some ECM contracts are serving a significant price discovery 

function led the Commission to conclude that changes to our act were necessary. 

 

In October, the Commission presented a report to its Authorizing Committees in Congress 

detailing our findings and recommendations regarding these energy markets. In our report, the 

Commission recommended that the CEA be amended so that when an ECM futures contract is 

determined to serve a significant price discovery function, the Commission would have the 

authority to: 1) Require large trader position reporting for that contract, 2) Require an ECM to 

adopt position limits or accountability levels for that contract, 3) Require an ECM to exercise 

self-regulatory responsibility over that contract in preventing manipulation, and 4) Exercise 

emergency authority regarding such transactions. 

These recommendations will allow the agency to properly oversee price discovery contracts 

while keeping in place the tiered regulatory structure that has fostered innovation and 

competition in these global markets. The President’s Working Group on Financial Markets 

PAGE 6 OF 7 
(PWG), of which I am a member, was fully engaged in the development of these 

recommendations by the Commission and supports these measured changes to the law. I am

hopeful that Congress will act quickly on this proposal as well as the CFTC’s reauthorization 

and funding to ensure that these markets are being properly overseen and policed. 

The CFTC report also recommends the formation of an Energy Markets Advisory Committee. It 

is my hope that this committee, which will be formed within the coming months, will be a forum

for those with knowledge of the energy markets, including producers, distributors, market users 

and consumers, to come together and discuss emerging issues in the energy markets. Also, I 

have convened an internal Energy Markets Working Group among CFTC staff that will serve as 

a clearinghouse for cross-divisional knowledge within the agency as we regularly come together 

to share expertise and information in an effort to keep pace with the markets. 

I will close by stating the obvious: the growth and complexity of the global derivatives business 

presents a challenge for regulators. But it is the flexibility provided by a principles approach to 

regulation, complemented by real-time enforcement, that has allowed the CFTC to effectively 

police the marketplace while encouraging innovation and growth in the derivatives industry. But 

the numbers speak for themselves. From the passage of the CFMA in 2000 to present, the 

notional value of over-the-counter derivatives transacted in the U.S. has grown by 276 percent. 

Over that same period of time, volume on the U.S. futures exchanges has grown 442 percent. 

By all measures, the U.S. derivatives industry has enjoyed enormous success under this 

progressive regulatory regime. But equally important is the fact that it hasn’t come at the 

expense of this agency’s strong enforcement program and its ability to wield a big stick in 

protecting the integrity of the marketplace. Again, thank you for having me speak today on this 

important topic. 

 

PAGE 7 OF 7