Commodity Futures Trading Commission 

Office of External Affairs

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 1155 21st Street, NW 

Washington, DC 20581 

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Testimony 

Written Testimony of 

Acting Chairman Walter Lukken 

Before the Subcommittee on Oversight and Investigations 

Committee on Energy and Commerce 

United States House of Representatives 

December 12, 2007 

 

Thank you, Mr. Chairman and members of the Subcommittee. On behalf of the Commodity 

Futures Trading Commission (CFTC or Commission), I appreciate the opportunity to discuss the 

CFTC, our role with respect to the futures markets, and our view of the markets as the 

government regulator charged with overseeing them. 

CFTC Mission

Congress created the CFTC in 1974 as an independent agency with the mandate to regulate 

commodity futures and option markets in the United States. The CFTC’s mission is broadly 

two-fold: to protect the public and market users from manipulation, fraud, and abusive practices; 

and to promote open, competitive and financially sound markets for commodity futures and

options. To do this, the Commission employs a highly-skilled and dedicated staff who work to 

oversee the markets and address any suspicious or illegal market activity. 

The Commodity Exchange Act (CEA or Act) grants the Commission exclusive jurisdiction with 

respect to accounts, agreements, and transactions involving commodity futures and options 

contracts that are required to be traded or executed on an exchange or a designated contract 

market, also known as a “DCM.” One of the purposes of the CEA is “to serve the public

interests . . . through a system of effective self-regulation of trading facilities . . . under the 

oversight of the Commission.” DCMs are regulated entities that are self-regulatory 

organizations (SROs) subject to comprehensive oversight by the CFTC. DCMs can list for 

trading any type of contract, they can permit intermediation, and all types of traders (including 

retail traders) are permitted to participate in their markets. The CFTC’s Division of Market 

Oversight (DMO) is responsible for monitoring and evaluating a DCM’s operations and it 

conducts market surveillance of all activity on DCMs, as described below. 
DCMs must comply with a number of designation criteria and core principles as a condition for 

initial CFTC approval and continuing operation. Once operational, DCMs, as self regulatory 

organizations (SROs), must establish and devote resources toward an effective oversight

program, which includes surveillance of all activity on their markets to detect and deter

manipulation and trading abuses. The CFTC regularly assesses the regulatory and oversight 

activities of DCMs through periodic examinations of DCMs’ self-regulatory programs to 

evaluate their compliance with applicable core principles under the Act and the Commission’s

regulations. 

The CFTC’s market surveillance mission regarding DCM activity is to ensure market integrity

and customer protection in the futures markets. Traders establishing positions on DCMs are 

subject to reporting requirements so that CFTC staff and the DCM can evaluate position sizes to

detect and deter manipulation. In addition, trade practice surveillance involves compilation and

monitoring of transactional-level data by the Commission and the DCM to detect and deter 

abusive trading such as wash sales, money laundering and trading ahead of customers (trade 

practice surveillance). 

Another mission of market surveillance is to identify situations that could pose a threat of 

manipulation and to initiate appropriate preventive actions. Each day, for the estimated 1,400 

active futures and option contracts in the U.S., CFTC market surveillance staff monitors the 

activities of large traders, key price relationships, and relevant supply and demand factors to 

ensure market integrity. 

Surveillance economists prepare weekly summary reports for futures and option contracts that

are approaching their expiration periods. Regional surveillance supervisors immediately review 

these reports. Surveillance staff advises the Commissioners and senior staff of significant market

developments at weekly surveillance meetings (non-public, closed meetings) so they will be 

prepared to take action if necessary. 

It should be noted that surveillance of DCM trading is not conducted exclusively by the 

Commission. As SROs, DCMs have significant statutory surveillance responsibilities. 

Typically, however, surveillance issues are handled jointly by Commission staff and the relevant 

DCM. Typically, the Commission gives the DCM, as the front-line regulator, the first 

opportunity to resolve any issue arising in its markets. If a DCM fails to take actions that the 

Commission deems appropriate, the Commission has broad emergency powers under the CEA to

order the DCM to take specific actions. The Commission has had to take emergency action four

times in its history. 

The Commission’s Division of Enforcement (Enforcement) also plays a large role in maintaining

the fairness and integrity of our markets. At any one time, Enforcement is investigating and 

litigating with approximately 700 to 1000 individuals and corporations for alleged fraud, 

manipulation, and other illegal conduct. Working closely with the President’s Corporate Fraud 

Task Force, Enforcement is staffed with skilled professionals who prosecute cases involving 

complex over-the-counter (OTC) and on-exchange transactions. Enforcement also routinely 

assists in related criminal prosecutions by domestic and international law enforcement bodies. 

During the last five years, Enforcement maintained a record level of investigations and 

prosecutions in nearly all market areas, including attempted manipulation, manipulation, 

squeezes and corners, false reporting, hedge fund fraud, off-exchange foreign currency fraud,

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brokerage compliance and supervisory violations, wash trading, trade practice misconduct, and 

registration issues. 

In the energy sector, Enforcement investigated and prosecuted Enron and BP, dozens of other 

energy companies, and hundreds of energy traders and hedge funds. At the same time, in other 

market sectors, Enforcement prosecuted more than 50 hedge funds and commodity pool 

operators for various violations, and filed actions against more than 360 individuals and 

companies for off-exchange foreign currency fraud and misconduct. 

In CFTC Enforcement actions in federal court, the CFTC may obtain temporary statutory 

restraining orders and preliminary and permanent injunctions, restitution to victims, 

disgorgement of ill gotten gains, civil monetary penalties, appointment of a receiver, and the 

freezing of assets. 

The CFTC also refers enforcement matters to the Department of Justice. Criminal activity 

involving commodity-related instruments can result in prosecution for criminal violations of the 

CEA and for violations of federal criminal statutes, such as mail fraud or wire fraud. 

Exempt Commercial Markets

The Commodity Futures Modernization Act of 2000 (CFMA) included a provision to create a 

new trading facility known as an Exempt Commercial Market (ECM). ECMs are not “registered

with, or designated, recognized, licensed or approved by the Commission.” ECMs, as well as 

transactions executed on ECMs, are statutorily exempt from most provisions of the CEA. 

Trading on an ECM is not subject to regular, ongoing market surveillance oversight by the 

Commission. The Commission does retain fraud and manipulation authority over ECMs. 

 

To assist the Commission in carrying out its fraud and manipulation authority, ECMs are 

required to maintain a record of allegations or complaints received by the trading facility 

concerning instances of suspected fraud or manipulation and to forward them to the Commission. 

ECMs are also subject to certain limited reporting requirements that require an ECM to identify

those transactions conducted on the facility with respect to which the ECM intends to rely on the 

statutory Section 2(h)(3) exemption, and which averaged five or more trades per day over the 

most recent calendar quarter. With respect to such transactions, the ECM is required to transmit

weekly to the Commission certain basic trade information. Information provided by ECMs can 

provide Commission surveillance staff with information regarding price spikes or unusual 

divergence between the price of a commodity traded on an ECM and the price of a related 

commodity traded on a DCM but do not identify individual traders. 

In addition, an ECM must maintain for five years, and make available for inspection upon 

request by the Commission, records of its activities related to its business as an electronic trading 

facility, including audit trail information sufficient to enable the Commission to reconstruct 

trading activity, and the name and address of each participant authorized to enter into 

transactions on the facility. Should the Commission need further information from an ECM, the 

Commission has the authority to issue a “special call.” A special call to an ECM is simply an 

indication that the Commission’s staff is seeking additional information. A special call, in and of 

itself, is not evidence of improper or illegal market behavior. 

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Energy products are eligible to be traded on ECMs by institutional participants. Due primarily to 

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

believed the risks associated with these institutional exchanges were low, thus the lower

regulatory requirements for these markets. 

Because the energy markets have changed dramatically since ECMs began trading, the 

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

have increased competition and lowered costs for derivatives trading, certain energy contracts

offered on ECMs now function as virtual substitutes for contracts listed on regulated exchanges,

with tight correlation and linking of prices and participants. 

With this as a backdrop, in September 2007, the Commission convened a hearing to examine the

oversight of trading on DCMs and ECMs. Commission staff, exchanges, ECMs, and industry 

and consumer groups testified before the Commission in a productive debate of the relevant 

issues. Based on this hearing, in October, the Commission presented a report to Congress 

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

Price discovery is a key determinant to Commission regulation and oversight, as others outside 

the marketplace begin to use prices to conduct business, such as farmers, utilities and others. As

such, price discovery was the primary focus when the CFTC began its review of the regulation of 

ECMs. 

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

settlement prices to DCM futures contract settlement prices raised the question of whether the 

CFTC has the necessary authority to police these markets for manipulation and abuse. Linkage 

of contract settlement prices was not contemplated at the time of the CFMA nor at the time of the

Commission’s 2004 rulemaking regarding ECMs that perform a significant price discovery 

function. Nevertheless, the Commission is now concerned that ECM cash-settled “look-alike” 

contracts may provide an incentive to manipulate the settlement price of the underlying DCM

futures contract to benefit positions in the “look-alike” ECM contract. 

Testimony from the Commission’s hearing and staff analysis on this subject led us to conclude 

that one ECM contract on the InterContinental Exchange (ICE) is serving a significant price 

discovery role and that ICE and the New York Mercantile Exchange (NYMEX) function as

virtual substitutes for each other in this particular natural gas contract. 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. 

That said, many witnesses from the hearing testified that ECMs provide a valuable platform for 

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

trading methodologies. ECMs serve as incubators for new concepts and provide robust 

competition with DCMs. This competition has spurred established DCMs to respond to ECM 

initiatives with innovations of their own, whether it is developing new products or accelerating

the pace of automation. 

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

leads the Commission to conclude that changes to the CEA are necessary in order for the

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Commission to detect and prevent manipulation in these markets. To that end, the Commission 

issued a report in October recommending changes to the CEA that would require large trader

position reporting; position limits or accountability levels; self-regulatory responsibility; and

emergency authority over ECM contracts determined to serve a significant price discovery 

function. These recommendations, crafted in consultation with the other members of the 

President’s Working Group on Financial Markets, have the support of the entire Commission. I 

am pleased to report that the House Agriculture Committee, which is the CFTC’s authorizing

committee, has circulated a discussion draft bill for possible markup that includes, among other 

things, language to implement the Commission’s recommendations. 

As another outgrowth of the Commission hearing, the Commission is in the process of 

establishing an Energy Markets Advisory Committee to conduct periodic public meetings on 

issues affecting energy producers, distributors, market users and consumers in an attempt to 

facilitate discussion and policy decisions as these markets evolve. Moreover, the CFTC intends

to work with FERC in an effort to jointly develop best practices for utilities and others who use 

the prices of regulated futures markets as benchmarks in pricing their energy products. 

I am confident that the Commission’s actions strike the right balance between ensuring that these 

markets remain free of manipulative conduct and still allowing the markets to grow and innovate 

on U.S. soil. 

CFTC Coordination with FERC

The Energy Policy Act of 2005 (EPAct) marked an important milestone in the on-going debate 

over the appropriate policy for regulating trading activities in our nation’s energy markets. As

called for by the EPAct, the CFTC and FERC, in October 2005, entered into a Memorandum of

Understanding (MOU) to coordinate information sharing. Accordingly, the respective staffs of 

the Commission and FERC are authorized to share information concerning various issues in the 

energy markets without the need for cumbersome access requests for each particular matter. To

that end, Commission staff remain in regular contact with counterparts at FERC, and FERC staff 

is routinely invited to attend Commission enforcement briefings and surveillance meetings. The

Commission’s Enforcement staff also meets quarterly with FERC counterparts to share 

information on issues and matters of mutual interest. 

The CFTC and FERC share the common goal of ensuring that the energy markets remain free 

from manipulation. I strongly support the broad grant of enforcement authority provided to 

FERC in the EPAct of 2005 to prevent manipulation of the physical energy markets as well as 

the goal of avoiding regulatory gaps in the oversight of these markets. 

Since the CFTC and FERC entered into the MOU, our agencies have had a largely positive, 

collaborative relationship. I am committed to continually developing this cooperation given the 

inter-relationship between the futures and physical energy markets. As the MOU recognizes, 

Congress granted the CFTC exclusive jurisdiction over the futures markets in connection with 

FERC’s new anti-manipulation powers. These mandates need not be inconsistent, as evidenced

by the working relationship we share with other federal and state enforcement authorities. I am 

committed to finding a similar balance with FERC. Already, our staffs have met to discuss the 

current MOU and any possible changes to it that would further coordinate our efforts. We are

also discussing ways to improve communication between Commissions to enhance collaboration 

and ideas to educate users of the markets on best practices for benchmarking against these 

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exchange products. I am hopeful that these efforts will help to align our mandates going 

forward. 

Speculation in the Commodities Markets

The current market environment has brought concern about the role that speculators play in 

affecting prices in our markets. The proper and efficient functioning of the futures markets 

requires both speculators and hedgers. While certain targeted controls on speculation are

appropriate, speculators, as a class, provide the market liquidity to allow hedgers to manage

various commercial risks. Unnecessary limitations on the amount of speculation that an 

individual or entity may engage in could limit the amount of liquidity in the marketplace, the 

ability of hedgers to manage risks, and the information flow into the marketplace, which could in 

turn negatively affect the price discovery process and the hedging function of the marketplace. 

Recently, the CFTC’s Office of Chief Economist examined the markets and the role that 

speculators play in them. The staff studied the relationship between futures prices and the 

positions of managed money traders (MMTs), commonly known as hedge funds, for the natural 

gas and crude oil futures markets. The staff also examined the relationship between the positions

of large speculators such as hedge funds and positions of other categories of traders (e.g., floor 

traders, merchants, manufacturers, commercial banks, dealers) for the same markets. 

The study found that when new information comes to the market and creates some price 

movement, it is the commercial traders (such as oil companies, utilities, airlines) who react to it 

first. When they react by buying/selling/changing production, they want to hedge their action 

and they enter the futures markets to do that. The producers need to hedge and need someone to 

take the other side – that is where the large speculators play a role. The price changes that 

prompt large hedgers to alter their positions in the very short run eventually ripple through to 

large speculator participants who will change their positions in response. The hedgers request 

liquidity for their risk management and the speculators provide the liquidity. 

The results also suggest that, on average, large speculators do not change their positions as

frequently as other participants, primarily those who are hedgers. The staff also found no 

evidence of a link between price changes and MMT positions (conditional on other participants 

trading) in the natural gas market, and found a significantly negative relationship between MMT

position changes and price changes (conditional on other participants trading) in the crude oil 

market. Hence, the report’s conclusions show that speculative buying, as a whole, does not 

appear to drive prices up. 

While speculation is critical to the markets, excessive speculation can be detrimental to the 

markets. Under the CEA, the concept of “excessive speculation” is based on trading that results 

in “sudden or unreasonable fluctuations or unwarranted changes in the price” of commodities

underlying futures transactions. The CEA specifically makes it a violation of the Act to

manipulate the price of a commodity in interstate commerce or for future delivery. The CEA 

does not make excessive speculation a per se violation of the Act, but rather, requires the

Commission to enact regulations to address such trading (for example, through speculative 

position limits). 

Pursuant to Section 4a of the Act, the Commission has utilized its authority to set limits on the 

amount of speculative trading that may occur or speculative positions that may be held in 

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contracts for future delivery. The speculative position limit is the maximum position, either net

long or net short, in one commodity future (or option), or in all futures (or options) of one 

commodity combined, that may be held or controlled by one person (other than a person eligible 

for a hedge exemption) as prescribed by a DCM and/or by the Commission. Moreover, CEA

Section 5(d)(5) requires that an exchange, “[t]o reduce the potential threat of market 

manipulation or congestion, especially during trading in the delivery month . . . shall adopt

position limitations or position accountability for speculators, where necessary and appropriate.” 

All agricultural and natural resource futures and options contracts are subject to either 

Commission or exchange spot month speculative position limits – and many financial futures 

and options are as well. With respect to such exchange spot month speculative position limits, 

the Commission’s guidance specifies that DCMs should adopt a spot month limit of no more

than one-fourth of the estimated spot month deliverable supply, calculated separately for each 

contract month. For cash settled contracts, the spot month limit should be no greater than 

necessary to minimize the potential for manipulation or distortion of the contract’s or underlying 

commodity’s price. 

With respect to trading outside the spot month, the Commission typically does not require 

speculative position limits. Under the Commission’s guidance, an exchange may replace

position limits with position accountability for contracts on financial instruments, intangible

commodities, or certain tangible commodities. If a market has accountability rules, a trader – 

whether speculating or hedging – is not subject to a specific limit. Once a trader reaches a preset 

accountability level, however, the trader must provide information about his position upon

request by the exchange. In addition, position accountability rules provide an exchange with 

authority to restrict a trader from increasing his or her position. 

Finally, in order to achieve the purposes of the speculative position limits, the Commission and

the DCMs treat multiple positions held on a DCM’s market that are subject to common 

ownership or control as if they were held by a single trader. Accounts are considered to be under 

common ownership if there is a 10 percent or greater financial interest. The rules are applied in 

a manner calculated to aggregate related accounts. 

Violations of exchange-set or Commission-set limits are subject to disciplinary action, and the 

Commission, or a DCM, may institute enforcement action against violations of exchange

speculative limit rules that have been approved by the Commission. To this end, the

Commission approves all position limit rules, including those for contracts that have been selfcertified by a DCM. 

It is clear that speculation is an important component of the futures markets, but there is a point 

when excessive speculation can be damaging to the markets. As a result, the CFTC closely

monitors the markets and the large players in the markets, in addition to position and 

accountability limits, to detect potentially damaging excessive speculation and potential 

manipulative behavior. 

CFTC Budget

Sufficient resources for the agency must accompany these legal and regulatory tools described in 

order for the Commission to adequately protect these markets from wrongful conduct. The 

budget that funds the CFTC’s operating divisions, its technology and surveillance operations, 

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and other support staff, is approximately $98 million for the current fiscal year (FY). The FY 

2008 President’s Budget request for the CFTC is for an appropriation of $116 million and 475 

staff – an increase of approximately $18 million and 17 staff over the FY 2007 continuing

resolution appropriation. 

We are grateful for the Administration’s recognition of the need for increased funding for our

agency. The FY 2008 Budget request is a good down payment in an effort to reverse a recent

declination in resources at the Commission, but it is, in perspective, a small recognition of the 

challenge we face. 

Since the CFMA was enacted, there has been a seven-fold increase in the rate of new product 

listings by U.S. exchanges. Nine new DCMs and nine new DCOs have been approved by the 

CFTC. Electronic trading has soared to approximately 60 percent of total volume this year, and 

that percentage is steadily increasing. The competition, product innovation, and increasing use of 

technology fostered by the CFMA meant exponential growth in the futures and option markets, 

especially during the last few years. It has also meant a continuing evolution of these markets in 

the form of new trading venues, new trading strategies, new risk management tools, and new 

customers. 

During this period of unprecedented growth for the futures industry, however, the CFTC’s

resources have been steadily diminishing. The CFTC needs additional staff in almost every 

program area and currently operates with a staffing numbers at an historic low. This historic low 

is contrasted by the increase in trading volume, trading platforms, product numbers and 

complexity, and cross-border business. To say the least, Commission employees are stretched. 

We have the resources to carry out the Commission’s mission on a daily basis by asking more of 

staff and deferring critical technological needs and other programs, but the CFTC cannot

continue on this path much longer. 

Technology is critical to enable our professional staff to adequately oversee the markets. 

However, budget constraints have required the Commission to put new systems development 

initiatives and hardware and software purchases on hold. For example, Commission investment

in technology, as a percentage of total budget, has fallen from approximately 10 percent to 

around seven percent. This trend is unsustainable given that so much of the growth in the futures 

industry is directly attributable to investments in technology. It is important that the 

Commission not be overwhelmed by the technologically innovative industry we regulate. 

Conclusion

In summary, the Commission takes very seriously its Congressional mandate to protect the 

public and market users from manipulation, fraud, and abusive practices. The proper regulation 

of the nation’s energy markets is one of the most significant issues facing this Commission. 

Energy prices discovered on these markets greatly impact our economy and every American – 

ranging from residential consumers to main street businesses to Wall Street firms. The CFTC

appreciates the opportunity to assist Congress in examining and appropriately adjusting the 

Commission’s authority in this area. Additionally, the Commission remains committed to 

collaborating with FERC to ensure that the energy markets are free from manipulation. I am 

grateful to testify today and look forward to answering any questions Committee members have 

on these pertinent and important matters. 

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